A series of scandals has cast a long shadow over the already beleaguered financial sector in recent months. IBA Global Insight examines what legal reforms are necessary to renew faith in the industry.
‘Barclays will operate to the highest ethical standards,’ new CEO Antony Jenkins told a room of analysts in September. ‘We have a unique opportunity to start the next phase of Barclays’ 320-year history.’ The speech was passionate and well received. Equally passionate was a speech by Citigroup CEO Charles Prince in 2004 following a spate of abuses at the bank, when he vowed to ‘create a companywide conversation about some of the kind of cultural and reputational things that have bitten us lately’. Four years later, Citigroup was hit by heavy exposure to toxic financial instruments – instruments that precipitated the biggest financial crisis of recent history
Words are wonderful things. Yet as the world emerges, bruised and bitter, from global financial meltdown, more is required than crusading rhetoric. Bankers may no longer be immune to failure, but they remain immune to the consequences of failure. Jobs have been lost and fines levied, but not one British banker has been sent to jail for endemic and systematic failures across the sector [see box]. Having brought the world to its knees, those responsible continue to walk upright – free, flagrant and impervious to harm.
Meanwhile, swingeing cuts have been imposed on the UK’s Serious Fraud Office (SFO), responsible for tackling high-level fraud and corruption, as well as on law enforcement agencies across the country. The government has cut corporation and income tax, reduced public spending and relaxed laws on tax havens – havens that contributed to the 2008 crisis by allowing banks to sidestep reserve requirements and investment banking rules.
Economic crime can no longer be excused as ‘victimless’ as incomes drop and communities falter. But only with constant, unrelenting public pressure can there be accountability. ‘We have passed the tipping point and people ought to be aware of what they have had to pay for this chicanery,’ says Jack Blum, one of the top white-collar defence lawyers in the US. ‘This is the time to get your pitchfork and start howling at the moon.’
The Serious Fraud Office (SFO) could clearly do with a few more pitchforks of its own. Due to lose 43 per cent of its 2009 budget by 2014, its armoury is currently looking rather weak. With just £30.5m in its coffers, it will be expected to investigate some of the most serious abuses ever encountered in the financial sector – a sector with the firepower and funds to hire the top white-collar lawyers in the business.
The cuts were one reason why former director Richard Alderman, who stepped down in April, chose to abandon complex prosecutions in favour of ‘quick wins’ and deals with companies. As a consequence, the SFO’s reputation suffered, many experienced people left and a glut of wrongdoing went unaddressed. ‘Under its former leadership, morale hit rock bottom,’ says Ros Wright, chair of the Fraud Advisory Panel and former director of the SFO. ‘I don’t think this was the direction that Judge Roskill, who wrote the original report, envisaged. He envisaged an elite organisation that tackled the very difficult, principally City-based frauds – the cases that nobody else was equipped to deal with.’
Lawyers involved reveal that the SFO was approached by US authorities about Libor abuses over a year ago, but declined to investigate. Some believe this was due to its political sensitivity, with the BAE bribery case – shut down by the government in 2006 following diplomatic pressure from the Saudis – still very much in the foreground. ‘It was all being politically fixed,’ says one City lawyer, who used to work at the SFO. ‘Libor became an indicator of economic solvency and it was in the national interest to prevent indicators from ratcheting up. It is a big political case and the UK dodged it.’
Now, since the Barclays scandal, the SFO has had a rethink and has been given £3m to pursue the investigation. Indeed, there are hopes that under new director David Green the office will find its way back on track. He has vowed to ‘rebalance the relationship between prosecution and civil settlement’, and seems to have the leadership his predecessor was lacking.
Yet £3m does not get you very far when a team of investigators is likely to cost around £1,500 an hour. The government may need to do more if it wants to heed Lord Justice Thomas’s warning in the recent bungled Tchenguiz case. ‘It is clear that incalculable damage will be done to the financial markets of London if proper resources, both human and financial, are not made available.’
Some might argue that incalculable damage has already been done. Lack of resources has meant a dearth of individual prosecutions, contributing to a culture of immunity among bankers. ‘You can go on fining banks for the next 100 years, but the threat of jail for individuals is the best deterrent,’ stresses Michael O’Kane, head of Business Crime at Peters & Peters. Fines, after all, are paid not by the guilty parties, but by the shareholders, and often barely make a dent in company accounts.
