Third installment in a five-part series on Silverglate’s book, Three Felonies a Day: How the Feds Target the Innocent.
“As a result of a burgeoning number of fraud investigations and prosecutions, I have become convinced that a concerted interagency effort is needed. We want to bring this additional firepower to bear on behalf of investors who might otherwise lose their confidence in the integrity of these markets.”
The Financial Fraud Enforcement Task Force, an interagency effort to investigate and prosecute those responsible for the current economic crisis, was established via executive order on November 17. But the above announcement was made twenty years prior. On January 31, 1989, then-Attorney General Dick Thornburgh touted the creation of a coordinated task force to bring to heel those responsible for the Wall Street scandals du jour.
Indeed, the present response to Wall Street failures seems straight out of a time-tested Washington playbook: Ratchet up enforcement, throw the miscreants in prison, and—voila—the public’s confidence in their markets and in their government is restored.
Arrest rates for “white collar” fraud have surged in the wake of recent well-publicized financial scandals, according to data generated (PDF) from the FBI’s Uniform Crime Reports. Over a two-year period after the savings-and-loan scandal and the creation of the task force described above (1990–1992), the number of fraud arrests increased 53%; over the same period following the dot-com bust (2000–2002), arrests jumped 26%. Now, with regulatory agencies expanding their probes of alleged insider-trading violations and the Justice Department promising more convictions, a raft of indictments appears inevitable. But do these enforcement efforts reflect true criminal violations? Putting aside the long-term efficacy of such periodic orgies of prosecution, there remains the nagging question of whether the defendants are guilty of any crime.
One’s unease lies not in the seeming futility of enforcement per se, but in the very nature of the laws that regulate financial fraud. For one thing, the sheer volume of regulatory codes makes adherence to legal standards a high hurdle. When Congress was considering the Fraud Enforcement and Recovery Act earlier this year, the National Association of Criminal Defense Lawyers and the Federalist Society—organizations on opposite ends of the ideological spectrum but joined at the hip in battling unfair and excessive federal prosecutions—authored a joint letter (PDF) to the Senate Judiciary Committee, pointing out that virtually all criminal provisions then under consideration were already encompassed within the existing federal criminal code. Congress ignored this nonpartisan and eminently sensible plea, passed the legislation, and added to the Justice Department’s armamentarium of overlapping and vague criminal statutes.
More pernicious than the volume of federal laws, however, is their imprecise wording. Prosecutors are given too much latitude in pursuing perceived wrongdoers whose conduct isn’t explicitly proscribed by statutory language. In a society of laws, fair notice as to what conduct might land a citizen in prison is a vital component of due process.
This should not be confused with a plea for de-regulation, which is largely a political and not a legal debate. Nor is it a plea for leniency for those who knowingly violate clear rules, even if those rules are unwise. But providing average citizens with clarity of their legal obligations is a vital civil liberties matter having nothing to do with whether one believes in more regulation or less. Timothy Lynch, director of the Cato Institute’s Project on Criminal Justice, spells out the need for specifically defined legal boundaries in his timely treatise on modern criminal law, In the Name of Justice (to which I contributed a chapter):
There is precious little difference between a secret law and a published regulation that cannot be understood. History is filled with examples of oppressive governments that persecuted unpopular groups and innocent individuals by keeping the law’s requirements from the people.
Galleon Group hedge fund founder Raj Rajaratnam, indicted (PDF) yesterday on 11 counts of securities fraud and conspiracy, would likely fit into this “unpopular” category, especially as his unflattering, hand-cuffed image from an October 16 early-morning “perp walk” continues to grace broadsheets and blogs. Rajaratnam is accused of having foraged around for—and obtained—purportedly non-public information from corporate insiders. But serious questions exist as to the line between legitimate research and illegal trading, as well as the extent to which insider trading laws even cover such outsiders who seek inside information. (Unlike Rajaratnam, others involved in the case might be insiders, and their legal obligations would be considerably clearer.)
The law criminalizing insider trading, enacted with the Securities and Exchange Act of 1934, prohibits “any person, directly or indirectly,” to “use or employ, in connection with the purchase or sale of any security…any manipulative or deceptive device.” Lawmakers assumed the SEC, which the Act created, would issue regulations to flesh out the vague language and effectuate the statute’s intent. But the SEC’s regulations tend to mimic, rather than clarify, the statute’s oracular wording, and neither the SEC nor Congress has been particularly eager to spell out precisely the nature of “securities fraud” or “insider trading.”
