Habib Bank Expelled From New York

The case of the Bank of Credit and Commerce International (BCCI), which had fairy tale beginnings and patronage from the ruler of Dubai, is a historic example of a global private Pakistani bank that was shut down because of large-scale financial crime and money laundering. BCCI gave other lenders “bad vibes” and quickly acquired the nickname “the bank of Crooks and Criminals”. The closure of BCCI gave rise to the most costly and extravagant litigation in a generation. Indeed, as the late Lord Bingham discerned, investigating BCCI’s global malpractice “if a possible task, is one which would take many years to carry out”. Now the story seems to be repeating itself with Habib Bank – Pakistan’s largest bank headquartered in Karachi with $24bn worth of balance sheet assets and $1bn in annual revenue – which has been fined $225m because its New York branch failed to comply with New York laws and regulations designed to combat money laundering, terrorist financing, and other illicit financial transactions. Compliance failures were said to have “opened the door” to financing Saudi sponsored terrorism. Transactions were “batch waived” and management was unable to explain their actions. The news comes just days after the announcement that the Department of Financial Services (DFS) is seeking to enforce a civil monetary penalty of $629.625m on the bank. These enforcement actions by the DFS are a grim reminder of the poor culture plaguing banks and misconduct besetting financial institutions. DFS said it would not let the bank “sneak out” of the US without due accountability. In terms of culpability, the failures can be classified as “corporate integrity-related regulatory breach” and/or “imputed breach” events.

Because of significant weaknesses in the its risk management capabilities, the branch received the lowest possible rating of “5” in the latest compliance assessment conducted in 2016. The case for using conduct costs as a framework for analysing in the banking sector in Pakistan has already been articulated on this blog. If anything, the fines imposed by DFS certainly make Habib Bank the foremost – i.e. number “1” –financial institution for poor conduct in Pakistan itself. But of course it is equally true that Habib Bank’s delinquencies are surpassed by the toxic level of failings connected to the £264bn in conduct costs incurred by the world’s foremost international banks including Bank of America, JPMorgan Chase, Morgan Stanley, Lloyds Banking Group, Barclays, HSBC and so forth. As Lord King aptly puts it a decade after the global financial crisis: “Very smart people thought it was fun and completely acceptable to exploit less smart people.” The scale of poor conduct in the New York branch, which processed banking transactions worth a total of $287bn in 2015, raises serious questions about the state of affairs in the banking sector in Pakistan itself where corruption is widespread and regulation is diluted in comparison to the West.

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.

King and Country: Reflections on the Costs of Market Misconduct

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.”

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

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.

Benchmark Manipulation and Corporate Crime: Insights on Financial Misconduct

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.

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.

Hunter into Prey: City Watchdog Exposes its Achilles’ Heel – Part 2

The issues in the last post must be examined in light of the scandal which erupted in late 2014 when the FCA came under heavy fire from the Davis Report because of the highly irresponsible way in which it had leaked sensitive data to the media earlier in March that year. Simon Davis, a partner in the Magic Circle firm Clifford Chance, stressed that there had been nothing less than systemic failure. Davis was adamant that the FCA failed to address the issue of whether the information given out might be price sensitive. The conclusion was unsurprising because the leak culminated in an article in the Telegraph headlined Savers locked into ‘rip-off’ pensions and investments may be free to exit, regulators will say which claimed that the regulator was planning an investigation of 30 million pension policies, some sold as far back as the 1970s. Consequently, big insurance companies had billions wiped off their share prices. The misapprehension that selected annuity products would be picked out meant that major UK insurers saw their share prices plummet. The insurers called for Wheatley’s resignation. Even the Chancellor George Osborne bemoaned he was “profoundly concerned” by the episode. In his inquiry, Davis unearthed multiple failures symbolic of a dysfunctional organisation, and he emphasised that the regulator was “high-risk, poorly supervised and inadequately controlled.”

Davis – who was unsparing in his criticism – held the FCA’s Board responsible for the flaws in the regulator’s controls on the identification, control and release of price sensitive information. The buck ultimately stopped with the board because it “failed in its oversight of the FCA’s executive and … failed to identify the risks inherent in the FCA’s communications strategy.” The episode required urgent action and an external organisation needed to review the board’s practices and effectiveness. So serious were the mechanical failures of corporate governance of the City watchdog. To scotch the confusion, in light of public hearings that ensued, on 17 March 2015 the House of Commons Treasury Select Committee (the Treasury Committee) published Thirteenth Report (2014-2015): Press briefing of information in the Financial Conduct Authority’s 2014/15 Business Plan (HC881).