The potential for abuse is growing in financial industries such as online lending, where technology is replacing traditional safeguards, the top lawyer in the U.S. Department of Justice's criminal unit said.
In an interview with Reuters on Friday, Leslie Caldwell, the assistant attorney general who leads the unit, said the Justice Department "has an eye on" the online lending industry. Her concern: the loans are backed by investors, not deposits and other "infrastructure" that is common among more traditional lenders, Caldwell said.
The online finance, or "peer-to-peer" lending industry, has boomed in recent years, promoting alternative sources of funding for consumers and small businesses. Technology has made it easy for companies such as LendingClub Corp, Prosper Marketplace Inc and On Deck Capital Inc, to set up marketplaces that pair borrowers with investors willing to lend money.
"There are a lot more of these peer-to-peer lenders, kind of mom and pop lenders," Caldwell said. "It's hard to say what those loans are worth and hard to predict the performance of those loans."
What's more, many online lenders then package and sell the loans, as residential mortgage-backed securities were sold in the run-up to the 2007-2009 financial crisis, Caldwell said.
The U.S. housing market plummeted as high-risk borrowers defaulted on those loans, beginning a downward spiral that would trigger a global liquidity crisis.
Caldwell said that online lending is a "sliver" of overall lending markets and that there is "nothing wrong" with the industry. "I'm not saying ... that we've uncovered a massive fraud, but just that there's a potential for things to go awry, like when underperforming loans were being sold in residential mortgage-backed securities," Caldwell said.
The market for online lending is a fraction of the market for mortgage-backed securities before the financial crisis. The U.S. Treasury estimates that loan origination by online lenders could reach $90 billion by 2020. Wall Street banks sold $854.6 billion worth of U.S. residential mortgage backed securities at the peak of issuance in 2006, according to Thomson Reuters data.
Caldwell's remarks come as the Justice Department is investigating LendingClub about events leading up to the company's ouster of its founder and chief executive, Renaud Laplanche, after an internal probe found the company had falsified documentation when selling a package of loans.
Last week, New York state's financial regulator launched an inquiry into online lenders' business dealings in the state.
Virtual currency is another technology-driven financial industry the Justice Department is following, Caldwell said.
"We see virtual currency as another example of something that there's inherently nothing wrong with, but there's a lot of potential for abuses," she said.
CULTURE AND CONSEQUENCES
U.S. and foreign banks, meanwhile, have significantly boosted their regulatory compliance resources in the wake of the financial crisis, in part, to avoid the public relations inferno that follows when abuses come to light, Caldwell said.
While top executives understand the importance of cultural change, it "still has a way to go" among lower-ranking employees, where a major focus on compensation incentives continues to drive behavior, Caldwell said.
Companies facing enforcement cases typically try to rouse sympathy from the Justice Department through presentations about the "collateral damage" such an action could spur, such as employees losing their jobs and harm to customers.
Caldwell's critics have pointed to those very types of outcomes in the 2002 collapse of Arthur Andersen, which followed a conviction in a prosecution that Caldwell oversaw as head the Justice Department's Enron Task Force from 2002 to 2004.
Arthur Andersen was accused of destroying documents tied to its work as the auditor of energy company Enron Corp, which collapsed in 2001. Its conviction was later overturned. Caldwell has said that Andersen was charged only after turning down a deferred prosecution agreement.
The Justice Department takes concerns about collateral consequences "very seriously," said Caldwell, who returned to the Justice Department in 2014 after more than ten years in private practice.
"Our goal is not to put companies out of business but to stop bad behavior and punish bad criminal behavior," Caldwell said.
But some companies go too far, she said. One bank, several years ago, created a mock newspaper article describing "all the horrible things" that would supposedly happen if the Justice Department fined the company, Caldwell said.
The perceived consequences included the company's bankruptcy and the economic collapse of a country. "Things like that are not particularly persuasive," Caldwell said.
BY THE NUMBERS
Some things, such as accounting fraud, never change, Caldwell said. The Justice Department is reviewing a "fair number" of cases that involve a tactic known as "smoothing earnings," in which companies jigger their accounting to level fluctuations in income from one period to another.
The maneuver can spark more interest in a company's stock from investors, who are often willing to pay more for shares in a company whose income is not erratic.
"There are always companies that are looking to make their numbers this quarter and they're willing to cannibalize next quarter and there's always a bit of a slippery slope when you go down that path," Caldwell said.