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Disproportionate Punishment

Adam Rust's picture

Posted January 22, 2015

Within a span of about six minutes during breakfast this morning, I received two pieces of information that reflect the odd way that our justice system addresses financial crimes. 

The first was the news that Standard & Poor's would be fined a total of $77 million by the Securities and Exchange Commission and two state Attorneys General for misrepresenting the quality of five commercial mortgage-backed securities issued back in 2011.  Additionally, they are barred from rating any new MBS for the next year. 

One analyst, observing that S&P's parent McGraw Hill has about $700 million in cash on its balance sheet, said that the company would have no real problem with the penalty. 

It was only a few minutes later that my Mom called. My mom loves good dish, and today, she had some.

"Do you remember John Smith (not his real name), back from the tennis program?" 

"Sure, I do," I said. "Is he ok?"

"No," she said. "He's not. He was arrested by the FBI last week. The FBI alleges that Smith and three of his business partners gave false information to a bank when they applied for a business loan. They received an $18 million loan. He has been charged with three counts of fraud. He may receive up to 90 years in prison."

So let's see: Standard & Poor's misrepresents the quality of billions of dollars in mortgages. The fine is $77 million, with no jail time for anyone.

John takes out a "liar loan" and could spend the rest of his life behind bars. 

The problem with fines for publicly-traded companies is that they put the punishment on to the wrong entity. Ultimately, when a company like McGraw-Hill is fined, the ones that pay for misdeeds are the current shareholders. The Directors who acted on their behalf pay nothing. In fact, some might have been able to use a revenue-enhancing strategy such as ratings inflation to elevate their compensation packages.