Wall Street Judge: Cynicism Tempered by Fraud Examiners' Efforts

Cressey Award recipient Judge Jed S. Rakoff said the real winners of the honor should be the members of the ACFE because they root out fraud to an unprecedented degree. “I wish I could say the same for the federal government,” he said during his Monday Opening Session address. “But I am regrettably, convincingly convinced that the federal government and the federal system of justice has somewhat retrogressed over the past couple of decades … in the prosecution of fraud … when it’s perpetrated by people at the highest levels of the financial establishment.”

Rakoff, U.S. District Judge for the Southern District of New York, said that historians of the Great Recession will say that fraud played a major role in creating a mortgage bubble that led to the crash, but that few of the people most responsible for that fraud were ever brought to justice. “This has led to me becoming a little more cynical about our legal system as a whole,” he said.

“Like many other people who grew up during the 1950s, 1960s, I was attracted to law in part because of the marvelous role of the Warren [Supreme] Court played in advancing justice,” he said. “After I finished law school and became a federal prosecutor in the early 1970s, I began to appreciate how much of our law centers on financial transactions and how vital it is to our economy to keep those transactions honest.”

He says the transition in the U.S. in the last 50 years from an industrial economy to an economy built on sectors like financial services is a great asset as long as the world believes that our markets are honest and transparent. When he was a young prosecutor, he said, he was impressed with how federal agencies, prosecutors and courts all combined to make sure that even the highest-placed businesspeople were not above the reach of the law in fraudulent transactions. Thus, he says, in the late 1960s, the Securities and Exchange Commission expanded securities fraud prosecutions to reach high-level executives, big-firm accountants and attorneys who had perpetrated huge frauds.

“The impetus created by that kind of approach carried over for several decades giving rise … to the successful conviction of Michael Milkin [fraudulent junk-bond bubble], prosecution of Charles Keating and 800 of his confederates [savings and loan bubble] and the prosecution of Bernie Ebbers [WorldCom] and Jeffrey Skilling [Enron],” he says.

But Rakoff said these frauds were nothing compared to those caused by mortgage-backed securities in the 2007-2008 financial meltdown. Fraud permeated every part of the system, he said — banks, mortgage companies, rating agencies. The mortgage bubble “was rooted in fraud at every level,” he said. “In the end the bubble burst. But the disaster was of such magnitude, that the one clear response of the government was to bailout the very banks that had created the problem for fear that otherwise the economy would collapse.” 

He said the government overruled federal managers such as Neil Barofsky, former special U.S. Treasury Department inspector general overseeing the Troubled Asset Relief Program, who wanted to prosecute financial institutions’ C-suiters. “To this day, no cases have been brought against virtually any of the high-level executives involved in the creation of this fraud,” Rakoff said.

The federal government, he said, locks up those who have committed crimes involving relatively modest amounts of money and lets fraudsters who have stolen trillions go free. “Mass incarceration, it seems, is only for the masses,” he said.

“One bright spot in this otherwise dismal conclusion is that at least since Sarbanes-Oxley private enforcement has increased; businesspeople don’t want another financial crisis to occur on their watch,” Rakoff says. “They’re increasingly using people like you to detect fraud as well as preventing it from happening. You should be very proud of your efforts.”