Narratives of Misconduct: Emerging Trends in the Finance Sector

26 11 2015

As seen on this blog, the spectre of misconduct hangs over the finance sector. Even after seven painful years of conduct related revelations, the fall out from the global financial crisis (GFC) continues to haunt consumers and banking institutions alike. To conceal the low-point in public confidence, empty rhetoric and hollow buzzwords such as “social licence” and “real markets” reign supreme while regulatory spin seeks to reconstruct the common person’s trust in the system. Equally, to make themselves palatable to the public, market pundits can be heard trumpeting the mantra of “inclusive capitalism”. Yet an overall lack of ethics permeates corporate culture and a continuing tendency to act in a twisted way can still be gleaned from events. If anything, the deficit in trust is increasing because resort to outright cheating can still be evinced in numerous instances. For example, along with Deutsche Bank, Barclays is in the spotlight yet again after paying £320 million in forex manipulation fines to the New York Department of Financial Services (NYDFS) earlier this May; today, it has been fined £72 million by the Financial Conduct Authority (FCA) for poor handling of financial crime risks. Equally, The Review into the failure of HBOS Group highlights the legacy of negligence in holding the finance sector to account. In addition to everyday outrage arising out of economic inequality, public anger in the finance sector has risen to a crescendo because the nadir of people’s sufferings has been reached. As the National Audit Office finds, state funds totalling £1,162 billion have been injected into the UK banking system to save it from collapse.

The paradox, of course, is that unlimited funds have been made available to rescue recklessly managed and overexposed banks – concerned less with integrity and more with ways to exploit token regulation – whereas the neediest in society are being shunned from basic necessities such as healthcare, care services, welfare and all the savage cuts that accompany the long-term goal of shrinking the state to 36% of GDP. Even to those who earnestly believe in the free market, official viewpoints and narratives often directly contradict reality. Most of all, officials fail to acknowledge wholesale abdication of duties owed to citizens and their attitude exposes a continuing tendency to overlook capitalism’s corruption. In the roundup below, among other things, further light is shed on developments trending in the bullring of financial misconduct and the theoretical jargon used by regulators is paired up with a cogent critique – by O’Brien, Gilligan, Roberts and McCormick – of the trickle down reforms enacted to positively anchor the finance sector to society’s needs.

On proper analysis, in antithesis to the belief that antidotes designed to remedy misbehaviour are now fully active in the bloodstream of the financial system, the existing state of affairs graphically illustrates that the authorities have always indulged in jettisoning the strategy that prevention is better than cure. In a similar vein, as argued by Adamti and Hellwig in The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about it, misleading claims and deliberate supervisory blindness are a product of collaboration between politicians and regulators. Adamti and Hellwig find that abstract top-down theoretical approaches remain embedded in myths because of an absence of matching theory to reality. In Willful Blindness: Why We Ignore the Obvious at Our Peril, Margaret Hefferen argues that “we turn a blind eye in order to feel safe, to avoid conflict, to reduce anxiety, and to protect prestige.” Following her philosophy, Adamti and Hellwig explain: “Willful blindness helps bankers and policymakers to overlook and ignore risks they take and to deflect criticism.”

An Accident Waiting to Happen

In addition to the scandals unearthed by the last seven years, The Review into the failure of HBOS Group further illustrates that crisis management mechanisms in banks and regulatory watchdogs are quite deficient in dealing with conduct related extremities which have historically beset the markets, in particular it exposes serious skills’ failures even in the running and supervision of simple banks let alone the ills that are associated with riskier activities such as casino style investment banking. Even in the spring of 2013, the Parliamentary Commission on Banking Standards (PCBS) had found the failure of HBOS to be “an accident waiting to happen”. For the PCBS, rather than the “best board” and “model for the future” metaphors employed by those who sat on the board, “the corporate governance of HBOS at board level” represented “a model of self-delusion, of the triumph of process over purpose.”

HBOS was formed by the 2001 merger of Halifax plc and the Bank of Scotland. Published on 19 November 2015, the Review found that the Financial Services Authority (FSA) was too trusting of big corporate types, i.e. the very firms it sought to regulate. As a consequence of the Review, Andrew Green QC has recommended that the new regulators, i.e. the PRA and FCA, should now (posthumously) reflect on whether the former senior management that steered HBOS to disaster should be subjected to enforcement action with a view to prohibition proceedings. Green found the FSA’s initial actions were totally compromised. For him, the “materially flawed” approach was worthless because the investigation into the debacle had been steered away from engaging with the root causes of misconduct.

