The Insider Trading Bread and Circus
In announcing the creation of an interagency task force to fight economic fraud in November 2009, Attorney General Eric Holder promised not only to hold accountable those who caused the collapse, but also “to prevent another meltdown from happening.” If past is prologue, the latest round of perp walks and show trials, far from administering justice or engendering real economic reform, will be much closer to what the ancient Romans called diversionary “bread and circuses.”
Attorney General Eric Holder announces the creation of the Financial Fraud Enforcement Task Force (Washington; November, 17 2009).
Last month, a three-year federal probe into Wall Street malfeasance reached fever pitch. At least six people—three technology company executives and three consultants—were arrested on fraud charges related to “insider trading,” following a ten-week span in which dozens of companies were subpoenaed and three hedge fund offices raided. More arrests are anticipated in the coming weeks.
This ever-expanding crackdown will doubtless net some real corporate criminals. But the very nature of insider trading fraud laws, and the dragnet techniques used by U.S. Attorneys, will likely result in the prosecution, even conviction and incarceration, of some innocents. At the very least, some defendants may be deprived of their fundamental right to due process of law—a problem whose immediacy may be best illustrated when compared to regimes without such protections for the criminally accused (a topic further explored below).
Believers in the rule of law would do well to step back and ask: What, if anything, will this sweeping inquisition do to prevent the next economic collapse? In a country where an increasingly larger share of the wealth is concentrated in an ever smaller slice of the population, show trials will not suffice to cure any real ills.
Figures from the not-so-distant past back this up. Arrest rates for white collar fraud have surged in the wake of recent financial scandals, according to data generated from the FBI’s Uniform Crime Reports. Over a two-year period after the savings-and-loan scandal (1990–1992), the number of fraud arrests increased 53%; over the same period following the dot-com bust (2000–2002), arrests jumped 26%. Yet these prosecutorial surges did nothing to prevent Wall Street’s most recent cratering.
Like scandals before, prosecutors have at their disposal an arsenal of ambiguous laws. Securities, wire, or mail fraud are the go-to statutes in financial probes; fall backs such as making “false statements” to a federal official or engaging in a “conspiracy” are often used when costly investigations turn up little or no dirt. With roughly 4,500 separate criminal offenses on the federal books—no one, not even Congress knows the precise total, especially when administrative regulations that expand criminal liability are added to the total—there’s no shortage of hooks on which to hang potential targets.
This time, professionals associated with “expert network” firms, which employ specialists to help assess industry developments, appear to be in the Justice Department’s cross hairs. In existence since the late 1980s, these firms exploded in popularity over the past decade and, according to a survey taken by Integrity Research, were consulted by some 36% of investment-management firms in 2009. Whether these networks, in providing their expertise, gathered or divulged inside information gleaned illegally appears to be the central question now before investigators.
It should be noted, however, that even before a single case has gone before a judge in this latest insider-trading probe, a “frigid chill” has swept over the expert network industry. Major investment banks have reportedly abandoned the firms altogether. Regardless of one’s inclinations toward expert networks, we must recognize the immense power of U.S. Attorneys and their regulatory-agency allies—they have completely up-ended an entire industry, virtually overnight.
Ambiguous laws serve to reinforce this prosecutorial power. Take regulations concerning insider trading, for example. In theory, insider trading involves the buying or selling of securities based on material corporate information still unknown to the public. Yet in fact the lines demarcating forbidden insider information from ordinary corporate data shared between companies and investors or analysts are blurred, empowering prosecutors to define the outer-reaches after-the-fact, on a case-by-case basis.
This ambiguity is hardly due to inadvertence. Rather, it is policy: When Washington wants to appear tough on Wall Street, prosecutors have an all-purpose “securities fraud” statute from which flows an endless stream of newly minted definitions—and hence criminal cases.
Congress and the SEC had a golden opportunity to provide clarity in the 1980s. The Insider Trading and Securities Fraud Enforcement Act of 1988, which provided increased penalties, passed unanimously (410-0) in the House and by voice-vote in the Senate. But it did nothing to define the crime.
In response to suggestions that essential clarity was lacking, John Dingell, then Chairman of the House Committee on Energy and Commerce, said that defining criminal insider trading would provide a “roadmap for fraud.” He further 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.” Dingell apparently saw no need for a roadmap for the law-abiding.
The abuse of vague criminal statutes stands out particularly glaringly, perhaps, to those who have lived under repressive regimes. Ninth Circuit Court of Appeals Chief Judge Alex Kozinski, who lived in Romania while under Soviet control, penned a stinging rebuke to federal prosecutors in a December 10 opinion. Agreeing that the securities fraud conviction of a former corporate chief financial officer should be vacated and the defendant acquitted, Kozinski pointed out that the prosecution “is just one of a string of recent cases in which courts have found that federal prosecutors overreached by trying to stretch criminal law beyond its proper bounds.”
Proper bounds, of course, begin with providing fair warning as to what the law forbids, an essential element of the “due process of law” guaranteed by the Fifth Amendment. Kozinski gets this, possibly because he recalls Soviet laws against “hooliganism,” which allowed the Kremlin to essentially declare criminal any and all critics of the regime.
Or perhaps a more current analogy better demonstrates the importance of due process. Consider the detention of Chinese-born American citizen Xue Feng, an employee of a Colorado-based research firm who obtained information in 2005 on oil wells in his native country. Three years later, Beijing authorities retroactively declared such information to be “state secrets,” arrested Mr. Feng, and, after a lengthy trial, sentenced him to eight years in prison.
To most Americans, something is plainly wrong with a researcher being imprisoned for gathering data deemed only after-the-fact to be off-limits. But to what extent, one must ask, do vaguely-worded laws against securities fraud in the U.S. provide a similar lack of notice?
Those interested in fundamental economic reform, or even simply in reform of the markets, should look at the forthcoming insider trading show trials with a skeptical eye. Are they meant to keep the system honest or, instead, to merely divert attention from the myriad regulatory and systemic failures? And, if the latter, are they diverting attention at the expense of innocent people caught up in the latest DOJ circus?
Paralegal Kyle Smeallie assisted in the preparation of this piece.
By on 04/01/2011