Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

23 May 2013

How the Bankers Got Away, and How to Stop Them Next Time

The problem of criminal sanctions in business
The crux of the matter


As faithful readers know, this blog proposes solutions to problems. It doesn’t just lament them.

A recent post bewailed the fact that not a single high-level Wall Street executive has gone to jail for causing the Crash of 2008, which destroyed the global economy and, with it, so many lives. Among the tragic ripples from that catastrophic event is a 300% jump in the suicide rate of not-quite-retired oldsters who are still unemployed.

That post was a rare lament. This one offers a new solution, in addition to breaking up the big banks.

This new solution involves criminal sanctions. As we will see, they have some advantages over purely structural, economic solutions like breakups. There is no reason Congress couldn’t adopt both solutions at the same time.

The problem of criminal sanctions in business

If there is a credible reason so many high-level rogue bankers escaped jail, it is this. White-collar criminal cases are hard to prove.

This is so for both legal and historical reasons. The question before us is whether those reasons are still valid today, and, if not, what we can do about it.

    The standard of proof
One reason why white-collar criminal cases are hard to prove applies to all criminal cases. The legal standard of proof is higher in criminal cases than in civil cases. A criminal prosecutor must prove a crime “beyond a reasonable doubt.” In contrast, a plaintiff in a civil case must prove fault only by a “preponderance of the evidence.” That means, roughly, getting a jury to believe that fault was “more likely than not.”

We impose the higher standard of proof in criminal cases to keep from throwing people in jail or (in death-penalty states) executing them for reasons that later turn out to be wrong. Late-life conviction reversals are embarrassing to the government. They shake the people’s faith in the justice system they themselves are supposed to run. In addition, lost years and lost lives are hard to return or replace.

The higher standard of proof helped O.J. Simpson in his notorious case. A jury acquitted him of murder, but he later lost a civil suit on much the same facts.

So the standard of proof matters, and it matters much in real life. But its’s hardly the whole story. What sometimes matters even more is what the standard of proof applies to. In O.J. Simpson’s case, the prosecution had to remove any reasonable doubt that Simpson had actually killed the victims. His defense attorneys created reasonable doubt, so Simpson walked.

    The intent element
But the O.J. Simpson case never got to an issue that weighs much more heavily in financial cases: criminal intent. One doesn’t usually slash people to death without some sort of intent. So in Simpson’s case, the big issue was whether he did it, not what was in his mind. Yet the opposite is often true of white-collar crime.

With very few exceptions, the law requires a criminal state of mind for criminal liability. Accidental or other unintended acts are not generally criminal, however awful their consequences may be.

As every first-year law student knows, lawyers use Latin to describe this criminal state of mind. The term is “mens rea,” Latin for “guilty mind.” It comes in four general flavors. From worst to better, they are: (1) purpose or deliberation, (2) knowledge, (3) recklessness, and (4) negligence. If you don’t have one of these guilty states of mind—or if the prosecutor can’t prove that you do beyond a reasonable doubt—you don’t go to jail.

In cases of white-collar crime, the intent element is the biggee. Why? Because white-collar crime is nearly always abstract. High-level executives don’t actually do the bad deeds; their less-well-paid minions do. So prosecutors have to prove that they ordered, coerced, instructed, cajoled or encouraged their minions to do wrong, and that they intended their minions to do so. And prosecutors have to prove all this beyond a reasonable doubt.

Even with positron-emission tomography, we can’t yet read minds. And even if we could, another feature of criminal law would prevent us from doing so. Courts can’t even force a criminal defendant to take a lie-detector test because our Constitution prohibits anyone from being “compelled in any criminal case to be a witness against himself[.]”

So, in essence, white collar crime cases require showing a jury that a high-level executive somehow communicated with a guilty underling, that the communication motivated criminal behavior, and that the high executive intended it to have that effect. And the jury must so believe beyond a reasonable doubt.

