Banking and Misconduct: A Critique of the Cure of Culture

28 03 2018

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. Read the rest of this entry »





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

21 03 2018

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. Read the rest of this entry »





King and Country: Reflections on the Costs of Market Misconduct

1 04 2016

Read as updated SSRN paper with reference to the Panama Papers. Because of the Budget 2016, the chancellor has been accused of “looking more like Gordon Brown as a purveyor of gimmicks.” In difficult times when calls for his scalp over the row regarding the budget seemed to have eclipsed everything else, the rare bit of good news for George Osborne is that he can use the opportunity provided by the threat of Brexit – “a leap in the dark” which may cost the UK £100 billion or 5 per cent of GDP and 950,000 jobs by 2020 – to camouflage and obfuscate the real problems of conduct in the world of economics and finance. On the other hand, in an important interview with Charles Moore the former Bank of England governor Mervyn King showed hallmark signs of euroscepticism and said the people need to make up their own minds about the upcoming referendum. King also warned that lenders have not stopped taking excessive risks with savers’ money and the result is “bankers have not learnt the lessons of the Great Crash”. Unsurprisingly, in his somewhat controversial new book The End of Alchemy he makes the case against financial sorcery by arguing that it must be squeezed out of the world’s banking system. Perhaps, such failings are amplified further because “financial crises are a fact of life” and we are “moving into a rerun of the credit crunch”. Indeed, Lord King calls banks “the Achilles heel of capitalism.”

Below I sketch important/emerging issues in the intersecting themes of economics, law and misconduct as seen in the media, especially through the lens of “conduct costs” – some other themes are also explored. Mentioning Walter Bagehot and his classic text Lombard Street, which argued that the BoE should provide short-term financial support in times of crisis, King advises us that the old “lender of last resort” model (LOLR) is in need of revision because “banking has changed almost out of recognition since Bagehot’s time.” The former governor argues that the time has come to replace LOLR with the pawnbroker for all seasons (PFAS) system. For him, it is time for financial institutions to drop LOLR and embrace PFAS and be prepared to advance funds to just about anyone who has sufficient collateral. “The essential problem with the traditional LOLR,” argues King “is that in the presence of alchemy, the only way to provide sufficient liquidity in a crisis is to lend against bad collateral – at inadequate haircuts and low or zero penalty rates.” Read the rest of this entry »





Navinder Sarao: ‘Flash Crash’ Trader’s Extradition Request Upheld

28 03 2016

The Government of the United States of America v Navinder Singh Sarao (23 March 2016)

The case of Nav Sarao, the “hound of Hounslow” who faces a potential sentence of 380 years’ imprisonment on 22 counts in the US, has inflamed emotions and commentators have expressed extreme sympathy with the rogue trader who is considered to be the main culprit behind the “flash crash” of 6 May 2010. The disproportionate nature of his predicament is clearly illustrated by the fact that if extradited and punished in America, Sarao may well receive a harsher sentence than Serbian war criminal Radovan Karadic who got 40 years for crimes against humanity and genocide but will enjoy the right to a lengthy appeals process. It has been argued that Sarao had to be caged because he discovered a way to beat the HFTs at their own game. At the time of his arrest, senior traders even made public statements about footing his legal bill. Seldom has a corporate crime case aroused such a passionate response. Fellow traders dubbed Sarao “our spoofing hero” and the case against him was labelled “ridiculous”. Yet in the Westminster magistrates’ court judge Quentin Purdy disagreed and found that Sarao was extraditable to the US on the charges levelled against him. On the other hand, in making factual findings in the case, judge Purdy found that the downturn in the market was not attributable to a single event and the cause of the flash crash “cannot on any view be laid wholly or mostly at Navinder Sarao’s door” because even though he was active on 6 May 2010 the date “is only a single trading day in over 400 relied upon by the prosecution.”

Against this, the Commodities Trading Futures Commission accuses the Brit of exacerbating the flash crash and claims he “was at least significantly responsible for the order imbalances” in the derivatives market which affected stock markets to make matters worse on the day. The judge found that if found guilty of market abuse under UK law, Sarao’s activity would result in a sentence of 12 months’ imprisonment being imposed on him and so the dual criminality test in section 137 of the Extradition Act 2003 was satisfied. He also stressed the importance of the public interest in upholding the controversial UK-US Extradition Treaty. Sarao is accused of engaging in a ferocious campaign to manipulate the price of the E-mini S&P 500 on the Chicago Mercantile Exchange by relying on a variety of exceptionally large, aggressive and persistent spoofing tactics. Read the rest of this entry »





