These SEC Insider Emails Reveal Why No Bankers Have Gone To Jail

Back In April 2010, the world was stunned when in what would be the first major case dealing with the fallout from the endemic fraud prevalent during the last housing and credit bubble, the SEC charged Goldman Sachs and Paulson with securities fraud over the infamous Abacus CDO, which was subsequently featured in Michael Lewis' Big Short book and movie. There was also hope that for the first time, bankers - ostensibly from the company that does "God's work" - would go to prison. None of that happened, and instead just a few months later Goldman walked away with a $550 million slap on the wrist, while a young Goldman banker, French citizen Fabrice Tourre, who was in his late 20's when Goldman was quietly colluding with Paulson to package a "time bomb" CDO it knew would explode in just a few months, was the only Goldman banker prosecuted. In 2013, Fabrice Tourre, a low-ranking trader,  was found liable for violating securities laws and ordered to pay more than $850,000. He also avoided prison time and is now a Ph.D. candidate at the University of Chicago.

He was the only banker who was named in the entire Abacus fraud, something which we laughed at long and hard in 2010 because according to the SEC, this meant the 20-year old was the mastermind behind all of Goldman wrongdoing; nobody else at the firm was aware of what had been going on.

But what was most appalling and what made it clear that the SEC is a captured organization, was not only that no other banker at Goldman was named, but that absolutely everyone avoided prison time setting a disastrous precedent which demonstrated that when it comes to criminal liability, Wall Street will henceforth have a permanent get out of jail free card.

Earlier today, ProPublica's Jesse Eisinger published a story that looks at the evolution of the SEC's collapse, and how from a regulatory agency meant to defend investors, it instead mutated into a captured, crony, revolving door (whose employees all too frequently end up working for the same companies they should be prosecuting) farce, whose only purpose is to protect criminal bankers from prison while handing out paltry fines which ultimately are paid by the company's shareholders while management walks away free.

Eisinger tells the story of one SEC lawyer, perhaps the last SEC lawyer with a conscience, James Kidney, who joined the agency in 1986. "He was thirty-nine at the time, having first worked a stint as a journalist. The “steam was elevated” at the agency when he started there, he said. Young lawyers were expected to go after the big names, and they did: the junk-bond king Michael Milken, the insider trader Ivan Boesky, the investment banker Martin A. Siegel."

As a trial lawyer, Kidney’s job was to develop a compelling narrative that could be presented to a jury of laymen unfamiliar with the intricacies of finance. “Jim was a great attorney. A lawyer’s lawyer. Sound legal mind, excellent writer, and a true trial lawyer,” said Terence Healy, the vice-chair of securities enforcement practice at Hughes Hubbard and a former colleague of Kidney’s at the SEC. But Kidney also exasperated some staffers who thought he wasn’t detail-oriented and didn’t grasp nuances.

More importantly, Kidney provided Eisinger "with a cache of internal documents and emails about the Abacus investigation" which demonstrate conclusively just how "captured" the securities regulator truly is. 

Kidney was assigned to take SEC's investigation against Goldman (and Paulson) and bring the case to trial. But, as Eisinger writes, "tight away, something seemed amiss. He thought that the staff had assembled enough evidence to support charging individuals. At the very least, he felt, the agency should continue to investigate more senior executives at Goldman and John Paulson & Co., the hedge fund run by John Paulson that made about a billion dollars from the Abacus deal. In his view, the SEC staff was more worried about the effect the case would have on Wall Street executives, a fear that deepened when he read an email from Reid Muoio, the head of the SEC’s team looking into complex mortgage securities."

This is where the email trail proving the SEC should be immediately disbanded and its tasks handed off to an impartial, third-party, ideally private agency, begins: 

Muoio, who had worked at the agency for years, told colleagues that he had seen the “devasting [sic] impact our little ol’ civil actions reap on real people more often than I care to remember. It is the least favorite part of the job. Most of our civil defendants are good people who have done one bad thing.”

