Banking and Misconduct: A Critique of the Cure of Culture

Strangely enough, after controversially abandoning a long-awaited revolutionary review of culture in banking, the FCA has started to invoke the mantra of culture yet again. In that regard, Transforming culture in financial services DP18/2 advocates a pressing need for financial firms to clean up their act because cultural complications have been “a key root cause of the major conduct failings that have occurred within the industry in recent history.” Being prescriptive about the panacea of culture is quite an odd thing for the FCA to indulge in yet again. Worse still, the idea that a wider culture is to blame makes a mockery of individual culpability and provokes irresponsibility. The approach is misconceived and fundamentally flawed. Jonathan Davidson, the FCA’s director of supervision, predicts at the outset of the discussion paper that organisational and societal change cannot be brought about by a “quick fix” because of “the complexity of human dynamics.” Events demonstrate that the FCA is in denial about the reality of things. Blaming bad culture has failed as a defence for many people such as Tom Hayes, Jonathan Mathew, Jay Merchant and Alex Pabon who were prosecuted and jailed for benchmark rigging. The FCA’s latest theory is that culture is manageable despite being immeasurable. On any view, this is a fallacious argument because the calculus of culture is not only measurable but has already been clearly recorded as conduct costs, £264 billion between 2012-2016, by the CCP Research Foundation. The systematic arrangement and coding of these costs shows that bad culture and culpability can be readily measured.

Generally, one can only agree with the practical effect of many a cultural mission statement, when everyday conduct, ethics and accountability are what will truly drive good outcomes for customers and engender trust. No issue is taken here on the good work many of the banks are doing in this space. The conduct costs research was never intended to be a means by which to bluntly expose a bank’s conduct costs. Rather, it was to identify a proxy indicator of culture. CCP Research Foundation readily accepts the limitations of this metric. It would further accept that there are many initiatives, controls and/or mitigants that, if properly implemented, would act to promote good behaviour and outcomes for customers; as opposed to shining a light on misconduct post facto. The indirect effect of the capture (and publication) of a firm’s (and/or its peer’s) conduct costs on behaviour is clearly subordinate to such a priori measures. Aside from the lack of guidance and substantive discussion on how to effectively measure and manage common grey area conduct risk, the fact that the regulator is highlighting the culture issue again must, on its face, be applauded. Importantly, any criticisms voiced in this post are my personal views alone.

Court of Appeal Opens the Door to LIBOR and Benchmark Misrepresentation Claims

Property Alliance Group Ltd v The Royal Bank of Scotland Plc [2018] EWCA Civ 355 (02 March 2018)

Infamously, the London Inter-bank Offered Rate (LIBOR) used to be a code word for corruption in the world of finance. In more ways than one, it is still a dirty word from the point of view of ethics. However, even now, despite planning to phase it out by 2021 and replacing it with a proxy, the FCA calls LIBOR a “systemically important benchmark”. Property Alliance Group (PAG) appealed Asplin J’s decision to dismiss its claims against the Royal Bank of Scotland (RBS) arising out of interest rate swap agreements. RBS advanced funds to PAG at interest rates referenced to LIBOR, which was published relying upon submissions from panels of banks on borrowing rates. These proceedings arose out of four swaps that RBS sold to PAG between 2004 and the spring of 2008. The first swap had a trade date of 6 October 2004 and a notional amount of £10 million. The second swap had a trade date of 25 September 2007 and a notional amount of £15 million for 4 years and then £30 million for a further six years. The third swap had a trade date of 14 January 2008 and a notional amount of £20 million. The fourth swap had a trade date of 16 April 2008 and a notional amount of £15 million. The global financial crisis of 2007-2008 trigged a fall in interest rates. All the swaps were tied to 3 month GBP LIBOR which plummeted and stayed low. The upshot was that the rates of interest that PAG was paying under the swaps far exceeded what it was receiving under them.

One consequence of the prolonged period of unusually low interest rates was that the swaps had a very large negative market-to-market value (MTM) from PAG’s point of view. The break cost incurred by PAG in 2011 was correspondingly substantial. PAG issued proceedings in 2013 seeking relief by way of rescission of the swaps and/or damages. The claims were divided into three categories: “the swaps claims”, which involved allegations of misrepresentation, misstatement and breach of contract on the part of RBS in connection with its proposal and sale of the swaps to PAG; “the LIBOR claims” which rested on RBS’s knowledge of and participation in manipulation of LIBOR rates; and “the GRG claims” by which PAG complained of breaches of contract arising out of its transfer to, and subsequent management within the controversial Global Restructuring Group to which RBS transferred its relationship with PAG in 2010. Asplin J dismissed the claims in their entirety. However, despite dismissing the onward appeal, light of the circumstances Sir Terence Etherton MR, Longmore and Newey LJJ were satisfied that RBS did make some representation to the effect that RBS itself was not manipulating and did not intend to manipulate LIBOR.

