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Honesty is the best policy – when there is money in it.
-         Mark Twain

What reserve price Justice?

COMPLIANCE: SEC-Bay? - Screen shot 2010 08 24 at 6.59.19 AM

On Wednesday, US District Judge Emmet G. Sullivan held his nose and approved a $298 million payment by Barclay’s Bank to settle criminal charges of violating US financial sanctions against Iran, Cuba, Libya, Sudan and Burma.  Noting that the charges were brought after Barclays itself reported internal findings to US officials, and that the bank cooperated in the investigation, the Justice Department disputed the Judge’s criticism that they had accorded the bank special treatment.
According to the settlement document, Barclays acknowledges that bank employees cooperated with requests from foreign banks to delete from funds transfers information identifying the originating banks, and that between 1995-2006 the bank processed more than $500 million of transactions that were prohibited under the Treasury’s Office of Foreign Assets Control (OFAC) rules.
We commented last month (30 July, “Quotations From Chairman Mary”) on the $160 million paid by Wachovia to settle liability for processing over US$ 420 billion in transactions from Mexico – including at least $4 billion in bulk cash – with no anti money laundering procedures in place.  The Justice Department identified $110 million in drug proceeds laundered through Wachovia, including money that went to purchase cargo planes and load them with cocaine.  Wachovia agreed to pay dollar for dollar the amount of drug money identified as being laundered through their neglect, plus a $50 million fine, for a total of $160 million.
Details of the cases differ.  Wachovia, says the Justice Department, “admitted failure to identify, detect, and report suspicious transaction in third-party payment processor accounts.”  Barclays, according to Justice spokesman Lanny Breuer, deliberately circumvented OFAC sanctions and “stripped vital information out of payment messages that would have alerted US financial institutions about the true origins of the funds.”  Each step of this process is potentially a separate criminal act.  Bank employees were allegedly asked by Iranian and other banks to remove information identifying the issuing bank and country of origin on some $500 million worth of transfers.  Failure to report such a request to internal Anti Money Laundering (AML) personnel is potentially a crime.  And if Barclays employees cooperated with these requests, each transfer was a separate criminal transaction.

On the other side, Barclays self-reported to Justice, and has spent $250 million improving their internal AML procedures.  Breuer said “we will take their disclosure, cooperation and remedial efforts into consideration.”
That’s some “consideration.”  Wachovia was dinged dollar for dollar on the illegal transfers, plus made to pay a fine of 45% of the total.  Barclays has negotiated a steep discount, paying only 60 cents on the dollar of the amounts processed, with no additional fine.  The government points out that both institutions have spent large sums of money to improve compliance – as though that were part of their punishment.
As far as anyone is telling – and we will never know the truth, because a settlement blocks any further information being divulged – Wachovia’s illegal transfers were the result of negligence on the part of the bank, while  Barclays’ transactions appear to be the knowing facilitation of criminal activity.  We do not care to offer an opinion as to which is “worse” – we don’t believe that no one inside of Wachovia knew what was going on, nor that nobody profited from turning a blind eye.  And given the terms of the Barclays settlement, we shall never know how widespread the crimes were, nor how high in the corporate structure they reached.  All we know is that Barclays has successfully negotiated down the price of major financial fraud – and for that, many in the shadowy world of not-quite-banking should be grateful.
Were we a senior executive or shareholder of either institution, we would make damn sure that people went to prison.  As taxpayers we believe we are entitled to that outcome.
Instead, it’s Welcome to the Homeland Shopping Network, where it’s All Money Laundering, All The Time!  It may be that Wachovia never had sufficient clout to get a better deal for itself.  Meanwhile Barclays, still a darling of the financial sector, is featured both above and below the fold on the front page of the FT’s Companies & Markets section (19 August).  The lead story quotes BarCap’s capital markets group’s estimate “that the 35 largest US banks will have to come up with half as much new capital as had been expected” under the new Basel rules, as compromises were reached on the structure of tier one capital.
Below the fold on the same page, the headline reads “Judge Accuses Barclays Of Paying For Justice In Sanctions Settlement,” quoting Judge Sullivan as saying the proceedings raised questions, such as “Why are the financial institutions being treated like this?”
Good question.  Under the settlement, Barclays is not permitted to dispute the charges that the bank knowingly stripped identifying information from funds transfers to avoid OFAC sanctions.  In other words, the bank’s employees knowingly committed crimes and were directly responsible for funneling at least half a billion dollars of illicit funds through the US banking system, and the bank would make sure that all the employees, and the executives on whose watch it happened, would stand in the dock and plead guilty, and go to jail for a long time, where they would be deprived of their Ferraris and their freedom, and not to mention the other unpleasant stuff that happens On the Inside… so yes, Barclays would be happy to do all this, except the DoJ decided they didn’t have to because after all the bank was so forthcoming five years after they found the crime in their midst…
This is why crime runs rampant.  It is encouraged.  It even has a price schedule.  And now, it’s negotiable.  Tired of overpaying for those nasty money laundering sanctions?  Come on down to DJ’s, where your crime is our dime!
Financial regulators publish sanctions guidelines that tell what you should expect to pay for any of a large number of violations.  In fact, managements confer with their lawyers, comparing sanction guidelines and established precedent to determine whether or not to break the rules.  Trust us.
Like a CDS or a simple listed option, the pricing requires inputs, based on assumptions.  What is the likely return if we break the rules?  What is the likelihood we will get caught?  How many people do we have to cut in on this to make it happen, and how much do we trust them?  What’s my piece of the action?  This can be mapped into a simple equation and run across a variety of scenarios.  Decisions to violate the rules are always based on a calculation of the low likelihood of getting caught (A), paired with a low likelihood of being successfully prosecuted (B), less probable legal fees (if B).  Reputational damage rarely factors into the equation because let’s face it, we already work on Wall Street...
The love affair between Washington and Wall Street marches on with a new round of settlements.  As long as no one goes to jail, the world will go on seeking new and untried forms of Bad Behavior – and the authorities will charge for the privilege.  Justice, despite Judge Sullivan’s demur, may not be for sale.  But clearly, you can rent it.
SEC boosters say they have substantially raised the price of corporate fraud – Judge Rakoff expressed his disgust with the B of A settlement, even as he signed off on the deal, decrying the fact that no one was held to account.  And the “record” Goldman settlement merely shows that the arrogant rich have to pay more for the privilege of renting the law.
It all seems to come down to popularity.  While the unloveable B of A gets a sharp uptick in the cost of lying to shareholders, Barclays managed to drive down the price of a ten year pattern of laundering money for the Iranian Revolutionary Guard.  Mark Twain said the efficiency of our justice system “is only marred by the difficulty of finding twelve men every day who don’t know anything and can’t read.”  The SEC and DoJ appear to have unearthed the mother lode.
As for Goldman, paying a half billion dollar fine for unloading fugazy paper on the Europeans looks like poetic justice.  Who do they think they are, Alan Greenspan?

Moshe Silver

Chief Compliance Officer