Who knew what in the banking scandals? And what if any lessons have been learned?
If the banking sector is to regain customers’ trust, it is clearly going to have to seek to avoid the sorts of scandals that have bedevilled it in recent years. Rather than just paying regulatory fines, settling deferred prosecution agreements, punishing a few minor players, paying lip service to reform, and getting back to business as usual, it is going to have to fundamentally change.
At the very least, banks’ managements are going to have to devote more time to analysing why the red flags over recent banking scandals were missed by so many people both inside and outside their organisations and what cultural and organisational changes they’re going to have to make to minimise the chance of repeat performances.
Two of the biggest recent banking scandals have involved Libor rigging and bogus accounts at Wells Fargo. At first glance, these seem miles apart. However, there are striking parallels between the two. Both were allowed to persist for many years; both were widely known about by bank bosses but ignored (or sometimes even actively encouraged); regulators were aware of both for months or even years before they intervened; and in each case bank staff were driven to commit wrongdoing by perverse incentives.
RIGGING THE RATES
The manipulation of Libor – a series of benchmarks used to price some $350 trillion of mortgages, consumer debt and other financial instruments – falls into two main categories. The first , “trader book-based”, which went on from 2005 to 2010, involved New York and Tokyo-based traders in many of the world’s largest banks pressurising their London-based submitters to change their inputs to suit derivatives positions.
The second, “lowballing”, phase occurred from August 2007 to 2009 and was part of many banks’ attempts to disguise their financial weakness during the global financial crisis. Problematically for many concerned, it is now increasingly clear that the second type of rigging was actively encouraged by both the UK government and Bank of England.
In both phases of Libor rigging, a tight-knit group of derivatives traders at global banks and interdealer brokers were surprisingly brazen, taking few steps to cover their tracks. After one Barclays trader helped a peer at another bank by shifting Barclays’s US dollar rate lower on 26 October 2006, the other trader said: “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger”, while in a 15 September 2009 message, RBS trader Neil Danziger celebrated one successful falsification by saying “im [sic] like a whores drawers.”
British-born maths whiz Tom Hayes was one of the key players. The banks that employed him – latterly UBS and Citigroup – were allegedly willing to reward him handsomely because of the leverage he had over a network of brokers and traders at other institutions and ability to “scalp the market” with their aid.
Aware of Hayes’ Libor manipulation skills, Citi handed him a $3.5m “signing bonus” on luring him from UBS in December 2009. Hayes appears to have used a mix of bribes (often delivered via so-called “wash trades”), inducements, psychological pressure and bullying to get his way.
However Hayes’s trading career came to an abrupt halt in September 2010 when Citi fired him after a colleague complained about his methods. In December 2012, in the wake of UBS and Barclay’s regulatory settlements over Libor, he was arrested and in June 2013 charged with eight counts of conspiracy to defraud.
During his trial, which ran from May to July 2015, Hayes portrayed himself as a small cog in a wider system of wrongdoing, telling the court “I acted with complete transparency to my employers. My managers knew; my manager’s manager knew. In some cases the CEO was aware of it.” However Hayes was to an extent stymied by the fact he had admitted dishonesty in pre-trial interviews with the SFO in a bid to avoid extradition to the US.
A FAIR PUNISHMENT?
In August 2015, Hayes was found guilty and jailed for 14 years. Widely regarded as an excessive sentence, this was reduced to 11 years on appeal. Today a network of supporters on social media, including Hayes’ father, wife and brother, and traders at other banks who have been acquitted of the same offence, are insisting that Hayes is innocent, and characterising him as a victim of miscarriage of justice.
But David Enrich, a Wall Street Journal correspondent and author of The Spider Network, a bestselling book about the scandal, is not convinced. “I feel there is a bit of revisionist history going on,” said Enrich. “Hayes has acknowledged to me – on many occasions – that he knew some of what he was doing was wrong.” Enrich therefore does not believe Hayes is innocent but adds that “what’s unfair is that a ton of other people deserve to be punished too – and that hasn’t happened.”
He is referring to the panoply of supervisors and bosses at UBS, Citigroup and other banks, were complicit or else actively participating in Libor rigging. These individuals have so far have escaped prosecution and many continue to hold senior roles in the industry.
The main reason these people have escaped prosecution, said Enrich, is because of the lack of concrete evidence. Senior bankers were generally much more careful about covering their tracks than Hayes, and prosecutors tend to very nervous about losing high profile cases.
Enrich adds that the industry lobby group, the British Bankers Association, could and should have done much more to ensure the integrity of the key interest rate. It was responsible for compiling and policing Libor numbers from 1986 to 2014 and, even though it was warned that banks were setting Libor with an eye on their derivatives books as early as 2005, did nothing to address the situation.
Enrich said: “I have been really surprised that the BBA hasn’t faced criminal charges over the Libor scandal. There is considerable evidence that, to the extent that a fraud was perpetrated by people, the BBA was a participant in fraud”.
