Hunting for Scalps

The pressure for convictions is great but prosecutors have their work cut out.

AMERICANS are turning creative as they strive to make sense of the crisis. On October 29th a group of artists will stage a “literal meltdown” by placing a 1,500lb (680kg) ice sculpture of the word “economy” in Manhattan’s Foley Square. The installation will, according to one collaborator, “metaphorically capture the results of unregulated markets.” For many, though, catharsis will come only through another capture: the arrest and courtroom humiliation of the erstwhile Wall Street titans the public holds responsible for the mess.

In today’s political climate, the government will feel immense pressure to put a few moneymen in the dock. The FBI alone is probing more than two dozen firms. Market regulators, state attorneys-general and the Department of Justice are also jostling to unearth wrongdoing, sifting through e-mails and seeking whistle-blowers at firms such as Fannie Mae, American International Group and Lehman Brothers, the only Wall Street firm allowed to go bust. At least 17 former Lehman executives, including Dick Fuld, once its boss, are expected to receive grand-jury subpoenas.

Investigators are likely to focus mainly on disclosure and valuation. Ken Lay, boss of Enron, the failed energy giant, was convicted in part because of upbeat public statements he made even as he knew the firm was in trouble. Some may try to draw a parallel with Lehman, which said its capital position was “strong” just days before it filed for bankruptcy.

But to constitute fraud there must be intent to deceive. Proving that beyond reasonable doubt may not be easy, even to a jury disinclined to give fat cats the benefit of the doubt. Likewise, sloppy risk management, though lamentable, is not illegal. Paradoxically, the severity of the financial storm could help defendants. “As the crisis has grown, it has become harder for prosecutors to charge that any single firm has committed fraud,” argues Robert Giuffra of Sullivan & Cromwell, a law firm.

Moreover, showing that executives deliberately overvalued complex mortgage securities could be hard. Those accused of masking losses can point to the continuing debate over mark-to-market rules, which regulators recently relaxed — though any e-mails that reflect internal doubts about marks could “create smoke”, says Mary Jo White of Debevoise & Plimpton, another law firm.

The legal climate has shifted in favour of corporate defendants, too. Some aggressive tactics used by prosecutors after the bursting of the dotcom bubble have been curbed: for instance, firms can again cling to attorney-client privilege — the right to keep their communications confidential — without it being viewed as unco-operative by the authorities. New sentencing guidelines means 25-year jail terms are less likely. In civil cases three Supreme-Court rulings have made fraud harder to prove.

Investigators are yet to turn up clear evidence of unethical behaviour, let alone anything that warrants a long stretch in jail. They have a lot more digging to do — witness the subpoenas just handed to analysts who covered Lehman, requesting information that might suggest they were misled. They may find dirt — but it will be harder to make it stick.

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