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RBS Isn't Sure Its Foreign Subsidiaries Could Survive In Prison

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The Wall Street Journalstory today about the next Libor domino to fall - RBS, which will be coughing up $700mm or so to regulators in the next few weeks - is full of quietly hilarious lines, perhaps none more so than the Journal's deadpan clarification that "the Justice Department has the power to file criminal charges without the bank’s blessing." For sheer backwardness, though, I think it's hard to top this:

As part of UBS's settlement last month, the Swiss bank's Japanese unit pleaded guilty to wire fraud, a felony. Justice Department officials were heartened by the lack of a negative reaction in the markets and among regulators around the world to UBS's guilty plea. Before the settlement deal, some officials had worried it could destabilize the bank. That has emboldened officials to pursue similar actions against banks like RBS, according to a person familiar with the matter.

The way a lot of people - sometimes even people at the Justice Department! - think about criminal law goes something like this:

  • If you do something naughty, we will charge you with a crime.
  • If you are convicted of that crime, bad things will happen to you.
  • You don't want bad things to happen to you.
  • So you won't do anything naughty.

This is called "deterrence." All of the parts of it are important: if you are convicted of a crime and bad things don't happen to you, then the whole system is mostly pointless. When the Justice Department is "heartened by the lack of a negative reaction" to a criminal conviction - when they're like "yay, no deterrent effect!" - then ... then ... gaaah.

Felix Salmon explains the equilibrium here: "The criminal prosecution, in these cases, seems to be little more than a CYA move on the part of the administration, which can now have a slightly straighter face when saying that it’s being tough on the banks." The process is (1) people scream "why are there no criminal prosecutions of banksters etc.?," (2) DOJ offers up some pretty fake criminal prosecutions - "we couldn't jail Jamie Dimon, but we brought you a guilty plea from a Japanese shell subsidiary," and (3) the problem of the awkward press conference is put off for another day.1

That's sort of a strange way to use the tool of criminal prosecutions. Does that suggest that better tools might be available?

Charlie Gasparino has been on fire this week and his column in the Post today on SEC nominee Mary Jo White strikes me as right on2: concerns that White might be too soft on banks because she represented them in private practice are silly, her experience as a prosecutor probably means that she will be an aggressive prosecutor of banks, and - prosecuting banks isn't really what's needed. What's needed is clear, sensible regulation that will achieve good outcomes for markets. A prosecution-first mentality leads to ... I dunno, that thing with UBS.3

Take Libor. If the Libor scandal was about a few bad apples knowingly committing the crime of Libor manipulation, the right response would be something like (1) prosecute and imprison those criminals and (2) maybe take back illicit profits from the banks but don't go too hard on them: they were victims too, in a sense. Or if it was about a few rogue banks that were basically criminal enterprises, with a knowingly illegal culture of Libor manipulation, then I guess you'd (1) jail a lot of people at those banks and (2) criminally prosecute the banks themselves - in a real, punitive way, not a "lack of a negative reaction" way. These two interpretations seem to be false; in any case no one's acting like they believe either one.

A third interpretation would start from the fact that as far as anyone can tell every bank manipulated Libor. BURN THEM ALL DOWN, maybe, but you might consider whether the universality of the manipulation means that the rules against it weren't all that great. For instance: there were none! Libor was just a poll conducted by a private organization; it wasn't clear to a lot of regulators that they even had jurisdiction over it. And the poll was pretty vague, asking banks to submit more of an opinion than a fact; it's not hard to understand why some banks might shade their opinion in a way that might help them. You'd notice also that everyone knew about this - the regulators, the central banks, everyone - but didn't do anything about it when it happened. Just prosecute it later!

Of course on that interpretation a bank-destroying prosecution would seem a bit harsh. So the preferred approach seems to be to make the banks cough up (a small portion of) their illicit profits, and then tack on a fake criminal prosecution just to check that box.

Jesse Litvak might be a similar story. Do his IMs to counterparties lying about his purchase price look bad, deceptive, fraudy? Oh, sure, no doubt. Are they very, very much on a continuum with absolutely standard practices in the OTC market? Definitely. Can they be prevented by after-the-fact criminal prosecution? Umm ... maybe? But where do you draw the line between Litvak's imaginary negotiations with counterparties, and the imaginary negotiations that bond salespeople conduct every day?

Could Litvak's behavior have been prevented by simple up-front regulatory solutions? Yes definitely without any doubt whatsoever. The corporate bond market is not 100% transparent, but trade reporting on TRACE means that what Litvak did to his RMBS customers could never happen in the US corporate bond space. Litvak tells Buyer "Seller is offering me at 80.25, I'll sell to you at 80.5," Seller is actually offering at 78, Buyer says okay, and there are two prints to TRACE at 78 and 80.5. Buyer sees the prints on Bloomberg, Buyer calls Litvak's boss and threatens to stop trading with Jefferies, Litvak is gone by lunchtime.4

TRACE. It just works. It's better than jail!

And real-time trade reporting is slowly coming to other sectors - some OTC derivatives, for instance - over a lot of objection. That'd be a good place for regulators to focus their time and political capital. Or, y'know, put Jesse Litvak in jail for squeezing $2mm from some hedge funds, whatever, either way.

Libor, similarly, is open to a range of solutions, though to be fair they're more complex than TRACE, which is why various blue-ribbon panels are working on them. (My solution, "just make fraud okay," seems not to have found much favor.) The gist of the solutions - have fewer Libors, try to tie them more closely to actual trades, specify what data banks should use in submitting Libors, and clearly say it's illegal to manipulate Libor - seem like a step in the right direction.