Supreme Court: Equity’s Darling and Guidance on Enforceability of Trusts where the Institution is Unknown

Akers & Ors (Respondents) v Samba Financial Group (Appellant) [2017] UKSC 6 (1 February 2017)

In this appeal, Lords Neuberger, Mance, Sumption, Toulson and Collins unanimously held that a trust could be created, exist and be enforceable in relation to assets located in a jurisdiction where the law did not recognise trusts in any form. Many of the issues in earlier proceedings fell away. But nonetheless, because of the shifting focus of submissions, Lord Mance prefaced his lead judgment by describing the issues as “novel and difficult”. Proceedings were brought against Samba Financial Group (Samba) by Saad Investments Co Ltd (SICL) and its Joint Official Liquidators (the liquidators) who were appointed in winding up proceedings in the Cayman Islands which were subsequently recognised in England as a foreign main insolvency proceeding under the Cross-Border Insolvency Regulations 2006. Samba sought to stay the claim on the ground that rather than England “there exists another forum [i.e. Saudi Arabia] which is clearly and distinctly more appropriate”. Over the course of time, the ground morphed into the argument that SICL’s claim had no prospect of success and the case proceeded in the Supreme Court on that basis. Similarly, the appeal was presented to the justices on certain assumed facts. Shares valued at approximately $318m in various Saudi Arabian banks were held by Mr Al-Sanea (AS) on trust for SICL which went into liquidation by virtue of which Mr Stephen John Akers came to be one of its liquidators.

AS was the registered owner of the shares in the Saudi Arabian Securities Depositary Centre and SICL claimed that he had agreed to hold these Saudi Arabian shares at all material times on trust. Six weeks after the liquidation, in a series of six transactions, the shares were transferred by AS to Samba to discharge personal liabilities he owed them. Two other assumptions were made. Firstly, that Cayman Islands law governed the trusts. And secondly that the law of Saudi Arabia, the “lex situs” of the shares, does not recognise the institution of trust or a division between legal and proprietary interests. Saudi Arabian law does, however, recognise the institution of amaana – a kind of bailment construable as a trust – but its precise effects remained unexplored in evidence. Relying on section 127 (avoidance of property dispositions, etc) of the Insolvency Act 1986, SICL and the liquidators argued that the transfers of shares were and are void as a result of the “disposition of the company’s property … made after the commencement of the winding up”. The English law doctrine of “equity’s darling” is missing from other jurisdictions where a transfer to a third party might override beneficiaries’ rights, possibly overlooking any equitable interest at all.

Conduct Costs on the Rise (2012-2016): No End in Sight

The latest findings on misconduct in financial services reveal an upward trend in conduct costs. During the five-year period 2012-2016, the world’s 20 leading banks have paid £264bn for bad behaviour. This represents an increase of 32pc on the period 2008-12. A worrying aspect of adverse bank behaviour is reflected in the uninhibited expansion of conduct cost provisioning. The key question, explains Chris Stears, relates to the average level at which these costs will settle. “We find ourselves wondering when, if ever, the level of conduct costs will start to decrease,” is how Roger McCormick puts it five years after publishing the first league table for international bank fines. These concerns can only be magnified by new developments such as the Royal Bank of Scotland’s recent $5.5bn settlement with the Federal Housing Finance Agency to resolve toxic mortgage claims in relation to the lender’s issuance and underwriting of approximately $32bn of residential mortgage-backed securities in America. Equally, the fact that the US Federal Deposit Insurance Corporation is suing major British banks for $400bn cannot possibly alleviate people’s worries or instil confidence in banking institutions. Brought on behalf of 39 rescued American banks, the US government’s claim in London relates to LIBOR “lowballing” and the defendants include household names such as such as Barclays, Lloyds Banking Group and Royal Bank of Scotland. Even partial success in a claim of this nature could radically enhance the present level of conduct costs.

