Federal officials this week revealed alleged fraud on a massive scale at Deutsche Bank (DB) and its MortgageIT unit, but once again they have refrained from using their most potent weapon: criminal charges.
The civil complaint filed by the U.S. accuses the German banking titan and its subsidiary of defrauding the government of up to $1.27 billion by engaging in reckless lending practices, lying about certain low-income mortgages and turning a blind eye to red flags.
Yet by choosing to bring a civil case, instead of a criminal one, the feds have assured that more alleged fraud on Wall Street during the housing bubble will be met with fines rather than more serious sanctions.
The reasons for the reluctance to charge Deutsche Bank or its employees with criminal charges are diverse, but likely come down to the higher burden of proof and collateral damage that go hand-in-hand with criminal charges.
“Firms can do significant damage to themselves, to taxpayers and their customers without committing crimes. Negligence, recklessness and stupidity can go a long way,” said Dan Richman, a law professor at Columbia.
Criminal v. Civil
For starters, it’s possible federal officials have not found evidence of criminal action by Deutsche Bank, MortgageIT or the companies’ employees. The complaint laid out widespread oversight lapses that allowed the alleged fraud to continue, but not necessarily intent to break the law that would be needed in a criminal case.
“The complaint seems to be more than anything sins of omission, not commission,” said Tom Engel, a principal at McKool Smith and a former assistant U.S. Attorney for the Southern District of New York.
For example, the Deutsche Bank charges describe how documents that would have alerted officials about alarming default rates were hidden in a closet at MortgageIT. Yet the complaint doesn’t disclose a smoking gun email that shows the reason why the documents went unread was to defraud the government.
Even if they believe the alleged fraud, which has apparently already cost the Federal Housing Administration $386 million in wrongful insurance payouts, does amount to a crime, they would have to meet a higher burden of proof in court.
In criminal cases, prosecutors much prove the offense “beyond a reasonable doubt,” while civil charges need just a preponderance of evidence – legal jargon for “more likely than not.”
“It’s really critical to separate the sad but clear right of American businessmen to make really stupid business decisions from the criminal law,” said Richman.
Due to the higher threshold the government must meet, criminal cases require considerably more time, resources and risk for prosecutors loathe to lose a high-profile case.
Criminal cases are likewise easier to for corporations, which often have nearly unlimited legal budgets, to defend.
“Beyond a reasonable doubt is a very high standard. It takes only one juror to say, ‘I’m not convinced,’” said David Feuerstein, a litigation partner at NYC-based Herrick, Feinstein. “That’s a very big burden to overcome.”
In this specific case, Feuerstein said Deutsche Bank would likely consider arguing it was the victim of fraudulent information transmitted to it by borrowers and corrupt mortgage brokers.
Federal officials also have big-picture concerns when they bring criminal charges against corporations because of the threat of collateral damage.
Those consequences were illustrated graphically by accounting giant Arthur Andersen, which was forced to close its doors in 2002 after being found guilty of criminal charges related to its auditing of Enron.
Likewise, criminal charges against Deutsche Bank could provoke regulatory actions like de-licensing from banking superintendents and the Federal Reserve, Engel said.
“The danger of the government bringing a criminal case is it could have serious economic repercussions not only for the bank, but for the American economy if you were to shut the darn thing down,” said Engel
U.S. officials would also need to be weary of foreign policy considerations as a criminal case would likely be frowned upon by German regulators, who could conceivably respond by targeting U.S. banks like Bank of America (BAC).
“Not just this administration, but all recent administrations have been appropriately careful about the use of criminal charges against significant market players where there was no massive criminality,” said Richman.
Some Americans may be struggling to understand why virtually no one involved in the Wall Street meltdown and housing crisis has gone to jail despite the damage done to the country. From Countrywide to Lehman Brothers, U.S. officials have held off on criminal charges.
“It’s easy to forget the government tried at one point to put people in jail,” said Feuerstein, alluding to the government’s failure to convict Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin in 2009 for securities fraud.
After it took the jury less than six hours to return not guilty verdicts in that case, “They may be suffering from sort of a hesitant trigger finger,” said Feuerstein.
It’s worth pointing out the U.S. is not exactly letting Deutsche Bank off with a slap on the wrists. Under the False Claims Act, the government is seeking asking a court to force the lender to pay three times the FHA’s eventual losses, which could total more than $1.27 billion.
“Civil isn’t so bad, especially if you can get triple damages,” said Randall LaSalle, a professor at the John Jay College of Criminal Justice.
The government also has some serious leverage in this civil case because it holds the threat of debarment, which would prevent Deutsche Bank from doing business with the U.S.
“That’s a huge threat and a very big lever,” said Feuerstein.