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Why ‘Rogue’ UK Bankers Can’t Escape US Regulators

Why ‘Rogue’ UK Bankers Can’t Escape US Regulators Economy Watch

In the wake of the recent spate in scandals involving British banks, the UK’s Serious Fraud Office (SFO) is now predictably making all the right noises about prosecuting miscreant bankers. Yet legal experts on both sides of the Atlantic argue that the SFO is too weak to live up to its promises; and say that the more aggressive US system could be a far likelier source of prosecutions.

Following the stunning revelations that erupted from the Libor scandal, David Green QC, director of the Serious Fraud Office in the UK, was inclined to announce that any banker found guilty of manipulation would receive prison sentences of up to 10 years.

Yet, Green’s words made little impression to one of Britain’s leading competition lawyers, Professor Alan Riley, from the City Law School in London.

Professor Riley said that unlike the US legal system, the UK lacked a plea agreement scheme, which had proven to be extremely effective against white-collar crime in the states. Furthermore, the UK’s cartel offence also includes a requirement of ‘dishonesty’, which is difficult to meet.

“The SFO rules will make it difficult to prosecute and we rarely see British regulators with the guts to carry it through in any case,” Professor Riley said. “A likelier source of prosecutions in the UK is the US Department of Justice, which had the capacity to extradite bankers through its extra-territorial legislation.”

“Since the early 1990s the US Justice Department has built one of the most effective white-collar prosecution machines in the world…Over 50 international cartels have been busted, billions of dollars imposed in criminal fines and hundreds of executives gaoled… And the US criminal antitrust regime has also handed down more than 25,000 prison days in 2009,” Riley added.

“In the US, they don’t mess around. People go to prison fast,” he noted.

As such, Professor Riley believes that if US regulators do eventually decide to extradite UK bankers to the states, “this would force changes to the legal system in the UK because we would look so pathetic,” he said.

“By comparison, the UK’s SFO has never been an aggressive prosecutor of insider trading, or anything else. Regulators in England have responded equivocally to news of wrongdoing and in many ways the Libor scandal has been more damaging to the reputation of the regulators than the regulated, especially in the UK”

According to Professor Coffee, the trials of Enron bankers just a decade ago, provides an important precedent for how extraditions would work. In 2002, three British bankers were indicted to Texas on seven counts of wire fraud against NatWest Bank after UK authorities failed to act. After a high-profile legal case, with the British media complaining about a transgression of the Magna Carta, they were extradited to the US in 2006 and pleaded guilty, receiving 37-month prison sentences.

But even that case is unlikely to match the scale of any of the scandals involving UK banks today, in particular the ongoing Libor scandal, which has shook the entire banking world.

Libor Lament

Libor, or London Interbank Offered Rate for short, is the world’s most important short-term interest rate benchmark, with more than US$10 trillion of securities and US$350 trillion of derivative contracts tied to it. Yet the Libor rate is not determined by an official body; but rather by the financial news company Thomson Reuters, on behalf of the British Bankers’ Association (BBA). The rate is based on daily submissions from BBA member banks, leading to massive conflicts of interest between the units of banks rating Libor and the desks trading derivatives.

Professor Coffee said: “Libor is a hypothetical rate which is open to abuse. I’m a teacher and I know that if you ask people to self-grade they will always give themselves higher marks.”

On June 27 2012, Barclays became the first bank to admit that they had rigged the Libor rate in their favour. It was fined US$200 million by the Commodity Futures Trading Commission, US$160 million by the US Department of Justice and £59.5 million by the UK’s Financial Services Authority for attempted manipulation of rates.

Barclays’ traders tried to influence rates for two reasons: from around 2005, they sought to benefit their trading positions. Then later, during the 2007–2012 global crisis, they deliberately lowered rate submissions to make their bank look healthier than it was.

Since Barclays came forward, the scope of the scandal has widened to include 17 of the 24 largest banks, all now under investigation. Barclays’ early confession has secured it a Prosecution Agreement, which means it cannot be prosecuted, though its individual traders can.

Professor Coffee says it is unlikely, however, that we will see criminal prosecutions happen immediately. That will be the long-term objective, but the first stage of the US investigation is reaching deferred prosecution agreements (DPAs) with major banks.

Under DPAs, the banks must allow elaborate internal investigations. The understaffed Commodity Futures Trading Commission outsources the laborious task of sifting through thousands of emails trying to find a kernel of incriminating wheat to independent legal firms.

