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article imageOp-Ed: Sell these major banks involved in corruption and scandals

By Monty Spivak     May 31, 2013 in Business
JPMorgan, Bank of America, HSBC Bank and Standard Chartered Bank, have been involved in both money laundering and LIBOR scandals. Should you trust management and invest in these banks?
Banking is a business of trust. Its origins, and for many, the continuing business model, is simple. One deposits funds with a safe and trustworthy bank, and this intermediary lends the depositors' money for a profit. The nature and management of the large, multinational financial organizations has made it easier to avoid complying with certain laws and regulations. Unfortunately, it appears that some of the major U.S. banks do not merit our trust.
I will start by stating that, in the developed countries, we can generally trust the financial regulators and elected governments; there is extrinsic evidence that we enjoy generally low levels of corruption. The next question is who else can we trust in the financial sector? We rely heavily on governance (such as accounting standards and elected boards of directors); expectations of fiduciary responsibility; and our legal systems - such as the Sarbanes-Oxley Act in the U.S. - to protect investors. It is shocking to learn that despite these safeguards, some of the best-known institutions have deliberately flaunted U.S. and international laws.
Let's start by examining who has participated in the largest and most recent banking scandals - money laundering and the LIBOR scandal.
Certain authors suggest that the banks are doing their best to comply with the laws. A pertinent comment is
Despite shortcomings, banks spend millions of dollars a year to guard against money-laundering. Compliance experts argue that violations are typically unintentional and often harmless because they aren’t always exploited by criminals.
That said, there is compelling evidence that some of the largest and most widely held banks have deliberately avoided U.N. trade sanctions and American law enforcement - they helped drug dealers and international terrorists launder money. This article is highly critical of both the banks and the U.S. legal enforcement of their money laundering:
HSBC, Western Union, Bank of America, JP Morgan Chase & Co, Citigroup, Wachovia amongst many others have allegedly failed to comply with American anti-money laundering (AML) laws...
In March 2010 Wachovia cut a deal with the US government which involved the bank being given fines of $160 million under a ”deferred prosecution” agreement. This was due to Wachovia’s heavy involvement in money laundering moving up to $378.4 billion over several years. Not one banker was prosecuted for illegal involvement in the drugs trade. Meanwhile small time drug dealers and users go to prison.
If any member of the public is caught in possession of a few grammes of coke or heroin you can bet your bottom dollar they will be going down to serve some hard time. However, if you are a bankster caught laundering billions of dollars for some of the most murderous people on the planet you get off with a slap on the wrist in the form of some puny fine and a deferred prosecution deal.
The banks commonly mentioned as enablers of the drug trade and other illicit activities (with U.S. ticker symbols) are:
1. JPMorgan (JPM)
2. Bank of America (BAC)
3. HSBC Bank (HSBC)
4. Standard Chartered Bank (SCBFF.PK) - details in "UK bank accused of Iran money laundering"
The other major fraud was the that certain major banks colluded to fix an important global rate - LIBOR. Wikipedia has an excellent summary of the LIBOR scandal:
The Libor scandal is a series of fraudulent actions connected to the Libor (London Interbank Offered Rate) and also the resulting investigation and reaction. The Libor is an average interest rate calculated through submissions of interest rates by major banks in London. The scandal arose when it was discovered that banks were falsely inflating or deflating their rates so as to profit from trades, or to give the impression that they were more creditworthy than they were. Libor underpins approximately $350 trillion in derivatives. It is controlled by the British Bankers' Association (BBA).
The banks are supposed to submit the actual interest rates they are paying, or would expect to pay, for borrowing from other banks. The Libor is supposed to be the total assessment of the health of the financial system because if the banks being polled feel confident about the state of things, they report a low number and if the member banks feel a low degree of confidence in the financial system, they report a higher interest rate number. In June 2012, multiple criminal settlements by Barclays Bank revealed significant fraud and collusion by member banks connected to the rate submissions, leading to the scandal.
Because Libor is used in U.S. derivatives markets, an attempt to manipulate Libor is an attempt to manipulate U.S. derivatives markets, and thus a violation of American law. Since mortgages, student loans, financial derivatives, and other financial products often rely on Libor as a reference rate, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide.