Not everyone agrees, of course. Stuart Popham, vice-chairman of EMEA Banking at Citigroup and former global senior partner of Clifford Chance, admits there is a ‘perception’ of pervasive wrongdoing in the banking sector that needs urgently to be addressed, but that doesn’t necessarily mean sending people to jail. ‘I can see why people would say, hold on, no-one has been prosecuted,’ he says. ‘But making poor decisions shouldn’t be a criminal act. Obviously we can’t have an industry without limits, but I think some of this is being judged in retrospect, which makes it very difficult to differentiate between poor decisions and scandalous decisions.’
Whether you're a Popham or a Roskill, what is clear is that UK authorities need the tools to take on complex prosecutions should they so wish. This would not mean the end of deals and plea bargains; quite the opposite. Once bankers believe they will be taken to court if found out, they will be more likely to step forward voluntarily or plead guilty early in proceedings. In the US, the Manhattan District Attorney’s Office is able to obtain pleas in the vast majority of serious fraud cases because defendants know that, if charged, there will be a 92 per cent chance of conviction.
According to Matthew Cowie, corporate investigations counsel at Skadden and former SFO prosecutor, there should always be room for both prosecutions and civil remedy. ‘Corporates can be a great vehicle for change and self-regulation, and effective enforcement action will always have an effect on the watching corporate world,’ he says. ‘However, most effective regulators know that without pursuing the long, hard cases, you cannot have credible deterrence.’
Until now, deals were pursued haphazardly and without any guarantee of being accepted by the courts. However, American-style deferred prosecution agreements (DPAs), due to come into effect by 2014, should help bring consistency into negotiations. Under a DPA, a company will escape prosecution on the proviso that it agrees to comply with certain conditions, such as the payment of a fine and measures to prevent future offending. Judges will be involved early in the process, while a ‘statement of facts’ will include a formal admission of wrongdoing. However, it is not yet clear how detailed the statement will be, and there remain concerns that DPAs will lack the depth and transparency of a full prosecution.
‘It is worth doing, given the situation we are in at the moment,’ says Robert Wardle, former director of the SFO. ‘But it should not stop prosecutors going after individuals. There is admittedly an illogicality saying we have enough evidence to prosecute, but we’re not going to do so unless you do it again.’
'‘The financial industry has used its revolving door with the government to weaken the regulations that constrain them’'
Economist and Nobel laureate
The SFO currently faces several legal and procedural hurdles to carrying out full investigations effectively and efficiently. One stumbling block is the need to prove intent by companies' ‘guiding mind’, which more often than not is the entire board of directors. This contrasts with the US, where companies can be held accountable for the actions of any one employee.
Perhaps the biggest burden for the SFO, however, concerns the rules of pre-trial disclosure. Under the current system, the prosecution must disclose all material to the defence that could potentially strengthen its case – which, in fraud investigations, can often mean millions of documents. In the Allied Deals fraud case, prosecuted jointly by the SFO and Southern District of New York, the Americans spent six weeks working on disclosure, whereas the British team spent two years. ‘The disclosure rules in the UK are very onerous on the prosecution and irrelevant for big fraud cases,’ says Wright. ‘You take in gigabytes of material and have to filter through it all, looking for the little gem that undermines your case and helps the defence. It is meaningless and impractical.’
Funded by the City, the Financial Services Authority (FSA) has escaped the worst ravages of the recession. Though far from flush, its budget has grown over the past four years, from £324.4m in 2008/9 to £505.9m in 2011/12, with the money split between its regulatory and prosecutorial functions. While it mainly focuses on insider dealing and market offences, it also has the power to prosecute offences outside the scope of the law governing financial markets, such as money laundering – should it so wish.
The FSA could, therefore, have investigated Libor when it first came to light. Former head of enforcement Margaret Cole says it was considered carefully before being rejected. ‘The industry that pays fees to fund the FSA might at some point argue that it is paying for an industry regulator not a prosecutor,' she says. 'Particularly if the FSA was thought to be going further than its remit and the case in question was more clearly in the domain of another prosecutor – usually the SFO.’