Regulators such as the Financial Services Authority also have much to answer for. Initially, the FSA was indifferent to claims that the rate had entered the realms of fantasy, and actually sought to block or stall US regulatory probes during 2008 and most of 2009.
Enrich suggests regulatory insouciance played a key part on prolonging the banking scandal. He said that: “Regulators missed all the red flags as they were more interested in fostering their jurisdictions as good places for banks to locate than in preventing misconduct.”
WHAT CAN BE LEARNED?
Tim Parkman, managing director of the compliance consultancy Lessons Learned Ltd, believes that the only way the scandal could have been nipped in the bud would have been for banks to have made some symbolic sackings.
“How could banks have prevented Libor rigging? First they should have found out what was going on – and that wouldn’t have been difficult given that everybody at all levels seems to have known about it. Secondly, they should have fired one really big hitter, and one senior bank executive – publicly – to make everyone aware the practice was off limits. The message would have gone out ‘pour encourager les autres’.”
“As in all areas of investment banking, the required systems and tools were in place to ‘catch’ Libor manipulation,” agrees Kweku Adeboli, a former UBS trader who spent three years in jail for his part in a rogue-trading scandal, but is now a culture and systems adviser. “If the banks had really wanted to stop Libor manipulation, they could have done so.”
At Wells Fargo, retail banking staff didn’t just fake a rate, they created two million fake accounts for customers – without the customers’ knowledge or consent.
Driven by a tough incentive regime, an obsession with cross-selling, and a rallying cry of “eight is great” (a reference to the bank’s target of selling eight financial products to each customer), Wells Fargo staff opened 565,000 bogus credit card accounts and 1.5 million bogus deposit accounts over a ten-year stretch. About 5 per cent of customers with fake accounts lost money.
MASS COMPLAINTS
The scandal first erupted into the public consciousness in 2013, after large numbers of Wells Fargo staff and some customers complained to the media, regulators, and members of U.S. Congress. However rather than question its systems, controls and culture, Wells sacked 5,300 employees for opening the accounts.
It was only after regulator the Consumer Financial Protection Bureau reached a settlement with Wells Fargo in September 2016 that the bank acknowledged anything untoward. While the bank agreed to pay fines totalling $185 million, it did not admit fault and nobody was held accountable.
Wells chief executive John Stumpf sought to minimise the scandal when he appeared before a Congressional committee last September, saying he initially believed the practices were harmless because the empty new accounts were “auto-closed” after a certain period.
However US Senator Elizabeth Warren tore into Stumpf, accusing him of “squeezing employees to breaking point” to bolster his share options. She added “You should resign. … You should be criminally investigated”. A few weeks later Stumpf stepped down..
Six months later, the San Francisco-based bank published a 113-page internal report with input from lawyers Shearman & Sterling. Unlike with Libor, this sought to pin the blame on Stumpf and his protégée, Carrie Tolstedt, who had run Wells’s retail bank since 2007 but who “retired” in December after earning $124 million from the bank. The board used clawback powers to relieve her of more than half of this and clawed back a similar amount from Stumpf.
The report suggested Stumpf had turned a blind eye to the abuses over a long period stretching back to 2002 but it was Tolstedt who was singled out for special blame. She was criticised for knowingly setting impossible targets, refusing to listen to complaints, driving dysfunctional behaviour, and misleading the board.
The report also blamed Wells Fargo’s decentralised, silo-like structure, saying this was an obstacle to joined up attempts by risk management, human resources and legal people to address the scandal.
William K Black, associate professor of economics and law at the University of Missouri, Kansas City, said the notion, as presented in the report, that Tolstedt had “somehow perverted an otherwise wonderfully benign culture” was absurd. “The problems go much deeper than that”.
Dennis Kelleher, chief executive of banking advocacy group Better Markets, described the report as a whitewash that was intended to protect the board and Tim Sloan, who succeeded Stumpf as chief executive, but had overseen Tolstedt throughout.
SOLUTIONS FROM WITHIN
Once again financial regulators have been shown to have been pretty useless. On 19 April the US banking regulator Office of the Comptroller of the Currency admitted that it had become aware of “700 cases of whistleblower complaints” about Wells Fargo’s sales practices and the gaming of incentive plans in January 2010 – but had decided against investigating further because Tolstedt had put it off the scent.
Parkman said: “Ultimately the solutions to these sorts of banking scandals can only come from within an organisation. A critical part of that is having effective whistleblowing procedures in place.”
He said it is essential that banks eliminate obstacles to people speaking openly, protect those who raise concerns, and promote a culture in which those who question things are rewarded. “This is why the recent allegations about Barclays CEO Jes Staley are so disturbing,” said Parkman.
Parkman, a former Standard Chartered banker, said the biggest of red flags in the banking industry is “when a bank rewards people for breaking the rules” – exactly what was happening with both Libor and Wells Fargo, though with Libor there is a question mark over what the rules were.