In the 1980s, both Congress and the SEC had an opportunity to provide clarity to securities fraud law. The Insider Trading Sanctions Act of 1984 (“ITSA”) substantially increased the penalties for insider trading. The Insider Trading and Securities Fraud Enforcement Act of 1988 (“ITSFEA”) further upped the ante by providing sanctions against those who “recklessly…failed to take appropriate steps to prevent” violations by others. Remarkably, despite near-unanimous support in both chambers of Congress, neither statute did anything to define precisely what insider trading was and what kinds of “outsiders” were covered.
During the ITSFEA hearings, Chairman John Dingell of the House Committee on Energy and Commerce claimed that any definition of insider trading would provide criminals with a “roadmap for fraud.” (It appeared not to occur to him that legal clarity is actually meant to provide a roadmap for lawful conduct.) Dingell explained that his committee “did not believe that the lack of consensus over the proper delineation of an insider trading definition should impede progress on the needed enforcement reforms encompassed within this legislation.”
It is reasonable to ask the question—especially in light of the early morning arrests, perp walks, sensational trials, and gargantuan prison sentences—whether the current system for dealing with “insider trading” by corporate outsiders who pursue as much information as their research skills and personal contacts allow comports with basic notions of due process of law.
Similar due process questions arose in the case of two former Bear Stearns hedge fund managers. Prosecutors indicted (PDF) Ralph Cioffi and Matthew Tannin on securities fraud charges for, in effect, presenting an optimistic picture to investors while aware of the possibility of collapse. When Cioffi and Tannin were faced with questions as the subprime mortgage market—in which their funds were heavily invested—looked ominously shaky, they doubtless agreed with the prevailing wisdom: Sure, a total collapse could happen, but the markets could instead stabilize and suddenly present managers with a huge buying opportunity. The situation, after all, was unprecedented in modern times.
Were a fund manager to respond to questions by publicly indulging his pessimistic side— “I think our liquidity has dried up and we may be on the verge of collapse”—he surely would have caused precisely that which he was hoping to avoid: a fatal “run on the bank.” Such a statement could rightly be seen as professional malpractice, subjecting the manager to endless civil litigation by disgruntled investors who doubtless could demonstrate that, at the time, an optimistic outcome was still a distinct possibility and that the manager’s predictions of doom were a reckless self-fulfilling prophecy.
The case was yet another example of the Justice Department targeting “professionals who have engaged in seemingly routine requirements of their job,” I wrote in the Wall Street Journal when the criminal investigation commenced in April 2008. Fortunately, jurors recognized the Catch-22 in which the Bear managers found themselves and acquitted Cioffi and Tannin on November 10.
In light of the legacy of the federal government responding to market downturns with task forces and ramped up prosecutions and perp walks, former Attorney General Thornburgh’s testimony (PDF) at a July 2009 Congressional hearing on the phenomenon of “overcriminalization” was a gratifying departure from remarks past. Said Thornburgh:
Make no mistake, when individuals commit crimes they should be held responsible and punished accordingly. The line has become blurred, however, on what conduct constitutes a crime, particularly in corporate criminal cases, and this line needs to be redrawn and reclarified.
Amen!
PJens says:
Protecting Investors or Prosecuting Innocents? The title makes it sound like an either or situation. It is very possible to protect investors and prosecute guilty people.
I agree fully that the language of the law, all laws, ought to be clear and easily understood.
I do think though that for a long time, investment fraud was under investigated. The statistics show great percentage gains in arrests, but I am quite certain our prisons are not overflowing with white collar criminals. I would like to see more investment cops on the (Wall) street, enforcing clear laws.
I would also like to see an incentive program, –high dollar prize maybe– set up to reward people who turn violators in. Professionals are very reluctant to expose a colleague they know is doing wrong. This has to change.
Quote
December 16, 2009, 10:26 amEzra says:
The inevitable result of over-regulation and criminalization of conduct relating to market transactions is to increase the risk of participating in market transactions. The idea that this sort of regulation can make market transactions safer is insane. Caveat Emptor is how market participants protect themselves. Disclosure is important, and fraud should be punished. But criminalization of ordinary course decisions based on subjective, post-hoc narratives, serves no useful purpose whatsoever, and many destructive ones.
Quote
December 16, 2009, 11:48 amLarryA says:
IOW, “These people are guilty of something. Don’t let justice get in the way.”
Another problem with vague laws is that it’s easy for the government to come up with a situation where if you do something they’ll prosecute you under one law, and if you don’t do the same thing they’ll nail you under another.