Libor notwithstanding, the FSA grew much needed prosecutorial teeth under Cole. Before she joined in 2005, it had never prosecuted an insider dealing case. In 2011, her last full year, she secured 11 convictions, with a further 16 awaiting trial. Long accustomed to being shielded from the law, traders were suddenly shocked – and scared.
The latest banking shenanigans… which we know about!
Money laundering: A US Senate probe found HSBC lacked money laundering controls to prevent billions of dollars being cleaned for Mexican drug gangs. Board members at HSBC included prominent establishment figures. HSBC apologised for ‘shameful’ systems breakdowns and set aside $700m (£445m) for potential US fines.
Libor manipulation: UK and US regulators fined Barclays a record £290m for attempting to manipulate the Libor inter-bank lending rate, leading to the resignation of chief executive Bob Diamond and chairman Marcus Agius. An inquiry by US and UK regulators and prosecutors is ongoing, and several major banks have been served subpoenas.
Sanctions busting: the New York Department of Financial Services fined Standard Chartered £217m for illegally hiding transactions with Iran. RBS is also being investigated for possible sanctions violations. As IBA Global Insight went to press, several other major banks were also being investigated.
Bribery and corruption: The SFO is investigating Barclays in relation to commissions paid by the bank to raise billions from Qatar and Abu Dhabi in 2008, which helped the bank avoid a bailout. The FSA is also looking into whether the bank adequately disclosed fees it agreed to pay the Qatar Investment Authority. Barclays has said it does not believe it has broken any disclosure rules. ‘The bank considers that it satisfied its disclosure obligations and confirms that it will cooperate fully with the FSA's investigation,’ the bank said in July. It declined to comment on the SFO investigation.
Mis-selling: The FSA report on 22 banks’ financial incentive schemes for the selling of Payment Protection Insurance (PPI), describes ‘a range of serious failings’, including a first past the post system whereby the first 21 sales staff to reach a target could earn a bonus of £10,000. In 2004, Barclays was found to be making ten per cent of its global profits from mis-selling PPI in the UK, but a call for an FSA investigation fell on deaf ears. FSA managing director Martin Wheatley – soon to be head of the FCA – says he will take personal charge of reforms
Mortgage fraud: In February, Citigroup agreed to pay $158.3m to settle claims its mortgage unit fraudulently misled the government into insuring risky mortgage loans for over six years. More than a third of the loans it granted went into default, resulting in millions of dollars in losses for the government. As part of the civil fraud settlement, Citigroup accepted responsibility for failing to comply with government requirements and submitting certifications that were fraudulent. The payments were in addition to the $2.2bn it has to pay as part of a wider $25bn settlement between the DoJ and the nation’s top five mortgage lenders. In August, the bank agreed to pay shareholders $590m to settle allegations it misled them in the marketing of mortgage debt. Citigroup denied the allegations, but said it entered into the settlement ‘solely to eliminate the uncertainties, burden and expense of further protracted litigation’.
Toxic culture: The SEC alleged that when Goldman Sachs structured and marketed a synthetic collateralised debt obligation (CDO) it failed to disclose a hedge fund’s role in both the portfolio selection process and taking a short position against the CDO. In July 2010, while not admitting or denying wrongdoing, Goldman Sachs agreed to a $550m settlement (described by the SEC as the largest commission penalty for a Wall Street firm). In March 2012, former Goldman executive Greg Smith resigned, saying: ‘I can honestly say that the environment now is as toxic and destructive as I have ever seen it…the interests of the client continue to be sidelined in the way the firm operates and thinks about making money.’ Goldman stated: ‘In a company of our size, it is not shocking that some people could feel disgruntled. But that does not and should not represent our firm of more than 30,000 people.’
Unlike the SFO, where the average employee salary is around £44,000 – the salary of a second year trainee at a magic circle firm (equity partners’ annual incomes are more like a million) – Cole was able to push up salaries by 30 per cent. ‘When we wanted to pass over cases to the SFO, we didn’t meet much of a desire to take them on,’ recalls one former senior lawyer at the FSA. ‘And what we were finding was that this was a funding issue.’
