New U.S. enforcements show move away from industry-wide "global" settlements

Enforcement cases against Standard Chartered for sanctions evasion and Barclays for Libor reference-rate manipulation reflect a new go-it-alone stance by regulators who are no longer waiting for industry-wide settlements or agreement by multiple agencies.

Such a shift may prevent individual firms from hiding behind a collective “everyone was doing it” view, and gives regulators more leverage to settle separately with different banks and impose higher sanctions and fines on some.

The Libor and sanctions-evasion enforcements were accompanied by the airing of damaging emails and phone transcripts provided by the firms who were cooperating with regulators. The documents can cause more reputational damage than just a fine, and be used to build civil lawsuits against the firm. Fear of such exposure couldor be an obstacle to cooperation by firms in future cases.

A shift away from group settlements means regulators may have to pick their battles more carefully, especially if firms become less likely to cooperate. With limited resources, multiple trials or rounds of individual settlement talks would stretch authorities' ability to take action against all firms that may have participated.

Prior industry "global" settlements

The group approach was used in the equity research global settlement led by New York Attorney General Elliott Spitzer, the Securities and Exchange Commission, and 10 banks. The 2003 settlement required payments of $1.4 billion payments, the highest of which was $400 million from Citigroup. It imposed new practices on relationships between investment banking and equity-research departments, including their physical separation to prevent flows of privileged information.

The standards initially applied only to the 10 firms, but they were later largely incorporated into Financial Industry Regulatory Authority rules that apply to all broker dealers. However, the settlement terms had limited duration, and some rules have since been revised, and superseded. The 2012 JOBS Act requires that SEC rules should not restrict communications by a broker-dealer’s analyst with a potential investor in an initial share offering of a firm under a certain size threshold, or “emerging-growth company.”

The same industry model was also used in a settlement among the Department of Justice and 49 state attorneys general against five major banks, over mortgage foreclosure abuses. The 2012 settlement for $25 billion requires bank payments to borrowers that had been foreclosed on, with over $20 billion in consumer relief. The agreement also contains standards that servicers must comply with for their mortgage-servicing and foreclosure practices.

The settlement gave federal and state authorities a large dollar headline, coming after President Barack Obama had called for such measures in the State of the Union. The new Consumer Financial Protection Bureau in August proposed extending servicer standards broadly similar to the settlement to all banks. However, the settlement’s terms on prosecutions and principal reductions were not as tough as advocates, such as the New York attorney general, had sought.

Standard Chartered and money laundering

Last week, New York’s State Department of Financial Services (DFS) threatened Standard Chartered with a loss of its New York license and suspension of its dollar-clearing services. The department alleges the bank schemed with Iran and hid from regulators 60,000 transactions, worth $250 billion – charges the bank disputes. This the first time a major institution has been threatened with exclusion from U.S. markets by a regulator, let alone a state.

The action diverges from prior anti- money-laundering enforcements, where large banks had received hefty fines as part of a deferred prosecution agreement with the Department of Justice. Deferred actions expire if the bank has complied with improved AML practices, and even large dollar fines can be small relative to bank earnings.

In July, the Senate Permanent Subcommittee on Investigations issued a report finding that HSBC’s poor AML controls exposed the U.S. financial system to risk of money laundering, drug trafficking, and terrorist financing. The Senate committee recommended that the federal Office of the Comptroller of the Currency and other regulators adopt tougher responses to AML violations, and treat money laundering as a safety and soundness issue, not consumer compliance.

“By definition, any banking institution that engages in such conduct is unsafe and unsound,” concluded the order to Standard Chartered by the newly established New York financial services department. The agency’s first superintendent is Benjamin Lawsky, a former aide to Gov. Andrew Cuomo, who made the appointment. The agency supervises banks, insurers and consumer finance. Before his election, Cuomo was the New York Attorney General, following Spitzer, both of whom cultivated a reputation for tough oversight of Wall Street.

Standard Chartered was unprepared for the New York action, and said it was already discussing a compliance review with U.S. and New York state regulators and authorities.

“The Group is engaged in ongoing discussions with the relevant US agencies. Resolution of such matters normally proceeds through a coordinated approach by such agencies,” said Standard Chartered’s release. “The Group was therefore surprised to receive the order from the DFS, given that discussions with the agencies were ongoing. We intend to discuss these matters with the DFS and to contest their position.”

There were reports that other U.S federal regulators and UK agencies were kept in the dark about the New York agency's plans. The bank is now urgently seeking a negotiated fine with both New York and federal regulators, before its scheduled enforcement hearing on Wednesday with the DFS. The action reflects an industry preference for pursuing a multi-regulator settlement with fines, rather than any limitations on its business.

Libor and Barclays

Barclays is the first bank to settle charges of manipulation and false reporting of Libor, a global interbank lending reference rate. It agreed to pay a total of $452 million to the U.S. Justice Department, the Commodity Futures Trading Commission and to the UK Financial Services Authority. Regulators said that the penalty had been reduced to reflect Barclay’s early and meaningful cooperation in disclosing Libor conduct. The settlement requires its future submissions to be based on actual transactions, not influenced by conflicts.