But still all this is only the gentle way in punishment. Conversely, the Qatari crisis that has hit Barclays may well trigger the beginning of the end for high-powered management personnel who have thus far generally enjoyed immunity from criminal justice. Ongoing fraud investigations against Barclays and John Varley (former CEO), Roger Jenkins (former Executive Chairman) and Richard Boath (former European Head) must have sent shockwaves through out the banking industry. The trio’s trial will undoubtedly be a closely watched and studied event and if they are convicted the game-changing Qatari fiasco shall define things for future times. The US authorities have also charged two managers from Société Générale, for participation in a scheme to rig US dollar LIBOR. Danielle Sindzingre and Muriel Bescond boosted Société Générale’s creditworthiness by submitting false information in relation to the rates at which the bank would be able to borrow money. As we already know the “numbers tell a story” and since the risks are very great “in the case of bank behaviour, they speak louder than words, and they tell a big, and scandalous, story.”

FSMA and Third Party Rights: Victory for FCA in Supreme Court

Financial Conduct Authority (Appellant) v Macris (Respondent) [2017] UKSC 19 (22 March 2017)

The FCA emerged triumphant in this appeal and the outcome has altered the fortunes of persons regulated by the City watchdog. Reversing the Court of Appeal’s judgment, the Supreme Court held by majority that Mr Achilles Macris (M) had not been identified in the Final Notice given to JPMorgan Chase (JPMC). Accordingly, any “third party rights” under section 393 of the Financial Services and Markets Act 2000 (FSMA) were not engaged because the notice did not identify M when interpreted by information readily available in the public domain. Lord Sumption found the analogy with the law of defamation to be unhelpful. Lord Mance said that this was “a difficult case” and Lord Neuberger said it was “difficult to resolve” the meaning of the word “identifies” in section 393(1)(a) despite the provision being a “good example” of Parliament’s enactment of generally lucid statutory language. Lord Wilson entered a note of dissent and he would have dismissed the FCA’s appeal. In 2012, the Synthetic Credit Portfolio (SCP) operated by JPMC had lost $6.2bn because of the rogue “London Whale” trades. Because of the notorious losses the Final Notice entailed a financial penalty or “conduct costs” of £137.6m. Between 2012-2016 the world’s 20 foremost international banks paid a total of £264.03bn in conduct costs of which JPMC’s share was £33.64bn. As the head of the Chief Investment Office, which managed excess deposits including the portfolio comprising the SCP’s traded credit instruments, M’s functions as JPMC’s employee were “controlled functions” under section 59 of FSMA.

The losses were linked to high risk trading tactics, feeble management and failing to react to information alerting JPMC to the SCP’s problems. The appeal, explained Lord Sumption, turned on the meaning of “identifies” and on the meaning of the notice to which that word is being applied. The section 393 procedure aims to enable identified third parties, such as M, working in financial services firms to make representations to the regulator and take the matter to the Upper Tribunal (UT). Persons not party to regulatory settlement but discredited in enforcement notices are protected from unfair prejudice via the mechanism in section 393. A copy notice must be served to the third party but M was not given one. M had not been identified by name or job title but only as “CIO London management”. M argued that since he had already been identified by name in a US Senate Committee report on the SCP’s losses, the FCA notices enabled anyone to deduce the identity of the person known as “CIO London management”. M was not a party to the FCA’s settlement with JPMC. He was separately fined £762,900.

Andrew Bailey on the Death of LIBOR

The ailing LIBOR benchmark, underpinning $500-$800 trillion worth of financial contracts, has been in a state of malaise for many years. Despite the efforts of regulators to revive the sick scandal-ridden benchmark, which suffered from a series of problems related to cheating and misreporting, it is unsurprising that its slow death will finally come in about four years’ time. As the Chief Executive of the FCA Andrew Bailey recently explained the funeral is set for 2021. But some clearly want LIBOR to live longer. Bailey called LIBOR “a public good” but questioned its current usefulness. Among other things, LIBOR related misconduct resulted in civil claims and fines of £9 billion. And, of course, in the criminal context it resulted in “clustered criminality” of which convicted LIBOR rigger Tom Hayes is a prime example. Clustered criminality, which only reflects a very small part of the ills affecting financial services, is when there “is at least strong suspicion that a crime has been committed and although the culprits may not be immediately clear it seems likely that more than one person was involved.” A succinct account of bankers lying, cheating and colluding to rig LIBOR is found in The Fix where Liam Vaughan and Gavin Finch expose the ills gripping the financial world. Hayes, who operated as “Tommy Chocolate” in the midst of the financial crisis, worked in a culture where “your performance metric” is all about “the edge” and making “a bit more money” because that is “how you are judged”.