Where its regulatory arm is concerned, the FSA has proved rather less successful. With RBS, it ignored five years of warning signs before the bank’s collapse in 2008. The FSA’s subsequent report revealed the authority only had six people to supervise both the bank’s investment banking and retail operations, and relied on senior management to ‘identify deficiencies’ in systems and controls.
It is hoped the FSA will do better after being split in April 2013 into the Prudential Regulatory Authority (PRA), supervising banking and wholesale money markets under the auspices of the Bank of England, and the Financial Conduct Authority (FCA), designed to protect consumers. Cole believes the FCA will continue as the enforcement arm of the FSA left off, but is less sure about the role of the Bank of England. The central bank may have to engage in litigation, she says, in which it lacks experience. ‘It will be interesting to see how the PRA deals with the disputes that will come its way when it takes over bank supervision. The “governor’s eyebrows” may not be enough to bring banks into line in today’s world, and the FSA’s experience shows that cases can be hard fought. Historically, enforcement by means of tribunal or court cases hasn’t been part of a central bank’s DNA.’
According to one former senior member of the FSA, the government was approached about taking Libor into the regulatory boundaries of the authority two years ago, but dismissed the idea. For O’Kane, the reason for such evasion is clear. ‘I don’t think this government, or probably any recent UK government, has the effective prosecution of white collar crime as a priority. The financial services industry is such an important part of UK GDP.’
There are certainly valid questions to be asked as to why investigations of HSBC, Standard Chartered and Barclays were all launched in the US rather than the UK. With all these cases, the shadow of BAE looms long – a case nominally dropped due to ‘national security’ considerations that the Saudis would stop sharing terrorism information, but which many suspect as having been influenced by their billion dollar custom. Former SFO assistant director Helen Garlick does not question the official explanation, but recalls that ‘there was a lot of propaganda during the case. Why are we risking carrying on an investigation that could lose British contracts that could be snaffled up by the French and Italians?’
It is an attitude that has long endured in the UK – and, in a country where business and political interests often overlap, the financial industry is effective at getting its voice heard. Last year, over 51 per cent of all Conservative Party funding came from the City, and many politicians of both major parties have strong interests in the sector. Former HSBC CEO Stephen Green, for example, was at the helm when some of the bank’s most egregious money laundering crimes were being committed, and is now a minister in the Treasury team examining banking reform.
'‘You can go on fining banks for the next 100 years, but the threat of jail for individuals is the best deterrent’ '
Head of Business Crime at Peters & Peters
Assisting such interests is a powerful lobbying industry. Popham, chairman of City lobbyists group TheCityUK, may disagree – ‘I don’t see it; I think politicians perhaps spend too much time trying to be popular and gain electoral success’ – but the industry is clearly thriving. Last year the British financial services sector spent more than £92m lobbying politicians and regulators, according to the Bureau of Investigative Journalists. A similar trend is evident in the States: last year Wall Street spent $480m on lobbying, according to www.opensecrets.org.
‘It is very interesting that in recent months, US white collar enforcement has been aimed at foreign (UK) banks,’ says O’Kane. ‘I suspect that there is a huge amount of lobbying pressure in the US to do so.’
One of the most powerful US lobbyists is Citigroup. Having been bailed out by the government in 2008, it employed more lobbyists than any other company which registered with Congress to influence new financial regulations in 2009, according to US Senate records. Last year, the bank was described as ‘recidivist’ (a repeat offender) by New York District Judge Rakoff after marketing a billion dollar fund of toxic mortgage-backed securities. Sick of what he saw as Citigroup’s perpetual reoffending, the judge refused to endorse a $285m deal with the Securities and Exchange Commission (SEC), and instead demanded a full trial. Citigroup and the SEC have jointly appealed.
‘The financial industry has used its revolving door with the government to weaken the regulations that constrain them,’ Nobel prize winning economist Joseph Stiglitz, told Vanity Fair in a recent interview, ‘and, even after it was manifestly clear that they were inadequate, to prevent the imposition of adequate new regulations.’
