This article was recently reproduced in CCH's Australian Competition and Consumer Law Tracker, Issue 3, March 2013.
While there has been a great deal of publicity recently about various global investigations into alleged LIBOR manipulation by up to 16 major banks, this is not the only scandal which is plaguing the banking industry. Indeed, there are an ever increasing number of scandals involving most of the world’s largest banks. For example, quite recently, in December 2012, HSBC was fined $US1.9 billion for failing to put measures in place to prevent money laundering in its
US and Mexican operations. The DOJ’s investigation found that HSBC
accounts in both of these locations were being used by drug dealers to hide
millions of dollars from the sale of drugs.
The DOJ also found evidence of the bank being used to transfer money to
criminals and suspected terrorists in other countries such as Russia, Iran and Saudi Arabia.
The HSBC settlement was followed in mid-December 2012 by the announcement of UBS’s $1.5 billion settlement with various regulators over its role in manipulating the LIBOR. I will be discussing this settlement in more detail in an upcoming post. In the meantime, I will be discussing yet another banking scandal, which stars UBS as one of the main protagonists– namely the criminal prosecution of three former UBS executives for big rigging in the
US municipal bond market.
The question raised by this particular case and many other banking settlements is – “Why are regulators taking such a soft approach with the banks in relation such serious, institutionalised, blatant and continuing criminal conduct?”
US, municipal bonds are issued by various
government entities, such as states counties and cities or public authorities,
such as schools, utilities, for the purpose of assisting these entities to raise
money for a variety of purposes such as special projects or to refinance debt.
In 2007 and 2008 the combined, the value of the municipal bond market in the
US was approximately $800 billion.
In some cases, the money raised from such bond issues is used for not-for-profit purposes such as the construction of low cost housing, school buildings or public roads.
As municipal bonds are often used for not-for-profit purposes, they have tax-exempt status under
US tax laws. However, in order to obtain and
maintain this tax exempt status municipal bond issuers are required to follow
specific rules set down by the Internal Revenue Service (IRS) and the US
Issuers will often seek to invest some or all of the bond proceeds in investment products, which are sold by banks, insurance companies and other financial service providers.
Issuers will generally select the investment product for the proceeds of the bond issue through a competitive tendering process. In other words, the issuer will seek a number of competing bids from sellers of investment products, and select the bid which they believe is most attractive. This competitive bid process is one of the requirements for claiming tax exempt status.
This is where UBS comes into the picture. Issuers will often hire third parties or brokers to act as their agents in conducting the competitive bidding process for the investment products. These brokers, including UBS, are then responsible for distributing the bid packages, answering questions about the bid specifications, assessing the competing bids and then advising the issuer of the outcome of the bid process.
The defendants in the DOJ case were Mr Peter Ghavami, Mr Garry Heinz and Mr Michael Welty.
At the relevant time of the offences, Ghavami was Managing Director and the co-Head of the Municipal Bond Reinvestment and Derivatives (MBRD) desk at UBS. Heinz and Welty were both Vice-Presidents and Marketers on the MBRD desk at UBS.
Somewhat surprisingly, UBS itself was not a defendant in the case, despite the fact that the illegal conduct was engaged in by three of its senior executives and whatsmore, UBS reaped the financial benefits of the fraud.
The reason UBS was not a defendant in the case was because it had entered into a non-prosecution agreement with the Antitrust Division of the US Department of Justice in April 2011. Under this agreement, the DOJ agreed not to prosecute UBS in return for its full cooperation in the DOJ’s ongoing municipal bond derivatives industry investigation and a payment of $160 million in restitution, penalties and disgorgement.
The relevant indictment describes the offences as follows:
25. From at least as early as August 2001 until at least July 2002…PETER GHAVAMI, GARY HEINZ and MICHAEL WELTY, the defendants (collectively, the "FSC Defendants"), and co-conspirators, including Financial Institution A, FSC (UBS), Financial Institution C, Financial Institution D, and others known and unknown, unlawfully, willfully, and knowingly did combine, conspire, confederate, and agree together and with each other to commit offenses against the United States of America, to wit, to violate Title 18, United States Code, Section 1343 all in violation of Title 18, United States Code, Section 371.
