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.

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”.

Case Preview: FCA v Macris: FSMA and Third Party Rights

On 3 November 2015, a panel of Supreme Court justices consisting of Lord Neuberger (President), Lord Clarke, Lord Hodge granted permission to appeal in the case of Financial Conduct Authority (Appellant) v Macris (Respondent) Case No: UKSC 2015/0143. In proceedings reported as [2015] EWCA Civ 490, the Court of Appeal unanimously dismissed the FCA’s appeal against the decision of the Upper Tribunal, reported as [2014] UKUT B7 (TCC). Longmore, Patten and Gloster LJJ held that Mr Achilles Macris, a Greek and US citizen, was identified and should have been given the right to make representations on certain matters set out in the final notice. The issue thrown up by the case is whether the FCA’s notices identified Macris for the purposes of section 393 of the Financial Services and Markets Act 2000 (FSMA) in which case the watchdog ought to have given him third party rights. The third party procedure secures the fair treatment of the reputation of third parties so that they are not presumed guilty in the enforcement process. Developments in these proceedings are keenly monitored by those who contend that they have not been given a right of reply despite being identified in FCA notices.

As regards identification, on 18 September 2013 the FCA gave a Warning Notice, a Decision Notice, and a Final Notice to JPMorgan Chase Bank, N.A. (the firm). All the notices were in identical terms and on 19 September 2013 the Final Notice (the notice) was published. It informed the firm about the imposition of a financial penalty, or conduct costs, of £137.61 million which was settled under the FCA’s executive settlement procedures. The firm was penalised as a result of losses incurred in the “synthetic credit portfolio” (the portfolio) it managed for its owner JP Morgan Chase & Co (the group), a corporate entity branded – by Michael Lewis’ controversial bestseller Flashboys – as mostly “passive-aggressive” but occasionally “simply aggressive”. The portfolio’s trading related to credit instruments, especially credit default swap indices. The firm is a wholly owned subsidiary of the group.

Narratives of Misconduct: Emerging Trends in the Finance Sector

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.

Conduct of Persons in Financial Services: Causing a Financial Institution to Fail

The Financial Services (Banking Reform) Act 2013 (the Act) is yet another Leviathan statute. The Act is spread out over eight parts encompassing one hundred and forty-eight sections and contains ten schedules. First of all, this wide-ranging legislation implements the recommendations of the Independent Commission on Banking (or ICB, chaired by Sir John Vickers). Equally, it also implements the recommendations of the Parliamentary Commission on Banking Standards (or PCBS, in relation to the LIBOR scandal) which aim to improve culture and standards in the banking sector. Moreover, under section 17, the Act also provides the Bank of England with the new stabilisation “bail-in option” under the Banking Act 2009. See updates here and here.

Independent Commission on Banking

In its final report, the ICB remarked that:

Banks are at the heart of the financial system and hence of the market economy. The opportunity must be seized to establish a much more secure foundation for the UK banking system of the future.

Recommending structural reform of the banking industry, coupled with measures designed to increase the capacity of banks to absorb losses, the ICB’s work focused on cost effective solutions as regards rescuing failing banks.

LIBOR: Misrepresentation and Amendment – Part I

Graiseley Properties Ltd & Ors v Barclays Bank Plc [2012] EWHC 3093 (Comm) (29 October 2012) also known as “Guardian Care Homes”.

The LIBOR scandal has added a fresh flavour to banking litigation in England and Wales and a handful of judgments, of which this was the first, have already been handed down. Apart from the fact that the decisions are published on BAILII, only scant Internet information is available on these interesting cases. Spread out over the next four posts, this LIBOR related miniseries sheds light on some of the decisions that the courts have made thus far. 

This widely anticipated LIBOR “test case” was initially scheduled for trial in the Commercial Court in October 2013. But because the Court of Appeal granted Barclays permission to appeal Mr Justice Flaux’s decision, it appears that the trial of the case in the High Court has been postponed until April 2014. Apparently, the quantum arising from this litigation is up to £37 million.

In this judgment, the Court held that, in the light of regulatory authorities’ findings of misconduct and wrongdoing on Barclays’ part in relation to LIBOR manipulation, Graiseley (G) was allowed to amend its claim for financial mis-selling against Barclays (B) to plead false and fraudulent implied representations made by B.

