Financial scandals: a lesson on risk, compliance and regulations

Financial scandals: a lesson on risk, compliance and regulations

 

There is always a risk when dealing with financial transactions in the business world. Many financial institutions have broken the law regarding money, either on purpose or by accident. There are even cases where the rules weren’t entirely clear, or the regulatory bodies didn’t do their job either.  

All the previous financial mishaps and scandals have pushed the current industry to change. Gray areas are being defined, new regulations are being written, and automatization is being implemented.   

Let’s look at four financial scandals – Libor, Forex, JPMorgan, and HSBC – which are some of the most significant cases of the last few decades, to learn from their mistakes.  

Here’s a quick history lesson on risk, compliance and regulations.   

 
Libor Scandal 

It was a scheme in which bankers at several major financial institutions conspired with each other to manipulate the London Interbank Offered Rate (Libor) for the banks to seem more creditworthy than they were. 

It is considered the greatest financial scandal and “led to more than $9 billion in fines for major financial institutions”, reported Bloomberg. 

The scandal caused a lot of mistrust in the financial industry. It led to many fines, lawsuits, and actions by different governments. Even though the scandal was discovered in 2012, there is evidence that it had been going on since 2003. 

A few regulatory bodies began to look into Barclays and fifteen other global financial institutions in 2003 for working together to change the Libor rate. 

From 2005 to 2007, swaps traders asked employees who submitted the rates to provide figures that would benefit the traders instead of those Barclays would actually pay to borrow money allowing for Libor to move up and down based on a trader’s position. The UK trader Thomas Hayes was the first person to be found guilty of manipulating the Libor rate. He took Barclays’ strategy one step further by contacting employees of competitor banks. 

“And that’s in keeping with the financial industry’s long-time mantra, which is, the way you make money as a trader is, first, you identify inefficiencies in the market: weaknesses, loopholes, things like that. Then you find ways to exploit those loopholes and those weaknesses and those inefficiencies. That can be in the form of having better information than your competitors. It can be in the form of having dumber clients than your competitors, or faster trading systems, or better technology — or the ability to subtly nudge something that you’re trading on. That’s what Hayes did with great pleasure, and great applause from his superiors,” said journalist David Enrich in an interview with Knowledge at Wharton. 

Some other banks involved in the scandal were Deutsche Bank, Barclays, Citigroup, JPMorgan Chase, and the Royal Bank of Scotland. 

Why was this a problem? 

Since Libor is used worldwide as a base rate for interest rates on consumer and corporate loans, manipulating it caused mispriced financial assets throughout the global financial system. 

One of the most affected economies was housing due to mortgage rate manipulation. For example, if a homeowner started a fixed-rate mortgage when the rates were manipulated high, the repayments would’ve been much more expensive than they should’ve been. 

However, one of the most present consequences was the reputational loss and diminished trust in the market. In 2012, a study published by securities broker and investment bank Keefe, Bruyette & Woods stated that the banks investigated for manipulating the Libor rate could end up paying $35 billion in private legal settlements on top of any fines from the government. 

 

Forex Scandal 

In 2013, it was revealed that banks colluded to manipulate exchange rates on the foreign exchange (or forex) market for their gain by sharing sensitive client order information on chatrooms for at least a decade. It is considered the second greatest financial scandal after Libor. 

Forex is a global, decentralized market where currencies are bought and sold. Large international banks are the leading players. Four banks (Deutsche Bank, Citigroup, Barclays, and UBS) are responsible for half of all trading. It’s a highly unregulated market that trades $6.6 trillion daily. 

After the scandal came to light, regulators from markets like the US, Asia, and Europe started looking into it. At the center of the investigation were the transcripts from senior traders’ online chats. They had names like “The Cartel”, “The Bandits’ Club”, “One Team, One Dream”, and “The Mafia.” 

“The Cartel”, in particular, had some of the most influential traders in London, such as Richard Usher, JPMorgan’s head of spot foreign exchange trading in 2010; Rohan Ramchandani, Citigroup’s head of European spot trading; Matt Gardiner, from Standard Chartered; and Chris Ashton, head of voice spot trading at Barclays.  

In the US, four banks — Citigroup, JPMorgan Chase, Barclays and Royal Bank of Scotland — pleaded guilty to a series of federal crimes over a scheme to manipulate the value of the world’s currencies. A fifth bank, UBS, was also accused of foreign currency manipulation but not criminally charged. The five banks agreed to pay about $5.6 billion in penalties in addition to the $4.25 billion agreed to pay to regulators. 