26. It was a part and an object of the conspiracy that the FSC Defendants, and co-conspirators, including Financial Institution A, FSC (UBS), Financial Institution C, Financial Institution D, and others known and unknown, unlawfully, willfully and knowingly, would and did devise and intend to devise a scheme and artifice to defraud, and to obtain money and property by means of false and fraudulent pretenses, representations, and promises, namely, a scheme to defraud municipal issuers and the United States Department of the Treasury and the IRS by manipulating the bidding process for investment agreements and other municipal finance contracts by colluding with each other, and further to deprive the municipal issuers of the property right to control their assets by causing them to make economic decisions based on misleading and false information, and for the purpose of executing such scheme and artifice, and attempting to do so, would and did transmit and cause to be transmitted by means of wire, radio or television communication in interstate or foreign commerce any writings, signs, signals, pictures or sounds, in violation of Title 18, United States Code, Section 1343.
In other words, the three defendants manipulated the competitive bidding process for investment products in order to defraud the issuers who had retained UBS as their broker, as well as both the US Treasury and the IRS.
The indictment provides specific details of how the three defendants went about defrauding both their clients and the government agencies:
a. the FSC (read UBS) Defendants increased the number and profitability of investment agreements and other municipal finance contracts awarded to Financial Institution A and FSC (UBS) by telling co-conspirators at Financial Institution C and Financial Institution D what price or price level FSC (UBS) intended to bid, discussing in advance the price at which Financial Institution C or Financial Institution D would bid for an investment agreement or municipal finance contract, and agreeing that Financial Institution A and FSC would be allocated the investment agreement or municipal finance contract;
b. on at least one occasion, the FSC (UBS) Defendants agreed with a co-conspirator at Financial Institution D that Financial Institution D would not bid against Financial Institution A and FSC (UBS) in exchange for Financial Institution A and FSC (UBS) purchasing securities from Financial Institution D;
c. from time to time, the FSC (UBS) Defendants would and did submit intentionally losing bids for investment agreements or other municipal finance contracts for which Financial Institution C was competing, in order to create the appearance that Financial Institution A and FSC (UBS) were competing for agreements or contracts when, in fact, they were not;
d. the FSC (UBS)Defendants falsely certified and aided and abetted the false certification that the bids submitted by Financial Institution A and FSC (UBS) complied with relevant Treasury regulations or were otherwise competitive, and aided and abetted the submission of corresponding false certifications by co-conspirators at Financial Institution C that the bidding process was bona fide and complied with relevant Treasury regulations or was otherwise competitive;
e. the FSC (UBS) Defendants caused municipal issuers to award investment agreements and other municipal finance contracts to Financial Institution A and FSC (UBS), or to Financial Institution C, which agreements and contracts the municipal issuers would not have awarded to Financial Institution A and FSC (UBS), or Financial Institution C, if they had true and accurate information regarding the bidding process;
f. by manipulating the bidding for investment agreements and other municipal finance contracts, the FSC (UBS) Defendants caused municipalities not to file required reports with the IRS or to file inaccurate reports with the IRS, and to fail to give the IRS or the Treasury money to which it was entitled as a condition of the tax-exempt status of the underlying bonds. This conduct jeopardized the tax-exempt status of the underlying bonds.
Despite the obvious implication that the three defendants had in fact facilitated a cartel amongst three sellers of investment products (described above as Financial Institution A, Financial Institution C and Financial Institution D), the Antitrust Division of the US Department of Justice decided to prosecute the three defendants for wire fraud.
It is also apparent from the indictment that the defendants engaged in fraud by submitting inaccurate reports to both the IRS and the US Treasury about the bona fides of the competitive bidding process.
