It used to be that financial institutions indicted on a criminal charge went out of business long before they had their day in court in a proper jury trial, which is their right. Instead, clients and employees would flee and regulators would be forced to withdraw their operating licenses. Unlike individuals convicted on a criminal charge, this is as close as things ever came to jailing an institution. Not anymore.
By sowing fear and intimidation among its regulators and law enforcement officials - based entirely on its own vulnerability to punishment - the Credit Suisse pleaded guilty to a criminal offense and emerged as a convicted felon clean as a whistle, with no apparent effect on its business, its management or its shareholders.
Having confessed to one count of criminal fraud, CEO Brady Dougan told a press conference on May 20th he didn’t think there would be any effects on the bank – no “material impact on our operations or capabilities.” There was the small matter of $2.6 billion in fines and penalties, but he said that could be earned back by the end of the year and wouldn’t affect the bank’s regulatory capital. No serious changes in strategy. No senior management changes. No discernible boardroom reaction. No client defections. No investor flight. Just business as usual. Credit Suisse stock in Zurich was up 2% on the day in an otherwise flat market.
Except for some media commentators, nobody seemed to care very much. The corporate-speak wordsmiths trotted out the importance of “putting the matter behind us.” Life goes on.
We like to think market discipline works. Corporate boards are supposed to be serious guardians of long-term shareholder value and oversee to the best of their ability and judgment the “market-economy trinity” that drives it – revenue growth, cost control and risk management. When things like market share losses or operating inefficiencies or excessive risk exposures pose a threat, directors presumably agitate for corrective action and in extreme cases change the management. Most shareholders in turn rely on institutional investors to watch out for their interests and vote their proxies. So owners ultimately depend on both asset managers and boards to do their jobs properly – the so-called “double agency” problem.
Especially in the case of large “systemic” financial institutions, regulators have an additional voice in corporate governance. They are supposed to represent the public interest and protect the taxpayer, the ultimate guarantor of financial system integrity. If the taxpayer must bear the risk, the taxpayer must have a voice. So the CS case can be considered a remarkable quadruple governance failure - the management, the board, institutional investors and the regulators. But if nobody really does care it may not be a failure at all, just a new chapter in the rules of the game.
At the other end of the spectrum, people worried about integrity of the financial system may consider the CS case a serious challenge to the institutional underpinnings of the liberal market system. Credit Suisse stood accused, certainly not alone, of aiding and abetting tax evasion (not tax avoidance) by tax residents of the United States, a country that taxes income earned globally and considers willful tax misreporting a criminal offense. Unlike its rival UBS, which settled civil charges of aiding and abetting tax evasion with the IRS back in 2010 - in a proceeding that included a $780 million fine and release of client information approved by the Swiss government. CS was late to the party. It had already been charged by the time a 2013 agreement was reached to extract “voluntary” disclosures and settlements with other Swiss banks that are now being individually negotiated.
As well, CS stood accused of obstruction and failure to cooperate with US authorities in their investigations (never a good idea), while two of its employees had already pleaded guilty to criminal charges and six more cases were pending.
Obstruction, conspiracy, evasion ... these are not good words, especially after politically charged remarks by US Attorney General Eric Holder that criminally prosecuting systemically important financial institutions may impossible due to the unacceptable economic risk of their own demise – and voilá, the now famous term “too big to jail” was coined. Right after the CS guilty plea, Holder somehow concluded: “This case shows that no financial institution, no matter its size and global reach, is above the law.” Really?
The Credit Suisse case breaks new ground on the slippery slope of accountability failures in the financial sector since the effective end of criminal prosecutions (subject to appropriately high standards of culpability) in cases like Daiwa Bank, Drexel Burnham and Arthur Andersen, firms which apparently were not considered “systemic” or immune from criminal prosecution at the time. All disappeared.
Each of these firms’ collapse involved significant damage to their stakeholders. But it’s a good guess that the thousands of talented, loyal and honest employees who lost their jobs soon found new ones, and for many it was the best thing that ever happened to them. Competitors quickly circled to take advantage of a golden opportunity to recruit. The market for talent actually works. Financial functions are immortal. Financial firms are not.
Like Voodoo, the concept of “too big to jail” is probably nothing more than a myth. But like Voodoo, though, it is a powerful one. Over the years has deflected regulatory enforcement into produced a waterfall of civil suits against prominent financial businesses. Most of the time they ended in negotiated “no contest” pleas, combining hefty fines and “deferred prosecution” agreements. Allegations of overzealous prosecutors extorting settlements from targeted banks were balanced by lots of repeat offenders - to the point that expected litigation costs now seem to be routinely provisioned in bank financial statements and operating budgets, just like any other costs, and have become part of the business model. Financial analysts and investors don’t appear to see anything unusual about litigation costs, and get nervous only when they turn out to be eye-watering.
Looking for the good news? Even with all the fault-lines in internal and external governance, there is a last line of defense - the threat to a firm’s reputational capital. But banks and other financial firms that require trust and confidence to operate presumably have valuable reputations at stake. First-rate clients prefer to deal with first-rate banks, so serious losses in reputational capital ought to be reflected in the share price. This in turn ought to catch the attention of management, boards, investors, and ultimately regulators.
Studies of the stock price impact of reputational losses have in fact shown that there are serious and immediate share-price effects triggered by an array of negative reputational events. In one study these averaged 7% of market capitalization. Still, reputations can be reestablished over time, and there’s no way of estimating the longer-term consequences. In an industry where the long term is often after lunch, stakeholders may not care very much about reputations - even in criminal cases - as long as they remain “fit and proper” to do business, which means that exemptions from regulatory decertification have to be negotiated in advance.
The Credit Suisse case is a feat of superb lawyering and regulatory acrobatics, vaulting substance and plain old common sense. It probably spells the end of “mortality” of systemic financial firms. It puts the last nail in the coffin of holding entire firms accountable by inflicting meaningful pain in hopes of changing behavior in an industry where violations are often “industry practice” rather than firm-specific aberrations.
So what’s the other good news? Cumulating outrange among a long-suffering and already testy public almost six years after the financial crisis with little apparent improvement in the conduct of financial firms raises the likelihood that in the next round of transgressions the focus will be on individuals rather than firms themselves – including officers and directors. Real people must have made decisions that led to prosecutable criminal behavior. Even in the organizational labyrinth of global financial conglomerates, meetings were held and people took positions, and in the end they can be traced. Those who are tagged for committing or conspiring in criminal violations will have to face due process, and most likely will be hung out to dry by their employers. In criminal cases, the recent Credit Suisse outcome suggests this may be the only way to go.