The United Kingdom’s Financial Conduct Authority (FCA) also imposed fines totaling $1.7 billion on the five banks for failing to control business practices in their G10 spot foreign exchange trading operations. 

Other banks involved in the scandal were HSBC and Bank of America. 

Why was this a problem? 

In these types of scandals, there are different types of wrongdoings that traders could’ve engaged in: 

  • Sharing confidential information in chatrooms, 
  • ‘Front running’ – using inside knowledge about upcoming client orders to build positions before the Fix and make a profit at the expense of banks’ clients, 
  • ‘Banging the close’ – concentrating trades of client orders right before or immediately after the close to push rates up or down, 
  • ‘Painting the screen’ – making fake trades with other traders that’ll be undone later to move the rate in a particular direction, 
  • ‘Personal account trading’ – using own money to trade.  

 

JP Morgan 

J.P. Morgan Securities LLC (JPMS), a broker-dealer subsidiary of JPMorgan Chase & Co., was fined $200 million in December 2021 for failing to track employees’ personal work emails and calls. 

Securities division workers used text messages, WhatsApp, and personal email to discuss company business. For this reason, the Securities and Exchange Commission (SEC) penalized the bank $125 million and added that the bank had “widespread and long-term failures” from January 2018 to November 2020.  

According to an SEC official, more than 100 people, including senior managers, used personal communications to send tens of thousands of messages that weren’t properly stored in the bank’s systems. The texts covered investment strategy and client meetings and numerous teams involved, including parts of the investment bank. 

JPMS acknowledged that it had violated federal securities laws to protect investors and fair markets with its conduct and agreed to pay the fine and implement improvements to its compliance policies and procedures, such as retaining a compliance consultant. 

In a separate ruling, the Commodity Futures Trading Commission (CFTC) fined the bank $75 million for similar actions from at least 2015. 

Why was this a problem? 

Federal laws require financial firms to keep detailed records of all electronic messages between brokers and clients so that regulators can ensure the firms aren’t breaking anti-fraud or antitrust laws. 

“Since the 1930s, recordkeeping and books-and-records obligations have been an essential part of market integrity and a foundational component of the SEC’s ability to be an effective cop on the beat,” said SEC chairman Gary Gensler. “As technology changes, it’s even more important that registrants ensure that their communications are appropriately recorded and are not conducted outside of official channels in order to avoid market oversight.” 

This scandal marked an important shift in poor recordkeeping as it rarely faced any consequences previously. The last major SEC fine before this case was in 2006 for merely $15 million against Morgan Stanly for failing to produce emails during an investigation on initial public offerings and research produced by analysts.  

 

HSBC Scandal 

HSBC was fined in 2021 for 64 million pounds as the Financial Conduct Authority (FCA), the UK’s financial watchdog, found “serious weaknesses” in how the banking giant’s automated systems monitored the hundreds of millions of transactions a month to identify possible criminal activity. 

According to the FCA statement, HSBC had failings in three key parts:  

Identifying indicators of money laundering or terrorist financing with scenarios that covered relevant risks until 2014 and then carrying out timely assessments for new scenarios after 2016. 

Testing and updating parameters in the system used to determine if a transaction was indicative of potentially suspicious activity. 

Reviewing the accuracy and completeness of the data fed into, and contained within, the monitoring system.  

“These failings are unacceptable and exposed the bank and community to avoidable risks, especially as the remediation took such a long time”, said Mark Steward, Executive Director of Enforcement and Market Oversight at the FCA. “HSBC continued their remediation to address these weaknesses after the relevant period.” 

HSBC agreed to settle with the FCA and didn’t dispute its findings, qualifying for a 30% discount on the fine. If it hadn’t arrived at this agreement, the bank would’ve had to pay a penalty of 91 million pounds.  

Additionally, the FCA recognized the bank’s commitment to its large-scale global remediation program, highlighting that there were some successful improvements, which included: 

Introduction of a system for data integrity checks and complete data mapping, and 

Implementation of a segmented methodology. 

Why was this a problem? 

HSBC’s failings happened over a long time. Even though many internal and external reports pointed out the problems at different times, the bank didn’t do enough to find and report potentially suspicious activity. 

The FCA’s ruling came after HSBC was put on notice of potential weaknesses. Even after HSBC Holdings agreed to pay in 2012 a $1.9 billion fine for providing money-laundering services to various drug cartels, such as Mexico’s Sinaloa cartel and Colombia’s Norte del Valle cartel, for more than $881 million. 

