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Deadlines Loom To Bring Financial Crisis Cases

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Watch Money, Power & Wall Street, FRONTLINE’s four-part investigation into the global financial crisis.

For close to five years, federal regulators have struggled to successfully prosecute Wall Street banks or executives for alleged misconduct during the financial crisis. Now, time may be running out.

Under federal securities law, the statute of limitations in fraud cases typically is five years. Given that many of the mortgage-related securities that precipitated the crisis were created in the boom years of 2006 and 2007, regulators have a rapidly closing window of opportunity to bring new charges.

As of July 18, the Securities and Exchange Commission had charged 110 entities or individuals in crisis-related cases, and won $1.39 billion in penalties. Those penalties include a $550 million agreement with Goldman Sachs to settle claims that it misled investors over a mortgage-related security called Abacus 2007-AC1. As part of the settlement, Goldman did not formally admit to the SEC’s allegations that it was betting against the underlying bonds marketed to clients in the Abacus deal.

But government watchdogs are quick to remind that enforcement has focused mainly on civil penalties, rather than criminal charges against executives from any of the Wall Street firms. The government’s first criminal case, a nine-count indictment against two former Bear Stearns executives for securities, mail and wire fraud, ended in November 2009 with a not guilty verdict.

The latest setback for regulators came Thursday, when the Justice Department said there was “not a viable basis to bring a criminal prosecution” against Goldman Sachs in an investigation case borne out of a congressional report on the bank’s role in the crisis. Earlier in the day, Goldman announced that the SEC had also dropped a separate probe into a $1.3 billion subprime mortgage deal by the bank.

The decisions followed a federal jury’s decision in late July to clear Brian Stoker, a former Citigroup executive, of charges that he misled investors in the sale of $1 billion in mortgage-backed securities. In a rare addendum to its decision, however, the jury said its “verdict should not deter the SEC from investigating the financial industry, to review current regulations and modify existing regulations as necessary.”

Although the clock may be ticking, legal experts say regulators still have options. Officials can look to extend the usual five-year deadline through a “tolling agreement.” Under such a scenario, the individual or company agrees to give the government a waiver allowing it to continue investigating rather than rushing an indictment to meet the statute of limitations. In return, the agreement offers the individual or firm the opportunity to explain why they should not face charges.

The government “would say, ‘we’d like you to agree, and if you won’t … then we’ll just indict you and sort out the rest of the case later. Whereas if you give us more time, that will give you a chance to argue that we shouldn’t charge you,’” explained Peter Henning, a professor of law at Wayne State University.  Attorneys at both the Department of Justice and the Commodity Futures Trading Commission, for example, are said to have reached such deals in their investigations into alleged rigging of the London Interbank Offered Rate, or LIBOR, according to reports from Bloomberg and Reuters.

Another route prosecutors are testing involves a statute passed in the wake of the savings and loan crisis known as the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).

The upside of using FIRREA, explained Jay Williams, a partner with Schiff Hardin LLP, is that the law offers the government a path to bring civil actions against misconduct typically addressed through criminal charges. In doing so, it extends the statute of limitations to 10 years while lowering the burden of proof needed to win a case. Whereas guilt must be established beyond a reasonable doubt in criminal cases, in FIRREA suits, violations must only be proven by a preponderance of the evidence. In other words, a jury must only determine that a violation is more likely than not.

The downside?

“They don’t get to throw people in jail,” said Williams.

The use of FIRREA in mortgage-related cases is somewhat uncharted territory. The law was originally passed to prosecute individuals who defrauded federally insured deposit institutions, but as Williams noted, the government has been encouraged by early victories in its broadening interpretation of the statute.

In February, for example, a Citibank subsidiary agreed to $158.3 million settlement with the Department of Justice in a FIRREA case. The bank’s Citimortgage unit was accused of submitting faulty loans to a federal-mortgage insurance program. 

Moving forward, “that is certainly something that is likely to embolden the prosecutorial use of this statute,” Williams said.

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