Quote
December 16, 2009, 1:03 pmHave You Committed Your Three Felonies Today? - Hit & Run : Reason Magazine says:
[...] Silverglate discussed vague anti-terrorism provisions such as the one that was use to prosecute University of Idaho [...]
pireader says:
Mr Silverglate –
You’ve now made three long posts on this topic. When you started posting, I commented that “to convince me there’s a problem, you’ll have to cite actual cases of people prosecuted and imprisoned for innocuous conduct.”
That example has yet to appear. Will it be forthcoming?
Quote
December 16, 2009, 1:19 pmChris Travers says:
pireader:
Other commentors have provided cases where individuals were. Usually the issue is that very unethical practices are used to force plea deals (see the Chong case whit mentioned re: the first post). I have personal knowledge of other cases.
Or do the other commentors’ cases mentioned have any weight here?
Quote
December 16, 2009, 2:03 pmDavid Drake says:
pireader–
Why do you require that the accused be convicted?
Cioffi and Tanner (cited in the original post) were found not guilty by a jury a few days ago. Isn’t this case–where a jury refuses to convict–a better measure of the “innocuous conduct” of the accused?
BTW–the defense costs here were probably astronomical, so it’s impossible to say that the defendants suffered no damage because they were ultimately acquitted.
Quote
December 16, 2009, 3:28 pmbyomtov says:
BTW–the defense costs here were probably astronomical, so it’s impossible to say that the defendants suffered no damage because they were ultimately acquitted.
Of course. And let’s not overlook the fact that going through the whole business — investigation, indictment, trial — was no picnic for the defendants. It’s easy to overlook the fact that while this sort of thing is all in a day’s work for the prosecutor it can take a huge emotional toll on the accused.
That doesn’t mean there shouldn’t be investigations and prosecutions of course, but it does seem to impose some sort of obligation on prosecutors (and their bosses) to get things done quickly, to be pretty damn sure of their grounds, and to evaluate cases critically.
Quote
December 16, 2009, 4:22 pmMonty says:
Part of the problem is how do you word a law to protect true outsiders, but stop those who wish to commit insider trading from relaying information for friends/relations to trade on? I think most people would agree that if a investor calls up a company and, while being forthright about thier identity, talks to someone they have never met before, and asks a question that prompts that person to reveal material, non-public information, it is not insider trading. If the investor instead calls thier best-friend since college, who is now an executive at the company, and cajoles them to reveal the same information, it probably would be insider trading. But what about “contacts”? How close of a relationship does a person need to have to infer that the information was aquired as a result of the relationship, rather then as a result of the inverstor’s excellent investigation skills? What about someone you have met a couple times at trade shows? What about somone in your bowling league? What about someone on your bowling team? What about the parent of a friend of your child? How do you write a law that draws a bright line where it should without either allowing real insider trading to go unpunished, or being overly expansive? Its a great place for the excercise of prosecutorial discretion, however the justice department has demonstrated time and again that vesting them with such discretion will result in prosecuting everyone they can the moment it becomes politically popular (and some times even when its not).
Quote
December 16, 2009, 4:37 pmPintler says:
Are you familiar with the Krister Evertson case? Here is his testimony before congress.
I agree it’s a good thing to keep sodium off of airplanes (although I do wonder how some Alaskan villages get all the things you don’t want to put on planes), but I’m not sure I would agree Mr. Evertson is the right person to make an example of, and the subsequent case in Idaho has the gloss of retribution for his acquittal in Alaska.
Before you say he should be slammed for shipping sodium via ground UPS (which is sent by air in Alaska), how about if your wife included a mercury thermometer in your checked baggage? Maybe you boxed up your new lithium ion cordless drill? Again, I’m not arguing putting those on airplanes is smart; I’m saying that felony prosecutions of people who unwittingly do so is not the right way to manage the problem.
Quote
December 16, 2009, 5:19 pmSuperSkeptic says:
Why is “insider trading” even considered a crime? Isn’t that the whole idea?
Quote
December 16, 2009, 9:17 pmProtecting Investors or Prosecuting Innocents? The Dangers of Vagueness in Financial Fraud Laws | Liberal Whoppers says:
[...] posted here: Protecting Investors or Prosecuting Innocents? The Dangers of Vagueness in Financial Fraud Laws Share this [...]
pireader says:
David Drake –Why do you require that the accused be convicted?
Because I’m questioning whether the problem is vagueness in the law (Mr Silverglate’s diagnosis) or an attitude/incentives problem among the prosecutors.