Do you begin to understand why the poorly paid peons go to jail and the guys (they are nearly all guys) with the obscene salaries, stock options, big bonuses and private jets get to walk?

    Circumstantial evidence
We can’t get direct evidence of a guilty mind because we can’t read minds. We can’t force the defendant to testify against himself because doing so would violate our Constitution. And even if we later develop technology to read minds reliably, we can’t use it on criminal defendants against their will, for the same reason.

So the only practical way to prove high executives’ involvement or complicity in financial and business crimes is to prove a communication with someone else. In most cases, the communication is unclear or ambiguous, so we also have to prove its meaning and interpretation. And we have to prove both its existence and interpretation beyond a reasonable doubt.

Wiretaps and other electronic means of eavesdropping are helpful in more brutal kinds of organized crime. If, for example, Murder, Inc., sets up shop in your neighborhood, a good prosecutor can get a search warrant and a wiretap against future murders.

But financial crimes are different. By the time anyone in authority realizes they are crimes—let alone crimes that could take down our economy—wiretaps are too late. Once the disastrous effects of financial crime become known, the relevant communications are all past tense. You would have to have a time machine to get a useful wiretap. All prosecutors can do is comb written records, and interview all relevant witnesses, for traces of past guilty communications. In so doing, they become a bit more like criminologists or archaeologists than police.

Criminal law has a couple of hand tools to help them do that. Normally, so-called “hearsay” rules prevent one person from testifying to what another said. But there are exceptions for proving state of mind and a pattern of criminal behavior, among others. So even without a writing that they can trace back to the defendant, prosecutors can rely on the testimony of people receiving the guilty communication as to its existence and meaning. Oral statements are not necessarily out of bounds.

But oral statements are problematic in practice for two reasons. First, good lawyers can destroy the credibility of almost any live witness testifying to an earlier oral communication, at least enough to raise a reasonable doubt. Second, the person receiving the guilty communication is usually an actual or potential criminal defendant, too.

Prosecutors can induce their testimony by offering the hearer a favorable “plea bargain,” i.e., a reduced sentence without trial. But if the two parties to the private communication agree to a thieves’ code of silence, there is very little any prosecutor can do. In most cases, diligent investigation won’t even reveal that a guilty communication ever occurred. And the parties have every incentive to keep silent; if they both shut up, neither will go to jail. Neither will even have to sit in the dock.

The advent of e-mail made proving white-collar crime a little easier. Financial criminals had been very careful about what they wrote in the old days, when they had to have their secretaries transcribe a paper letter and then read and sign it themselves. But now, with e-mail, they often write their own communications, sometimes in haste and without much circumspection. A single slip can support a successful criminal prosecution.

But rare slips on the part of high executives are pretty thin reeds on which to support a criminal shield against massive financial crime. They certainly won’t protect our whole economy from collapse. The Masters of the Universe didn’t get where they are by being careless or lacking in circumspection.

In the years leading up to the Crash of 2008, the whole banking culture was rotten to the core. From the bankers’ perspective, “everyone was doing it.” And everyone was getting rich doing so. If you were in the business of mortgage-backed securities, you had to be a fool to stay honest and poor, or so it seemed.

In that environment, the thieves were thick, and the code of silence was strong. It still is. The best federal prosecutors could hope for was making a few examples with cases built on circumstantial evidence and argued well to intelligent juries. More’s the pity, our federal chief prosecutor apparently decided that the effort was not worth the reward, or that it might impair our recovering global economy.

The crux of the matter

But all this is necessary background. We still haven’t gotten to the crux of the matter. Now we do.

The best case against our rogue bankers was criminal fraud. Bankers made thousands of loans that wouldn’t be paid back, and they knew that. Then they packaged them as mortgage-backed securities and sold the securities to investors. At the time they sold those securities, they knew they were junk, but they sold them with lots of promotion and razzle-dazzle. So they defrauded their investors, causing the Crash when the whole house of cards inevitably collapsed.