After all, the FSA itself found grounds for taking action against former HBOS chief executive Andy Hornby. Yet eerily no action was taken against him and no records of FSA meetings were maintained; the upshot was that Green was unable to discern the (contemporaneous) actions of FSA officials and the basis of their rationale. Culpable individuals were let of the hook en masse. Only Peter Cummings, former head of corporate lending at HBOS, was singled out for his misconduct related failings which were fixed by way of a ban and a £500,000 fine. In reality, as argued by Alex Brummer of the Daily Mail in his book Bad Banks, “Crosby and Hornby were ambitious to turn HBOS into a fifth force in British Banking (along with RBS, Barclays, Lloyds, and HSBC) and they appeared to countenance no limits to its expansion.” Cummings became the whipping boy for the whole board. Under pressure from Hornby, the bank’s £120 billion loan book was constructed on Cummings’s reliance on a high degree of leverage, risk controls were poor and £34 billion of lending was recklessly concentrated with a mere 30 customers.

Of the £52.6 billion written off, from HBOS’s assets which ballooned from £477 billion in 2004 to £690 billion in 2008, by Lloyds Banking Group after it took over in 2008 – the year taxpayers injected £11.5 billion into HBOS, Cummings’s corporate book was responsible for £22 billion and the PCBS was of the view that the failure of governance merited action from the chairman, Lord Stevenson of Coddenham. In 2013, the PCBS had also urged regulators that Stevenson, James Crosby and Hornby “should be prohibited from holding a position at any regulated entity in the financial sector”.

Unsurprisingly, six thousand claimants who contend that they were mislead in relation to the affairs of HBOS before a vote on a takeover was taken by Lloyds are seeking £350 million in damages from Lloyds and senior directors and will have their case heard next year. While they applaud the criticisms levelled at politicians and regulators, these shareholders are frustrated that the Review fails to deal with the deep-rooted problems connected to Lloyds’s acquisition of HBOS; a deal involving a £20.5 billion bail-out which had the government’s approval and blessings. Limited comfort can be found that the deal was completed during the worst recession in a century. However, Ivan Fallon, author of Black Horse Ride: The Inside Story of Lloyds and the Banking Crisis, recently wrote that a Lloyds director confessed to him that the bank failed to identify the “crazy stuff” during the deal-making process; the insider said that failures in due diligence left huge gaps and a valuation of HBOS made one week would be out of date by the next with the end result that trying to keep up with events “was trying to catch a falling knife.” Yet Lloyds is disputing the claims. As seen below, similar problems have unfortunately not yet been consigned to the dustbin of history.

Here and Now: British Banks Today

Preliminary data analysis for the four major UK Banks (Barclays, HSBC, Lloyds Banking Group and RBS) can be found in the revised version of the Seven Deadly Sins: ‘Retrospectivity, Culpability and Responsibility’ paper. The revised paper by Roger McCormick, Tania Duarte and Chris Stears presents the results of the first stage “culpability grading”, applied to the conduct costs record of these four banks over the 2008-2014 period and interprets “seven deadly sins” over seven years, using the four major UK banks as a pilot study. The infographic data demonstrates trends that these four UK banks are mostly prone to case 2 (corporate integrity-related regulatory breach) and case 4 (corporate conduct/behavioural failure) type events. All four banks exhibited instances of case 1 (clustered criminality) during 2008-2014 and all of them also generally demonstrated a tendency to be particularly prone to misconduct arising from case 2 and case 4 related problems.

In The Big Short: Inside the Doomsday Machine, in discussing what he calls being In the Land of the Blind, Michael Lewis discusses the asymmetric nature – “like laying down money on a number in roulette,” he calls it – of casino style betting in the world of banking. Lewis explains that he found it easy to abandon a lucrative career in finance because he did not want to be the fall guy for some institution when it went down; he did not want to take the rap for misconduct and unethical behaviour. Among other things, while waiting for the end of Wall Street as he had known it, he said (at pages xv-xvi) in a chapter headed Poltergeist:

Over and over again, the financial system was, in some narrow way, discredited. Yet the big Wall Street banks at the center of it just kept on growing, along with the sums of money that they doled out to twenty-six-year-olds to perform tasks of no obvious social utility.

As the second largest British bank, Barclays is a big household name in the UK and the Conduct Costs Project Research Foundation (CCPRF) estimates that its conduct related fines presently add up to more than £12 billion. Because it has recently made front-page headlines again, its troubles are worth exploring.

As noted at the outset, today Barclays has again been fined £72 million by the FCA for myriad failings relating to a £1.88 billion pound transaction that Barclays arranged and executed in 2011 and 2012 for a number of ultra-high net worth clients. Senior managers failed to provide supervision. Insufficient oversight, in turn, created an indifference to features in the business relationship indicative of a high risk of financial crime. The FCA, therefore, found it “wholly unacceptable” that Barclays “ignored” its own internal procedures designed to mitigate the risks of financial crime and “overlooked obvious red flags to win new business and generate significant revenue.”

