Too big to jail, indeed.

U.S. District Court Judge Jed S. Rakoff has written a scathing indictment of the federal government’s approach to prosecuting Wall Street finance and banking executives, concluding that timidity, lack of resources, and a desire by individual prosecutors to pluck the low hanging fruit of fraud cases has left the country’s top financial wheeler-dealers unscathed by the likely crimes that seized up the world economy.

Particularly galling, Rakoff writes in The New York Review of Books, is the sense among Justice Department officials that some financial institutions are too big to be disciplined. “This excuse — sometimes labeled the ‘too big to jail’ excuse — is disturbing, frankly, in what it says about the department’s apparent disregard for equality under the law,” wrote Rakoff, who previously rankled Justice officials and corporate executives by refusing to approve civil settlements over corporate wrongdoing that did not include an admission of guilt.

And there likely were many crimes committed in the financial collapse. While pointedly saying he has no opinion on whether crimes occurred, Rakoff cites the findings of the Financial Crisis Inquiry Commission that fraud lurked behind the transactions that collapsed the economy. Yet U.S. Justice Department officials “have been more circumspect,” and point to three factors in their decisions not to prosecute: Proving fraud is hard; the sophisticated buyers of ill-fated mortgage-backed securities should have known better; and that going after the crooks could destabilize the economy. From the article:

Without multiplying examples further, my point is that the Department of Justice has never taken the position that all the top executives involved in the events leading up to the financial crisis were innocent; rather it has offered one or another excuse for not criminally prosecuting them—excuses that, on inspection, appear unconvincing. So, you might ask, what’s really going on here? I don’t claim to have any inside information about the real reasons why no such prosecutions have been brought, but I take the liberty of offering some speculations. At the outset, however, let me say that I completely discount the argument sometimes made that no such prosecutions have been brought because the top prosecutors were often people who previously represented the financial institutions in question and/or were people who expected to be representing such institutions in the future: the so-called “revolving door.” In my experience, most federal prosecutors, at every level, are seeking to make a name for themselves, and the best way to do that is by prosecuting some high-level person. While companies that are indicted almost always settle, individual defendants whose careers are at stake will often go to trial. And if the government wins such a trial, as it usually does, the prosecutor’s reputation is made. My point is that whatever small influence the “revolving door” may have in discouraging certain white-collar prosecutions is more than offset, at least in the case of prosecuting high-level individuals, by the career-making benefits such prosecutions confer on the successful prosecutor.

So why no prosecutions? Rakoff blames it on shifted priorities after the Sept. 11 attacks, when the FBI’s financial-frauds staff dropped from around 1,000 people to about 120; a decentralization of prosecutions to regional offices with insufficient expertise in the complex world of banking and finance and different priorities; the federal government’s role in shoring up post-collapse banks and financial institutions blurred the lines; and a policy shift from prosecuting individuals in favor of corporations in the belief that it would be easier to change corporate culture.

That last factor seems the most significant. An accused corporation can negotiate a settlement, pay a fine, promise not to sin again, then pass along the costs to consumers and shareholders and maybe fire a subordinate executive or two for public relations value. Meanwhile, the individuals responsible — or who most benefited from willful ignorance — pay no penalty for their crimes.

I suggest that this is not the best way to proceed. Although it is supposedly justified because it prevents future crimes, I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect. It is technically suspect because, under the law, you should not indict or threaten to indict a company unless you can prove beyond a reasonable doubt that some managerial agent of the company committed the alleged crime; and if you can prove that, why not indict the manager? And from a moral standpoint, punishing a company and its many innocent employees and shareholders for the crimes committed by some unprosecuted individuals seems contrary to elementary notions of moral responsibility. These criticisms take on special relevance, however, in the instance of investigations growing out of the financial crisis, because, as noted, the Department of Justice’s position, until at least recently, is that going after the suspect institutions poses too great a risk to the nation’s economic recovery. So you don’t go after the companies, at least not criminally, because they are too big to jail; and you don’t go after the individuals, because that would involve the kind of years-long investigations that you no longer have the experience or the resources to pursue.

It’s a significant argument Rakoff makes. The New York Times “Sidebar” columnist Adam Liptak said Rakoff accused the government of failing “in its rudimentary responsibilities, offering excuses instead of action.” He asked Rakoff what prompted the essay, an unusual step for a sitting judge.

“As a judge, I got to see many cases that grew out of the financial crisis and to see situations that gave me pause,” he said. “When I added my own background as both a prosecutor and defense counsel, I was struck by how things were proceeding in a different way than they had in the past. “That caused me to think about it more than I otherwise would have,” he said, “and I thought my views as a citizen might commend themselves to others.”

One hopes his fellow citizens — especially those in charge of regulating the financial world and prosecuting its criminals — pays attention.

—Posted by Scott Martelle.