The bank may have considered the settlement as concluding the matter with a routine, if sizeable, fine. Given the discount received for cooperation, its competitors could face larger penalties when they too agreed settlement terms. However, the fine turned out to have been only the start, and the public backlash against Barclays sparked by the action was unprecedented, compared to other enforcement actions against the industry.

Three top bank officials, the chief executive, chairman, and chief operating officer all resigned within days. There were hearings in the UK and U.S. legislatures, and the UK Treasury said authorities were exploring possible criminal investigations against individuals. An investigation of future Libor reforms is being led by Martin Wheatley of the FSA, who is also CEO-designate of the Financial Conduct Authority (FCA). A separate inquiry by the UK Parliament has also begun into the professional standards of the banking industry.

Barclay’s CEO in testimony tried to pin some blame on regulators, claiming a senior official at the Bank of England directed him to submit lower rates. This was denied by the regulator, which became caught in a pointing match with U.S. regulators, as to warnings received from the NY Fed and Treasury. This led the Fed and Bank of England to disclose emails on the issue, including Barclay’s traders admitting to actions.

Such cross-country disagreements between regulators may impact future communication or cooperation.

The CFTC obtained the highest ($200 million) fine from Barclays and drove the process. CFTC Chairman Gary Gensler said the agency began investigating interest-rate setting in 2008, due to questions about the decline of actual unsecured lending among banks, the basis of Libor. The Commodity Exchange Act prohibits attempts to manipulate and falsely report information affecting prices of a commodity, such as Libor on interest rates.

The high level of fines and severe impact on the bank came despite their cooperation, and heightens the risk to firms of providing assistance. This needs to be weighed against risks of higher sanctions for a firm that settles later than its peers after a protracted battle. The UK FSA fined Barclays a record $92 million, notably still less than half as much as CFTC, as officials claimed the bank had a culture of "gaming" them.

Unlike previous violations that involved a number of firms, no industry-wide Libor settlement appears to be on offer. Harsh consequences for Barclays and its chief executive are influencing the behavior of other banks. Some point to other firms as worse offenders, or that their CEOs were not specifically aware or involved. This scenario increases pressure on banks to cooperate with authorities, and point out violations by their own traders.

Firms need to factor in greater risks of document disclosure by whistleblowers. The SEC’s Sean McKessy, who heads a unit implementing Dodd-Frank whistleblower rules, said “our staff will be much better able to pursue an investigation of your tip if they have specific examples, details or transactions to examine.” The new UK FCA regulator stated it “is going to place a lot of emphasis on the data and other intelligence that we get in from the industry…as a key way to find out what’s happening to consumers and in the market.”

Higher penalties

The recent acquittal of Citigroup officer Brian Stoker for misleading investors in a collateralized debt obligation trade is instructive. While finding him innocent, the jury also sent a message that “this verdict should not deter the SEC from continuing to investigate the financial industry.” The jury foreman stated in an interview with the New York Times that he “wanted to know why the bank’s CEO was not on trial.” The bank had already settled charges with the SEC on the case last October, agreeing to pay $285 million in fines and restitution, without going to trial.

U.S. Judge Jed Rakoff had declined to approve Citi’s settlement with the SEC due to it being too small, and for it not requiring any admission of guilt. SEC Enforcement Director Robert Khuzami said Rakoff “committed legal error by announcing a new and unprecedented standard” for settlements, which could force it to go to trial more frequently. The SEC and the firm are seeking an appeals court review of the decision.

"The new standard adopted by the court could in practical terms press the SEC to trial in many more instances, said Khuzami. An admission of wrongdoing would also leave a bank open to paying out more in civil lawsuits that piggy-back on information published by the regulator. The expected fall in cooperation will “likely result in fewer cases overall and less money being returned to investors,” the SEC said.

Khuzami said $285 million was most of the recovery the SEC could have obtained at a trial, as “in a case like Citigroup, the applicable statute does not entitle the SEC to recover the amount lost by investors.” As well as recovering ill-gotten gains, the statute only allows a monetary penalty to the amount of a defendant’s gain.

A newly proposed bipartisan bill, the SEC Penalties Act, would increase the potential fines up to triple the amount made by the offender, and also apply for recidivists that have already been convicted by the SEC in the last five years.

“If a fine is just decimal dust for a Wall Street firm, that’s not a deterrent,” said Senator Charles Grassley, a sponsor of the bill that is supported by the SEC and administration. “It’s just the cost of doing business. A penalty should mean something, and it should get the recidivists’ attention.” If this bill passes, or Judge Rakoff’s decision stands on appeal, firms will likely be facing higher fines, or more trials, going forward.

“Public confidence was severely damaged not only by the financial crisis of 2008 but by the apparent lack of accountability in the aftermath of the crash,” said New York Attorney General Eric Schneiderman in July. He pointed to opinion polls showing only 18 percent of Americans have a lot of confidence in U.S. banks, an all-time low. Arrest of traders or executives for Libor manipulation would allow the Obama administration to point to tough actions, possibly in advance of the November election, that respond to public concerns.

All three banks exposed in the last 6 weeks, Barclays, Standard Chartered and HSBC are UK-based, and the lead authorities are American. The cases show that violation of U.S. regulations by banks with operations overseas cause as much risk as not complying with national rules and keeping the home regulator happy.