Although the newly appointed Barclays chief executive James E “Jes” Staley, a Bostonian who will be replacing Anthony Jenkins (sacked for growing frustration over “cumbersome bureaucratic” conduct costs and stricter capital requirements), has pledged to increase investor and customer trust in the scandal ridden institution, it appears that in America itself the bank will also pay another penalty of $150/£98.9 million to the NYDFS for alleged abuses and manipulation via its electronic trading platform (see press release and consent order).

In May, along with four other major banks, in a $2.4/£1.6 billion fine for conspiring to manipulate the spot trading in the foreign exchange market, Barclays paid $710/£470 million to the US Department of Justice (DoJ, see plea agreement), $485/£320 million to the NYDFS, $400/£263.9 million to the Commodities Futures Trading Commission (CFTC) and $342/£225.6 million to the US Federal Reserve. Barclays also paid a record fine, $441/£284 million, to the FCA.

The new $150/£98.9 million penalty is significantly smaller than those imposed in the past as it is reflective of a smaller number of trades but it is nonetheless important because Barclays is accused of gaming the system by backing out of trades at the last minute in circumstances where the market moved against the bank. The bank is terminating its Global Head of Electronic Fixed Income, Currencies, and Commodities (eFICC) Automated Flow Trading for misconduct related to automated, electronic foreign exchange trading through its “Last Look” system. Anthony J Albanese, Acting Superintendent of the NYDFS explained that:

This case highlights the need for greater oversight and action to help prevent the misuse of automated, electronic trading platforms on Wall Street, which is a wider industry issue that requires serious additional scrutiny.

A former JP Morgan investment banker who will commence his role from December, Staley has already written a memo to his staff that “trust is the most precious asset a bank can have” and exhorted them that integrity and values must not be abandoned because “the cultural transformation of the group” needed to be accomplished and better relations with regulators were imperative.

While such rubric has been applauded by the industry, the slipperiness of Staley’s approach, perhaps like others of his ilk camouflaged as regulators, is amply demonstrated by Robert Jenkins’s closing keynote speech When timidity triumphs – at the recent Confidence, ethics, and incentives in the financial sector conference in Luxembourg – which invites us observe that any confidence in financiers is easily nullified because even a partial list of misdeeds in the finance sector runs to at least 50 bullet points.

“I feel keenly we must continue to strengthen trust in Barclays,” argues the future Barclays boss who will be paid £8 million annually for his services to the bank. Staley is clearly eager to move things on for Barclays but the new rumble with the NYDFS is a first of a kind case in which algorithms were allegedly abused on a trading platform. The bank’s dodgy strategy was to allow trades to go through when markets moved in its favour but trades were declined in circumstances benefitting the client. Correspondence, in the form of an email discussion, from an unnamed managing director (who headed automated electronic forex trading) to members of staff in Barclays openly directed employees to “obfuscate and stonewall” if queries were made in relation to rejected trades. (The seriousness of misuse of algorithms in the fiance sector has been heightened by developments in the CFTC where Regulation Automated Trading or “Reg AT” opened for public comment just the other day on 24 November 2015. “Reg AT” represents a series of risk controls, transparency measures, and other safeguards to enhance the US regulatory regime for automated trading.)

Sophisticated customers of the bank such as hedge funds used to receive messages saying “NACK”, or “not acknowledged”. One customer attempting to place orders received 300 such messages in one day alone in December 2010 but when he expressed his reservations about the situation the bank ignored him and took no further action. The system introduced a “hold” period, between customer orders being received and executed by Barclays, which allowed the bank to instantaneously filter out trades in circumstances where price movements were poised against it. In other words, the system was crafted to reject orders from customers which would be unprofitable to Barclays.

The failings in relation to the so-called “Last Look” system occurred between 2009 and 2014 and even though changes to the system were introduced in September/October 2014 owing to the ongoing forex probe, despite revising its questionable methods, Barclays benefitted from its dodgy set up until 2015 because:

Barclays neglected to update one of its trading platforms, causing 7% of its trading volume to continue under the asymmetrical paradigm until August 2015. 

Blowing in the Wind

Ultimately, despite attempts to revive public trust in the finance sector, Carney and Osborne’s anecdotes about effectiveness of their reforms to change the culture of misconduct are little more than straws in the wind. As seen in the last post, George Osborne recently compared bad bankers to shoplifters and Mark Carney explained that nobody at the Bank of England (BoE) “will be hugging a banker”. Despite the FCA’s climb down on PPI mis-selling evinced in the imposition of a two-and-a-half year time limit on claims, the chancellor also appeased voters by insisting that the scandal ridden world of finance was continuously being purged of wicked firms and individuals who prey on unsuspecting and gullible consumers (it is, however, hard to discern any limits on liability in view of the Supreme Court’s judgment Plevin v Paragon Personal Finance Ltd [2014] UKSC 61). As The Freewheelin’ Bob Dylan exhorted everyone long ago in 1963:

the answer, my friend, is blowin’ in the wind.