Proving almost all of this would have been easy. The banks massively violated their own credit policies in making the loans. Any idiot would have known that the resulting loans were risky, if not worthless. But the banks sold them to investors anyway. All that seems easy to establish, even beyond a reasonable doubt.

But the sticky part is intent. Did high executives actually know what was going on beneath them, and did they intend to defraud their investors? Their excuses are that: (1) everyone was doing it, and (3) the credit-rating agencies rated their securities as investment-grade. (Let’s leave aside for the moment the fact that their banks paid the rating agencies for their ratings.) Did they intend to defraud anyone when the whole industry was doing the same thing and the rating agencies, in essence, blessed it?

But we still haven’t gotten to the crux of the law. What is the standard of intent? Remember the four flavors of mens era or criminal intent from the Model Penal Code: (1) purpose or deliberation, (2) knowledge, (3) recklessness and (4) negligence.

In financial cases, only the first two flavors apply to criminal fraud, as distinguished from civil fraud. That’s a fine distinction, but it’s vital.

If you run over a pedestrian in a crosswalk, you can’t escape either a civil suit for damages or a prosecution for criminal negligence by proving you didn’t see her. Even proving that you were distracted while texting on your cell phone won’t help you; it will only dig you in deeper. You will still be liable for negligence, or even for recklessness, which might subject you to punitive as well as compensatory damages, or a stiffer criminal sentence.

But your case is different because it involved death or personal injury. The same rules just don’t apply to economic crimes. In all but a few cases, they don’t even apply to civil suits for economic injury alone.

They guy who built and maintained the factory that recently collapsed in Bangladesh, killing over a thousand workers, could be liable for criminal negligence or even recklessness. He probably will be. But the people who destroyed the global economy by absolutely corrupt and rotten practices leading up to the Crash of 2008 can go to jail only if a prosecutor can prove beyond a reasonable doubt that they purposely intended to defraud their investors or did so knowingly.

The very corrupt and rotten banking culture in which they operated makes their legal defense formidable. It goes something like this:
“How can you accuse us of purposely or knowingly intending to defraud our investors? They were our customers. Defrauding them would ruin our business. We just did what everyone else in the industry was doing, and what the rating agencies had blessed. We might have been negligent, or even reckless, but we just didn’t know.”
Thus does “everybody was doing it” become a credible defense to a charge of financial crime.

That defense didn’t work at Nuremburg. Accused there of killing six million Jews, top Nazi leaders couldn’t walk by saying “everyone was killing Jews.” Yet our bankers got away with destroying the global economy with a similar defense. They didn’t even have to actually put it on; they just got their lawyers to convince Justice Department lawyers it would work.

If there is any rational difference, it is the distinction between direct murder and more abstract financial crimes. Yet thousands of unemployed not-quite-retired workers have committed suicide—and more undoubtedly will yet—due to causes that the rogue bankers set in motion. Financial crimes, too, have consequences. They can cause death as surely as gas chambers.


What this post reveals is a fundamental flaw in our law. “Everbody was doing it” was no defense at Nuremburg, and it’s no defense to most crimes. But it is a defense to financial crimes on the issue of criminal intent.

If the whole industry was doing what you’re doing, and if the only watchdogs on the block (the rating agencies) blessed it, how can you be accused of purposely or knowingly intending to defraud your customers?

No rational businessman seeks to defraud his customers, for fear of losing them. But you can’t lose them if everybody else in the industry is doing the same thing. They have nowhere else to go.

So in this instance defrauding customers for profit may have been the rational, self-interested thing to do. Juries with ninth-grade education would have been hard-pressed to apply this abstract line of reasoning and infer actual knowledge or purpose in defrauding. A good defense lawyer could put them in the bankers’ position and evoke a strange sort of sympathy. Maybe that’s precisely what the wimpy Lanny Breuer feared.