BBC News published an article detailing the timeline - demonstrating how the banks arranged to fix the rate since 2005! This is the list of LIBOR banks involved in setting U.S. dollar rates:
1. The Bank of America (BAC)
2. JP Morgan Chase (JPM)
3. Citibank, NA (C)
4. Bank of Nova Scotia (BNS)
5. Bank of Tokyo-Mitsubishi UFJ Ltd
6. Barclays Bank plc (BCS)
7. BNP Paribas (BNPQY)
8. Credit Agricole (CRARY)
9. Credit Suisse (CS)
10. Deutsche Bank AG (DB)
11. HSBC (HBC)
12. Lloyds TSB Bank plc (LYG)
13. Rabobank
14. Royal Bank of Canada (RY)
15. Société Générale (SCGLY)
16. Sumitomo Mitsui Banking Corporation (SMFG)
17. The Norinchukin Bank
18. The Royal Bank of Scotland Group (RBS)
19. UBS AG (UBS)
It is a concern that these are, globally, most of the world's major financial institutions. Almost all are TBTF - "Too Big To Fail" - most are on a list of 29 banks worldwide that are considered to be "systemically important financial institutions" - financial organisations whose size and role mean that any failure could cause serious systemic problems. It is worrisome that 3 of the 4 money-laundering banks are also named in the LIBOR list, and are on the TBTF list. The 4 that make both scandals lists are globally significant. According to "World's 50 Biggest Banks 2012", HSBC ranks 2nd; JPM is 9th; BAC is 10th; and Standard Chartered is 41st, in the world.
I thought that there may be others who have expressed concern about the trustworthiness of banks which are flaunting regulators and breaking laws, and found "Why You Shouldn’t Invest in JPMorgan". A few of the many points are:
It's not quite so clear that the company is serving its customers and society well. Some of the evidence is pretty troubling, in fact. One analyst noted that JPMorgan has paid well over $8.5 billion in regulatory and legal settlements since 2009 to settle accusations spanning multiple lines of business. A few of the charges included:
"Egregious" violations of sanctions against Cuba, Iran, Sudan, and the Former Liberian Regime of Charles Taylor...
In summary, we'd say the company delivers significant value for its management and employees. It's debatable, to say the least, how well it's serving its customers and society at a large. And despite management's myopic focus on today's bottom line, it's our view that the value long-term investors in this business are receiving isn't sufficient to the risks they are taking...
So, assuming we're not already dissuaded from investing in such a company, the question we now have to ask is: Can we trust the leadership team at JPMorgan?
When Warren Buffett looks for an investment, he insists that the people operating it are "honest and competent." The recent JPMorgan Whale Trade debacle as outlined by the Senate Permanent Subcommittee on Investigations raises some reasonable doubt about those two attributes.
I am not looking at the JPMorgan Whale Trade (a summary is in the previously-referenced article, and is basically a London trading loss of $6 billion) - which should concern investors, but it is only one bank misrepresenting to investors and regulators.
Need more reasons? How about a history of engaging in very risky activities and not learning from them? "The High-Yield Alternative To The World's Most Insane Investment" has some humorous anecdotes, and identifies JPMorgan Chase (JPM) as a recent example of an "insane investment".
Many of us have either worked for, or consulted with, a number of large organizations. The nature of a well-functioning bureaucracy is that there is the sharing of information, and checks and balances in the system to ensure compliance and that organizational processes and goals are met. For example, expenses must be approved, and the greater the amount of the expense, the higher the expense is elevated in the approval hierarchy. Therefore, it is typically very difficult for a single person to make unapproved large trades, incur enormous expenses, or defraud shareholders or clients, without the knowledge of their management. There have been occurrences of this, but these are relatively rare, and for smaller dollar amounts. In other words, deliberately "fiddling" with LIBOR or disregarding U.N. sanctions requires collusion across the organization, and involvement of layers of management. These are not small, isolated incidents - they are not like rogue traders who acted alone and evaded controls - but required tacit approval by the executive. Moreover, these illegal acts have persisted over a long period of time; it is impossible for management to be unaware.