He said that quickly pollutes the organisation’s culture and desensitises people to wrongdoing. He said another red flag to watch out for is a “culture of secrecy in which people don’t feel free to talk and are scared of management.” That red flag was billowing wildly over RBS between 2000 and 2008 – and at many other banks.
Ultimately Parkman does not think that banks be able to avoid major scandals until investors change their stance and lose their impatience for short-term returns. At Wells Fargo, he said, investors were so in love with the share price performance and earnings-per-share growth the bank was delivering, they were incurious as to how it was delivered. “It’s institutional investors pressurising management for bottom-line growth that ultimately drives most of the wrongdoing in the financial sector.”
Adeboli concludes: “The real problem is the gap between policy and practice. The only solution that works is a forward-looking focus on culture, systems and something altogether more purposeful than stripping profits from complex systems.”
WORST OF THE REST
STANDARD CHARTERED – SANCTIONS BUSTING
In 2012, Standard Chartered paid $1 billion to US authorities to settle charges it had illegally hidden transactions with Iran and other countries that were subject to US sanctions between 2001 and 2010. The New York State Department of Financial Services said the bank had laundered up to $250bn, hiding billions of Iranian financial deals. In the build up to the DPA, relations between bank and the authorities became strained.
The bank’s finance director, Richard Meddings said: “You f***ing Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians?” which the US authorities saw as reflecting “obvious contempt” for US banking regulations and a refusal to acknowledge wrongdoing.
In 2012, the DFS accused the bank of being a “rogue institution” whose actions left the US financial system “vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes”. The DPA, which effectively means Standard Chartered is still on probation, is due to expire in December.
LESSONS FOR STANDARD CHARTERED
- Open defiance doesn’t go down well with regulators, especially with U.S. regulators, nor does getting consultants to whitewash the crime scene. Show humility and co-operation if found out.
- Never create transaction records that lie about the underlying transactions [Standard Chartered did this by ‘stripping’ Iranian references from SWIFT messages].
- Be extremely careful not to flout the terms and conditions of a DPA.
PAYMENT PROTECTION INSURANCE “MISSELLING”
Britain’s bank mis-sold Payment Protection Insurance (PPI) on a massive scale to their UK retail customers, alongside credit cards and loans, from the 1980s to the 2010s. It was supposed to insure repayments could be made, even if customers lost their jobs, fell ill or died.
However, the PPI policies – which were often more profitable to the bank than the underlying loans – were redundant and the banks mostly knew it. Over one million policies were sold to self-employed people and students, who by definition could not claim as they didn’t have “jobs” to lose. The FSA made some attempts to rein things in after 2005 but it was only when the high court ruled banks must compensate affected customers that the compensatory floodgates opened.
At the time, Lloyds Banking Group chief executive António Horta-Osório acknowledged blame and set aside £3.2bn for payouts. The FSA initially predicted an industry-wide bill of £4.5bn but this has since surged to £26.2bn – making PPI one of the biggest banking scandals of all time.
LESSONS OF PPI
- Take early and decisive action before the wrongdoing becomes endemic / normalised.
- Once the “mis-selling” is normalized, the chances of it being addressed or punished are inversely related to the profits it generates.
- Never assume sales staff will understand the basic legal points of products they are selling. Systems and procedures must be idiot proof.
HSBC’S LAUNDERING OF DRUGS MONEY
In December 2012 HSBC entered a $1.9 billion deferred prosecution agreement with the US authorities after accounts in Mexico and the US were found to have been used by drug barons to launder money. If HSBC had been criminally indicted for these offences, the US government and others would no longer have been able to conduct business with it, which might have spelt curtains for the bank.
This explained why, ahead of the DPA, both the FSA and chancellor George Osborne intervened on HSBC’s behalf in the hope of averting criminal proceedings. A US Senate investigation also found HSBC had regularly circumvented restrictions on dealings with Iran, North Korea, and other rogue states. HSBC admitted to having inadequate money-laundering controls, pledged to tighten them up and apologised.
“We accept responsibility for our past mistakes,” said chief executive Stuart Gulliver. Like Standard Chartered, the bank remains on probation, amid sporadic allegations from US regulators that it is struggling to meet tighter anti-money-laundering requirements, until its DPA expires in December.
LESSONS FOR HSBC
- Don’t assume that acquired companies will share your values [HSBC acquired Bital, then Mexico’s fifth largest bank, in 2002, but it didn’t even have a compliance department]
- If an acquired firm’s compliance is found to be wanting, impose a tough regime as quickly as possible.
- The fine for an offence will represent only a portion of the overall financial fallout, with remediation (including the introduction of new systems and staff training programs) costing the same again, or more.
This article was published under the headline Crime and punishment: Notes from a scandal, in FS Focus, the financial services faculty publication of ICAEW, in May 2017