In The Spider Network, David Enrich tells the “wild story” of Hayes – who he dubs “a maths genius” – and the backstabbing banking mafia which operated a thoroughly crooked financial system. Breaking the silence in an exclusive interview with The Sunday Times, Hayes’s wife Sarah Tighe vowed to “never stop fighting for my autistic husband, the LIBOR fall guy”. Hayes, who achieved notoriety by miraculously dodging extradition to the US, was jailed for 14 years for fraud but his sentence was reduced to 11 years. Tighe is fighting for her husband’s release and said that she “went apeshit” when officials tried to seize her assets as well. Her morale will undoubtedly be strengthened by the news that former Rabobank traders Anthony Allen and Anthony Conti, who are both British and were convicted at first instance for rigging LIBOR, have had their convictions overturned by the US Court of Appeals for the Second Circuit in New York which found that constitutional rights against self-incrimination had been breached. Tom and Sarah will probably also find solace in the fact that the cycle of cheating was so extreme that even the Bank of England is now implicated in LIBOR manipulation.

Early Redemption of ‘Cocos’: Win for LBG in Supreme Court

BNY Mellon Corporate Trustee Services Ltd v LBG Capital No 1 Plc & Anor [2016] UKSC 29 (16 June 2016)

Almost like the British public on Brexit, the Supreme Court remained closely divided on the issue of whether the Court of Appeal erred in its construction of the terms of enhanced capital notes (ECNs) by relying on technical and specialist information as part of the factual matrix. Formally described as ECNs, the loan notes were contingent convertible securities (or “Cocos”). Lord Neuberger (with whom Lord Mance and Lord Toulson agreed) dismissed BNY Mellon’s appeal whereas Lord Sumption (with whom Lord Clarke agreed) would have done otherwise. As Lord Sumption said in his brief note of dissent, the case was “of considerable financial importance to the parties” but it raised “no questions of wider legal significance”. The outcome in the case is a major blow for investors (receiving up to 16pc interest) who had hoped that the court would not have held that the terms of the bonds (or ECNs) allowed Lloyds Banking Group (LBG) to redeem them early at face value. The High Court found in favour of the bondholders but the Court of Appeal reversed that decision, one that the Supreme Court has upheld: albeit not without doubts and dissent. Led by Mark Taber, the bondholders disputed that the ECNs had been disqualified as capital and resorted to litigation. A disgruntled Taber said that the division between the justices “raises massive issues over the role of the regulators”.

He is particularly aggrieved that the court’s judgment does not engage with the arguments aired about statutory requirements that bond prospectuses must be accurate and provide crystal clear information to investors so that they may make informed choices and decisions. Worse still Taber also complains that he lobbied the FCA’s new boss Andrew Bailey to make germane information – about the exact scope of the regulator and LBG’s knowledge about impending changes to capital requirements when the ECNs were issued – available to the court. But since his request was not granted, he argues that because the courts are not willing to intervene it must be the City regulator’s job to interpret the prospectuses. “I believe the changes they knew about, which were not disclosed in the ECN prospectus, meant that a capital disqualification event was a certainty at the time the ECNs were issued. If the court had been told this I think it would have made a difference,” is how Taber expressed his frustration with the situation. However, his claim appears to directly contradict even Lord Sumption’s dissenting judgment that despite its financial importance the appeal contained no legally significant questions of wider importance.

“Land Banks” and Collective Investment Schemes: Supreme Court on s.235, FSMA

Asset Land Investment Plc & Anor v The Financial Conduct Authority [2016] UKSC 17 (20 April 2016)

The Financial Conduct Authority is in the news a lot these days. Andrew Bailey has been handpicked to head the agency but the chancellor George Osborne has come under fire for making the appointment without conducting a formal interview, thereby sidestepping the two candidates (Tracey McDermott and Greg Medcraft from Down Under) formally on the shortlist. However, the beleaguered FCA chairman John Griffith-Jones agreed with outgoing chief executive McDermott and both of them were “happy” with the chancellor’s appointment of Bailey – a beefy looking BoE insider who impressively holds a doctorate in economic history. As seen in the last post, Panama has been in the news a lot. The FCA had originally given 20 banks until 15 April 2016 to report on the extent, if any, of their involvement and links with Mossack Fonseca or firms serviced by them. But now it warns that prosecutions over the Panama Papers are not clear-cut. According to Mark Steward, head of enforcement, the media frenzy is “quite different from prosecutions – the two don’t necessarily go together”. This case involved a Panamanian corporation called Asset LI Inc trading as Asset Land Investment plc against which the FCA brought proceedings for carrying on “regulated activities” without authorisation contrary to the general prohibition in section 19 of the Financial Services and Markets Act 2000. Schemes for investing in land with development potential are commonly known as “land banks” and the operation of such initiatives first came into the regulatory perimeter under section 11 of the PERG Manual of the FCA Handbook.  

