Now that the U.S. Justice Department has accused two former employees of JPMorgan Chase & Co. of trying to hide losses in the London Whale trading debacle, it might be easier for the Securities and Exchange Commission to demonstrate whether it has even a minimal amount of backbone.
The agency, according to Bloomberg News and other reports, is considering a deal in which the bank would pay a penalty and admit to some kind of wrongdoing stemming from the $6.2 billion trading loss. This would mark a break with the SEC's infuriating practice of working out settlements with banks and brokerage firms that allow them to neither admit nor deny wrongdoing. (The SEC also filed civil claims against the two traders.)
There were so many things wrong with the SEC's neither-admit-nor-deny as its default position for litigation that it's hard to know where to start. As good a place as any is with U.S. District Court Judge Jed Rakoff, who held up a proposed settlement between the SEC and Citigroup Inc. in late 2011. Rakoff said he couldn't tell from the secret terms the two sides had agreed to whether the $285 million penalty Citigroup would pay was commensurate with whatever the bank had neither admitted nor denied doing.
This opacity was one reason Congress has ratcheted up pressure on the agency to say why it could never manage to make a company fess up. And although most Americans didn't have more than the foggiest idea what caused the financial crisis, they know that no one on Wall Street seemed to have gotten busted.
The general public also sees the towering cynicism behind settlements that contain neither-admit-nor-deny language. Wall Street operates under the justifiable assumption that the financial wrist-slaps by the SEC amount to little more than the cost of doing business. As long as bankers and traders know that the odds are against being cited personally for misconduct, then why worry?
Relying on neither-admit-nor-deny also happens to be very convenient for the SEC's enforcement division, leading to a sort of legalistic moral hazard. Staff lawyers may have been more willing to bring enforcement actions against targets, knowing they might never have to build a case strong enough to prevail in court. And we all know that the track record of the SEC when it goes up against Wall Street -- poor Fabrice Tourre notwithstanding -- isn't very impressive.
Nonetheless, the SEC has been so hooked on these types of settlements that it borders on the absurd. On more than one occasion, the SEC made parallel civil allegations against a company also accused of criminal wrongdoing. Even in cases where the firm admitted wrongdoing or was found guilty in the criminal case -- meeting a tougher legal threshold than required in civil litigation -- the agency stuck with neither-admit-nor-deny settlement terms for its own charges.
This was too much even for former SEC enforcement chief Robert Khuzami, who in January laid out new settlement guidelines. When a company is found guilty or admits to law-breaking, the SEC said it now would cite the facts in the criminal case and omit its waffling language -- but only "in the minority of our cases where there is a parallel criminal conviction," the agency said in a news release. In other words, we don’t like this and plan to do it as little as possible.
But let's be optimistic here. There's a new SEC boss in town -- Mary Jo White -- and Khuzami has left the agency to join a big law firm. Two months ago, White said in some cases the agency won't accept neither-admit-nor-deny settlements, even if there isn't a corresponding criminal complaint against a firm, as there surely won't be in the London Whale mess because it might compromise JPMorgan's ability to stay in business.
According to an SEC memo, ``there may be certain cases where heightened accountability or acceptance of responsibility through the defendant's admission of misconduct may be appropriate.'' Those might involve harm to large numbers of investors or when a firm tried to hinder the SEC's probe.
There will be plenty for the legal types to chew over if the SEC makes admissions of wrongdoing part of its arsenal of regulatory weapons. Of course, what matters most is whether this alters behavior in the financial industry for the better.
(James Greiff is a Bloomberg View editorial board member. Follow him on Twitter.)