Thus does the standard of intent for financial crimes, coupled with the requirement for proof beyond a reasonable doubt, permit a corrupt banking culture to destroy the global economy, and then allow bankers to evade personal responsibility because everybody (in their exalted circles) was doing it. Our legal system let the law of the rotten crowd prevail over justice.

In such cases, negligence would be a much better standard of intent. Under a negligence standard, it doesn’t matter what you actually know. What matters is what you “should have known.” Notwithstanding their corrupt culture, their competitors’ mutual idiocy, and the blessing of good paid-for credit ratings, any rational banker should have known that massively violating his bank’s own credit standards was not a good idea.

If you negligently kill someone, you can go to jail for negligent homicide, aka manslaughter. That’s probably what will happen to the Bangladeshi owner of that collapsed garment factory. The same is true if you negligently injure someone. But if you destroy a whole economy, you can’t go to jail unless the prosecutor can prove you purposely intended to do so, or knew that would happen. Does the difference make sense?

This difference in standards of intent exists largely for historical reasons. In the old days, financial transactions had little reach. They were often just deals between two gentlemen. They were private matters. Their consequences in the larger society were small and unexplored.

Today we are more civilized and informed. We know that rogue financial transactions can destroy whole economies, throw millions out of work, deprive millions more of their homes, cause massive increases in suicides, and even motivate wars. The last century’s great cataclysms, including the two great wars, had economic motivations, if not economic causes. The Great Depression, which helped cause the greatest war in human history, started with a banking “innovation” much like today’s derivatives: buying stock on margin.

So today we know from painful, recent history that massive economic crimes are not victimless. In fact, they can have victims far more numerous than any other crime save genocide.

Does that mean that every economic fault should be a crime, with a standard of negligence? Probably not. Doing that would impair ordinary business and subject every business decision to second-guessing in a court of law. We should reserve the negligence standard for banking and financial transactions that threaten economic stability.

After all is said and done, banking and finance differ from other businesses. They are more abstract. Their raw material is money, so they tend to attract people whose sole or primary motivation is getting rich. More to the point, they have been responsible, directly or indirectly, for every economic crash, panic, depression and “great recession” in history.

Have you ever heard of a general economic collapse caused, for example, by copper mining companies, electronics companies, railroads, or steel? Finance needs stricter rules because it is the lifeblood of any capitalist economy. If it fails, we all fail, no matter how well or even brilliantly we do our jobs.

So we should hold bankers to a general standard of reasonable care, and we should do so by criminal sanctions, just to make sure we have their attention. We should not let bankers, ever again, take our economy down with self-evidently rotten and corrupt practices and then walk free by arguing that everybody was doing it and it was “blessed” by private for-profit businesses with obvious conflicts of interest.

If we want to introduce a criminal negligence standard by degrees, we should start with transactions that have significant financial effects. When Robert Rubin was Chairman of Citibank, he apparently received that e-mail from a senior vice president reporting massive and systematic violations of Citibank’s own credit standards. As he later testified, he thought he saw the e-mail and he thought he sent it to some unnamed minion for handling.

You have only to view his testimony [set timer to 28:00 and enjoy!] to understand how little the whole thing meant to him. (He probably didn’t really remember the e-mail at all; his lawyers probably advised him not to say he didn’t receive or read it, for fear of later contradiction by computerized records.) Some time later, our government invested $25 billion in Citibank, and Citibank accepted it, in order to avoid a general financial meltdown.

Even to someone of Rubin’s exalted status, $25 billion is sum of money worth remembering. Once he got that e-mail, he should have been smart enough to see a problem of that size coming. If not, he should have been retired and on the lecture circuit, rather than purportedly running a bank whose size made it a linchpin of our national economy.

We don’t have to hold every business, let alone small businesses, to a standard of criminal negligence in their ordinary business operations. But we ought to do that for big bankers. If we hold them to a negligence standard for big things, a lot more Robert Rubins well be a lot more careful in the future. Our economy will be safer, and so will we all.

