BNA INSIGHTS: 2012: Annus Horribilis for the Banking Industry
By Paul L. Lee, Debevoise & Plimpton LLP.
The year 2012 proved to be an annus horribilis for the banking industry at least from the perspective of regulatory and enforcement risk. Some might counter with the observation that 2012 was simply another annus horribilis in a series of such years for the banking industry. But by virtually any measure the horrors of 2012 exceed those of prior years. The regulatory and enforcement developments in 2012 prompt the question whether a permanently heightened regulatory and enforcement risk profile is now the new baseline for large banking institutions. This essay analyzes the most significant enforcement developments in 2012 and assesses the prospects for heightened scrutiny and increased enforcement action against the banking industry in 2013.
Unprecedented Enforcement Action
There is no precedent for the heightened regulatory and enforcement action seen in 2012. A faint precedent at best can be glimpsed from experience in the years following the dotcom crash and the Enron-like scandals. Under the title “Wall Street Fine Tracker,” Forbes tracked the fines paid by Wall Street firms from 2001 through 2003. It calculated the amount paid in total fines and settlements of class actions by Wall Street firms at almost $3 billion in 2002 and in excess of $4.2 billion in 2003. By contrast, the fines alone paid by UBS, HSBC and Standard Chartered Bank in the month of December 2012 exceeded $3.7 billion, including in the case of HSBC and UBS the two largest individual fines in U.S. banking history. Together with the fines paid earlier in 2012 by Standard Chartered Bank, Barclays and ING, the total for these five institutions exceeded $5.1 billion. Surveying the new enforcement scene, Adair Turner, chairman of the U.K. Financial Services Authority, is reported to have observed — in a private setting — that there is now an “arms race” among the regulators in pursuit of larger fines.
The Banking Industry as Public Enemy
The individual fines do not begin to tell the full story. They do not take account of the significant potential liability to private litigants, for example, in the LIBOR and other matters. Nor do they take account of the substantial reputational damage done to the institutions involved and the banking industry as a whole. In any event, fines do not appear to satisfy the public demand for retribution. The editorial pages of leading publications have for several years called for criminal prosecutions following the perceived misdeeds that led to the financial crisis. As the details of the LIBOR scandal emerged in June and July of 2012, such estimable publications as Bloomberg andThe New York Times encouraged the law enforcement authorities to seize the opportunity presented by these investigations to indict institutions and individuals at last. The announcement in December 2012 of the deferred prosecution agreement with HSBC for anti-money laundering and sanctions law violations resulted in press criticism of the fact that neither the institution nor any individuals were indicted. It also confirmed the suspicion in the mind of many observers that the regulators and law enforcement authorities view large financial institutions as “too big to indict.”
These criticisms may have been anticipated by the authorities because only a week after announcing the HSBC deferred prosecution agreement, the Department of Justice announced a settlement of LIBOR bid-rigging charges with UBS involving an agreement by a Japanese subsidiary of UBS to plea to a felony count as well as the criminal indictment of two former UBS traders. If the Department of Justice officials thought that the additional criminal action against the UBS subsidiary and former traders would go any distance to satisfy the critics, they were mistaken. The New York Times for one concluded that the settlement was structured so as to permit the plea by the subsidiary to shield the parent company and the indictment of the two traders to shield the management of the parent company. In some respects the Department of Justice may have become a victim of its own rhetoric. In announcing the settlement and the plea by the subsidiary, the Department described the UBS bid-rigging as an “epic” scandal. The New York Times editorial wanly concluded that there was nothing “epic” in the Department of Justice response. The equally esteemed Financial Times opined in words borrowed from the Department of Justice that the scale of UBS’s involvement in the bid-rigging was “astonishing” and in its own words that the bank’s “cavalier” attitude to compliance “simply beggars belief.”
There is no precedent for the heightened regulatory and enforcement action seen in 2012.
The public discourse over the banking industry has acquired a poisonous tone. It has admittedly been many decades since an observer would have presumed to suggest that it might be a wonderful life to be a banker — at least in the popular estimation. The opprobrium currently attached to Wall Street and the banking industry exceeds anything encountered since the time of the Great Depression. One does not require polling results to gauge the public distemper. A casual reading of reportage by the press and declamations by legislators in the U.S. and the U.K. indicates the anger and disdain directed at the financial sector. This anger was on prominent display during the U.S. Senate subcommittee hearing on HSBC and U.K. Parliamentary committee hearings on Barclays in July of 2012. These hearings can be seen in the most generous light as designed to seek truth, but certainly not reconciliation. A Parliamentary Commission has continued the quest in the New Year with hearings on the UBS involvement in the LIBOR bid-rigging scandal.