In this case, Muoio is referring to career criminals who have violated securities laws on countless ocasions, but for whatever reason, he believes that bringing justice to these "real people" is the "least favorite part of the job." Incidentally bringing justice to criminals is the only part of his job, but he believes they deserve a chance because they have "done one bad thing."

This attitude agitated Kidney, and he felt that it held his agency back from pursuing the people who made the decisions that led to the financial collapse.

To be sure, Kidney has criticized the SEC publicly in the past, and the agency’s handling of the Abacus case has been previously described, most thoroughly in a piece by Susan Beck, in The American Lawyer, but the documents provided by Kidney offer new details about how the SEC handled its case against Goldman. As ProPublica writes, the SEC declined to comment on the emails or the Abacus investigation, citing its policies not to comment on individual probes. In a recent interview with me, Muoio stood by the agency’s investigation and its case. "Results matter. It was a clear win against a company and culpable individual. We put it to a jury and won," he said.

Kidney, for his part, came to believe that the big banks had “captured” his agency — that is, that the SEC, which is charged with keeping financial institutions in line, "had become overly cautious to the point of cowardice." He is right.

ProPublica writes that soon after he joined the case, Kidney believed that the evidence the SEC staff had assembled justified charges against more people and he argued for, at the very least, an investigation of higher-level executives.

The SEC team had not interviewed Tourre’s direct superior, Jonathan Egol. Nor had they questioned top bankers in Goldman’s mortgage businesses or any of the bank’s senior executives. Even more surprising to Kidney, the agency had not taken testimony from John Paulson, the key figure at his eponymous hedge fund. It seemed to Kidney, as he reviewed the case materials, that the agency had spent more time and effort investigating much smaller insider-trading cases. Just two weeks after he joined the case, on August 14th, Kidney urged the team to broaden its investigation and issue key participants in the Abacus deal what are known as Wells notices — official notification that the SEC is considering charges.

Specifically, Kidney - just like us 6 years ago - could not understand why SEC staffers were reluctant to investigate Tourre’s bosses at Goldman or anyone at Paulson. Charging only Goldman, he said, would send exactly the wrong message to Wall Street. "This appears to be an unbelievable fraud," he wrote to his boss, Luis Mejia. “I don’t think we should bring it without naming all those we believe to be liable.

His boss, and virtually everyone else at the SEC, disagreed. This is what happened next:

Kidney’s view of the case put him at odds with Muoio, who was widely respected at the agency for his analytical abilities. Kidney said that he was aghast when, in an email sent a month later congratulating his team on their work investigating Tourre, Muoio described potential targets of SEC charges as “good people who had done one bad thing,’’ and he did little to hide his irritation.


I am in full agreement that when we sue it can be devastating, and that we have sued little guys way too often on flimsy charges or when they have been punished enough,’’ he wrote back. “But I’m not at all convinced that Tourre alone is sufficient here.”


Kidney later explained to Muoio that he was pushing for a more assertive approach because he believed that the SEC had grown too passive in its oversight of Wall Street. “The damage to the reputation of the [SEC] in the last few years and the decline of the institution are very troubling to me,” he wrote.


Kidney and Muoio battled for months. Kidney felt that the agency was overly dependent on the kind of direct evidence it had against Tourre. Part of the problem was that high-level Goldman executives had been savvier in how they communicated: when topics broached sensitive territory in emails, they would often write “LDL” — let’s discuss live.

Not only was SEC employee Reid Muoio against persectuing bankers, he was actively working against the case.


Kidney pressed the team to take what he thought were obvious investigative steps. He had been told by a staff attorney in the group that Muoio had vetoed the idea of calling Paulson to testify, and the agency hadn’t subpoenaed Paulson’s emails initially, relying mainly on the voluntary disclosure of documents. “We didn’t get subpoena power until late in the investigation,” a staff attorney acknowledged to Kidney in an email sent late in August of 2009.