“Groups of 50 or more young lawyers will spend weeks reading years of emails at a cost of US$20 million, or US$30 million to the bank, which is part of their penalty,” said Professor Coffee.

And if emails at Barclays are anything to go by, damning evidence of misconduct will almost certainly be found; especially as some of the Barclays emails were almost hilariously underhanded.

One of the most incriminating came when a former Barclays trader, now at a different bank, got some help from the Libor fixers. He responded:

Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.”

In another exchange of emails, one trader wrote:

The big day [has] arrived … as always, any help would be greatly appreciated.

After the Libor assessor complied, the trader wrote back:

When I retire and write a book about this business your name will be written in golden letters.”

But the submitter did not want it publicized:

I would prefer this to not be in any book!” he wrote.

On a more serious note, Professor Coffee expects the Barclays fine of US$450 million to be the baseline figure for fines. Furthermore, Coffee also anticipates a rush by banks to accept plea bargains in order to avoid the greatest fines and prison sentences, which tend to be reserved for the slowest to cooperate.

Professor Coffee adds that the targets of prosecutors are also likely to be middle and lower-ranked traders, rather than senior executives who were not involved in bidding on Libor.

“I expect some well-publicised prosecutions, but not hundreds simple because they won’t assign all their troops to one category of crime,” he said. “But I do expect hundreds, or even thousands of law suits. These are motivated by entrepreneurial plaintive attorneys driven by big economic incentives. In such cases, attorneys hire clients rather than clients hiring attorneys!”

The larger financial institutions and mutual funds, such as Vanguard, could sue the Libor fixers, he said. They were paid on the Libor rate and when that rate was reduced they suffered losses. But they won’t want to get caught up in the larger class of all mutual firms, Professor Coffee noted.

"If they all settle individually, they can do it privately without disclosure of the settlement. The defendants will always deny they are going to settle and will want to keep the sums quiet. There are immense problems of proof, but if settlement do occur they are likely to be non-public.”

Yet, the long-term consequences of the Libor scandal, Professor Coffee believes will be be positive, and changes to regulatory regimes.

Professor Coffee doubts that Libor will remain in the control of a private club. Market rates, including the rates on interest on swaps, could be used instead.

Overhauling Regulations

Meanwhile, in the UK, the application of US criminal antitrust rules to the Libor case is likely to have a major impact on regulation. One outcome is that the UK and, other countries, could radically overhaul its antitrust regime on US lines.

“It has the potential to turbo-charge banking reform in the G20. If the Division can demonstrate price-fixing in respect of Libor and hold individual executives accountable, and potentially open up inquiries into other rate- setting mechanisms, then it is difficult to see how such a development would not trigger momentum toward much more radical global banking reform,” said Professor Riley.

A reminder of the power of US regulators came recently when New York’s top banking regulator, the New York State Department of Financial Services (DFS) threatened to suspend British bank Standard Chartered plc from doing business on Wall Street indefinitely.

According to the New York Times, the DFS accused the British bank of hiding nearly US$250 billion in financial transactions to Iran that were in clear violation of US law.

The DFS said the bank had “schemed” with the government of Iran for over a decade in order to conduct more than 60,000 secret transactions, which had reaped “hundreds of millions of dollars in fees” for SCB and “ left the US financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes."

Describing the bank as a “rogue institution”, the DFS went on to detail numerous suspect transactions between SCB and a number of Iranian clients, including the Central Bank of Iran, Bank Saderat and Bank Melli.

British regulators need to match their US counterparts, according to Geraint Anderson, the former banking analyst in London and author of Cityboy: Beer And Loathing In The Square Mile. He said regulatory reform in the UK was essential to prevent a repeat of the Libor scandal.

“Bankers assess risk and reward day in and day out. If punishments are minor and rewards are massive they will always chase that risk,” he said. “That’s why I wasn’t surprised at all by Libor."

“Bankers need to think that if they do wrong, they will be severely punished. It’s also important we see prosecutions because people are very upset by bankers’ behaviour. They think they get away with it and have become very cynical. Prosecutions are the only way to control this greedy, hyper-competitive environment.”

This article was written by David Smith and originally published on Economy Watch under the title: Why ‘Rogue’ UK Bankers Can’t Escape US Regulators

Tags: banks , Barclays , BBA banks , british banks , Commodity Futures Trading Commission , derivatives , financial regulations , interest rate , interest rate benchmark , Libor , libor scandal , regulation , Scandal , securities , Serious Fraud Office , SFO , Standard Charted
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