One may also question whether the press in its reporting and the legislators in their pronouncements simply reflect the public anger or actually amplify it. It is likely a bit of both. In any event it seems clear that the public outcry has influenced the approach of law enforcement and regulatory authorities to their LIBOR and other enforcement actions. When the New York Department of Financial Services pronounced Standard Chartered Bank a “rogue institution” in its August 2012 enforcement action, it merely borrowed a phrase used by a member of Parliament to describe Barclays during the Parliamentary committee hearings on the LIBOR scandal. The public anger from the financial collapse and the government financial assistance to the banking sector (to banks both large and small) is still strong and, if anything, will metastasize with each new hint of scandal in the banking sector. The Wall Street Journal editorial writers in fact suggest that the LIBOR scandal has become the regulators’ surrogate for all that supposedly went wrong in finance before the panic of 2008. It seems that through the inadvertence of some and the malfeasance of others, the banking sector has constituted itself a public enemy. All the current signs suggest that notwithstanding the doubts of The New York Times, this will bean epic period of regulatory and law enforcement action against the banking sector in terms of penalties and remediation requirements.
Governance Challenges in the New Enforcement Era
This new era of regulatory and law enforcement action in the banking sector presents significant new challenges for governance in the sector. There are several different perspectives that may be brought to bear on the problem of governance. The first and most obvious perspective is how more robust governance might reduce regulatory and enforcement risk at least for future activities. A related perspective is how more robust governance might help as well to manage the risks of legacy activities, as these risks are actualized through existing investigations and enforcement actions. The banking sector is already experiencing an explosion of liability, some actualized from regulatory fines and settlements of civil litigation, other still potential from pending regulatory and law enforcement investigations and civil litigation, from a wide range of historical business practices and activities. Many of the practices and activities have been changed or terminated, but the prospect of regulatory, law enforcement and civil litigation action against institutions for past practices and activities is substantial and a matter of concern to the market since the ultimate size of any actualized liability is difficult to project.
One additional perspective on governance may come from the analysis of how improved governance might have helped the institutions to identify the risks in their legacy practices and mitigate those risks at an earlier stage. The recent enforcement actions provide useful insights for this historical analysis. In some cases they indicate that an institution’s governance and control structure had simply not identified the risk. In other cases they indicate that the risk had been identified by a control function such as compliance but was not addressed because the business function overrode the control function. In still other cases they indicate that the business and control functions identified the risk and the need to change practices but lacked the resources or a sense of urgency to correct the practices. In the most extreme cases there is even the suggestion that senior business and control functions may have simply decided as a business matter that they would run the risk of liability. Regulators have long known that control functions in many institutions do not have a strong enough voice and can be easily overridden by the business managers. The regulators will find confirmation of this belief in virtually all of the recent enforcement actions and may find further reason to be concerned that in some cases senior management and control functions were complicit in, or turned a blind eye to, the activity.
The recent law enforcement actions suggest that there is still another perspective to be brought to governance of regulatory and compliance risks. The law enforcement and regulatory actions themselves have had a profound effect on governance, in the short-term leading to the replacement of senior management and board members and in the long-term leading to changes in governance structure and board responsibility. This analysis here partakes of an oscillating nature, alternating between the effects of governance on these risks and the effects of these risks (or more precisely, their actualization from enforcement and litigation actions) on governance. To put this idea in a more pointed way, one might contrast the aspirational effect that sound governance might have on mitigating regulatory and enforcement risk with the demonstrable effect that recent regulatory and enforcement actions have had on governance from the perspective of management and the board. As even a cursory review of the recent regulatory and law enforcement actions indicates, the enforcement process itself has fundamentally affected governance. In announcing its settlement agreements with HSBC and UBS, the Department of Justice specifically noted that each institution had changed its senior leadership and restructured its compliance structure and taken numerous steps to enhance compliance and other control functions. In the case of Barclays, the effects of the law enforcement and regulatory actions on management and board were even more dramatic, playing out virtually in real-time as the Parliamentary committee hearings were in progress. Both the chairman of the board and the chief executive officer were forced to resign. Corporate accountability, as guided not so very gently by the regulators, was particularly swift in its exactions for Barclays…Tweet this!