Victims of Financial Wrongdoing Need a More Muscular S.E.C.
APRIL 4, 2015
Given the many billions of dollars financial companies have paid in regulatory and legal settlements related to the mortgage crisis, how much money has actually found its way into the pockets of investors harmed by their actions?Less than you may think. To start with, little of the cash generated in most of the Justice Department settlements went to investors. Much of this money went into Treasury coffers or to various states while troubled borrowers were promised loan modifications and other relief as part of the deals.
Wronged investors are entitled to receive money, however, from lawsuits filed by the Securities and Exchange Commission. While the S.E.C. cannot, by law, seek compensatory damages for losses incurred by investors, the agency does collect penalties and disgorgement of ill-gotten gains from both institutions and individuals.
Sometimes the S.E.C. puts the dollars it collects into a fund to be distributed to a class of victims the agency has identified; other times it forces defendants to repay those investors directly.
The S.E.C. says it tries, whenever possible, to extract money from wrongdoers on behalf of investors. And an analysis of financial crisis lawsuits cited most recently on the S.E.C.’s website shows that 23 of themgenerated nearly $2.6 billion for investors.
Among the larger S.E.C. recoveries was $285 million from a 2011 case against Citigroup over a $1 billion collateralized debt obligation and $250 million returned to investors after Goldman Sachs’s settlement of the Abacus C.D.O. case in 2010. Investors also received $275 million from a mortgage securities deal struck last year with Morgan Stanley.
Returning almost $2.6 billion to investors is not nothing. But the S.E.C.’s recoveries pale in comparison to the amounts generated by law firms that brought class actions on behalf of stockholders and debtholders.
In the 17 largest securities law class actions arising out of the financial crisis, investors have recovered almost $8.3 billion, net of legal fees and expenses, court records show. These recoveries included $1.1 billion in two class actions against Citigroup, $850 million received from the American International Group and $523 million from Lehman Brothers.
Among the 17 private lawsuits and the 23 S.E.C. cases, six overlap — meaning the same financial institutions were sued on the same facts by both the agency and private plaintiffs. On a direct comparison, the recoveries generated by class-action lawsuits far exceeded those collected by the S.E.C.
In those six cases, the S.E.C. recovered $400 million for investors while the private plaintiffs received almost $3.8 billion, net of legal fees and expenses.
Consider, for example, the lawsuits against Bank of America. Both the S.E.C. and investors claimed that Merrill Lynch executives had not disclosed losses and bonus payments at the firm before it was purchased by the bank. Private plaintiffs received almost $2.3 billion in their case; from the S.E.C.’s suit, investors received $150 million.
Then there is the case against Angelo R. Mozilo and other top executives of Countrywide Financial. The private lawsuit generated $516.4 million for investors; the S.E.C.’s recovery for investors was just over $48 million.
Finally, private litigation against New Century Financial, a defunct mortgage lender, recovered $107.6 million, while the S.E.C.’s lawsuit recovered $1.5 million for investors.
“Private litigation prosecuted by sophisticated plaintiffs and their counsel — who are not restrained by the limited resources and bureaucracy of government agencies — has delivered far larger recoveries for victims than companion government actions,” said Gerald H. Silk, a partner at Bernstein Litowitz Berger & Grossmann, a securities class-action law firm.
To some degree, of course, this is because the S.E.C. cannot recover losses for investors. By law, the agency cannot seek a penalty that exceeds the financial gain a wrongdoer made, even if losses incurred by investors as a result of the improprieties are far greater. For instance, if investors lost $100 million in a Ponzi scheme in which the overseer pocketed $10 million, the S.E.C. can seek to recover only the $10 million in ill-gotten gains and another $10 million in penalties. And the S.E.C. has secured significant sums for investors in some matters where there was no class action. For example, in three big C.D.O. cases, the agency returned a combined $661 million to investors from Citigroup, Goldman Sachs and JPMorgan Chase.
When asked about the size of the recoveries the S.E.C. has generated for investors, Andrew J. Ceresney, the agency’s director of enforcement, said: “We have been vigorous in our efforts to hold individuals and companies accountable for abuses related to the financial crisis. One of our highest priorities in these cases is to return money to harmed investors, in addition to punishing and deterring misconduct.”
The S.E.C. can pursue powerful remedies that private plaintiffs cannot. For instance, the S.E.C. can bar people from serving as directors or officers of companies and suspend lawyers and accountants from practicing before the agency. In the financial crisis cases identified by the S.E.C., the agency said it had barred or suspended 40 people.
The agency can also force the people it sues to pay penalties out of their own pockets; this is much harder for private plaintiffs to do.
Still, the disparity in recoveries is telling. It shows, among other things, how crucial it is for investors to be able to bring private actions under the securities laws.
“The S.E.C. can’t do everything,” said Norman Poser, a professor emeritus at Brooklyn Law School and a former S.E.C. official. “The Supreme Court has said there is an implied private right of action under the securities laws for exactly that reason.”
While both plaintiffs and the agency have different roles to play, Congress should still consider expanding how much the S.E.C. can extract in penalties, perhaps making them commensurate with the losses investors incurred.
The S.E.C. has asked Congress for this authority, Mr. Ceresney said. But it has not been granted. “Allowing us to recover penalties equal to investor losses would assist us in fulfilling our investor protection mission,” he said.
As the financial crisis shows, the S.E.C.’s penalties often proved to be nominal costs of doing business for reckless institutions or their employees. The agency is clearly hamstrung in its efforts to generate recoveries on behalf of harmed investors.
Isn’t it time to ensure that when the S.E.C. comes knocking, the fine fits the crime?