Benchmark Manipulation and Corporate Crime: Insights on Financial Misconduct

22 03 2016

In the second innings things were different. The reverse swinging old ball meant that the Serious Fraud Office’s openers came back to the pavilion with a duck and those charged with misconduct and put in the dock began to eye up the opportunity of scoring a hat trick. Coupled with the reduction in Hayes’s sentence by the Court of Appeal (Lord Thomas of Cwmgiedd CJ, Sir Brian Leveson PQBD and Gloster LJ, see here) on the ground that he was not in a managerial position and suffered from autism, the fact that Darrell Read, Danny Wilkinson and Colin Goodman, Noel Cryan, Jim Gilmour and Terry Farr were found not guilty of LIBOR manipulation casts doubt over future successful prosecutions in benchmark rigging cases. Hamblen J directed the jury to convict the brokers if they had played a “significant” role in helping him rig LIBOR. Apparently they had not. The Court of Appeal’s refusal to grant Hayes permission to appeal to the Supreme Court may provide limited comfort to the SFO but the acquittal of the above brokers charged in the second “sham” LIBOR trial has reversed the momentum gained by the authorities. The brokers’ exoneration exposes the SFO to the accusation that it has been wildly swinging a sledgehammer to smash a nut. So, having tasted blood after Tom Hayes’s conviction, taking a gung-ho approach to weeding out the City’s “bad apples” seems to have backfired because the clever brokers had simply let Hayes believe whatever he wanted.

According to the brokers, the SFO “didn’t investigate it properly and didn’t listen”. Despite big increases to its funding, claims that the SFO’s director David Green QC has overseen a “string of successes” and that the extension of his contract for two years is a “boon” for justice are proving to be totally without merit. These days it is the SFO which is in the dock and Tom Hayes’s tormented father Nick Hayes used the opportunity to defend his son and said: “Today Tom Hayes stands tall. He refused to testify versus the LIBOR brokers and paid the price … I’m proud of him.” Of course, measured against such poor performance, the fact that the embattled agency wants a top-up of £21.5 million in emergency funds for “blockbuster” probes to bolster its dwindling fortunes amounts to expecting rewards for failure; it is completely unjustified. Read the rest of this entry »





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

17 12 2015

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. Read the rest of this entry »





SFO v Standard Bank: First UK Deferred Prosecution Agreement

7 12 2015

The director of the Serious Fraud Office (SFO), David Green QC, has overseen a turnaround in the ailing agency’s fortunes. Green is reportedly paid £175,000 annually and the press suggests he is likely to continue his role for another two years after his four-year term expires in April 2016. With successes such as the conviction of benchmark fraudster Tom Hayes (presently jailed in Lowdham Grange Prison) already under his belt, Green has his sights set on securing further convictions in other ongoing benchmark prosecutions. In Hayes’s appeal, Sir John Thomas LCJ has directed that a medical report should be filed by 9 December 2015. Hayes argued the Nuremberg defence and said that he was merely following orders. But he failed miserably in winning the jury’s sympathy and is a broken man. He suffers from Asperger’s syndrome and attention deficit hyperactivity disorder but that did not stop Sir Jeremy Cooke from sentencing him to 14 years’ imprisonment for his fraudulent ways. Of course, only recently the SFO also secured the UK’s first deferred prosecution agreement (DPA). In SFO v Standard Bank Plc, the president of the Queen’s Bench Division, Sir Brain Leveson approved the UK’s first DPA in a bribery case connected to a £397/$600 million sovereign note deal involving Tanzania.

Two things stand out about this case. It is the first example of a UK prosecutor entering into a DPA or a “plea deal”. Moreover, the situation was equally novel because it was the very first time that the offence of failing to prevent bribery – under section 7 of the Bribery Act – was used since its introduction in 2010. The government considers DPAs as a new and important enforcement tool to deal with corporate economic crime. DPAs came into existence in the UK by virtue of section 45 and schedule 17 of the Crime and Courts Act 2013. The present case turned on the Tanzanian government’s wish to raise funds by way of a sovereign note private placement. The bribe took place when, in March 2013, Standard Bank’s former sister firm Stanbic Bank Tanzania paid £4/$6 million to Enterprise Growth Market Advisers (EGMA). The SFO contended that the improper payment’s purpose was to induce a representative of the Tanzanian government to favour Standard Bank and Stanbic’s proposal for the sovereign note deal. Stanbic and Standard Bank shared the transaction fees of £5.6/$8.4 million that were generated by the placement. Read the rest of this entry »