Congress Passes Legislation Strengthening Securities Fraud and Financial Fraud Enforcement

Congress has passed and cleared for the President legislation improving enforcement of securities fraud and financial institution fraud involving asset-backed securities and fraud related to federal assistance and relief programs. The legislation expands the scope of securities fraud provisions and extends the prohibition against defrauding the federal government to the TARP program and to the stimulus bill. The measure also authorizes additional appropriations for the SEC to investigate and prosecute fraud, and creates a Senate Select Committee to examine the causes of the current financial crisis.

The Fraud Enforcement and Recovery Act, S 386, was introduced by Senator Patrick Leahy, chair of the Judiciary Committee, and Senator Charles Grassley, Ranking Member on the Finance Committee. It is based on a sense of Congress that fraud contributed to an unprecedented collapse in the mortgage-backed securities market. The legislation is designed to ensure that this kind of collapse cannot happen again. A main component of the reform is the reinvigoration of federal anti-fraud measures. The original Senate bill was passed with amendments by the House, creating a blended compromise measure that combines the original S. 386 with HR 1748, the Fight Fraud Act, sponsored by House Judiciary Chair John Conyers. The Senate agreed to the amendments, with a minor amendment of its own; and the House agreed to the Senate amendment and cleared the legislation for the President, who is expected to sign it.

The differences between the Senate and House measurs do not appear to be terribly significant, one of which is the composition of the commission, which the House measure calls the Financial Crisis Inquiry Commission and the Senate calls the Federal Markets Commission. The final legisaltion calls the tribunal to Financial Crisis Inquiry Commission. Also, a section in the Senate bill amending the international money laundering provision in the federal money laundering statute to make it a crime for individuals to transport or transfer money in and out of the United States to evade taxes was dropped by the House.

The Fraud Enforcement and Recovery Act, S 386, makes a number of important improvements to fraud and money laundering statutes to strengthen prosecutors' ability to combat this growing wave of fraud. Specifically, the legislation would amend the federal securities fraud statute to cover fraudulent schemes involving commodities futures and options, including derivatives involving the mortgage-backed securities that caused such damage to the banking system.
The Act authorizes additional appropriations for the SEC to fight financial fraud of $20 million for fiscal years 2010 and 2011. The legislation specifically states that the additional funds are to be used for investigations and enforcement proceedings involving financial institutions. The Act also adds $1 million a year for two years for the salaries and expenses of the SEC’s Inspector General.

A week after the measure cleared the Committee, Senators Leahy and Grassley wrote a letter to the Senate leadership urging prompt action. They noted that the draft legislation includes important improvements to federal fraud and money laundering statutes to strengthen prosecutors' ability to confront fraud in mortgage lending practices, to protect TARP funds, and to cover fraudulent schemes involving commodities futures, options and derivatives, as well as making sure the government can recover ill-gotten proceeds from crime.The bill also amends the definition of financial institution to extend federal fraud laws to mortgage lending businesses that are not directly regulated or insured by the federal government. These companies were responsible for nearly half the residential mortgage market before the economic collapse, yet they remain largely unregulated and outside the scope of traditional federal fraud statutes.

This change will apply the federal fraud laws to private mortgage businesses just as they apply to federally insured and regulated banks.Expanding the term financial institution to include mortgage lending businesses will also strengthen penalties for mortgage frauds and the civil forfeiture in mortgage fraud cases. It would also extend the statute of limitations in investigations of mortgage fraud cases to be consistent with bank fraud investigations. The new definition would also provide for enhanced penalties for mail and wire fraud affecting a financial institution, including a mortgage lending business.The bill would also amend the major fraud statute to protect funds expended under the Troubled Asset Relief Program (TARP) and the economic stimulus package, including any government purchases of preferred stock in financial institutions. This change will give federal prosecutors and investigators the explicit authority they need to protect taxpayer funds.This amendment will make sure that federal prosecutors have jurisdiction to use one of their most potent fraud statutes to protect the government assistance provided during this most recent economic crisis, including money from the TARP and circumstances where the government purchased preferred stock in companies to provide economic relief.

The legislation will also strengthen one of the core offenses in so many fraud cases, money laundering, which was significantly weakened by a recent Supreme Court case. The bill would amend the federal criminal money laundering statute to make clear that the proceeds of specified unlawful activity include the gross receipts of the illegal activity, not just the profits of the activity. The money laundering statutes make it an offense to conduct financial transactions involving the proceeds of a crime, called specified unlawful activity in the statutes. These statutes, however, do not define the term “proceeds” and the term has been left to be defined by the courts.

For 22 years, since the money laundering statutes enactment in 1986, courts have construed “proceeds” to mean gross receipts and not net profits of illegal activity consistent with the original intent of Congress.But in United States v. Santos, 128 S.Ct. 2020 (2008), the Supreme Court suggested that the term “proceeds” was ambiguous and gave the term a narrower meaning. In this decision, according to Senator Leahy, the Court mistakenly limited the term “proceeds” to the profits of a crime, not its receipts, and as a result, the decision limited the money laundering statute to only profitable crimes, and permits criminal defendants to reduce their culpability for money laundering by deducting the costs of their criminal conduct.For example, under the decision, an executive who committed securities fraud could not be charged with money laundering if the fraud were unsuccessful in making a profit, even though there was a fully completed financial transaction. This decision is contrary to the intent of Congress in passing the money laundering statutes, said the chair, and weakens one of the primary federal tools used to recover the proceeds of illegal activity, including mortgage and securities frauds.