Roger McCormick On Sustainable Banking

Workshop on the Financial Sustainability of Banks, Speaker: Professor Roger McCormick (London School of Economics) Chair: Professor Emilios Avgouleas (University of Edinburgh) held at UCL Faculty of Laws, Bentham House, Endsleigh Gardens, WC1H 0EG on Feb 6, 2013. 

A league table of Bad Banks might lead to improvements in the ethics of Banking, argued LSE’s Professor Roger McCormick at a UCL’s Centre for Ethics and Law event on Sustainable Banking. He drew on evidence to the Banking Standards Committee criticising the idea that what Banks needed were more lawyers and compliance staff. Doubting the efficacy of Codes of Conduct, he advocated a focus on steps that might genuinely influence banking conduct. If it is the case that codes and process measures can simply be worked round and recognising that basic values may be important it was necessary to find other techniques. Structures played a role: Professor McCormick pointed to the de-federalisation of Barclay as a positive sign that the Bank might be taking control of the compliance and ethics problems it faced, with reporting lines direct into the CEO.

But there was a profound need to realign the interests of boards who had often not been informed of illegalities and other problems in their Companies.

FSA: LIBOR Internal Audit Report

Punishing banks – Barclays, UBS and RBS – by imposing fines against them for manipulated LIBOR submissions has been a vexing issue for the Financial Services Authority (FSA). After receiving its final notice, Barclays told the Treasury Committee (see Fixing LIBOR: some preliminary findings) that – in order to avoid negative media comment (lowballing) – the issue that firms were making inappropriate LIBOR submissions was raised with the FSA on 13 occasions. Noting media and academic concern, the Treasury Committee highlighted that:

44. Barclays’ continuing manipulation of its own LIBOR setting took place against a background of media concern about the LIBOR setting process during the [financial] crisis. On 25 September 2007, an article by Gillian Tett in the Financial Times entitled “LIBOR’s value called into question” noted the complaint of the Treasurer of one of the largest City banks that “The LIBOR rates are a bit of a fiction. The number on the screen doesn’t always match what we see now.”

45. On 16 April 2008, the Wall Street Journal published an article called “Bankers cast doubt on Key Rate amid crisis” by Carrick Mollenkamp. This noted that: “The concern: Some banks don’t want to report the high rates they’re paying for short-term loans because they don’t want to tip off the market that they’re desperate for cash. The LIBOR system depends on banks to tell the truth about their borrowing rates.

Public Law Duty and Cross-Undertaking for Losses to Third Parties

The Financial Services Authority (a company limited by guarantee) (Respondent) v Sinaloa Gold plc and others (Respondents) and Barclays Bank plc (Appellant) [2013] UKSC 11

Affirming the Court of Appeal’s decision reported at [2011] EWCA Civ 1158, see Patten LJ at [55], the Supreme Court has unanimously dismissed the appeal in this case. The court held that there is no general rule that an authority such as the Financial Services Authority (FSA), acting pursuant to a public law duty, should be required to give a cross-undertaking in respect of losses incurred by third parties. Equally, on the facts of this case, no particular circumstances existed whereby the FSA should be required to give such a cross-undertaking. For the full details of this case in the Court of Appeal and High Court (which held that the FSA was required to give a cross-undertaking in respect of losses incurred by third parties), the preview to this case is available here.

Just to recap briefly, cross-undertakings are a critical feature of a freezing (formerly Mareva) injunctions. Usually, applicants must give a cross-undertaking in damages to the court. This is to compensate respondents and any affected third parties in the event  the court decides that the applicant was not entitled to injunctive relief (a discretionary remedy). Where no cross-undertaking is given, the courts will refuse to grant an injunction. However, in situations where freezing injunctions are procured by public bodies (such as the FSA) pursuing law enforcement functions, the courts usually do not require such bodies to provide a cross-undertaking in damages to safeguard the respondent’s position. Lord Mance of Frognal gave the leading judgment and Lord Neuberger PSC, Lady Hale, Lord Clarke and Lord Sumption JJSC concurred with his Lordship.