Of one thing we can be certain. If we don’t do that, and if we don’t break the too-big-to-fail banks up, something like the Crash of 2008 will happen again. The only question is when, not if. Having a legal system that allows bankers to escape criminal sanctions by creating a rotten culture and then claiming “everybody does it” and “the rating agencies we paid said we could” is a sure invitation to disaster.

No rational parent would let a naughty child get away with such excuses. So why should we let our big bankers?

Postscript: One other point is well worth making. Under a legal standard of purposeful or knowing action, the bankers’ defense on the issue of intent is entirely credible. Even I don’t think their primary purpose, or even an important purpose, was defrauding their customers.

Their primary purpose was to make money any way they could. The rotten culture they had helped build said they could sell their securities backed by rotten mortgages. Their competitors said they could, and actually did. The ratings agencies gave their blessing. So it is entirely possible for a jury to believe that the bankers had no criminal intent or knowledge, i.e., that, in modern terms, the devastation to our nation’s and the global economies was just “collateral damage.”

Defense attorneys could not so bamboozle a jury under a negligence standard. Why? In a negligence case, the jury determines (subject to control by the judge) both what the standard of care for avoiding negligence is and whether the defendant met it. In legal terms, the standard of care is a mixed issue of law and fact.

So a criminal negligence case would go as follows: the defense attorney would argue that selling securities backed by mortgages that massively violate the bank’s own credit standards is “reasonable care,” as long as other banks do the same thing and rating agencies bless the process. The prosecutor would argue the contrary.

We all know how juries would rule, and how many rogue bankers would be in jail, under those circumstances. The key difference between crimes involving negligence and crimes involving higher intent is that the jury determines the standard of care, based on expert testimony and subject to control by the judge for basic reasonableness and conformity with precedent.

No Fed Chairman or regulator can possibly imagine all the things that bankers may one day do, or how those things may affect our global economy. So laws that prohibit specific practices, or that depend on proof of evil intent beyond a reasonable doubt, are useless in protecting our economy. They are analogues to our military leaders preparing to fight the last war.

Only a general standard of reasonable care, applied after the fact by twelve men and women, good and true, can keep our bankers careful, circumspect and honest, despite the enormous temptations that their profession puts before them daily. It would be not only substantial justice, by poetic justice as well, for the people who make that decision to be precisely the ordinary folk who must suffer the “collateral damage” of bankers’ experimental effort to enrich themselves.

Two things would prevent juries from second-guessing and micromanaging all bankers’ business decisions. First, they would only get to judge real cases in which bad decisions had already caused massive economic failure. Second, as judges always do, the judge would throw out unreasonable verdicts based on passion, prejudice, or neglect of substantial evidence. The bankers would have a good chance—with the best lawyers that money can buy—to make their own case in court. But that case would be about whether what they did was reasonable and prudent for modern bankers to do, not what was in their minds.

Helping to decide such issues is what our juries do, and why they lay claim to being parts of the world’s fairest and most people-oriented system of justice. Let’s bring them back and help them save our economy from the myriad unknown risks that our once and future bankers may force us all, unwittingly and unwillingly, to take.



  • At Fri Jul 05, 04:09:00 PM EDT, Blogger madtom said…

    Thanks, Jay, this post is a real keeper for its detailed analysis of legal points that we laypeople don't often appreciate, but . . .

    I have to take exception to one major point, embodied in this quote: "No rational businessman seeks to defraud his customers, for fear of losing them. But you can’t lose them if everybody else in the industry is doing the same thing. They have nowhere else to go.

    So in this instance defrauding customers for profit may have been the rational, self-interested thing to do."