Such influence, whether from direct lobbying or a ‘revolving door’ of overlapping interests, is clearly far from beneficial for society. The most powerful use their dominance to secure their position at the top of the tree, while the rest slip slowly down the trunk. ‘Inequality leads to lower growth and less efficiency,’ added Stiglitz. ‘Lack of opportunity means that [a country’s] most valuable asset – its people – is not being fully used.’
Popham concedes that many people seem to share Stiglitz’s view. He believes, however, that the answer lies in outlining a clearer vision of what role the industry should hold in society. ‘We need to show that the financial sector occupies a different position in society than is popularly seen, and is not a distinct entity. It needs to be seen as helping new businesses be created, as being involved in social purposes, as a key employer.'
Secrets and lies
One great beneficiary of this political influence is the offshore world. Wealthy elites and multinational corporations are able to stash their funds away from the prying eyes of regulators and tax authorities, while banks and lawyers get rich from providing the services that allow them to do so.
Such ‘secrecy jurisdictions’ take money from needy communities and increase polarisations of wealth, while encouraging illicit financial activity. But this has not stopped Britain becoming one of their chief champions, with tax havens spread throughout its overseas territories. ‘London is the centre of a web of arrangements that allow companies and individuals to engage in activities offshore that should be the subject of effective enforcement,’ says O’Kane. ‘Secrecy jurisdictions are the number one problem for global enforcement to tackle.’
Michael Todd QC, chairman of the Bar Council of England and Wales, agrees that tackling tax havens should be a priority. ‘I am not so concerned with a place where someone does not pay much tax,’ he says. ‘I am more concerned with whether secrecy is a bar to proper regulation. We wish to ensure there are proper safeguards for the investing public in a legal sense, as well as a commercial and financial sense, so that any investigatory powers an agency has can be used effectively.’
According to Blum, ‘all the UK banks’ were engaged in violating US sanctions on Iran. After tougher sanctions were imposed, he says, international bankers would send out private memoranda explaining the ‘common wisdom’ on how to circumvent them. ‘The Iranians will pay a premium for people who help them cheat the system,’ he explains. ‘It’s good business.’
Despite this, money laundering is yet to be taken seriously in Britain. The FSA has only prosecuted one case, and shows little inclination to do more. Yet there is much to be investigated here. HSBC recently paid $1bn to the US DoJ for laundering $14bn of drug money and – according to James Henry, former chief economist at McKinsey & Company – was lucky not to be shut down. ‘Investigators I spoke to at the bank say this is like the Bank of Credit and Commerce International (BCCI) in the 90s,’ he told Democracy Now in a recent interview. ‘The only difference is that that was a Pakistani bank that we decided to close down.’
'‘For those of us who believe in the rule of law, depriving democratic governments of revenue by manipulating the laws of offshore havens is exceptionally bad government’
Former New York assistant district attorney
A July 2012 report by Henry, commissioned by Tax Justice Network, reveals that the world’s richest people have up to $32tn stashed in offshore tax havens. Private banks handling the most offshore assets are UBS, Credit Suisse, Goldman Sachs, Bank America and HSBC.
Blum is adamant the system must change. He is bewildered by a mechanism that allows banks to avoid the laws of the jurisdiction where they are licensed, and then be saved by taxpayers in that jurisdiction when they fail. ‘What exactly is the value added from these people who make so much money at the expense of the rest of us?’ he asks. ‘Zilch.’
Former New York assistant district attorney John Moscow, who led the fraud prosecution against BCCI alongside the SFO, is equally infuriated. ‘For those of us who believe in the rule of law, depriving democratic governments of revenue by manipulating the laws of offshore havens is exceptionally bad government,’ he told a subcommittee of the US House of Representatives in 2006. ‘We should work together to establish the rule of law worldwide. We should join to abolish bank secrecy laws and practices.’
It is clear that banks urgently need to rein in excesses and overhaul their corporate governance. To do so requires a vastly improved system of oversight and regulation. To achieve such a system requires political resolve. To create this resolve requires persistent and unrelenting howling at the moon, with pitchforks at the ready. Then, perhaps, the Antony Jenkins and Charles Princes of this world will know that the tipping point has long since been passed, and words are no longer enough.
Rebecca Lowe is Senior Reporter at the IBA and can be contacted at firstname.lastname@example.org