Taking a stand for investors

U.S. District Judge Jed S. Rakoff shook the securities establishment to its core in 2009 when he refused to sign off on a $33 million settlement between the Securities and Exchange Commission and Bank of America Corp. The SEC had sued the bank for not disclosing an agreement to pay up to $5.8 billion in bonuses to executives of Merrill Lynch & Co. Inc. after it bought the brokerage firm. At the time, Mr. Rakoff wrote that the proposed settlement, in which the bank would neither admit nor deny the allegations, “was a contrivance designed to provide the SEC with the facade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry — all at the expense of the sole alleged victims, the shareholders.” Today, Mr. Rakoff, 69, who sits in the Southern District of New York in Manhattan, remains steadfast in his desire to protect shareholders and hold individuals accountable for fraud as the greatest deterrents on Wall Street. Indeed, Mr. Rakoff is keeping investors' best interests at heart, said Ryan Bakhtiari, president of the Public Investors Arbitration Bar Association. “It's absolutely critical that there is somebody on the bench who is willing to stand up for investors, because investors typically don't have the kind of power or bargaining power that Wall Street does,” said Mr. Bakhtiari, who also is a partner at Aidikoff Uhl & Bakhtiari. Recently, Mr. Rakoff sat down to discuss the BofA case, lessons learned from the financial crisis, how regulators go after fraud, and the SEC. Q. Last month, BofA settled the class action involving its acquisition of Merrill Lynch and agreed to pay $2.4 billion to investors, and denied the allegations in the complaint. How do you respond to the language in the settlement? A. It doesn't seem to me the amounts involved in those settlements [with the SEC in 2009] were likely to have a deterrent effect. This [latest settlement] is a much larger amount. One could imagine it could have a meaningful deterrent effect. The basic thrust of the SEC's allegations in the Bank of America case was that management had, in effect, defrauded their own shareholders. The allegations were that management did not make shareholders aware of the huge losses that Merrill Lynch had experienced in the fourth quarter [of 2008]. The point I raised [in 2009] is, if management defrauds the shareholders, then it is important that the shareholders not be asked to pay. That's like victimizing them twice. In the [2009] SEC settlement, the money would go to the SEC from the shareholders, who were the victims of the fraud. That seemed to me to be nonsensical. It was the shareholders themselves who were defrauded. They shouldn't have to pay. Q. Would you like to see more-aggressive pursuit against senior management in such cases? A. Yes. But senior management is the wrong way to characterize it. [Claims should be brought] against the individuals, at whatever level, who were responsible for the fraud, if there was a fraud. In the Bank of America suit, there was never any admission, so we don't know to this day if there was a fraud or not. If human beings commit fraud, you should go after them both as a matter of simple morality — because people should be punished for misconduct — but it's also a matter of good deterrence. Q. What did the courts and regulators learn from the financial crisis? And what needs to happen to improve in these cases? A. I think that at a minimum, we all learned that there is reason to believe that the ratings agencies were not as careful as they should have been. I think it's fair to say that the banks were not as careful as they might have been. But one thing you learn as a judge is, it's hard to make generalizations. You need to look at each individual case. Q. Are settlements in which people admit or deny nothing a deterrent to future bad behavior? What is it going to take to deter such behavior by the banks and the executives involved? A. In my own personal opinion, not my judicial opinion, I think that there is nothing like a criminal prosecution to have deterrence. People are willing to pay amounts of money, even sometimes substantial amounts of money, to get problems behind them. But no one wants to go to jail. And the threat of jail, experience has shown, is the most effective deterrent. Short of that, I think going after individuals who are responsible, even on a civil basis, is more likely to be a deterrent than going after companies. Q. What could the SEC be doing better? Should civil penalties be heftier and include admissions of guilt? A. First, I'm not an official at the SEC, and the SEC has to be given considerable deference. These are good people trying to arrive at their best judgment as to what is in the best interest of the public. In my personal view, not my judicial view, I would think it would be more effective for the SEC to go after more individuals. And it would be more effective to take cases to trial if you couldn't get admissions, and that would be a more effective deterrent. But I could be wrong. That's just my personal view. Q. The SEC has been critical of you, saying that you overstepped your bounds at times. How do you respond to that? A. If you look at my decisions, I've decided cases more often in favor of the SEC than against them. But where I have disagreed with them, at times, I have disagreed with them sharply. They are no wimps in that respect. They have fired back. You can't be a federal judge if you have a thin skin. Q. What can be done to shore up consumers' and investors' confidence in financial institutions, markets and Wall Street in general? A. The American market has less fraud than most markets. The biggest reason for that is what the SEC does very well, which is demanding transparency. That's the heart of the securities laws: the demand that you tell the shareholders what the facts are. And I think a correlate of that is what I've been preaching, which is, it's important when there are crises and frauds that the truth come out. It's not simply a question of getting a paper settlement with someone, but rather that the facts come out. I think it's important because it educates the public. I think it's important because it serves a deterrent effect. I think it's important because it helps you understand what steps you could take to prevent similar frauds in the future. And frankly, I think it's important because truth is a value in and of itself. Q. Do you have a financial planner or financial adviser? A. No. I don't have the money to have a financial adviser. Judges are notoriously underpaid. bkelly@investmentnews.com Twitter: @bdnewsguy