Based on all of this evidence, these banks do not seem to have trustworthy management. Should investors trust their financial statements? Trust that they have as controls, when those who provide the controls are enabling those breaking the laws, cheating customers, and paying fines from money that would otherwise belong to shareholders? How many steps removed are these institutions from an Enron fraud? Enron lied about its financials - balance sheet and income statement - and ultimately declared bankruptcy; a number of their executives were jailed for their fraudulent activities. Muddy Waters built a franchise by exposing fraudulent accounting of Chinese companies. Misrepresenting and manipulating financial statements to shareholders and regulators is not exactly a far reach from the largest banks deliberately fixing prices and financially enabling global criminal and terrorist organizations.
This leaves the question of what investors should do, and under what circumstances should investment decisions be reconsidered. Alternatives include:
1. Buy more of these bank shares - perhaps they have reformed and have learned their lessons, or the single culprit has been fired? Many Investment Analysts rate these banks a "Buy".
2. Sell (or sell-short) the securities - after all, "cheaters never prosper".
3. Hold: Wait for the authorities to address the issue. Continue to allow the current bank executives free reign - for example, let Jamie Dimon retain both executive roles at JPM as shareholders recently voted. Perhaps, eventually, the U.S. Department of Justice will treat banks who enable drug dealers in the same way that they would treat anyone else.
4. Boycott (really means: Sell): Demand a return so astronomically high, as to provide insurance against the risk of fraud and misrepresentation. Drive the share price so low that management gets fired.
The remaining question is when to reconsider these 4 banks as investment candidates. Until the underlying problem is addressed, there is nothing to prevent the next illegal activity. Here are a few considerations:
1. Paying a fine is not good enough. Customers, investors, and other victims, remain cheated. Payment of a fine to avoid or limit liability or prosecution does not make it "all better". The criminals who perpetrated the act have not been punished, and there is insufficient disincentive to avoid repetition.
2. Systematic corruption must be fixed - our modern financial system cannot thrive with "flexible ethics". The culprit banks need new controls and their boards need to bring people from the outside. The solution is not just a few people in the organization chart, but a substantial reform of the senior management team.
3. Government - the other involved party - is encouraging these frauds through inconsequential fines and a failure to introduce criminal charges; they can demand reform by laying charges against the perpetrators at the executive levels - it sounds extreme, but Iceland jailed its most senior bankers for making reckless loans before the financial crisis; perhaps the U.S. - one of the least corrupt countries in the world - can do this for money laundering? Judge John Gleeson may take steps about HSBC financially enabling terrorists, as reported in the Telegraph on May 23, 2013, but the U.S. Department of Justice is reportedly challenging this!
4. The companies involved in illegal activities must publicly reform - they need to notify the public and shareholders how they are changing to comply with the norms and laws. These enormous. global banks, have millions of stakeholders who need to be properly informed of the failures and remediation. If they genuinely strive to correct the situation - for example, advertise how the reform is being implemented - we may, again, believe that it is safe to invest. A good example of how this has recently occurred is the bribery scandals involving SNC Lavalin (SNCAF.PK). The Canadian police arrested and charged the CEO for bribery in various domestic and foreign jurisdictions. Other executives were also investigated and criminally charged. This was front-page news in the Business Section of the Canadian newspapers, and the lead item on the news, for months. Subsequently, the replacement CEO publicly apologized, and committed to cooperate with authorities - via full-page advertisements in the newspapers of the respective countries. On May 27, the SNC-Lavalin Group Inc. launched what it calls an “amnesty program” aimed at ferreting out any corruption. To me, this seems to be a genuine and transparent effort to right a wrong, and ensure that it will not recur.
Investors depend upon trustworthy governance - otherwise the financial markets could not function effectively. Investors should "vote with their wallets" - invest and spend money where it aligns with one's objectives (and values). If you choose to entrust organizations with your capital, you should demand a return which is consistent with the risk. In the cases of these large financial institutions, one needs to determine if there is an appropriate risk/return trade-off. The banks involved in the recent scandals do not provide a compensatory return. Therefore, I believe that the most prudent action is to SELL your shares of these banks: JPMorgan (JPM), Bank of America (BAC), HSBC Bank (HBC), and Standard Chartered Bank (SCBFF.PK).
DISCLOSURE: No positions.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of
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