The chancellor nodded to Carney’s “bad apples” analogy as his preferred analytical approach. Osborne equally relied on the arguments aired by his ousted right-hand man Martin Wheatley and he came close to embracing the straitjacket that the imposition of financial penalties is a panacea for curing behavioural issues arising out of the legacy of misconduct in the finance sector.

“If anyone thought that being unethical in the financial services industry is a good way to make money I suggest they look at the very big fines,” wheezed the chancellor tritely in aid of the efficacy of regulatory penalties to convince the disquieted public that Number 11 Downing Street is in control of the maladies shrouding global banking and finance. So the chancellor considers the fines to be a metaphor for wholesale conduct improvements in the industry. Osborne and Mogadon “Mañana” Mark Carney – as John Crace prefers to call the latter because of the governor’s Canadian drawl, his unrelenting tendency not to lose sleep over anything and to know all things as a “yawner” – have been making grand speeches on reform; but given how far away they actually are from the average person, their shiny white teeth, daintily coiffed hair and choreographed arguments amount to little more than banter and small talk for the majority of society. A smaller welfare state at the cost of rescuing unethically run banks only inflames misunderstandings between the public and politicians/state officials.

Yes the fines may be large, but in the grand scheme of things they represent little more than a drop in the ocean. To borrow an expression coined by JP Morgan Chase’s boss Jamie Dimon (who relied on the size of the synthetic credit portfolio to absorb large losses) in the wake of the notorious London Whale losses of $6.2 billion, properly understood the fines may well be no more than “a complete tempest in a teapot”. The conciliatory tactics adopted by regulators in tandem with simultaneously revved up rhetoric seems to confirm the inevitability of this fact. As the defeat in the House of Lords on 26 October 2015 over tax credits and today’s U-turn on the issue (owing to an unexpected hypothetical windfall of £27 billion) in the Spending Review (see all documents) has ably shown, the chancellor is as slippery as a snake. It is hard to be certain, and I hope that I am wrong, but for all we know the chancellor may be fiddling away like Nero rather than stopping Rome from burning down; on the other hand, by getting Mogadon “Mañana” Mark Carney to play along with him, perhaps he is just being wise by doing in Rome as Romans do. For John Crace:

Mogadon “Mañana” Mark is a miracle of economic and comic genius by always being right at the same time as always being wrong. A contradiction of creative nihilism.

To bolster his political ratings so that he may one day occupy neighbouring 10 Downing Street as prime minister (a goal on which he has his sights firmly set), George Osborne leapt at the chance to attack bankers. Because of wholesale public disaffection for the industry, he proclaimed that white collar criminals who had “caused the single biggest crash of our lifetimes” would be treated no different to “shoplifters”: society’s retribution would not be contained; after all, as intimated by the FEMR, sentences for bad bankers shall be increased to 10 years’ imprisonment.

To the governor, the shocking events after the GFC exposed markets as “fragile, unfair, ineffective and unaccountable”. For him, the introduction of the Senior Managers Regime next year would compel senior personnel to ensure that their juniors are aware of exactly what a “true market” entails. As he pointed out at his Mansion House address, only a third of the public thought that markets work in order to benefit society. On 11 November taking such thoughts to the next level in his Open Forum 2015 Introduction, Carney threw up a series of questions and he specifically posited:

Are there other places where the pendulum has swung too far, preventing markets from serving society as they should?

In response, Carney reasoned that much more needs to be done to cure the ills of “too big to fail” and more “bad apples” need to be weeded out from the City, but he simultaneously proclaimed that:

The era of heads-I-win; tails-you-lose capitalism is drawing to a close.

On the other hand, the influential ratings agency Moody’s anticipates that European banks will have to shoulder yet more liabilities in fines and litigation in the aftermath of the GFC. Moody’s believes that the banks have forked out almost $219/£145 billion in litigation costs since 2008 and it is of the view that Barclays, RBS and HSBC run a high risk of being penalised for misconduct. Barclays does not deny that it will be facing more penalties in the future. Indeed, as the CCPRF’s international results table discloses, global banks incurred a grand total of £205.56 billion in conduct costs during 2009-2014 and the year-on-year comparison between 2013 and 2014 shows an increase in the grand total by £32.34 billion.