If it’s the latter, then you’d see prosecutions that fail in the courts. Sustained convictions for innocous behavior are evidence that the problem lies in the laws themselves.
Chris Travers–Other commentors have provided cases where individuals were ... see the Chong case whit mentioned re: the first post
Again, I’m questioning Mr Silverglate’s diagnosis–whether the problem is vagueness in the laws. Chong was prosecuted for selling drug paraphenalia, specifically bongs.
You may think that a law against selling drug paraphenalia is dumb. (I do, for example.) But there seems little doubt that bongs are drug paraphenalia, or that Chong’s Nice Dreams company was selling them as such.
I’m looking for a case where some poor schlub selling hair clips got convicted because they were subsequently used as roach clips.
Pintler–Are you familiar with the Krister Evertson case? .... how about if your wife included a mercury thermometer in your checked baggage?
After reading Mr Evertson’s account to Congress, I looked up the EPA’s version of the case in which he was actually convicted. They provided some details that Mr Evertson had left out:
Ten tons of sodium is not quite comparable to inadvertently packing a mercury thermometer.
Quote
December 17, 2009, 9:50 amPintler says:
1)His original crime — the one in Alaska, where he was acquitted — was for shipping sodium via ground UPS, without attaching the required ‘air transport is a no-no’ sticker. I don’t know the exact details, but I know I have shipped e.g. ammunition, aerosol cans, and so on by going to the main UPS facility in Seattle, asking what I should do, and taking that advice. Given that the UPS workers had different opinions about what the requirements were, I think that a felony prosecution for shipping via UPS w/o adding the right stickers is unwarranted — it could be you or me, even if we tried out best to comply with all the complex regulations.
2)I am not surprised the EPA feels they were in the right :-). And they may be, but: 10 tons is a small truckload. It would make a zinger of a fire, but (with the disclaimer I am not a hazmat expert) it’s not clear it is any more dangerous than an equivalent amount of gasoline or propane or what have you. If someone transports 3000 gallons of gasoline w/o taking all the required precautions, but arrives at the destination without mishap or harm to anyone, are felony charges really appropriate, as opposed to a moderate fine, agreement to comply rigorously in the future, and so on?
Quote
December 17, 2009, 12:21 pmChris Travers says:
pireader:
Ok. I know one individual who was convicted of medicare “fraud” by accidentlly filing for reimbursement with the wrong billing code. The conviction was upheld because the prosecutors had threatened others into pressuring the individual in question to plead “no contest.”
In that case, though, vagueness might be less of a problem than reward systems for prosecutors who get lots of convictions.
Quote
December 17, 2009, 1:45 pmDavid Drake says:
Pireader said:
I strongly disagree with this distinction. Vagueness in the law gives prosecutors the chance to indulge their attitudes or take advantage of perverse incentives by prosecuting people who did nothing really wrong. We should not have to rely on juries or courts of appeals to protect us against prosecutorial abuses.
Quote
December 17, 2009, 4:36 pmpireader says:
Perhaps I should make my view clearer. Yes, there’s a serious problem with prosecutorial attitudes, incentives and behavior. But Mr. Silverglate has offered a diagnosis of the problem–that vague laws are a key enabler of their mis-behavior–which I find dubious.
Pintler, on Evertson’s first case–I think that a felony prosecution for shipping via UPS w/o adding the right stickers is unwarranted
It sounds like an idiotic prosecution. The jury agreed, and acquitted Evertson. What’s vagueness got to do with it?
Pintler, on Evertson’s second case–If someone transports 3000 gallons of gasoline w/o taking all the required precautions, but arrives at the destination without mishap or harm to anyone, are felony charges really appropriate, as opposed to a moderate fine, agreement to comply rigorously in the future, and so on?
By his own account, Mr Evertson was offered a plea bargain, but rejected it. Although guilty, he went to trial with a loser defense; that seldom works out well. Here’s the Ninth Circuit’s take.
Chris Travers–In that case, though, vagueness might be less of a problem than reward systems for prosecutors who get lots of convictions.
Yes!
David Drake–I strongly disagree with this distinction. Vagueness in the law gives prosecutors the chance to indulge their attitudes or take advantage of perverse incentives by prosecuting people who did nothing really wrong. We should not have to rely on juries or courts of appeals to protect us against prosecutorial abuses.
OK, we agree that abusive prosecutors are a problem. So where’s your evidence that vague laws are a key tool in their abuse? More to the point, where’s Mr Silverglate’s?
Quote
December 17, 2009, 6:00 pm