OPINION: This week, two different approaches to embedding restraint began to take shape as London-headquartered banks reflected on the exceptional power of the United States Department of Justice to shift cultural mores through the flexing of its prosecutorial discretion.
Both provide tangible evidence of the Department’s renewed interest in the financial sector. This interest will increase dramatically in coming months with negotiated settlements in relation to the London Interbank Offered Rate (Libor) manipulation scandal expected.
HSBC is in the process of submitting a pool of three suitably qualified candidates to the position of independent compliance monitor to the Department of Justice, a pool that the Department can unilaterally reject as part of the bank’s $1.92 billion settlement in relation to the bank’s violation of Anti-Money Laundering and Counter-Terrorism Financing legislation. Meanwhile, Barclays — which reached a financial settlement in relation to its role in the Libor scandal — announced that it had recruited Hector Sants, the former chief executive of the Financial Services Authority, as group head of Compliance and Government and Regulatory Relations. Given Sants' previous support for the necessity of regulating culture, the appointment serves as a litmus test for both the bank and his own credibility.
The critical but unresolved question for banks and regulatory authorities on both sides of the Atlantic — as well as here in Australia — is to what extent the imposition of an external monitor rather than recruiting through the revolving door of regulatory authority and industry reflects “the new normal”.
At its core, this involves an adjudication of what constitutes the appropriate level of external oversight over ongoing corporate practice. It extends far beyond narrow issues of capitalisation. Instead, it focuses attention on how to ensure warranted trust in the operation of free markets while balancing more intrusive supervision with expertise and accountability.
ASIC chairman Greg Medcraft, who takes over the leadership of IOSCO next March, has noted that free markets can only operate with “appropriate regulation”, meaning an emphasis on “working with industry to see if they can better self-regulate or co-regulate”. As with the media industry in the aftermath of the Leveson inquiry, however, the banking sector is drinking in the last chance saloon, with existing regulators increasingly marginalised.
The terms governing the appointment of a corporate compliance monitor for HSBC are exceptionally revealing of the level of distrust. Notwithstanding the fulsome approval of the remedial actions taken by the bank, it is abundantly clear that the Department of Justice is, at best, sceptical of self-regulation. That scepticism has an explicit extra-territorial dimension and extends beyond the bank to the global markets in which it operates.
“To the extent that HSBC Holdings' compliance with obligations as set forth below requires it, HSBC Holdings agrees to require that its wholly-owned subsidiaries comply with the requirements and obligations set forth below, to the extent permissible under locally applicable laws and regulations, and the instructions of local regulatory agencies,” runs the opening paragraph of the job description for the position of Corporate Compliance Monitor (Attachment B).
The position is a fixed term for five years, at the end of which HSBC must sever ties with the monitor for at least one year. The role is to evaluate the effectiveness of the internal controls, policies and procedures of the holding company and its subsidiaries in relation to both anti-money laundering legislation and the remedial action taken in response to the identified failures.
An initial report is required within 90 calendar days of the appointment, which itself is mandated within 60 days of the agreement. Four additional reviews are to be conducted on an annual basis, unless the agreement is either terminated or rendered moot because a further material breach triggers immediate indictment.
The reports are to be contemporaneously submitted to the board of directors of HSBC Holdings and the chief of the Asset Forfeiture and Anti-Money Laundering Section of the Criminal Division, the address of which is helpfully provided, as well as to the Federal Reserve and the FSA in London. Interestingly, the FSA is not given any defined right to engage with the monitor, nor is any of the other parties to the agreement. This is the Department of Justice’s show. (To be fair to the FSA, it has separately agreed that HSBC should establish an AML/sanctions compliance board level committee, review policies and procedures and notes the employment of an independent monitor who is to communicate to regulators.)
Although HSBC can identify and propose the candidate, the Department of Justice retains a veto over the appointment and the procedures governing the production of her reports.
The arms-length terms are underscored by giving the monitor the right to report any difficulties associated with gaining access to sensitive material, with the Department having the right to make a final determination on what should be disclosed without reference to further external adjudication.
The monitor, although ostensibly independent, is unquestionably an agent of the Department.The work plan for conducting the evaluations must be submitted to and approved in advance by the Department. Moreover, “any disputes between HSBC Holdings and the monitor with respect to the work plan shall be decided by the Department in its sole discretion”.
Although the monitor is encouraged to work closely with HSBC in the preparation of the reports, the bank itself lacks the discretion on whether to implement any recommendation unless considered “unduly burdensome, inconsistent with local or other applicable law or regulation, impractical, costly or otherwise inadvisable”.
In such an event, the bank has to provide reasons for the objections “and shall propose in writing an alternative policy, procedure or system designed to achieve the same objective or purpose”. The parties are then given thirty days to reach an agreement.
“In the event HSBC Holdings and the monitor are unable to agree on an acceptable alternative proposal, HSBC Holdings shall promptly consult with the Department, which will make a determination as to whether HSBC Holdings should adopt the Monitor’s recommendation or an alternative proposal, and HSBC Holdings shall abide by that determination.”
Moreover, the Department is to be informed of improper conduct or a material violation uncovered in the course of the monitor’s investigation. It will also report such activity directly to the bank’s chief legal officer, but this can be bypassed if deemed appropriate by the monitor. The whistle-blowing protection is further embedded in the contractual terms as “HSBC Holdings shall not take any action to retaliate against the Monitor for any such disclosures or any other reason”.
The Department of Justice has agreed, in principle, to keep the reports classified, recognising that the information contained in the compliance monitors reports may include “proprietary, financial, confidential, and business information”. Public disclosure “could discourage cooperation, impede impending or potential government investigations and thus undermine the objectives of the monitorship”.
Even here however, the Department can override the commitment to confidentiality if it “determines in its sole discretion that disclosure would be in furtherance of the Department’s discharge of its duties and responsibilities or is otherwise required by law”.
Taken together, the provisions governing the appointment and ongoing work of the Monitor reflect an unparallelled extension of external oversight. Just as significantly, they transfer knowledge directly to the Criminal Division of the Department of Justice, whose remit is governed by very different imperatives than prudential or market conduct regulators.
A new cop is on the beat and making its presence felt. Those drinking in the last chance saloon are on notice that anti-social behaviour orders have been written and will be applied in the event of further infractions. It is not before time. The challenge for the Department of Justice, however, is to exercise its enhanced power with restraint and within accountable boundaries. If not, the cycle will turn once more.
Professor Justin O’Brien is director of the Centre for Law, Markets and Regulation in the UNSW Faculty of Law.
This opinion piece was first published in The Conversation.