 

Compliance, risk and regulations 

From the point of view of regulatory reporting, “risk” is any event that could hurt a bank. Projected financial condition, which could include less capital and liquidity, or “resilience,” which is the bank’s ability to handle short or long periods of stress, are some examples.

We’ve catalogued the different types of risk into four categories: operational, compliance, strategic and reputational. However, these shouldn’t be considered separate risks because they don’t cancel each other out. Instead, most banks are exposed to more than one in a way that is interdependent and related.  

The Libor, Forex and JPMorgan scandals are clear examples of operational risk due to failed processes, inadequate behavior and poor quality control. But they’re also an example of compliance risk since those actions led to violations of laws and regulations.  

The HSBC scandal shows strategic risk from poorly implemented business decisions and operational risk from failed systems. And these, once again, led to compliance risk by nonconforming with guidelines and regulations.  

And all of these had what we consider the most significant risk: reputational. Since these cases involved money from customers, the financial institutions’ names will always be tied to the scandals in the eyes of the public. As a result, it will be harder for the bank to make new contacts, relationships, services, and customers, which will hurt its ability to compete.   

 

In conclusion 

Bad things can happen when a business doesn’t take compliance seriously. And if solid controls and automated systems were in place to stop money laundering, financial firms would probably catch more situations like this before they get too bad. 

People will always be tempted to cut corners, break the law, or take advantage of gray areas to make money quickly. But our financial scandals have shown that we can’t take shortcuts regarding compliance and following the regulations. If there’s one thing sure, automation is vital to helping businesses stay compliant and transparent across a wide range of processes. 

Our solutions at Trans World Compliance follow a simple three-step process that allows financial institutions to streamline their classification, remediation, and reporting process in a flexible, secure, and precise way. 

Moreover, we will help you navigate FATCA and CRS regulations swiftly and precisely with our jurisdiction-specific rule bases and XML generation engines. As a result, you’ll improve reporting accuracy and provide proof and evidence to regulators and stakeholders of the quality of your due diligence efforts. 

We can’t stress the importance of a regulatory compliance policy enough. It shows that the company wants to ensure that all its employees follow the rules and laws that apply to their industry. It also shows that the company takes compliance and risk mitigation seriously. 

 

Add new comment

About text formats

Financial scandals: a lesson on risk, compliance and regulations

 

There is always a risk when dealing with financial transactions in the business world. Many financial institutions have broken the law regarding money, either on purpose or by accident. There are even cases where the rules weren’t entirely clear, or the regulatory bodies didn’t do their job either.  

All the previous financial mishaps and scandals have pushed the current industry to change. Gray areas are being defined, new regulations are being written, and automatization is being implemented.   

Let’s look at four financial scandals – Libor, Forex, JPMorgan, and HSBC – which are some of the most significant cases of the last few decades, to learn from their mistakes.  

Here’s a quick history lesson on risk, compliance and regulations.   

 
Libor Scandal 

It was a scheme in which bankers at several major financial institutions conspired with each other to manipulate the London Interbank Offered Rate (Libor) for the banks to seem more creditworthy than they were. 

It is considered the greatest financial scandal and “led to more than $9 billion in fines for major financial institutions”, reported Bloomberg. 

The scandal caused a lot of mistrust in the financial industry. It led to many fines, lawsuits, and actions by different governments. Even though the scandal was discovered in 2012, there is evidence that it had been going on since 2003. 

A few regulatory bodies began to look into Barclays and fifteen other global financial institutions in 2003 for working together to change the Libor rate. 

From 2005 to 2007, swaps traders asked employees who submitted the rates to provide figures that would benefit the traders instead of those Barclays would actually pay to borrow money allowing for Libor to move up and down based on a trader’s position. The UK trader Thomas Hayes was the first person to be found guilty of manipulating the Libor rate. He took Barclays’ strategy one step further by contacting employees of competitor banks. 

“And that’s in keeping with the financial industry’s long-time mantra, which is, the way you make money as a trader is, first, you identify inefficiencies in the market: weaknesses, loopholes, things like that. Then you find ways to exploit those loopholes and those weaknesses and those inefficiencies. That can be in the form of having better information than your competitors. It can be in the form of having dumber clients than your competitors, or faster trading systems, or better technology — or the ability to subtly nudge something that you’re trading on. That’s what Hayes did with great pleasure, and great applause from his superiors,” said journalist David Enrich in an interview with Knowledge at Wharton. 

