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The ethical deal

The choreography of enforcement in the UBS case

The time difference between London and New York gave the Financial Services Authority an immediate, if short-lived advantage in presenting an image of a regulatory agency determined to address in a systematic manner the corrupting influence of widespread market manipulation. The FSA announced that as part of its settlement agreement with UBS, the Swiss bank would pay a fine of $260m (160m STG), the largest ever imposed.

The Director of Enforcement at the FSA Tracey MacDermott, condemned what she described as the cavalier approach of UBS traders, who in seeking to manipulate the London Interbank Offered Rate (Libor) over a sustained period had done much to undermine the integrity of the measure, used to benchmark derivative contracts across the globe. ‘The integrity of benchmarks are of fundamental importance to UK and international markets. UBS traders and managers ignored this,’ she said in a statement released by the FSA. Given the details in the Final Notice, the scale of the deception, carried out across three continents with the awareness of senior management, is nothing short of shocking.

For example, on 18 September 2008, a Trader explained to a Broker: “if you keep 6s [i.e. the six month JPY LIBOR rate] unchanged today … I will f**king do one humongous deal with you … Like a 50,000 buck deal, whatever … I need you to keep it as low as possible … if you do that …. I’ll pay you, you know, 50,000 dollars, 100,000 dollars… whatever you want … I’m a man of my word”. UBS entered into at least nine such wash trades using this Broker Firm, generating illicit fees of more than £170,000 for the Brokers (page 4). The choreography also demonstrated the disproportionate investigative power of the Department of Justice in Washington, as well as the Commodity and Futures Trading Commission, the agency that has led the investigation into the manipulation of Libor. The CFTC investigation, enhanced by the subpoena power of the Anti-Trust Division of the Department of Justice, had already led to the imposition of $450m fines on Barclays earlier this year (a fraction of which went to the FSA). That prosecution and settlement was based, in part on Barclays awareness of the UBS probe, which reached its stunning denouement in a federal court in Connecticut yesterday, with the Criminal Division of the Department of Justice clearly in the ascendancy.

By the time the New York market opened the scale of the retribution for UBS’s deception became apparent with the announcement that the total fines imposed on the bank had reached $1.5 billion ($700 million for the CFTC, $500m for the Department of Justice, $260m for the FSA. In addition $63m of improper profits is to be provided to the Swiss regulatory authority, which does not have the capacity to levy direct fines). In other words, US regulatory authorities secured just under 80 per cent of the total financial penalties.

The Department of Justice also announced that criminal prosecutions would proceed against two traders. Furthermore a non-prosecution agreement with the parent company was announced in exchange for a $400m fine. UBS Securities Japan, the subsidiary of the Swiss firm at the heart of the scandal agreed to plead guilty to manipulating the Libor rate in exchange for a $100m fine. All in all, a good day’s work for the Department of Justice, which last week secured a $1.92 billion settlement from HSBC in exchange for a deferred prosecution.

It is indicative of the importance of the prosecutions that the Attorney General, Eric Holder, appeared at the press conference announcing the results. ‘The non-prosecution agreement illustrates the significant steps that UBS has taken to help investigators uncover LIBOR misconduct, and to implement remedial measures strengthening the company’s internal controls,’ he said.

The UBS investigation is also exceptionally revealing of power politics within the Department of Justice. The bank had received conditional immunity from the Anti-Trust division of the Department in exchange for its cooperation with the CFTC investigation. This did not, however, apply to the Criminal Division, a much more powerful component of the sprawling department, opening according to the New York Times, tension over how to proceed until the Criminal Division prevailed.

The Assistant Attorney General in charge of the Criminal Division, Lanny Breur, made it clear that the investigation into Libor is far from completed. Speaking in Washington, Mr Bruer, maintained that the scale of the UBS manipulation was nothing short of ‘astonishing.’ ‘We cannot and will not tolerate misconduct on Wall Street admitted to by UBS today and Barclays last June. We will continue to follow the facts and the law wherever they lead us.

Initially, that will lead back to the United Kingdom where negotiations with Royal Bank of Scotland, a bank now under government ownership because of disastrous mismanagement in the lead up to the GFC, poised to complete negotiations as early as February. Should a deferred prosecution or non-prosecution deal be placed on RBS it raises a host of complicated diplomatic problems between the UK and the US.

For its part, the FSA is concentrating on how to clean up Libor, with a consultation paper advocating an expansion of the number of banks submitting rates, if necessary by compulsion.

Given the extent of the manipulation, a lot more than compulsion in the setting of the rate will be required to fix Libor. 2013 promises to be an even more dangerous time for banks and their regulators with the imperatives of retribution and reform equally balanced.

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