New York’s Benjamin Lawksy and the SEC’s Kara Stein and Luis Aguilar Push for Tougher Sanctions Against Bank Executives

While the long-suffering American public is still waiting for prosecutions of bank executives for blowing up the global financial system, reform-minded regulators are taking steps to inflict other types of pain on them if they engage in misconduct.

New York’s Superintendent of Financial Services, Benjamin Lawsky, proposed in a speech last week (hat tip Adrien) that New York State adopt Sarbanes-Oxley-like rules that would require bank executives to certify personally that their firm had adequate money laundering controls. Established readers will recall that we’ve repeatedly cited Sarbanes Oxley as an obvious means for not simply fining bank executives (and the charges rack up quickly) but in providing a clear path to prosecution, since the Sarbanes Oxley language for criminal prosecutions tracks the language for civil violations. In other words, it was clearly designed to allow the SEC to launch a civil case, and if it found evidence of serious enough violations, to refer it to the Department of Justice to elevate it to a prosecution. Sarbanes Oxley required senior executives, at a minimum the CEO and the CFO, to certify the accuracy of financial statements and the adequacy of internal controls personally. We’ve argued that balance-sheet destroying loss bombs is prima facie evidence of inadequate risk controls. It’s not hard to make the case if one wanted to, given the limited authority of bank risk control units as well as numerous, well documented cases of destructive bonus-gaming strategies, like retaining supposedly hedged CDOs, and pushing through mortgage securitizations that were clearly in violation of investor agreements.

The fact that the SEC has been loath to use a tool designed precisely to go after miscreant bank executives is one of the strongest pieces of evidence of how craven the SEC has become. Although that is in large measure due to a succession of industry-friendly chairmen, it also results from the fact that the SEC, unlike banking regulators, is subject to Congresssional appropriations. Congress has kept the SEC resource-starved and powerful Congresscritters have a tendency to threaten the agency if they go after targets that have strong allies in Congress, which these days is just about every individual and firm of consequence in the financial services industry.

By contrast, Lawsky has taken a state banking agency, normally a backwater, and turned it into a regulatory catalyst by making creative use of his authority over the US branches of foreign banks. Federal regulators can’t stand being end run by what they consider to be a secondary player and feel compelled to assert their authority in the areas where Lawsky has made progress. One of the noteworthy features of the money-laundering settlement with BNP Paribas was that Lawsky insisted upon, and got the ouster of key executives. He intends to make this a new standard in enforcement. As he stated in his Columbia speech:

Real deterrence, in our opinion, means a focus not just on corporate accountability, but on individual accountability.

Even though, as we discussed, the SEC has serious impediments to improving its enforcement game, Commissioner Kara Stein, who has gone to war with the SEC’s chairman Mary Jo White, is also pressing the agency to get tougher with bank executives who run afoul of the law. Kara Stein and her fellow Democrat commissioner are pushing for lifetime bans, similar to the type of sanction that can be imposed on brokers. From the Wall Street Journal:

The U.S. Securities and Exchange Commission is divided over whether it should impose severe restrictions on banks and their executives who break securities rules. For top executives, those punishments could include a lifetime ban from working at publicly traded companies. And some at the Commission are advocating greater use of “bad actor” bars against financial firms found to have committed misconduct, which would impose strict limitations on their ability to sell wealthy investors stakes in private offerings like hedge funds.

While the SEC has tended to allow companies to avoid automatic disqualification, two commissioners want that to change.

“These bars are triggered because parties cannot be trusted with the more flexible regulatory privileges provided in certain parts of the securities laws,” said SEC Commissioner Kara Stein, a Democrat, at a Washington, D.C., conference last week. “Congress designed them to do that, and that’s how I’ve been seeking to have the Commission apply them.”

Another SEC commissioner said fines against companies are not enough to dissuade corporate fraudsters. Commissioner Luis Aguilar said corporate leaders found to have committed fraud — particularly repeat offenders — should face lifetime bans on serving as officers at publicly traded companies. “If our remedial sanctions were ineffective in reforming a fraudster, then we must seriously consider removing them from the industry—permanently,” Mr. Aguilar said at last week’s conference.

Predictably, the Republican commissioners have opposed Stein and Aguilar’s efforts to enforce the automatic disqualification rules. Mary Jo White has usually sided with them but has been forced to sit out some decisions due to conflict of interest.

Interestingly, the Wall Street Journal story finishes on a pro-enforcement note, a sign that popular views are starting to shift:

To avoid the risk of disqualification it will be crucial for companies settling misconduct charges to highlight strenuous steps they have taken to avoid becoming repeat offenders, said Mark Radke, an SEC defense specialist at Schiff Hardin LLP said.

“You need to show why there is no risk of recidivism, Mr. Radke said. “The easiest way to show you can avoid recidivism is to sell unit X [that was engaged in the misconduct] or you might fire all the management in that unit.”

And last week, New York Attorney General Eric Schneiderman proposed launching a program that will pay whistleblower awards. Since New York’s Martin Act is a powerful enforcement tool, this has the potential to give whistleblowers a venue that will compete with the SEC. In addition, the Wall Street Journal reported that the SEC is investigating the efforts of corporations to stymie its whistleblower program, such as making employees sign agreements requiring them to hand over any whistleblower awards to the company. Talk about cheek.

The fact that these developments are taking place in close succession suggests that the tide is beginning to move in the direction of more serious enforcement actions. While admittedly we are a very long way from being where we need to be, the perception that enforcement needs to be serious and targeted at the responsible parties is a necessary precursor for effective action.