Wall Street Justice Means Nobody Gets Pinched: Jonathan Weil

Here’s another discouraging lesson for anyone hoping the people who caused the financial crisis will be brought to justice someday. Just because the Securities and Exchange Commission has accused a too-big-to-fail company of committing an outrageous fraud, that doesn’t mean the agency will hold anyone accountable for it.

Imagine that: A fraud without fraudsters. To believe the SEC, this is exactly what happened at General Electric Co.

It’s been 18 months since GE paid a $50 million fine to settle the SEC’s claims that it had resorted to accounting fraud to avoid missing Wall Street analysts’ earnings predictions back in 2002 and 2003. At the time the deal was disclosed, the SEC said it had concluded its investigation with respect to GE, which neither admitted nor denied the commission’s allegations.

However, the SEC left open the possibility it would sue one or more of the individuals responsible for the alleged fraud at some later date. There’s been no word from the SEC about the case since it filed its settled complaint in August 2009.

Now we can say how the story ends. An SEC spokesman, John Nester, told me the SEC’s investigation is over, and has been since spring 2010. The SEC won’t be suing any individuals as a result of its probe. Nester declined to comment further.

For all the times the SEC has been criticized for going soft on corporate fraud, the GE settlement stands apart. To understand why, you need to dig into the details of the SEC’s allegations against the company.

Knowing It’s Wrong

The SEC accused GE of committing fraud with scienter --that is, with intent or knowledge of wrongdoing -- in violation of section 10(b) of the Securities Exchange Act of 1934. There’s no more serious claim in the SEC’s arsenal. Yet somehow the SEC couldn’t finger a single person at GE who violated any rules at all, much less anyone who committed fraud deliberately.

The case is now such a distant memory that Jeffrey Immelt, GE’s chief executive since 2001, last month was named chairman of President Barack Obama’s Council on Jobs and Competitiveness. A GE spokeswoman, Anne Eisele, declined to comment.

We can only guess why the SEC decided not to sue any actual people in this case. Maybe the evidence was weak, and GE paid the equivalent of greenmail just to make the SEC go away. Perhaps the SEC’s original targets threatened to litigate until the end of time if they were sued, draining the agency’s limited resources. Or maybe the SEC’s lawyers decided to cut them a break for some nobler reason.

We don’t know and probably never will. Too bad the U.S. district judge who approved the settlement, Robert Chatigny of Hartford, Connecticut, rubber-stamped it without asking the parties any questions.

Corporate Collectivism

Another possible explanation: Perhaps the SEC reasoned that a bunch of individuals collectively had enough information to know GE’s accounting was wrong, but no one person knew everything. In legal circles, this theory sometimes is called collective scienter. In other words, in a civil claim against a corporation, the knowledge of one or more employees is combined with the misstatement of another employee to establish scienter, even if none of them acted with scienter individually.

The problem with this theory is that most federal appeals courts have rejected it, according to a 2009 New York University law review article by Bradley Bondi that was published while he was counsel to SEC Commissioner Troy Paredes, one of the commission’s two Republicans. To be sure, all the judicial rulings in the area of collective scienter involve private securities litigation. So the question of whether the SEC can use the theory remains unanswered, Bondi wrote. Bondi, now a partner at the law firm Cadwalader Wickersham & Taft in Washington, in his article urged the SEC to avoid the approach.

Proving Liability

Here’s how the Second Circuit Court of Appeals described the traditional approach to corporate liability in a securities fraud suit: “To prove liability against a corporation,” the court wrote in a 2008 decision, “a plaintiff must prove that an agent of the corporation committed a culpable act with the requisite scienter, and that the act (and accompanying mental state) are attributable to the corporation.”

The court where the SEC filed its GE complaint is part of the second circuit. By the logic of the appeals court’s 2008 decision, the SEC couldn’t have established that GE acted with scienter unless it proved one of its employees did, too. Now we know the SEC gave up trying to bring such a case.

Given all this, here’s why the GE case would worry me if I were the general counsel for a public company. Even if the SEC had no evidence that any of my company’s employees committed a 10(b) violation, its lawyers still could try to string together a bunch of diffuse facts to make it look like the company had deliberately committed fraud, in hopes of pressuring it into a settlement that would lead to a splashy press release.

The message for investors is equally troubling. It makes no sense that GE could have defrauded its shareholders unless some living, breathing people committed the same violations. So either the wrongdoers got off scot free, or the SEC shouldn’t have brought the case it did against the company.

This isn’t enforcement. It’s a charade.

Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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