Steve Rattner, Auto Bailout Advisor, in SEC Crosshairs

Public officials of all sorts have tried ratcheting up their halting efforts to Do Something about Wall Street chicanery to appease an unhappy public. One manifestation has been increased frequency of a long-established enforcement pattern, of picking off select, high profile targets while leaving many corrupt practices in place.

The object lesson du jour is Steve Rattner’s imminent fall from grace. Rattner, former head of investment banking at Lazard, abruptly quit his post as advisor to the Obama administration during its auto industry bailouts because a pension fund bribery case involving Quadrangle Partners, the firm Rattner created post-Lazard, had become too hot to ignore.

One of the open secrets of the municipal financing business is that it is rife with illegal payments (and in fairness to the authorities, this is an Augean stable level of mess). While the SEC has extracted large fines from other private equity firms, it wants to bar Rattner from working in the securities industry for three years. The New York Times discusses the details of Quadrangle’s evident misdeeds:

The S.E.C. and the New York attorney general, Andrew M. Cuomo, have suggested that Mr. Rattner improperly paid off a political operative to win lucrative business from the New York state pension fund — in one case, by arranging to help distribute a low-budget film for the brother of a pension fund official.

Mr. Rattner’s former firm, Quadrangle Group, paid $12 million in fines to settle with state and federal officials in April, but Mr. Rattner was left out of that agreement because he would not accept the S.E.C.’s proposal that he be barred from working on Wall Street, people briefed on the case said.

Now, the S.E.C. must decide whether to pursue separate civil charges against Mr. Rattner or drop the case altogether.

The attorney’s general’s office is not involved in the S.E.C. talks: Mr. Rattner was granted immunity from criminal action by Mr. Cuomo’s office in return for his testimony before a grand jury

Yves here. On the one hand, having someone prominent in finance-land be singled out for a penalty is long overdue. And a peculiar irony here is that even though most readers will regard this punishment as too light, Rattner cares acutely about his social standing. But while a sanction would hit Rattner in a sensitive spot, will it make a difference to other industry executives? Almost certainly not. It will have no deterrent effect. Others in the industry will simply conclude that Rattner’s firm was sloppier than its peers in dispensing favors.

So the real significance of the SEC move is arguably:
1. That the agency is willing to take on targets that would embarrass the Adminsitration

2. That the SEC is still badly hampered. Before readers start howling, I suggest you read Frank Partnoy’s bookInfectious Greed and then we can talk. Partnoy, a derivatives salesman turned law professor, recounts at some length the considerable obstacles the SEC faced starting in the 1990s in prosecuting complex financial frauds (and Partnoy is no apologist). Deregulation was a major factor, but some other stunners included some highly detrimental, out of left field court decisions. One eliminated secondary liability. If you are a victim of a fraud, you can only sue the party with whom you had a relationship.

To illustrate, let’s say Ripoff Roger hands you a fancy offering document with names of reputable-looking accountants and experts verifying key aspects of the investment. It turns out to be wildly misrepresented. Well, if Ripoff Roger can prove that he informed his advisors of the questionable aspects, he is off the hook legally, and the impoverished investor can’t sue them. This is precisely how Joe Cassano, the head of AIG Financial Products who drove it off the cliff, has gotten away scot free.

I’m not saying the SEC is a paragon. It should be taken to task for its screw-ups. But critics need to recognize the difficulty of prosecuting complex financial frauds, particularly when the effect of deregulation has been to render many activities which by common sense standards out to be criminal permissible. So in the absence of meaningful re-regulation (and that includes updates notions of what constitutes fraud), it will remain completely rational for regulators to focus on high-profile cases that are comparatively easy to win, which can leave much more destructive practices intact.