As the year ended, Muoio remained opposed to bringing charges against anyone but Tourre. In a December 30th email, sent to the entire group investigating the deal, Muoio offered an explanation for what had happened during the bubble years: “Now that we are gearing up to bring a handful of cases in this area, I suggest that we keep in mind that the vast majority of the losses suffered had nothing to do with fraud and the like and are more fairly attributable to lesser human failings of greed, arrogance and stupidity of which we are all guilty from time to time.”

And that right there is the smoking gun strawman: ignore the "one off" crime because most of the fraud took place because someone was really just too stupid to know otherwise. Even if that someone worked for the firm which prides itself on having a more strict acceptance ratio than Harvard, and where figuring out how to outsmart everyone else on Wall Street, not to mention Congress and Main Street, is a key ingredient of successfully advancing to partner level.

Kidney pressed on and pushed the agency to bring charges against Egol, Tourre’s superior at Goldman, arguing that the SEC should at least interview him. According to Kidney, Muoio once again hindered the investigation and dismissed the idea, saying that the agency knew what Egol would say. “That’s a cardinal sin in an investigation,’’ Kidney said that he told Muoio. “You can’t assume what somebody will say.”

Kidney also wanted to go after those who made the most money on the Abacus fraud: John Paulson and more importantly, the person who invented the trade that made John Paulson a billion dollars, Paolo Pellegrini.  In late October of 2009, Kidney circulated a long memo arguing that the SEC should consider charging Paulson & Co., John Paulson himself, and Paolo Pellegrini, who was the hedge fund executive who worked on the Abacus deal.

“Each of them knowingly participated, as did Goldman and Tourre, in a scheme to sell a product which, in blunt but accurate terms, was designed to fail,” Kidney’s memo said. “In other words, the current pre-discovery evidence suggests they should be sued for securities fraud because they are liable for securities fraud.”

Once again, Muoio intervened:

Some of Kidney’s colleagues initially supported his idea to pursue scheme liability, but Muoio seemed to think that doing so would hurt the agency’s solid but narrower case against Goldman. “I continue to have serious reservations about charging Paulson on our facts,’’ Muoio wrote. “And I worry that doing so could severely undermine and delay our solid case against Goldman.”  He was, of course, referring to the "case" in which not a single Goldman banker would be charged criminally, and only a 20 year old trader would see a civil lawsuit filed against him. Muoio’s viewpoint, again, prevailed.

* * *

Muoio, defended himself to ProPublica, and in an interview with Eisinger dismissed Kidney’s complaints. “I cannot imagine any basis for claiming ‘regulatory capture,’ given that I have never worked in industry or finance and given the cases I have made, including very significant cases against banks, auditing firms, companies and senior executives," he said.

Well, the basis is the glowing trail of evidence that Muoio, and the SEC, are clearly corrupt, and only a society that is too stupid, or too captured itself, is unwilling to accept it.

Kidney, clearly the only lawyer at the SEC with any integrity did not give up:

Even after he lost the debate over scheme liability, Kidney continued to argue for charging Jonathan Egol with securities-law violations. One staffer wrote that the SEC had testimony, but little documentary evidence, proving that Egol had reviewed the Abacus documents. “The law surely imposes liability on others besides the literal scrivenor [sic], or we are in big trouble,” Kidney shot back in an email. “Why are we working so hard to defend a guy who is now a managing director at Goldman so we can limit the case to the French guy in London?”


“I am sure you are not suggesting we charge Egol because of his position within the company,” Muoio replied. “Nationality is also clearly irrelevant and I hope that’s the last we hear from you on that subject. Tourre admits he was principally responsible for the problematic disclosures.”


Members of the SEC staff finally interviewed Egol in January. Muoio would later tell the SEC inspector general: “We didn’t lay a glove on him.” But Kidney felt differently. As he saw it, Egol had acknowledged reviewing all the documents that the SEC had deemed misleading.

And then, a miracle happened: someone at the SEC actually did their job and on January 29, 2010, after months of investigation and debate, the SEC provided a Wells notice to Jonathan Egol. 

Once again, enter banker defendant #1, SEC employee Reid Muoio:

In March, Muoio wrote an email arguing against charging Egol, saying that, among other reaons, he “will strike most jurors as nice, likable, down-to-earth family man.” 