In Financial Services Authority v Fradley [2005] EWCA Civ 1183, the Court of Appeal had described the drafting of section 235 (collective investment schemes) of FSMA as “open-textured” by virtue of which words such as “arrangements” and “property of any description” are to be given “a wide meaning”. Arden LJ found in Fradley that section 235 must not be construed so as to include matters which are not fairly within it because contravening section 19 may result in the commission of criminal offences, subject to section 23(3) of FSMA. Lord Carnwath of Notting Hill found her Ladyship’s approach to be “helpful guidance”. On the other hand, he remained cautious of drawing analogies from comparative Commonwealth legislation presented to the court – such as the Australian Corporations Act 2001 – on the ground that differences in drafting warranted keeping the discussion strictly within the boundaries of UK statutes and authorities. Like the first instance judge, the Supreme Court referred to the English and the Panamanian company indiscriminately as “Asset Land”.

Supreme Court on the ‘Houdini Taxpayer’

UBS AG & Deutsche Bank v Revenue and Customs [2016] UKSC 13 (9 March 2016)

As infamously explained by jailed fraudster Tom Hayes, UBS must be credited with issuing a “handbook” on rigging LIBOR. Doubling Hayes up, in the ongoing LIBOR trial, Jonathan Mathew, one of five charged Barclays traders, says that he was merely following orders and just did what his boss taught/told him to do. The five men say everyone in the big banks “knew LIBOR was rigged”. As seen in an earlier post, along with Barclays traders, Deutsche Bank traders are facing criminal charges for EURIBOR manipulation and proceedings are ongoing in the case of R v Christian Bittar & Ors – first appearances were made at Westminster Magistrates’ Court on 11 January 2016 and a mention hearing was held on 18 March 2016. Former Deutsche trader Martyn Dodgson has also been convicted for insider trading in Operation Tabernula. In the instant case, echoing Templeman LJ in W T Ramsay Ltd v Inland Revenue Comrs [1979] 1 WLR 974, Lord Reed described UBS and Deutsche Bank’s behaviour as “the most sophisticated attempts of the Houdini taxpayer to escape from the manacles of tax.” The banks, which Lord King calls “the Achilles heel of capitalism”, may be disappointed with the Supreme Court’s ruling but most people will only be too delighted that top executives should become acquainted with some degree of retributive justice. The dry issue of tax is a hot political topic these days and the Panama Papers (see here) culminated in calls for the prime minister to resign for being a hypocrite.

Though this post is about the Supreme Court’s judgment, I use the opportunity to discursively expose other important tax issues reported in the media. Of course, Deutsche Bank announced last October that it would axe 9,000 full-time jobs and it has just recent lost its global position as a top-three investment bank. Research from Coalition, that ranks global investment banks by total revenue from fees and trading, shows that Citigroup and Bank of America are ahead of Deutsche Bank. JPMorgan Chase and Goldman Sachs retained their positions in first and second place respectively. Tim Wallace writes in today’s The Sunday Telegraph that once a cash cow, investment banking is now is serious crisis and jobs and pay across the sector has declined. It is a vicious cycle and the following insightful analogy is invoked “shrinking an investment bank is hard. It is like unravelling a jumper – once you start pulling on the thread it is hard to stop … then all of a sudden, you haven’t got a jumper at all.”

Catalyst for Change: Towards a Model of Conduct Costs in Pakistan

Reposted from the Conduct Costs Pakistan Blog which I have recently started. As measured by the CCP Research Foundation, in the aftermath of the collapse of Lehman Brothers seven years ago, global “conduct costs” are approaching stratospheric levels and are presently estimated to be $300 billion. But none of the data reflected in the final sum can be traced to Pakistan – a market economy whose legal system closely resembles the English legal system, despite the politically retrograde Islamisation of the 1980s – in clear and unambiguous terms. This blog is written with the ambition of articulating a conduct costs’ model in Pakistan, a developing country which is in need of such analysis so that its 192 million people are put in a position to make informed choices about banking and financial services.

In constitutional terms, a sound basis for the study of conduct costs can be found in Articles 37 and 38 of the Constitution of Pakistan 1973. Laid down in Part II: Fundamental Rights and Principles of Policy, Chapter 2: Principles of Policy of the Constitution, Article 37 requires the state to promote social justice and Article 38 imposes on the state a duty to promote the people’s social and economic well-being. On an alternative level, in The End of Alchemy, Professor Mervyn King relies on all his experience as a central banker to explain the wider dynamics of the global economy. He invites us to embrace the underlying theoretical argument that banks are “the Achilles heel of capitalism”. This attractive proposition is as advantageous a place to begin a study of the banks in Pakistan as it is in the west.