Some other banks involved in the scandal were Deutsche Bank, Barclays, Citigroup, JPMorgan Chase, and the Royal Bank of Scotland. 

Why was this a problem? 

Since Libor is used worldwide as a base rate for interest rates on consumer and corporate loans, manipulating it caused mispriced financial assets throughout the global financial system. 

One of the most affected economies was housing due to mortgage rate manipulation. For example, if a homeowner started a fixed-rate mortgage when the rates were manipulated high, the repayments would’ve been much more expensive than they should’ve been. 

However, one of the most present consequences was the reputational loss and diminished trust in the market. In 2012, a study published by securities broker and investment bank Keefe, Bruyette & Woods stated that the banks investigated for manipulating the Libor rate could end up paying $35 billion in private legal settlements on top of any fines from the government. 

 

Forex Scandal 

In 2013, it was revealed that banks colluded to manipulate exchange rates on the foreign exchange (or forex) market for their gain by sharing sensitive client order information on chatrooms for at least a decade. It is considered the second greatest financial scandal after Libor. 

Forex is a global, decentralized market where currencies are bought and sold. Large international banks are the leading players. Four banks (Deutsche Bank, Citigroup, Barclays, and UBS) are responsible for half of all trading. It’s a highly unregulated market that trades $6.6 trillion daily. 

After the scandal came to light, regulators from markets like the US, Asia, and Europe started looking into it. At the center of the investigation were the transcripts from senior traders’ online chats. They had names like “The Cartel”, “The Bandits’ Club”, “One Team, One Dream”, and “The Mafia.” 

“The Cartel”, in particular, had some of the most influential traders in London, such as Richard Usher, JPMorgan’s head of spot foreign exchange trading in 2010; Rohan Ramchandani, Citigroup’s head of European spot trading; Matt Gardiner, from Standard Chartered; and Chris Ashton, head of voice spot trading at Barclays.  

In the US, four banks — Citigroup, JPMorgan Chase, Barclays and Royal Bank of Scotland — pleaded guilty to a series of federal crimes over a scheme to manipulate the value of the world’s currencies. A fifth bank, UBS, was also accused of foreign currency manipulation but not criminally charged. The five banks agreed to pay about $5.6 billion in penalties in addition to the $4.25 billion agreed to pay to regulators. 

The United Kingdom’s Financial Conduct Authority (FCA) also imposed fines totaling $1.7 billion on the five banks for failing to control business practices in their G10 spot foreign exchange trading operations. 

Other banks involved in the scandal were HSBC and Bank of America. 

Why was this a problem? 

In these types of scandals, there are different types of wrongdoings that traders could’ve engaged in: 

  • Sharing confidential information in chatrooms, 
  • ‘Front running’ – using inside knowledge about upcoming client orders to build positions before the Fix and make a profit at the expense of banks’ clients, 
  • ‘Banging the close’ – concentrating trades of client orders right before or immediately after the close to push rates up or down, 
  • ‘Painting the screen’ – making fake trades with other traders that’ll be undone later to move the rate in a particular direction, 
  • ‘Personal account trading’ – using own money to trade.  

 

JP Morgan 

J.P. Morgan Securities LLC (JPMS), a broker-dealer subsidiary of JPMorgan Chase & Co., was fined $200 million in December 2021 for failing to track employees’ personal work emails and calls. 

Securities division workers used text messages, WhatsApp, and personal email to discuss company business. For this reason, the Securities and Exchange Commission (SEC) penalized the bank $125 million and added that the bank had “widespread and long-term failures” from January 2018 to November 2020.  

According to an SEC official, more than 100 people, including senior managers, used personal communications to send tens of thousands of messages that weren’t properly stored in the bank’s systems. The texts covered investment strategy and client meetings and numerous teams involved, including parts of the investment bank. 

JPMS acknowledged that it had violated federal securities laws to protect investors and fair markets with its conduct and agreed to pay the fine and implement improvements to its compliance policies and procedures, such as retaining a compliance consultant. 

In a separate ruling, the Commodity Futures Trading Commission (CFTC) fined the bank $75 million for similar actions from at least 2015. 

Why was this a problem? 

Federal laws require financial firms to keep detailed records of all electronic messages between brokers and clients so that regulators can ensure the firms aren’t breaking anti-fraud or antitrust laws. 

“Since the 1930s, recordkeeping and books-and-records obligations have been an essential part of market integrity and a foundational component of the SEC’s ability to be an effective cop on the beat,” said SEC chairman Gary Gensler. “As technology changes, it’s even more important that registrants ensure that their communications are appropriately recorded and are not conducted outside of official channels in order to avoid market oversight.” 

