Banks face the RICO Act in Libor probe
Earlier this week I wrote about the increasing evidence that Libor, the most important number in the world, has been corrupted by the very banks who create it.
Libor’s the interest rate that underlies $360 trillion of financial contracts worldwide. Interest rate swaps and corporate loans, but also mortgages, student loans, credit cards and more. What’s $360 trillion dollars? That’s the economic size of 24 United States of Americas.
Hearing that the Libor panel banks — the biggest, most global in the business — may have been colluding to distort this number is like hearing that there’s a nuclear bomb buried under the Hoover Dam. Libor and its counterparts are nothing less than the foundation that underlies countless financial contracts all around the world. (More background here.)
But don’t just take my word for it: a veritable alphabet soup of global regulators are currently investigating. The SEC, the CFTC, the Department of Justice, the UK’s Financial Services Authority, and Japan’s Financial Services Agency are all involved. Several lawsuits have also been filed and are working their way through U.S. courts. One of these lawsuits is from Charles Schwab. It ought to be named “Schwab vs. the Street, the City and the Continent”. Its defendants include Bank of America, Credit Suisse, JPMorgan Chase, Barclays, UBS, RBS, Deutsche Bank and Citigroup, among others. And it’s from reading the complaint that one gets a sense of the huge liabilities that these banks are now facing. For it seems that among its other accusations, Schwab is also dropping the RICO bomb.
RICO — the Racketeer Influenced and Corrupt Organizations Act — provides not just for civil complaints, but also “extended criminal penalties” for those found guilty of violating its statutes. Created in the 1970s, RICO is most closely associated with the prosecution of the Mafia. Since then its use has expanded to include targets as diverse as Major League Baseball and Michael Milken. A RICO conviction means that a person or enterprise has been found to have engaged in acts as part of a criminal organization. How’s that for a branding exercise?
From Wikipedia, with my emphasis:
Under RICO, a person who is a member of an enterprise that has committed any two of 35 crimes—27 federal crimes and 8 state crimes—within a 10-year period can be charged with racketeering. Those found guilty of racketeering can be fined up to $25,000 and sentenced to 20 years in prison per racketeering count. In addition, the racketeer must forfeit all ill-gotten gains and interest in any business gained through a pattern of “racketeering activity.” RICO also permits a private individual harmed by the actions of such an enterprise to file a civil suit; if successful, the individual can collect treble damages.
How much might these ill-gotten gains be? From Schwab’s complaint, with my emphasis:
Defendants each had a substantial financial incentive to manipulate LIBOR because each had billions of dollars in exposures to movements in interest rates. Citibank, Bank of America and JPMorgan, for instance, reported billions of dollars (notional) in interest rate swaps during the period under study; even a small unhedged exposure to interest rates would have had a substantial effect on revenues. Indeed, all three banks reported increased net interest revenues in the first quarter of 2009, when LIBOR fell dramatically. Similarly, in 2009 Citibank reported it would make $936 million in net interest revenue if rates would fall by 25 bps per quarter over the next year and $1.935 billion if they fell 1% instantaneously. JP Morgan also reported significant exposure to interest rates in 2009: it predicted that if interest rates increased by 1%, it would lose over $500 million. HSBC and Lloyds also predicted they would earn hundreds of millions of additional dollars in 2008-2009 in response to lower interest rates, and lose comparable amounts in response to higher rates. These banks collectively earned billions in net interest revenues during the Relevant Period. Underreporting the banks’ costs of borrowing also had the benefit of disguising the true risks to their solvency and liquidity during a time of economic crisis and intense political pressure.
And not only is Charles Schwab is accusing the defendants of violating RICO, but also of conspiring to violate RICO. As Vaugh Iskanian and Annie Kellough wrote in the Oklahoma Bar Journal last year (emphasis mine):
The standard for violating the conspiracy provision under RICO is much more liberal and, potentially, any entity that knowingly endorses or encourages the substantive violations could be held accountable. Without actively participating in any racketeering activity, it is still “unlawful for any person to conspire to violate any of the provisions” of RICO.
The conduct of the entity itself does not have to fulfill the requirements for violation of the substantive provisions. Knowledge and facilitation of the acts is sufficient to find an entity guilty of conspiracy under RICO.
As you can see, the major banks may face gigantic liabilities for any wrongdoing found in this Libor probe. And since they are engaged in furious bouts of firing and suspending that looks suspiciously like scapegoating, they are clearly, rightfully worried about where all of this might lead. So it’s very interesting to read in Dealbook that some of the world’s largest hedge fund managers are starting to “warm to bank stocks”. They’d better make sure that they don’t get burned.
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Category: Banking
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