    Although it is quite true (and a matter of some personal concern to me) that there's nowhere else for the customers to go, there's a much bigger reason for the businessman's unconcern. He does have someplace else to go. The business is not his personal corner store, but a giant corporation. Even if it fails entirely, he will take a significant personal fortune with him when he goes. He will keep the proceeds of the fraud he committed against the customers and stockholders alike.

    Even if he isn't ready to retire with his fraudulently obtained salary, bonuses and insider trading profits, he has a great future in a federal regulatory agency, where other players in this game of revolving doors will find him a useful position to occupy. He may enjoy years of continued employment while ensuring that his colleagues can with impunity continue playing the same games with other people's money and lives.

    To me it looks like the entire system has been corrupted, including its black-and-white laws, the regulations written under those laws, and the officeholders nominally tasked with enforcing proper procedures. So I don't see how a small change in one legal interpretation can have much effect.

    Consider another facet of the whole financial fraud event: If many (tens of?) thousands of cases of presenting fraudulent documents to the courts in foreclosure proceedings can be lumped into a cutely named category like "robosigning" and "settled" with a remedy that leaves the wealthy perps better off while doing nothing for the victims, where do we find any light of hope in the system?

  • At Sun Jul 14, 02:53:00 PM EDT, Blogger Jay Dratler, Jr., Ph.D., J.D. said…

    Dear Tom,

    Welcome back, and sorry to be late in posting and responding. (I've been learning carpentry by building a new front courtyard gate.) It's good to see you in good health.

    You basic point is valid and well stated. Of course there is a divergence between personal and corporate interest—as well as societal interest—for many bankers today. The goal of public policy, as well as the law, should be to bring all three interests into close alignment. It has utterly failed to do that for at least a decade.

    But what I suggest in this post is not just a “small change in one legal interpretation." It would be a major change comparable to the ancient transition from legal remedies for intent-based wrongs (as a substitute for private vengeance) to the wrong of negligence, or failure to use proper care.

    Imagine a world in which a bad driver who injured you, or killed a loved one, in an auto accident had no liability unless you could prove he or she intended to do harm. You would have to suck up your injury or personal loss or (in Texas) draw your concealed weapon and go after the driver.

    That’s precisely where we are with bankers today. They can destroy entire economies with stupid, greedy schemes, and yet walk away with hundreds of millions, unless we can prove they intended to defraud someone. We can’t make them pay, let alone put them in jail, just by proving that they did what no reasonably prudent person would have done under the circumstances (such as massively violating their own credit policies).

    Although I’ve practiced law for over a quarter of a century (as a “solicitor,” not a litigator), I’m not a big fan of trial lawyers. But they do have their uses. Unleash them to go after bankers who are negligent, and you would see four immediate effects. First, lawsuits would skyrocket, and so would E & O insurance rates. Second, some people who ought to pay big would. Third, if the change included criminal law, we would finally see some people who caused so many to suffer for their private benefit go to jail. And last but not least, shareholders and directors would rebel and start paying more attention to what banking managers do.

    There are also other solutions. My personal favorite is breaking the big banks up, using temporary, market based nationalization, so as to make them small enough to fail. There are lots of reasons to believe this solution might be the best for our economy, although denying us, the people, the retributive effect of criminal law. Those reasons are too complex to recite in a comment, but you can get an idea from the companion post to this piece and from an earlier post on breakups linked above.

    As for regulation, I agree that it can be woefully ineffective, especially at times like today, when much of Congress has eagerly abdicated its public-interest role. Regulators do tend to get captured, even in the best of times.

    But that's not reason to despair. It's reason to look for other remedies that work, including (1) better civil law, (2) better criminal law, (3) and breaking the big banks up so that their managers feel an immediate hit from bad behavior, just as partners in old partnership law firms used to do.

    You may know that the only candidate for president from either party in the last cycle to advocate breaking the big banks up was Jon Huntsman, Jr., the Mandarin-speaking, most experienced candidate that the GOP marginalized and dissed. Such are our times.

    Best always,



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