This scandal marked an important shift in poor recordkeeping as it rarely faced any consequences previously. The last major SEC fine before this case was in 2006 for merely $15 million against Morgan Stanly for failing to produce emails during an investigation on initial public offerings and research produced by analysts.  

 

HSBC Scandal 

HSBC was fined in 2021 for 64 million pounds as the Financial Conduct Authority (FCA), the UK’s financial watchdog, found “serious weaknesses” in how the banking giant’s automated systems monitored the hundreds of millions of transactions a month to identify possible criminal activity. 

According to the FCA statement, HSBC had failings in three key parts:  

Identifying indicators of money laundering or terrorist financing with scenarios that covered relevant risks until 2014 and then carrying out timely assessments for new scenarios after 2016. 

Testing and updating parameters in the system used to determine if a transaction was indicative of potentially suspicious activity. 

Reviewing the accuracy and completeness of the data fed into, and contained within, the monitoring system.  

“These failings are unacceptable and exposed the bank and community to avoidable risks, especially as the remediation took such a long time”, said Mark Steward, Executive Director of Enforcement and Market Oversight at the FCA. “HSBC continued their remediation to address these weaknesses after the relevant period.” 

HSBC agreed to settle with the FCA and didn’t dispute its findings, qualifying for a 30% discount on the fine. If it hadn’t arrived at this agreement, the bank would’ve had to pay a penalty of 91 million pounds.  

Additionally, the FCA recognized the bank’s commitment to its large-scale global remediation program, highlighting that there were some successful improvements, which included: 

Introduction of a system for data integrity checks and complete data mapping, and 

Implementation of a segmented methodology. 

Why was this a problem? 

HSBC’s failings happened over a long time. Even though many internal and external reports pointed out the problems at different times, the bank didn’t do enough to find and report potentially suspicious activity. 

The FCA’s ruling came after HSBC was put on notice of potential weaknesses. Even after HSBC Holdings agreed to pay in 2012 a $1.9 billion fine for providing money-laundering services to various drug cartels, such as Mexico’s Sinaloa cartel and Colombia’s Norte del Valle cartel, for more than $881 million. 

 

Compliance, risk and regulations 

From the point of view of regulatory reporting, “risk” is any event that could hurt a bank. Projected financial condition, which could include less capital and liquidity, or “resilience,” which is the bank’s ability to handle short or long periods of stress, are some examples.

We’ve catalogued the different types of risk into four categories: operational, compliance, strategic and reputational. However, these shouldn’t be considered separate risks because they don’t cancel each other out. Instead, most banks are exposed to more than one in a way that is interdependent and related.  

The Libor, Forex and JPMorgan scandals are clear examples of operational risk due to failed processes, inadequate behavior and poor quality control. But they’re also an example of compliance risk since those actions led to violations of laws and regulations.  

The HSBC scandal shows strategic risk from poorly implemented business decisions and operational risk from failed systems. And these, once again, led to compliance risk by nonconforming with guidelines and regulations.  

And all of these had what we consider the most significant risk: reputational. Since these cases involved money from customers, the financial institutions’ names will always be tied to the scandals in the eyes of the public. As a result, it will be harder for the bank to make new contacts, relationships, services, and customers, which will hurt its ability to compete.   

 

In conclusion 

Bad things can happen when a business doesn’t take compliance seriously. And if solid controls and automated systems were in place to stop money laundering, financial firms would probably catch more situations like this before they get too bad. 

People will always be tempted to cut corners, break the law, or take advantage of gray areas to make money quickly. But our financial scandals have shown that we can’t take shortcuts regarding compliance and following the regulations. If there’s one thing sure, automation is vital to helping businesses stay compliant and transparent across a wide range of processes. 

Our solutions at Trans World Compliance follow a simple three-step process that allows financial institutions to streamline their classification, remediation, and reporting process in a flexible, secure, and precise way. 

Moreover, we will help you navigate FATCA and CRS regulations swiftly and precisely with our jurisdiction-specific rule bases and XML generation engines. As a result, you’ll improve reporting accuracy and provide proof and evidence to regulators and stakeholders of the quality of your due diligence efforts. 

We can’t stress the importance of a regulatory compliance policy enough. It shows that the company wants to ensure that all its employees follow the rules and laws that apply to their industry. It also shows that the company takes compliance and risk mitigation seriously. 

 

Add new comment

About text formats