In addition to settling with regulators, banks are continuing the trend to settle complex litigation such as the case of In re LIBOR-Based Financial Instruments Antitrust Litigation, 11-md-2262 (S.D.N.Y.); in those proceedings the over-the-counter (OTC) claimants have reached a $120 million settlement with Barclays and in addition to the payout, the bank has agreed to cooperate with the claimants in their continued litigation against the other defendant banks.

The compromise has won plaudits from the OTC claimants’ lawyers who dubbed the developments an “important breakthrough in resolving this long-running litigation” which can be traced to 2011, when Barclays and other international banks were sued by the City of Baltimore and other purchasers who alleged that powerful predatory banks colluded to artificially suppress the US Dollar LIBOR rate during the GFC. In June 2012, Barclays admitted to manipulating LIBOR in settlements with American and British regulators. In an earlier English case concerning interest rate swaps worth £70, known as Guardian Care Homes see [2012] EWHC 3093 (Comm), [2013] EWHC 67 (Comm), [2013] EWHC 2793 (Comm) and [2013] EWCA Civ 1372 Barclays also entered into a settlement and got off the hook by offering the claimants Graiseley properties (owners of Guardian Care Homes) the option to restructure the loan facility, thought to be worth about £40 million.

The Social Licence

“When the pendulum swung back it did so in dramatic fashion,” claims the iconic Howard Davies in his sketch of the global meltdown Can Financial Markets Be Controlled? “Bankers have vanished from the Honours lists in London. They are barely respectable in New York,” explains the first ever chairman of the abolished FSA (2001-2013).

In this hostile environment, to save face, the attractive idea of a “social licence” has been invoked by the global financial elite in the hope of finding a solution to the spectre of conduct related issues dogging the finance sector. Governor Carney has famously declared that the “Age of Irresponsibility is over” and like the fashionable mantra of “good governance” the idea of a “social licence” is in vogue in banking circles these days. He reasoned in his Mansion House 2015 speech that whilst “not ends in themselves” markets are nonetheless “powerful means for prosperity and security for all” which “need to retain the consent of society – a social licence – to be allowed to operate, innovate and grow.” Arguing that “real markets are resilient, fair and effective” because “they maintain their social licence”, Carney equally urged us that repetitious misconduct of the type witnessed in the financial services sector in recent years calls “that social licence into question.”

Yet the governor was clear that the BoE’s own “arcane governance blurred” its “accountability and, by extension, weakened the social licence of markets.” But he was pleased with reforms to the BoE’s governance and looked forward to the government’s “intention to introduce legislation further strengthening the governance and accountability of the Bank.” As demonstrated by a speech in May 2014 and then again in conversation at Mansion House in June 2015, Carney espouses “inclusive capitalism” and in line with the principles of the standard stakeholder theory of sustainable development he advocates that the financial sphere does not exist in a vacuum and needs tethering to the greater needs of society.

The governor’s words chime with this July’s Fair and Effective Markets Review (FEMR, see here). Endorsing the FEMR the governor demanded a “better balance between individual and firm accountability”. Continuous engagement with these hotly debated issues is a key ingredient for success in the much-ridiculed governor’s eyes and he stressed that “individuals must be held to account”. In order to build real markets for the good of the people, Carney was unambiguous that responsibility must no longer be shirked and “key elements of the Senior Managers Regime [see here] should be extended to all firms active in wholesale FICC markets, including dealers and asset managers.” As noted on this blog in the past, the FCA’s fallen conduct Czar Martin Wheatley disagreed with the extent of Carney’s wisdom on the extension of the new regime to asset managers.

Carney’s arguments as regards the social licence to operate (SLTO) – which has surfaced as the BoE’s preferred strategy – have been analysed in Professional standards and the social licence to operate: a panacea for finance or an exercise in symbolism? by O’Brien, Gilligan, Roberts and McCormick for whom the potential of the “model has enormous [global] traction for the finance industry”. In their impressively argued paper juxtaposing an Anglo-Australian perspective on professionalism in the finance sector, the authors argue that the SLTO traces its roots to World Bank research on sustainable development and in particular:

It refers to the ongoing capacity of a business to conduct its affairs outside of a government-sanctioned or legally enforced process. The World Bank noted that community legitimacy is based on securing the “free, prior and informed consent of local stakeholders”, a requirement of a prior United Nations initiative to support the rights of indigenous people. Extending that obligation to areas where there are no such legal requirements to reach or maintain consent can be problematic. It may be difficult to identify relevant stakeholders or rank competing views. It is important to note at the outset that the social licence process in itself has no legal standing. It is a voluntary initiative designed to demonstrate good faith and, crucially, build trust; hence its practicality and allure to the Governor of the Bank of England. It is a description of the pressure facing a business in the event that it loses public support and therefore legitimacy, prompting the business risk of formal rejection of a specific project or a requirement for more invasive oversight. It is also a model for effective community engagement and how to attain and/or retain legitimacy, credibility and trust. As such it can be an effective risk-management tool.

