Prosecuting Banks May Be Great Politics But It Is Lousy Economics

Roy C. Smith

The action of the US Justice Department against BNP Paribas and other foreign banks is not, as some in Europe think, a protectionist effort – US banks have suffered even more.

In fact, it is an exercise in political showboating that started 15 years ago.

In 1999, when Eric Holder was Bill Clinton’s Deputy Attorney General, he wrote a memo on “Bringing Criminal Charges Against Corporations”. It set standards for Federal prosecutors when considering charges against large corporations for which normal civil penalties seem insufficient.

Until then, corporations had been charged with criminal offenses only if their actions were deemed to be a “criminal enterprise” – something so corrupted by management that it was the same as racketeering.

Holder’s idea was that boards should be responsible for avoiding criminal actions and for co-operating with the Justice Department in its investigations. His memo has been amended by successors, to ease the conditions of full co-operation, but retains the threat of criminal indictment for insufficient co-operation. It puts a lot of power in the hands of politicians. It played its part in the collapse of Enron and its auditor Arthur Andersen, which exoneration came too late to save.

When the financial crisis occurred, the banks were vilified and Holder was back as Attorney General. President Barack Obama was under a lot of pressure to show that he was tough on them.

Much of the damage they experienced was due to mark-to-market write-offs, as opposed to fraud or criminal misconduct. No culpable senior executives could be found to indict. But the public wanted someone to blame, or it would blame the government.

So Holder came up with civil (not criminal) fraud indictments, not of top-level individuals who would have fought the charges, but of corporations, which almost assuredly, after Arthur Andersen, would not. Goldman Sachs, then Bank of America and JP Morgan Chase, succumbed to what looked like shakedowns for corporate offenses to which no senior individuals were linked. They paid about $25 billion in settlements, fines and legal fees.

That was a lot, but not enough for many bank critics who still wanted bankers to be jailed.

So the new chair of the Securities and Exchange Commission, Mary Jo White, a former federal prosecutor, said she would seek admissions of guilt from banks that had agreed to settle. Despite the banks’ concern that stakeholder litigation would ensue, some such admissions were obtained.

Even that was not enough to satisfy the authorities. So in May, Holder gave his “banks are not too big to jail” speech, which presumably meant that banks as corporations would be charged with criminal offenses.

Criminal Charges

The next bank on the legal assembly line was Credit Suisse, seeking to settle a long-standing tax-evasion case. Here the Justice Department, which had already indicted eight employees (though no senior managers), decided to seek a guilty plea. A settlement for $2.6 billion was agreed, plus a meaningless criminal admission of guilt by a non US subsidiary of the bank.

Credit Suisse chief executive Brady Dougan said the settlement would have no material adverse effect on the bank, and it would replace the lost capital with asset sales and other measures. Holder claimed victory, but he probably could have got the same or even more from a civil case.

Now BNP Paribas is being pushed to pay $10 billion to settle criminal charges that it abused US money-handling rules for clients in Iran and other sanctioned countries. The charges are similar to those settled for $1.9 billion by HSBC in 2012, but that case was civil, not criminal.

Whatever its political appeal, the stream of high-profile legal actions by US political officials is destabilizing to the banks, and largely unfair. They reduce bank capital when regulators want it increased. Further, the uncertain, almost whimsical, nature of banks’ exposure to government litigation makes investors question their creditworthiness – never good in a bank. Further still, the penalties are assessed on the shareholders of the banks, not on executives, who should be prosecuted if there is evidence.

It is time to end this form of symbolic litigation and let banking get back to normal. Economic recovery depends on it.

Published in eFinancial News, June 2, 2014