by Anonymous

2012, more than any other year since the Financial Crisis, was fraught with large financial scandals hitting the headlines in major financial centers around the world. Record fines were handed out by legal and regulatory authorities around the world, and multiple CEOs were forced to step down. Coming in a year following the Occupy Wall Street protests, this has put unprecedented pressure on banks to review and improve their ethics practices. What follows is a recount of the major scandals around the world, followed by some takeaways for 2013.

Standard Chartered

Standard Chartered is a London based bank that focuses on lending in emerging markets. Although they do not have any American lending, they operate in New York City for capital markets and clearing purposes. A New York State financial regulator accused Standard Chartered of conspiring with Iranian businesses to circumvent sanctions against the country. This money laundering may have been to the tune of $250 billion over a decade. Standard Chartered denies the majority of the charges, but nevertheless they have paid $227 million in fines to settle the claims. New York had been threatening to revoke their license to operate in the State, which could have been a death sentence for the bank.  However, Standard will survive to see another day, although their reputation as a world-class lender despite their denial of the accusations may be permanently blemished.

Wal-Mart

Wal-Mart may not be a bank (but as you will see, that is part of the story), but it still managed to make headlines similar to the rest of the banks on this list. In 2012 it came to light that officials in Wal-Mart’s Mexico business were handing out bribes to local officials to secure building permits and other favors. Despite being highly unethical, this is also illegal under the Foreign Corrupt Practices Act (FCPA), since Wal-Mart is an American based corporation.  Wal-Mart has acknowledged the wrongdoing and official investigations (including by Congress) are underway, with a fine likely to come. Fines under the FCPA in the past have neared $1 billion, and Wal-Mart’s may near that amount or exceed it based on the extent of the bribery scheme, and if top executives had any hand in covering up the practices.

This scandal comes at a time when Wal-Mart is expanding its financial services footprint. Wal-Mart recently launched a banking alternative debit-card service with American Express, and offers a multitude of other financial services to clients. Wal-Mart has failed to acquire a banking license in the United States despite multiple attempts, although they do operate a bank in Canada and offer a credit card through this Canadian subsidiary (for Canadians only). American regulators have been opposing Wal-Mart’s banking push not because they worry Wal-Mart could become a monopoly in the traditional sense, but for other pervasive concerns. A traditional monopoly dominates an industry horizontally – they control the entire industry. Regulators are concerned that Wal-Mart could exert a vertical domination on the economy and “dissolves the line between banking and commerce,” as former Congressman Barney Frank put it in 2007. Given the ethical allegations that have come to light in Mexico, gaining a banking license in the United States may be all the more difficult now.

The Goldman Letter

On March 14, 2012, Greg Smith, a 12 year employee of Goldman Sachs, published an op-ed in the New York Times (link) which explained why he chose to leave Goldman Sachs. The letter read like Occupy Wall Street’s laundry list. Smith explained how leadership changed the culture from one of humility to a purely profit-seeking machine with absolutely no regard for its clients’ well-beings whatsoever. If it made Goldman Sachs money, even at the expense of a client, then the corporate culture was to pursue the deal. The most resounding line from the letter comes when Smith explains how many managers at the bank refer to their clients as “Muppets.” Since Smith’s letter was just a piece in the New York Times, not a regulatory filing or an official complaint, no charges or fines have stemmed from or are expected to stem from Smith’s departure. Goldman Sachs has issued sharp rebukes of the letter, and other Wall Street investment banks have issued statements espousing Goldman’s reputation. However, Goldman’s reputation, has been further tarnished, and the complaints of Occupy Wall Street and the 99% have been somewhat validated by the letter.

Nomura Insider Trading

The insider trading scandal at Nomura, a Japanese bank, may not be well known in the United States, but it proved that Tokyo is not immune from banking scandals, which mostly plagued London and New York in 2012. It emerged that Nomura had been leaking information on upcoming shares offerings to clients. This 2012 scandal was the fourth insider trading scandal since Kenichi Watanabe became the bank’s CEO. This fourth scandal was the straw that broke the camel’s back. Watanabe, along with the bank’s COO, both resigned as a result of the scandal.

Payment Protection Insurance

Payment protection insurance (PPI) is a product sold to borrowers which insures the continuity of debt repayments in the event that a life event (death, unemployment, etc.) makes the borrower unable to make payments. It helps the borrower avoid more debt and bankruptcy, and is a prevalent financial product in the UK. Unfortunately, it seems that many banks, the largest being Lloyds of London, a British banking behemoth that only survived the Financial Crisis due to substantial support from the British government, were systematically selling PPI to borrowers who would be unable to successfully make claims on the insurance. As a result, the banks are being forced to reimburse many borrowers for their PPI. Estimates of total liability at the banks have reached 12 billion GBP. Lloyds alone has put aside 5.3 billion GBP for claims.

HSBC Money Laundering

Similar to Standard Chartered, HSBC fell in with a rough crowd. For years various government agencies and regulators have been suspicious of HSBC’s anti-money laundering controls (or lack thereof), but events came to a head in July when the Senate held hearings into faulty practices and apparent abuses at the bank. It turns out that HSBC had been allowing Mexico and Colombian drug cartels, as well as the economically sanctioned countries of Iran, Sudan, Libya, and Myanmar, to launder money through the bank. HSBC, unlike many of the other banks on this list, acknowledged and accepted the allegations, although they did add the caveat that all of the offenses took place in the past and that the bank has already made great strides in improving its internal financial controls. Nevertheless, the bank has paid a $1.9 billion fine to American authorities, and another fine is expected to be collected by European authorities some time in 2013.