Yet the authors are keen for us not to get blindsided by the potential spin underpinning the governor’s remarks vis-à-vis a SLTO. For them “culture is a two-way process. It shapes individuals and in turn is shaped by them.” Greater openness is therefore key in the financial sector and the retention of the social licence turns on transparency and accountability. The interaction of finance and society and the criticality of making markets serve society better is the key focus of the study and Karl Polanyi’s classic text The Great Transformation: The Political and Economic Origins of Our Time remains at the heart of the authors’ thoughts; it serves as their point of departure. To these thoughts we can add the argument made by Clifford Geertz in The Interpretation of Cultures (at page 90) that:

Cultural acts, the construction, apprehension, and utilisation of symbolic forms, are social events like any other; they are as public as marriage and as observable as agriculture.

Ultimately, for McCormick et al the award and renewal of the licence “implies social involvement”. The study, which clearly wants to relieve the reform of the finance sector from the same wheezing old clichés and top-down strategies, goes on to conclude that the abdication of responsibility and accountability exposed by the GFC was driven by a tendency to bypass everyday honesty and decency. The study critically examines the top-down nature of change in the finance sector, which it accepts is not without value, and invites Carney and his fellow regulatory Nietzschean supermen to engage with “a holistic research agenda” honing in on the “empirical investigation of actual practice” and turning rhetoric into a robust form of change that is able to review and benchmark progress and holds the sector accountable in line with its stated obligation to reform itself. Indeed, as shown by myriad cases of misconduct:

Existing codes of conduct at corporate, industry or professional level proved incapable of addressing hubris, myopia and the decoupling of ethical considerations from core business. The failure to articulate and integrate purpose, values and principles within a functioning ethical framework created or exacerbated socially harmful corporate cultures. These cultures elevated technical compliance over substance. Ethical obligation was stated but not delivered. Deterrence was defective and ineffective. There was little or no accountability. No credible mechanisms to identify institutional or systemic risk were put in place. While the structural reform agenda has been significantly advanced and there is much promise in the SLTO model, there is a very real danger that the old lies of finance – that this time is different, that markets always clear and that markets are moral – will retain their power over the incredulous. Carney has warned that is essential that “to resist their siren calls, policymakers and market participants must bind ourselves to the mast. That means building institutional structures that make it harder to act on the lies.” There is little point, however, going into a storm on a boat not fit for purpose.

FCA’s Controversial Enforcement Model

As seen in the last post, Christian Bittar, the former Deutsche Bank money markets derivates manager who was sacked in 2011, has won his Tribunal case – reported as Bittar v FCA [2015] UKUT 602 (TCC) (10 November 2015) – against the FCA for improperly identifying him in April’s historic benchmark manipulation settlement with American and British regulators which left Deutsche Bank nursing fines totalling $2.5 billion.

Bittar has been privately warned by the FCA that it wants to fine him £10 million for benchmark rigging, but he alleged that he was not provided the opportunity to make representations before the watchdog’s findings were published. He was identified in the FCA’s final notice as “Manager B” and in the US as “Trader 3”. As for the charges relating to fraud, it has been reported that Bittar’s lawyers have responded that the trader “intends to fully contest the criminal proceedings started today by the SFO.”

Bittar’s victory in the Upper Tribunal (before Judge Timothy Herrington and Sue Dale) is more than mere symbolism; it represents the industry’s larger right to make representations to clarify matters before information in relation to FCA probes is made available in the public domain. As in the case of Macris – which the FCA is appealing to the Supreme Court and in relation to which permission to appeal is pending – Bittar argued that whilst he was not expressly named in the final notice it was nevertheless possible to identify him. The Upper Tribunal concluded that the matters included in the Decision Notice identified Bittar in the relevant sense and manner and the preliminary issue was decided in his favour as provided for in section 394 of the Financial Services and Markets Act 2000 (FSMA).

As observed before on this blog, in FCA v Macris [2015] EWCA Civ 490, the issue before Longmore, Patten and Gloster LJJ was whether the FCA’s notices identified Achilles Macris for the purposes of section 393 of FSMA in which case the watchdog ought to have given him third party rights. The Court of Appeal held that Macris had been identified by the FCA and should have been given the right to make representations on certain matters set out in the final notice. The case is significant as the notices identifying Macris were connected to the “London Whale” trades by virtue of which the notorious trader Bruno Iksil caused losses of $6.2 billion (translating to £51 billion in shareholder value). Notably, Iksil has been let of the hook because the FCA ultimately decided to climb down on its efforts to bring him to justice – but only after a costly three-year investigation – because the Regulatory Decisions Committee found that the watchdog did not have a good enough case and it decided not to take any further action.