The Antitrust Division provided further details in the indictment about the defendant’s illegal conduct in colluding with another broker – namely, that they had engaged in wire fraud by:
- discussing and agreeing with CDR (another broker) which of Financial Institution A's competitors should and should not be solicited to submit bids for a particular investment agreement or municipal finance contract;
- obtaining from CDR information about the prices, price levels, rates, conditions or other information related to competing providers' bids, including, in some instances, the exact price, price level, or rate of competing providers' bids;
- determining Financial Institution A and FSC's (UBS’s) bids after obtaining information from CDR about the prices, price levels, rates, conditions, or other information related to competing providers' bids;
- submitting intentionally losing bids for certain investment agreements and other municipal finance contracts brokered by CDR to make it appear that Financial Institution A and FSC (UBS) had competed for those agreements or contracts when, in fact, they had not;
- agreeing to pay and arranging for kickback payments to be made to CDR in the form of fees that were inflated, relative to the services performed, or unearned. These payments were made in exchange for CDR's assistance in controlling and manipulating the competitive bidding process and were not disclosed to the municipal issuers that hired CDR, or to the IRS…
Finally, Heinz was also prosecuted for witness tampering:
65. On or about November 24, 2006…GARY HEINZ, the defendant, unlawfully, willfully, and knowingly did attempt to corruptly persuade another person, with intent to influence the testimony of a person in an official proceeding, and to hinder, delay, or prevent the communication to a law enforcement officer information relating to the commission or possible commission of a Federal offense, to wit, HEINZ, after becoming aware of the grand jury investigation, directed cooperating witness one (CW1) to "forget that [brokered investment agreement] deal," and for CW1 to meet with cooperating witness two (CW2) so that they could get their story straight regarding a payment CW2 caused Financial Institution D to make to Financial Institution A and FSC (UBS) in exchange for FSC (UBS) steering an investment agreement to Financial Institution D.
It appears that the DOJ decided to pursue conspiracy to commit wire fraud and wire fraud charges against the three defendants, rather than Sherman Act offences, due to statute of limitations issues. The relevant conduct occurred between 2001 and 2006, however the statute of limitations for criminal conspiracies, including antitrust conspiracies is five years (18 U.S.C. § 3282).
While the statute of limitations for mail fraud and wire fraud prosecutions is also five years, this period is extended to 10 years for mail and wire fraud scheme which affects a financial institution (18 U.S.C § 3293).
Each of Ghavami, Heinz and Welty were found guilty by the jury of conspiracy to commit wire fraud, as well as a number of substantive wire fraud charges. Heinz was found not guilty of the witness tampering offence.
The conspiracy wire fraud and substantive wire fraud charges each carry a maximum penalty per count of 30 years in prison and a $1 million fine.
Ghavami, Heinz and Welty will be sentenced in the New Year.
Following the jury’s verdict Scott Hammond, the Deputy Assistant Attorney General of the Antitrust Division’s criminal enforcement program stated:
For years, these executives corrupted the competitive bidding process and defrauded municipalities across the country out of money for important public works projects. Today’s convictions demonstrate that the division is committed to holding accountable those who seek to unfairly and illegally undermine competitive markets.
However, one has to ask the question why the DOJ decided to enter into a non-prosecution agreement with UBS given the extremely serious nature of the fraud which was carried out by three very senior UBS executives. One would have expected that the DOJ would have appreciated the importance of taking a criminal prosecution against both the corporate entity as well as the three senior executives.
Indeed, there appears to be a disturbing and growing trend amongst regulators around to the world to go soft on the major banks in relation to their criminal activities, by agreeing to non-prosecution agreements in return for very large dollar settlements.
It is clear that from an enforcement perspective these settlements are entirely inappropriate.
First, unless criminal prosecutions are taken against banks, the specific deterrence message will not get through. Banks will start to see such conduct as fraud, price fixing, and bid rigging as simply as a cost of doing business if they can simply pay a fine and move one. Indeed, there are signs that many of the major banks have already formed the view that they can avoid being held criminally liable for their actions if they simply offer the regulator enough money.
Second, by allowing banks to settle serious fraud and antitrust offences with the payment of a large fine, regulators will be failing to achieve another fundamental goal of any enforcement action – namely to achieve general deterrence. Other banks will not be deterred from engaging in illegal conduct because they will get the message from these financial settlements that the only sanction they will exposed to (if they are caught) is a large fine, which may or may not exceed the financial gains from the illegal conduct.
