Prosecute The Bankers, Not The Banks

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DealBook ran an interesting piece by Peter J. Henning on Monday about the continued legal problems faced by major U.S. and European banks. It seems that all the losses, fines, convictions, and bad publicity over the last few years has not stopped the illegal behavior in the sector. In fact, notes Henning, some of the biggest names in banking have announced that they are taking reserves in expectation of future fines.

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As the author notes:

Citigroup, Royal Bank of Scotland, and Barclays all announced new reserves last week totaling more than $2 billion to deal with investigations into foreign exchange rate manipulation, while HSBC added $378 million on Monday. The cases involve collusion in the $5.3 trillion daily foreign exchange market to affect rates. These come on top of announcements from Deutsche Bank and JPMorgan Chase that they had each added about $1 billion to their reserves for the expected cost of settlements. 

We have seen settlements with prosecutors and regulators for this kind of misconduct before, no doubt reached in the hope that the penalties would deter future violations. In late 2012, a UBS subsidiary pleaded guilty to manipulating the London Interbank Offered Rate, or Libor, while the parent company reached a nonprosecution agreement with the Justice Department that required it to pay over $1.5 billion. A few months earlier, Barclays entered into a deferred prosecution agreement with federal prosecutors for its Libor manipulation that resulted in over $450 million in penalties.

Basic economic theory suggests that either banks do not care about these multi-billion dollar fines or the fines have not yet reached a point were they are material enough to change the behavior of bankers. Indeed, Henning notes that these massive penalties do not seem to have had much effect on the sector:

… simply extracting more money out of the banks does not seem to have had much of an effect on their operations, apart from increased spending on compliance. The past year has seen record-breaking settlements with Bank of America and BNP Paribas for violations related to mortgage-backed securities and the economic sanctions laws, but whether those penalties have any real effect on how other banks operate is certainly an open question.

So we have a situation where fines continue to go up, compliance spending continues to go up, but improper actions continue to happen. What is the reason? Personally, I think the problem lies with the fine prosecutorial philosophy embedded in today’s system. As the Economist pointed out in a recent issues, the idea that punishing companies for what individuals do is fundamentally flawed:

If the main aim is deterrence, companies may be the wrong targets for prosecution. In a speech before the New York Bar Association last November that was widely shared on social media, Jed Rakoff, a federal judge in New York, argued that the focus should be on individuals, and that not prosecuting individual malefactors after the financial crisis, despite widespread indications of fraud, may “be judged one of the more egregious failures of the criminal justice system in many years”.

I wholly agree with Mr. Rakoff. Fining a company for what an executive does wrong is both misguided and unfair both to other employees and to shareholders. If a law is broken, prosecute the criminal and not the criminal’s place of employment. Taking profits that belong to shareholders away because of illegal activity is not the right way to deter criminal activity, as the U.S. government must surely be realizing. As the DealBook piece concludes:

The government has imposed billions of dollars in fines over the past few years for corporate violations, part of an effort to show that no company is “too big to jail.” The greater hurdle is whether global banks will ever go far enough to truly reform their cultures and make compliance with the law something more than an easily ignored motto.

In the end, it should not be up to thank “banks,” because corporations should not be treated as people, either in the positive or negative sense. It should be up to the bankers to fix the behavior of Wall Street. People commit crimes, not companies.

Read more:

http://dealbook.nytimes.com/2014/11/03/banks-cycle-of-misbehavior/?emc=edit_dlbkpm_20141103&nl=business&nlid=1363671&_r=1

http://www.economist.com/news/briefing/21614101-corporate-america-finding-it-ever-harder-stay-right-side-law-mammoth-guilt

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