Street Fight: Time to Send Bankers to Jail

Last Updated May 6, 2010 7:00 PM EDT

News last week that the feds have opened a criminal investigation into Goldman Sachs (GS) raises an obvious question: Would putting more bankers behind bars help prevent another financial crisis?

Some experts think it would. Henry Pontell, a criminologist at the U. of California, Irvine, told lawmakers on Wednesday that fear of going to prison can be an effective deterrent for white-collar crime. "We know that upper-class businesspersons fear shame and fear incarceration and will attend to credible threats of such consequences if they knowingly break the law; they are par excellence rational calculators."

Fear of punishment is enough to keep most employees in line (and I'm innocent, boss, I swear!) After all, despite the ample opportunities for people to rip off their companies, the vast majority don't. Perhaps that's because most folks are basically honest. But it also suggests that workers rationally weigh the rewards of doing something they shouldn't against the risk of getting caught, and perhaps going to the slammer.

One reason why the threat of prison may have more deterrent value for your average "big swinging dick" is that really rich dudes aren't scared by the prospect of civil penalties. Goldman chief Lloyd Blankfein, who in 2007 made $68 million, is a billionaire several times over. So are most Wall Street bank CEOs. To this crew, the fines typically awarded in financial fraud cases are chump change.

Take former Maurice "Hank" Greenberg. Last year the former AIG chief paid a $15 million fine to settle federal charges that he misrepresented the insurer's financial performance. In settling the case, Greenberg said he never would've agreed to the deal if he'd been charged with fraud, rather than simply violating securities law. The message: In his line of work, financial penalties are simply a cost of doing business.

To be clear, we need to draw a distinction between deterrence and justice. Murderers obviously should go to prison whether or not that discourages further killing. Likewise, locking up the Bernie Madoffs of the world is necessary regardless of whether that discourages future Ponzi schemes.

The problem with administering justice is that it merely restores moral order; preventing disorder is a whole lot better. To punish a murderer, of course, there's got to be a corpse. And that's where things get murky in assessing Wall Street crime.

Under securities law and industry rules, brokerage firms operate under what's known as "suitability duty," meaning they're required only to recommend investments that are suitable to clients. That's different than the fiduciary duty that, say, a registered investment adviser has to retail customers. Under that stricter standard, an adviser must have a good reason for believing that their recommendations will benefit customers, and is also obliged to disclose any conflicts of interest.

Strictly speaking, in other words, securities firms aren't required to act in the best interests of their clients. Mostly, a brokerage only needs to ensure that investors are qualified to participate in a given transaction and that they get what they paid for. That's why Goldman execs could keep a straight face last week in telling the Financial Crisis Inquiry Commission that it acted as a neutral party in arranging its Abacus CDO.

For the sake of argument, though, let's say we've caught some banker in flagrante delicto stuffing CDOs with toilet paper. What kind of jail time should we be talking about here? As with other offenses, it depends on the magnitude of the crime, including the size of the financial loss and the number of victims.

For securities-related crimes, Columbia University law school professor John Coffee favors a maximum penalty of five years for investor losses of less than $1 million (He notes that the American Bar Association stipulates that sentences in excess of 10 years should be reserved for dangerous criminals.)

Some readers may question if sending financial perps up the river amounts to rough justice. Not to me. The pain inflicted by Wall Street on millions of homeowners, investors and other Americans has been staggering. More broadly, their actions nearly brought the financial system, and the U.S. economy, to its knees.

If you can't do the time, don't do the crime.

Image from Wikimedia Commons
  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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