Third, there is a strong suspicion that the DOJ and other regulators are entering into such lenient settlements with banks for the sole reason that they are banks. There is strong support for the view that regulators have been reluctant to pursue criminal prosecutions against large banks because to do so may jeopardise their banking licences. If any of these banks were to lose their banking licence this would put them out of business, which would in turn have negative effects on the stability of financial markets.
Regulators have to start realising that their approach to bank settlements is seriously flawed. They should not be taking a more lenient approach to criminal conduct by the major banks because they are concerned about the potential effects on the financial system of a bank failing because it has lost its banking licence. Rather, regulators should be treating banks in the same way they would treat any other company which had engaged in blatant price fixing and big rigging behaviour.
Interestingly, the DOJ’s recent practice in relation to bank settlements seems completely out of step with its own statements about the value of establishing corporate criminal liability. As stated by Mr Gregory Werden, Scott Hammond and Belinda Barnett of the Antitrust Division in a recent speech to the National Institute on White Collar Crime:
In our view, eliminating corporate criminal liability would significantly undermine cartel deterrence in several distinct ways. First, corporate criminal liability has a deterrent effect independent of that from monetary sanctions because a criminal conviction stigmatizes a corporation. Second, the deterrent effect of monetary sanctions imposed through civil damages actions would be greatly diminished without assistance from criminal enforcement. As elaborated below, criminal enforcement against corporations detects the cartels, establishes the liability of the defendants, and provides valuable evidence for proving damages. Third, corporate criminal liability and substantial fines are essential in the operation of the Antitrust Division’s leniency program.
There is still time for regulators such as the Antitrust Division to start taking principled and appropriate enforcement responses to banking malfeasance. For example, the remaining LIBOR settlements appear to offer the Antitrust Division numerous opportunities to pursue criminal prosecutions in relation to the serious and highly detrimental collusive activity which was engaged in by a number of the major banks. As only two of the likely 16 LIBOR settlements with major banks have as yet been finalised, the Antitrust Division appears to have at least 14 opportunities to do the right thing from an enforcement perspective and pursue criminal prosecutions.
Unfortunately, from an enforcement perspective even a criminal prosecution may not be sufficient to achieve specific and general deterrence in the banking sector. Rather, what may be necessary is for one of the major banks to actually lose their banking licence following a successful criminal prosecution. It is probably the case that the major banks will only start to take due notice of the deep-seated and institutionalised culture of corruption in their organisations if one of their number pays the ultimate price for its criminal activities by losing its banking licence. Only through such an extreme outcome will banks start realising that they cannot continue behaving badly on the assumption that they will be able to buy their way out of the consequences of their actions.
 HSBC Holdings Plc. and HSBC Bank USA N.A. Admit to Anti-Money Laundering and Sanctions Violations, Forfeit $1.256 Billion in Deferred Prosecution Agreement, Department of Justice News, 11 December 2012 – at http://www.justice.gov/opa/pr/2012/December/12-crm-1478.html
 UBS Securities Japan Co. Ltd. to Plead Guilty to Felony Wire Fraud for Long-running Manipulation of LIBOR Benchmark Interest Rates, Department of Justice News,
19 December 2012
 Three Former UBS Executives Convicted for Frauds Involving Contracts Related to the Investment of Municipal Bond Proceeds, Department of Justice News,
31 August 2012 - http://www.justice.gov/opa/pr/2012/August/10-at-1071.html
 See Indictment in
Peter Ghavami (aka
Peter Ghavamilahidi), Gary Heinz and Michael Welty at http://www.justice.gov/atr/cases/f265300/265389.htm USA
 Non-Prosecution Agreement between US Department of Justice and UBS AG, dated
2011 – at http://www.justice.gov/atr/public/press_releases/2011/270720a.pdf
 Indictment, op. cit., pp. 9-10.
 Ibid, pp. 10-11.
 Ibid, pp. 19-20.
 Ibid., p. 38.
 DOJ News, op.cit., footnote 3.
 Gregory Werden, Scott Hammond and Belinda Barnett, Deterrence and Detection of Cartels: Using all the Tools and Sanctions, The 26th Annual National Institute on White Collar Crime, 1 March 2012, p. 9 - http://www.justice.gov/atr/public/speeches/283738.pdf