The inspector general of the Federal Deposit Insurance Corporation told The Wall Street Journal recently that the agency had opened criminal investigations into about 50 banks that had failed since the financial collapse in 2008. While that makes it sound like prosecutors will soon be filing charges against a number of bank executives, do not hold your breath waiting for a flood of prosecutions.
The last time there was a surge in bank fraud prosecutions was in the early 1990s during the savings and loan crisis that led to the collapse of nearly 1,800 financial institutions. Unlike that era, the number of bank failures has totaled 311 since 2008, and most of those were smaller institutions that got caught up in construction lending.
Although some larger banks did collapse in 2008, like Washington Mutual and IndyMac Bancorp, those failures appeared to be more related to aggressive mortgage operations that fell apart during the collapse of the housing market rather than misconduct by executives. And banks were hardly the most prominent contributors to the financial crisis, with the mortgage lender Countrywide Financial playing a significant role, while the collapse of Bear Stearns and Lehman Brothers triggered much of the upheaval in the bond market.
The F.D.I.C., which is led by Sheila C. Bair, can comb through the records of a failed bank to see if there were any improprieties that contributed to its demise, at which point the agency can only recommend cases to the Justice Department for possible criminal prosecution but cannot pursue them on its own.
Calling the examinations “criminal investigations” overstates what is really taking place. The F.D.I.C. cannot compel witnesses to testify and produce documents like a federal grand jury, and its review is limited largely to scrutinizing the documents from the failed bank to see if there are telltale signs of fraud or improper lending practices.
Once the F.D.I.C. makes a criminal referral to the Justice Department, it is up to prosecutors to put together a case, which can take months or even years as documents are subpoenaed and witnesses interviewed to determine whether there is sufficient proof of a crime to seek an indictment.
The better way to understand the F.D.I.C.’s role is that the agency identifies the transactions and loans that appear suspicious enough to warrant a full-scale criminal investigation, at which point the Justice Department takes over.
There are several statutes the Justice Department can employ to pursue prosecutions of bank executives and customers if there are indications of wrongdoing. Among them are the broad bank fraud statute that reaches any scheme or artifice to defraud (18 U.S.C. § 1344); a false statement statute that specifically focuses on communications with financial institutions (18 U.S.C. § 1014); and prohibitions on false entries in a bank’s books and records (18 U.S.C. § 1005), bribery of a bank officer (18 U.S.C. § 215) and embezzlement or misapplication of bank funds (18 U.S.C. § 656).
Proving a violation, however, requires more than just showing that a bank officer acted recklessly or that management made bad business decisions by engaging in questionable lending.
Excessive risk-taking by banks, like diving into subprime loans or qualifying borrowers without any documentation — so-called “no doc” loans — certainly appears foolhardy, but until mismanagement and stupidity are made into federal offenses, making bad decisions is not enough to prove a crime.
The longer statute of limitations for filing charges involving a financial institution also illustrates how difficult these cases can be. While most federal offenses require the government to initiate its prosecution within five years, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 extended the time period to 10 years for banking crimes.
Congress adopted this provision at the urging of the Justice Department during the savings and loan crisis because of concerns that the complexity of the cases and the sheer volume of bank failures during that period would result in a number of potential prosecutions being lost.
These types of cases are not easy to investigate and prosecute, so the number of F.D.I.C. criminal inquires is not necessarily a strong indicator of the likelihood of prosecutions any time soon.
A more powerful weapon in the F.D.I.C.’s arsenal is its authority under 12 U.S.C. § 1821(k) to sue officers and directors of a failed financial institution for monetary damages “for gross negligence, including any similar conduct or conduct that demonstrates a greater disregard of a duty of care (than gross negligence) including intentional tortuous conduct.” This can be a much more expeditious means to recover at least some money from those who the F.D.I.C. can show mismanaged the financial institution.
Most important, the standard of proof is by a preponderance of the evidence rather than the higher criminal standard of proof beyond a reasonable doubt.
As part of any claim against a bank executive, the F.D.I.C. can also try to pursue the insurance company that provided the liability coverage for the bank’s executives and directors.
Some of the more flamboyant prosecutions during the savings and loan crisis involved high-living bankers who used the institution’s assets as a piggy bank, financing extravagant board meetings at expensive resorts while doling out loans to a favored few. The tales of extravagance in that earlier era have not surfaced in the most recent spate of bank failures, so proving that executives may have committed a crime will not be easy.
Even if there are prosecutions arising from recent bank failures, they are unlikely to involve the kind of lurid facts that draw the media’s attention and make a defendant into a poster child for the financial crisis.