The alternative is to have occasional long-after-the-fact prosecutions of things that look like misbehavior in hindsight, as a way to deter future misbehavior. If you think that Libor manipulation and Litvak's scalping were clearly evil at the time, and easily distinguishable from customary and permitted practices, then: I guess that's a fine solution. But you gotta mean it. If the go-to tool of financial regulation is the threat of criminal prosecution, and if you dissipate that threat by preferring criminal prosecutions with no bad consequences, then what are you left with?

U.S. Wants Criminal Charges for RBS [WSJ]
When banks face criminal charges [Reuters / Felix Salmon]
The perils of Mary Jo: The SEC needs more than a prosecutor [NYP / Charlie Gasparino]
RBS in for another round of bonus awkwardness, with added Libor angle [FTAV]

1.I listened to yesterday's Litvak press conference and the prosecutors were asked "why are there no charges against Jefferies?" Answer: "investigation ongoing, etc. etc." The important thing is to cover, very loosely, all the bases. "Why are no banks prosecuted?" "Well, UBS['s Japanese subsidiary] was." "Why are no individuals prosecuted?" "Well, Jesse Litvak was." Etc. Shift the debate.

2.With the caveat that I don't endorse his conclusion that White is "totally unqualified to run the Securities and Exchange Commission." He's right that the hunt for the toughest available prosecutor is the wrong way to staff the SEC, but just because she was hired by a bad process doesn't mean she'll be bad. I'm of the best-athlete school of thought on this one; why judge her solely by her resume? Even former federal prosecutors can turn their lives around and do some good in the world.

3.Here is a caveat to the tune of: I know that the SEC doesn't bring criminal charges (though it helps develop them), and that the CFTC is mostly in charge of Libor. The comment is on a regulatory-prosecutorial mindset, not particular agency jurisdiction.

4.Presumably there are modest ways around this transparency - tell us some in the comments! Certainly it doesn't prevent big markups on bonds in seasoned inventory (but why would that be a goal?). But crossing from one customer to another in a near-instantaneous riskless principal trade for a negotiated markup - the place where Litvak was apparently cheating - that's going to be clearly reflected on TRACE.


RBS Trader Whose Instant Messages Clearly Show Him (Allegedly) Engaging In Libor Manipulation Not Going Down Without A Fight

One thing that most people probably agree on is that having their instant messages, e-mails, and phone calls end up court would be cause for at least a little embarrassment. Everyone's thrown in an emoticon they aren't proud of, some of us have used company time to chat with significant others about undergarments, and the vast majority of workers have spent a not insignificant amount of the workday talking shit about their superiors. Of course, the humiliation gets ratcheted up a notch in the case of people who 'haha' (and in extreme circumstances "hahahah') their own jokes* which, just for example, involve habitual Libor manipulation. Tan Chi Min knows what we're talking about: “Nice Libor,” Tan said in an April 2, 2008, instant message with traders including Neil Danziger, who also was fired by RBS, and David Pieri. “Our six-month fixing moved the entire fixing, hahahah.” And while having such an exchange become public would be tremendously awkward for most, you know what's really 'hahaha' about this whole thing is that 1) Tan was the one who wanted people to read the above, which was submitted as part of a 231-page affidavit earlier this month and 2) He's trying to use it as evidence that he didn't deserve to be fired. The conversations among traders at RBS and firms including Deutsche Bank AG illustrate how the risk of abuse was embedded in the process for setting Libor, the benchmark for more than $300 trillion of securities worldwide......Tan, the bank’s former Singapore-based head of delta trading for Asia, [is] suing Britain’s third-biggest lender by assets for wrongful dismissal after being fired last year for allegedly trying to manipulate the London interbank offered rate, or Libor. Tan, who 'allegedly' tried to manipulate the London interbank offered rate, also included this conversations as part of his defense: “What’s the call on Libor,” Jezri Mohideen, then the bank’s head of yen products in Singapore, asked Danziger in an Aug. 21, 2007, chat. “Where would you like it, Libor that is,” Danziger asked, according to a transcript included in Tan’s filings. “Mixed feelings, but mostly I’d like it all lower so the world starts to make a little sense,” another trader responded. “The whole HF world will be kissing you instead of calling me if Libor move lower,” Tan said, referring to hedge funds. “OK, I will move the curve down 1 basis point, maybe more if I can,” Danziger replied. And this: In another conversation on March 27, 2008, Tan called for RBS to raise its Libor submission, saying an earlier lower figure the bank submitted may have cost his team 200,000 pounds. “We need to bump it way up high, highest among all if possible,” Tan said. Tan also asked for a high submission in an Aug. 20, 2007, instant message to Scott Nygaard, global head of RBS’s treasury markets in London. “We want high fix in 3s,” Tan said in the message. “Neil is the one setting the yen Libor in London now and for this week and next.” Also this: “It’s just amazing how Libor fixing can make you that much money or lose if opposite,” Tan said on an Aug. 19, 2007, conversation with traders at other banks, including Deutsche Bank’s Mark Wong. “It’s a cartel now in London.” And this philosophical one, for good measure: “This whole process would make banks pull out of Libor fixing,” Tan said in a May 16, 2011, chat with money markets trader Andrew Smoler. “Question is what is illegal? If making money if bank fix it to suits its own books are illegal... then no point fixing it right? Cuz there will be days when we will def make money fixing it.” The defense rests. RBS Instant Messages Show Libor Rates Skewed for Traders [Bloomberg] *Although actually people who do this probably don't even have the good sense to be ashamed of themselves.