JP Morgan and the London Whale

The scandal at JP Morgan, similar to Goldman Sachs, does not involve any lawbreaking, regulation skirting, or any other sorts of malfeasance. However, it does stand out as one of the costliest scandals on this list, as well as a spectacular failure of management. In early 2012 reports came out of London that a JP Morgan trader had taken such large positions in an asset class that JP Morgan’s trades were singlehandedly moving the market in this asset. This trader was dubbed the London Whale. The assets were index-linked to credit default swaps on American corporations. Derivatives of derivatives, if you will. When such large positions such as these are taken in an asset the result could be market manipulation (which JP Morgan has not since been accused of) or an outsize risk to the bank, since the asset could become illiquid, with the only holder of the asset being the bank itself. The then and still CEO of JP Morgan, Jamie Dimon, called these allegations a, “tempest in a teapot,” and dismissed them.

Jamie was wrong. A few months later Dimon disclosed massive losses on the London Whale’s bets. The losses are around $6 billion, and are centered in the bank’s Chief Investment Office, which handled the difference between the bank’s assets in liabilities. The Whale’s bets were meant to be “hedges.” Part of the unseen risk may be due to a change in the VaR model used on the portfolio. VaR, standing for value-at-risk, is a measure of the amount of money the bank could lose on a very bad day. Banks set limits to their VaR to curtail risk. Changing some of the parameters in the model allowed risk controls were relaxed, allowing the London based unit to up the ante and make such large bets on the market. Not only does this indicate a lack of proper model risk oversight, but regulators are also investigating the bank for using accounting trickery to cover up the losses when they were first realized in the spring of 2012.

In addition to JP Morgan shareholders, Jamie Dimon may be one of the largest victims of the London Whale’s outsized ambitions. JP Morgan navigated through the Financial Crisis very well, even assuming the toxic assets of the failed Bear Sterns. Dimon was rightfully known as the best risk manager in the industry. This reputation, like the reputation of CEO’s and other bank managers up and down this list, has been permanently tarnished. Dimon was dragged before Congress and flogged. In addition, any hopes he had of President Obama appointing him the next Secretary of the Treasury upon Tim Geithner’s departure were dashed (the President has since appointed his Chief of Staff, Jack Lew, for the position).

LIBOR Rigging

LIBOR is little known outside of the financial industry, but it is a critically important figure, even for those of us who do not work in finance. LIBOR, standing for London Interbank Offering Rate, is an index of short term interest rates for dollar based lending. Many trillions of dollars in contracts around the world, including interest rate swaps (the most common form of derivatives) and adjustable rate mortgages, are linked to LIBOR.

LIBOR is calculated based on daily submissions by traders in London based offices of major banks around the world. The traders are supposed to submit what rates they would have to borrow dollars at, if they were to solicit dollars in the interbank market. However, it has surfaced that since the very same people that trade the derivatives, the bank traders, are also making daily submissions to determine the index, they have been tacitly colluding to fix rates for their own profit, and to the detriment of the counterparties on the other side of the bets that they are making.

Barclays Bank was the first bank to be put under the gun. Their CEO, American born Bob Diamond, among other bank executives, was forced out, in addition to given a public beating in Parliament. UBS has also now paid $1.5 billion in fines to regulators for what amounts to fraud, which is more than three times the $450 million Barclays had to fork up. Regulators are also close to settlements with other major banks around the world, including Deutsche Bank, HSBC, JP Morgan, and others.  Central banks, most notably the Bank of England, have also been roped into the scandal. During the Financial Crisis banks were on very thin ice, and central banks were prodding them to do anything possible to ensure financial markets that they were continually viable. This prodding may have included the Bank of England suggesting to Barclays to submit the rosiest LIBOR quotes possible, to show that they could still borrow at reasonable rates from other banks. Although this is dishonest, it needs to be distinguished from the downright fraud that traders were conducting at other times, in order to profit off of inaccurate quotes at the direct expense of their clients and counterparties.

Conclusion

2012 could have been a bright year for banks. 2011 saw their backyard filled with angry Occupy Wall Street protesters stirring up anti-bank sentiment worldwide. In 2012 banks could have shown their good face and publicized to the world the good things that they do for communities and their clients. Instead month after month they made headlines for fraud and unethical behavior. Banks in all financial centers of the world were involved with more banks making the news than avoiding it. What this means for 2013 is that regulators are going to be making an unprecedented push for banks to constantly check and disclose their internal financial controls. These are the fail-safe processes that are meant to catch errors, improprieties, and illegal or unethical behavior.

Employees at banks loathe controls. They consume time that can be spent on other money-making activities, are cumbersome, and are subject to constant review by risk-control groups in the institutions, such as Internal Audit, External Audit, SOX Offices, Model Validation, and others. However, these scandals prove that a culture of control awareness at a bank (or other large corporations, such as Wal-Mart) could preserve the reputation of banks and prevent billions and billions dollars in fines. In addition, large financial institutions will find it increasingly difficult to stave off calls for them to broken up into smaller more manageable entities if they are too large to control, and all people see them at being good for is preying on their clients and causing more harm than good in the developing world.