Moreover, in Ashton v FCA [2015] UKUT 569 (TCC) (21 October 2015), a former Barclays trader called Chris Aston who became embroiled in the rigging of foreign exchange benchmarks because of being a part of “the cartel”, won a preliminary legal battle and will therefore be able to use evidence from the FCA’s conclusions in its forex investigations against Barclays and UBS. Yet again, the FCA was accused of abandoning normal investigative procedures and of not seeking the identified individual’s input on the evidence against him/her. As in the cases of Macris and Bittar, the point that the FCA improperly identified and besmirched individuals – while disciplining firms such as Barclays and UBS for manipulating the $5.3 trillion-a-day forex markets is also at play in the Ashton case and these cases militate a critical rethink of the manner in which the FCA conducts its investigations and publicises its findings. Overall, such retrograde behaviour by the regulator has profound implications for those – such as former forex traders – confronted by civil and criminal probes in Britain and America.

Winning the Global Race?

Sir Hector Sants, the CEO of the FCA’s predecessor FSA who stepped down in June 2012 and now works for Oliver Wyman, only recently recommended divesting the FCA of its penalty imposing powers as part of an overhaul of the regulatory system so as to restore confidence in the UK’s competitive edge which had worn thin under the ousted Martin Wheatley’s “shoot first and ask questions later” (see here) model of regulatory action. Sants’s approach can be questioned in light of The Review into the failure of HBOS Group because, positioned at the other extreme of the spectrum, he seems to have embraced a pacifist approach to regulation and in his Report into the FSA’s enforcement actions following the failure of HBOS Andrew Green QC found it surprising that Sants was clueless to the FSA’s failures, in particular that there was “inadequate communication between him and enforcement.”

Other officials such as John Tiner (FSA Chief Executive, 2003-2007) are said to have designed an “insufficient approach to supervision”; Sir Callum McCarthy (Chairman FSA, 2003-2008) insufficiently oversaw FCA executives and “was too trusting of firms’ management and insufficiently challenging”; Margret Cole (who headed enforcement from 2005-2012) is said to have engaged in “highly unsatisfactory” decision-making and indulged in a “misguided approach”, she is accused of having a lax attitude to things. The Review found that Cole’s soft touch to supervision was “insufficient” because she veered off the regulatory track toward the view that only strongly actionable cases – or those with very high prospects of success – merited investigation and enforcement action. In their roles as “sleeping policemen”, individuals such as Sants, Tiner, McCarthy and Cole appear to be highly culpable in manifesting unmitigated negligence rather than doing their legal duty to the public. The dominant culture of shirking responsibility in regulatory circles is recorded in an enforcement manager’s remarks to Green that “enforcement against big bankers had become virtually impossible.”

Nonetheless, despite his failures as an official, in light of the analysis advanced by Sants, the chancellor’s contentions about the efficacy of the global fines leaves a lot to be desired. In a report for the British Bankers’ Association entitled Winning the Global Race, outlining the key threats to the competitiveness of the UK as a centre for wholesale and international banking, Sants has made 23 recommendations in aid of preserving the UK’s significance in the banking industry. Indeed, he said in unambiguous terms that the government should:

consider separation of responsibility for redress from current FCA mandate to a new independent body.

The report is clear that banking is the world’s most mobile industry. Indeed, in light of this fact Sants suggests urgent action to save the situation in order to ensure that the UK remains a global leader in banking and the allure of the City for the international banks is not hampered by regulatory red tape.

As highlighted above, the Winning the Global Race report is emphatic that the banking and financial services sector makes a significant contribution to the economy, in particular:

  • Financial services as a whole remains the biggest export industry and the largest contributor to the UK’s balance of payments, accounting for 45% of total surplus in services. The UK exports £62 billion of financial services annually, making it one of the world’s biggest net exporters of financial services.
  • The banking sector contributes almost 5% of the UK’s Gross Value Added (GVA), employs more than 405,000 people and contributed £31 billion in tax in 2014
  • The UK banking sector is the third largest globally, with £4.5 trillion of international banking assets in total as of 2014.
  • International banks are responsible for more than 50% of the industry’s UK GVA contribution, more than 30 per cent of its employees and over 50% of UK banking tax receipts are from international banks.

On the other hand, the report points out a number of trends which are a clear source of concern:

  • There has been an 8% fall in employment in the UK banking sector since 2011.
  • There has been a 12% reduction in assets in the UK banking sector since 2011. Meanwhile banking assets have grown in the US (+12%), Hong Kong (+34%) and Singapore (+24%).
  • Return on equity for the wholesale industry has dropped from an average 18% per annum in 2000-06, to 10% between 2011-14, and is estimated to fall a further 3.5% by 2017.
  • In activities linked to capital formation like cross-border lending and initial public offerings of equity, the market share of the UK is static or falling.

