Prosecutor Pleasantly Surprised to Find There's a Law Against Fraud

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Like a lot of people, I mostly subscribe to a model of financial regulation where (1) regulators write rules to prevent naughtiness, (2) bankers sit down and try to find ways around the rules, and (3) the bankers tend to be better at their part than the regulators are at theirs. There are various conventional explanations for Part 3, with a popular one being that there's more money in subverting regulations than in writing them.*

Another sort-of explanation is that the banking side of this game is a fundamentally creative endeavor: You sit down with a blank piece of paper and try to find a brand-new, never-before-seen way to do the things you want to do. The regulatory side is a fundamentally reactive one: You see what the bankers have come up with and then write some new rules to shut it down. So naturally the game looks like a series of wins for the bankers, with the regulators constantly trying to figure out and shut down whatever clever new stuff the bankers have cooked up.

I think that is useful background to help make sense of this DealBook story by Peter Lattman and Ben Protess about a Los Angeles federal prosecutor named Leon Weidman, who discovered, much to his and his colleagues' surprise, that there was already a law -- called the Financial Institutions Reform, Recovery and Enforcement Act of 1989 -- against some banking shenanigans. Otherwise it does not make much sense; there are sentences like this:

Mr. Weidman discovered Firrea in the early 1990s while thumbing through materials in his office's law library.


Federal prosecutors in Manhattan were among the first to seize on Mr. Weidman's work. ... The office soon sent several prosecutors on a fact-finding mission to Los Angeles, where they met with Mr. Weidman to discuss the law.

The law is not supposed to be a surprise! You shouldn't need to go on a fact-finding mission to Los Angeles to learn what the law is! Especially if you're a prosecutor. If there's a law that nobody, not even the prosecutors charged with enforcing it, knows about, and that they can only find out about by going on a pilgrimage to meet the secret keeper of that law, then there's something wrong. Two things wrong: It undermines the rule of law generally, but also the deterrent value of that particular law.

So you may not be surprised to learn that there are some substantive objections to the Justice Department's current widespread use of Firrea, which defense attorneys say is overly aggressive and goes beyond the purposes for which the law was intended, though they would say that. My colleague Jonathan Weil pointed out a particularly silly fact about the current Firrea craze in February: the Justice Department's lawsuit against Standard & Poor's for mis-rating mortgage-backed securities was brought under Firrea, which requires that a bank be harmed. The banks that were harmed, in the government's theory, include Citigroup and Bank of America, which sold the mis-rated mortgage-backed securities. Weil "asked Justice Department officials to explain how the underwriter of a CDO could be defrauded by an S&P rating on the CDO it underwrote" and got an unsatisfying answer, suggesting that even those officials know that it's kind of a stretch.

But as Lattman and Protess report, judges have so far mostly sided with the Justice Department in its novel and aggressive uses of Firrea, so this one would seem to count as a win for regulators. And it's an unusual kind of win, one where the regulators used the sort of blank-sheet-of-paper, how-do-we-get-around-the-rules-to-do-what-we-want creativity that you more typically see on the other side. There may be good reason to worry about prosecutors creatively subverting the intent of the law, but the banks aren't really in much position to complain.

* Another is just, like, if you want to do a thing, there are generally a million economically equivalent ways to do that thing, each of which has a different name. So the regulator needs to write down a million names and say "don't do any of those things." The banker just needs to find the one name the regulator forgot to write down.

** Also that Weidman "lives in West Los Angeles with his wife, an artist, and their 95-pound Labradoodle," which is a big labradoodle. That's like three of my wheaten terrier, who is often mistaken for a labradoodle and who is now making her first appearance on Bloomberg View, say hi to her everyone. Your theory of financial regulation won't help you with the labradoodle though.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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Matthew S Levine at