President Signs Legislation Strengthening Securities Fraud and Financial Fraud Enforcement; Creating Commission to Examine Causes of Financial Crisis

James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

President Obama has signed the Fraud Enforcement and Recovery Act (FERA) improving the enforcement of securities and commodities 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 to include commodities and derivatives fraud and extends the prohibition against defrauding the federal government to the TARP program and to the stimulus bill. The legislation also provides the Department of Justice with the tools it needs to fight fraud in the use of funds under TARP and the American Recovery and Reinvestment Act. The legislation creates the Financial Crisis Inquiry Commission to examine and report on the causes of the financial crisis.

The measure also authorizes additional appropriations for the SEC and other federal agencies to investigate and prosecute fraud, and creates a Select Commission to examine the causes of the current financial crisis. This legislation also makes a number of important improvements to fraud and money laundering statutes to strengthen prosecutors' ability to combat this growing wave of fraud.

In a signing statement, the President said that the legislation was needed because the federal government's ability to investigate and prosecute securities and other financial frauds is severely hindered by outdated laws and a lack of resources. The legislation provides the resources necessary for federal agencies, from the Department of Justice to the SEC to pursue financial fraud cases. FERA also expands DOJ's authority to prosecute fraud that takes place in many of the private institutions not covered under current federal bank fraud criminal statutes, noted the President, institutions where more than half of all subprime mortgages came from as recently as four years ago.

FERA, 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 antifraud measures. FERA is a major step toward holding accountable those who have caused so much damage to the US economy, while at the same time protecting economic recovery efforts from the scourge of fraud.

FERA makes a number of important improvements to antifraud 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 federal securities antifraud statute was added to the U.S. criminal code by Section 807 of the Sarbanes-Oxley Act, which created a new federal felony for securities fraud with a 25-year penalty. Section 807, codified as 18 U.S.C. §1348, made it easier to prove securities fraud while at the same time increasing the penalty. Before Sarbanes-Oxley, federal prosecutors were forced to resort to a patchwork of technical offenses and regulations that criminalized particular violations of the securities laws, or to treat the cases as generic wire or mail fraud. Sarbanes-Oxley criminalized any scheme to defraud persons in connection with securities or public companies to obtain their money or property. Importantly, FERA extends the strong provisions of Section 807 to frauds involving commodities, including derivatives, such as options and mortgage-backed securities.

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.