In addition to the above four FSA officials named above, eight prominent bankers involved with HBOS are caught by The Review; these individuals are James Crosby, Andy Hornby, Lord Stevenson, Colin Matthew, Lindsay Mackay, Mike Ellis, Phil Hodkinson and Peter Cummings. The press has unsurprisingly characterised these 12 individuals, i.e. the four regulators and the eight bankers, as the “dirty dozen”. The result of the long-awaited report on HBOS is that regulators will analyse the whether or not enforcement proceedings pursued against the faltering management “as early as possible next year” because the initial decision to let them off the hook was found to be “materially flawed”. The consideration of whether or not grounds exist to strike off the executives involved from holding directorships of any UK business now lies with the business secretary Sajid Javid.


The above situation is all the more interesting in light of the fact that the head of the Prudential Regulation Authority (PRA) Andrew Bailey has told MPs that any attempts to sidestep the ring-fencing requirements (for banks holding deposits of more than £25 billion) under the Financial Services (Banking Reform) Act 2013, which come into force in 2019 and implement the recommendations made by the Vickers Review, will not be overlooked or watered down to suit the banks.

By definition “ring-fencing” refers to the mechanism that is designed to avoid further bank bailouts by the taxpayer such as the rescue of the HBOS and RBS subsequent to the onset of the GFC in 2008, which cost the taxpayer £50 billion. Pointing out that the initial regulatory response to RBS was a 298-word press summary recommending no further action whereas the subsequent public outcry lead to the production of a full 450-page report in 2011, Andrew Tyrie MP – chairman of the Treasury Select Committee and the PCBS – said that the committee has been “instrumental” in delivering to the public the degree of transparency it deserves.

Tyrie is extremely keen to bridge the widening gap between public trust and the finance sector. Barclays had reportedly intimated that it would move to a structure whereby its ring-fenced retail bank would become the group’s wholly owned subsidiary. Overhauling the group to match the needs of the day naturally involve trimming down the struggling investment banking arm in order to ease into the onerous ring-fencing rules entering into force in a few years. Under Part 1, sections 1 to 12, the 2013 Act addresses the ring-fencing requirements. In particular section 1 stipulates that the PRA must ensure, that while acting in relation to ring-fencing matters, to further its general objective of promoting the safety and soundness of authorised persons by exercising its functions so as to protect the continuity of core services.

Bailey also advised banks to desist from using the media as a conduit to lobby the PRA on regulatory issues such as ring-fencing; in his evidence, he said to the Treasury Select Committee that tactics used by banks relying on press pressure do “not go down well” with the PRA, the body in charge of supervising the ring fence, which he described as “approachable”. These remarks were made in close proximity to the comments made against the “too big to fail” syndrome by Andrew Tyrie MP that regulators such as Bailey and his PRA should break up banks by force in the event banks try to meander their way around the ring-fencing rules (which the PCBS endorsed in its final findings published in mid-2013). Eager to breathe new life into public confidence in banking, Tyrie has also been demanding real-time action for misconduct and wants regulators to decide on new bans in relation to HBOS “in months, not years”; he also wants its auditors KPMG investigated further.

Of course, O’Brien, Gilligan, Roberts and McCormick note in their paper that the PCBS recorded significant deficits in ethics and pondered whether the void could be filled by an influx of professional norms. They highlight that the PCBS found major problems and went on conclude that the banking world:

is a long way from being an industry where professional duties to customers, and to the integrity of the profession as a whole, trump an individual’s own behavioural incentives.

For the PCBS, fivefold failures in ethical standards meant that that the creation of a professional body was at least a generation away but that the possibility for the industry to set out a series of milestones (developed further in the FEMR) showing commitment to preserving professional standards was not entirely foreclosed. In the round, the authors identify crucial failures in the FICC Markets Standards Board championed by Carney because it fails to “envisage a role for itself in disciplinary procedures in the event of breaches of codes of conduct.” In the final analysis, as Calvin Benedict has convincingly argued in an excellent recent paper entitled Developments in Sustainability Accounting: The trade-offs in “Conduct Costs” Reporting:

For real markets to maintain their social licence, it is crucial that private market participants (including banks and stakeholders) and public authorities collectively act to countervail the overshadowing of an ethical malaise and lapses in banking standards.



One response

29 12 2015
Tom Hayes: LIBOR Fraudster’s Sentence Reduced, But Conviction Upheld | Global Corporate Law

[…] of the Treasury Select Committee Andrew Tyrie MP, has urged an investigation of KPMG’s audit of HBOS because it audited the bank before its failure in 2008 but decided not to investigate the banking […]

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