And then another familiar name emerged:

On the afternoon of March 22nd, the team gathered in the office of Robert Khuzami, the SEC’s director of enforcement, for a meeting. Kidney, Lorin Reisner, and one other lawyer present were in favor of suing Egol; Muoio remained implacably against, as did others. Most of the lower-level staffers stayed quiet.

Ah yes, our good old friend, Robert Khuzami, star of such posts as SEC Whistleblower Blows the Whistle on Revolving Door Fraud (Khuzami: You're Outed), Circle Jerk 101: The SEC's Robert Khuzami Oversaw Deutsche Bank's CDO, Has Recused Himself Of DB-Related Matters, the same Khuzami who was General Counsel of one of the the most criminal banks in the world, Deutsche Bank, during the time when Deutsche Bank Hid $12 Billion In Losses To Avoid A Government Bail-Out,
and of course the same Robert Khuzami Who Stands To Lose Up To $250,000 If He Pursues Action Against Deutsche Bank.

In the matter of SEC litigation against DB, Khuzami had no choice but to recuse himself. Against Goldman, however, he made it clear whose interests he protects:

The following day, Khuzami emailed the group with his decision: “I am a no on Egol. An extremely difficult call,” he wrote. “The lack of consensus among our group is itself, for me, confirmation of this conclusion.” Khuzami did not respond to a request for comment for this article.

Kidney had lost. "He was offered the job of handling the expert witnesses for the trial but knew what that meant — that he was getting demoted. He declined."

And just like that, the only person who actually fought to put criminal bankers behind bars was kicked out of the SEC. He retired in 2014 after becaming disillusioned. Upon retiring, in 2014, he gave an impassioned going-away speech, in which he called the SEC “an agency that polices the broken windows on the street level and rarely goes to the penthouse floors.”

* * *

As for Goldman, on July 15, 2010, the SEC settled with Goldman for $550 million. Goldman Sachs did not admit any wrongdoing. The SEC wrung an apology out of the bank, which the agency perceived as scoring a victory that critics called inadequate.

It would be the only SEC action brought against the bank for its actions in this corner of the mortgage securities markets just before the meltdown, although a Senate investigation uncovered questionable behavior related to other Goldman mortgage securities. The Justice Department recently settled a case with Goldman that charged that the bank had misrepresented mortgage-backed securities. The bank had to pay on the order of $5 billion. The Justice Department did not charge any individuals.

To this day, not a single banker has gone to prison for crimes during the last credit bubble.

* * *

In the conclusion to the Propublica piece, Kidney reflected on why the SEC has so miserably failed in its mission.

The oft-cited explanations — campaign contributions and the allure of private-sector jobs to low-paid government lawyers — have certainly played a role. But to Kidney, the driving force was something subtler. Over the course of three decades, the concept of the government as an active player had been tarnished in the minds of the public and the civil servants inside working inside the agency. In his view, regulatory capture is a psychological process in which officials become increasingly gun shy in the face of criticism from their bosses, Congress, and the industry the agency is supposed to oversee. Leads aren’t pursued. Cases are never opened. Wall Street executives are not forced to explain their actions.

And why is that? The answer, of course, came from the very top. In this case Eric Holder who admitted on the record that banks are simply "Too Big To Prosecute"

GRASSLEY: On the issue of bank prosecution, I'm concerned that we have a mentality of too-big-to-jail in the financial sector of spreading from fraud cases to terrorist financing and money laundering cases -- and I cite HSBC. So I think we're on a slippery slope.


HOLDER: The concern that you have raised is one that I, frankly, share. And I'm not talking about HSBC now. That (inaudible) be appropriate. But I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy. And I think that is a function of the fact that some of these institutions have become too large.

This is better known as the "send one banker to jail, and the financial system crashes" defense.

Sadly, since nothing will change and the system is broken beyond repair and more corrupt with every day, it is an excuse that will be used extensively following the next, and far greater, financial crash.


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