Capital punishment for bankers? Expectations and realities - - PowerPoint PPT Presentation

Capital punishment for bankers? Expectations and realities

Restoring trust in the financial industry, ICMA Asset Management and Investors Council Meeting & Seminar, Zurich, 8 April 2014 Daniel Zuberbühler

Daniel Zuberbühler 1

Ov Over erview iew

• 1. Introduction
• 2. Personal sanctions against top bankers

2.1. Switzerland: Report of Parliamentary Oversight Commission on UBS-crisis 2.2 UK Parliamentary Commission on Banking Standards 2.3 Germany: § 54a: Criminal provision in Banking Law

• 3. Sanctions against banks as enterprises

3.1 Criminal liability of banks 3.2 Monetary sanctions arms race against large financial institutions

• 4. Prudential alternatives to personal or monetary sanctions

4.1 Much more common equity / capital punishment 4.2 Organisational simplification / reduction of complexity

Daniel Zuberbühler 2

1.

• 1. Int

ntroduct

• duction

ion Disclaimer: no death penalty for bankers

• Fall-back into dark middle ages
• Own goal for supervisors: search for culprits will extend to them
• Financial crisis: nobody looks good ! restraint in judgement

Call for sanctions understandable after mega-crisis

• Hold culprits accountable ! enhance responsibility of successors
• Bankers are ideal targets, because overpaid and discredited
• „Paid too much for doing the wrong things“
• General loss of trust in banks as consequence of crisis
• But hypocritical reproach of criminal behaviour in Switzerland for

business-model with foreign tax evaders

Daniel Zuberbühler 4

2.

• 2. Per

ersonal

• nal sanct

anctions ions agains gainst top

• p bank

banker ers „Voluntary“ resignations of top managers & board members after mega-losses or even state bail-out

• Market pressure (shareholders / customer reactions)
• Call for resignation by media and politicians
• Hint from supervisory authority, without formal enforcement
• Take-over by other bank

Only lower employees formally dismissed or criminally prosecuted ! unsatisfactory and unjust Politicians try to hold top bankers accountable for past or at least future failures

Daniel Zuberbühler 6

2.1 2.1 Swit itzer erland: land: GP GPK-R K-Repor eport on

• n UB

UBS, , 30.5.10 30.5.10

Parliamentary oversight on Government and Administration: only behaviour of federal authorities examined

• Motions and recommendations primarily addressed to authorities
• FINMA: what did UBS top management know about QIA-violations?
• Industry ban (FINMAG 33) for departed execs.: no retro-activity

Recommendation 19: „GPK holds UBS accountable“

• Independent expert group should examine bank-internal handling by

BoD, GEB and audit firm, in particular

• Opportunity of criminal procedures / civil-law actions
• Relief from liability for crisis years by General Assembly
• Severance payments for upper and middle management
• Transparency on dispensation with criminal & civil-law actions against

former UBS-Management ! UBS transparency report of 14.10.10

Daniel Zuberbühler 7

Exper xpert opinion

• pinion by

by Tobias

• bias Straumann

aumann: : The he UB UBS Cris isis is in in His Histor

• rical

ical Per erspect pectiv ive, e, 28.9.2010 28.9.2010

UBS top managers were no gamblers, but in their self-perception (and external assessments) risk-avers and rather conservatively prudent, but without sense for hidden risks, sound distrust, independent judgement, strong leadership In historic comparison UBS did not commit unusual mistakes

• Subprime: Whenever financial bubbles rise, many market participants are

tempted into ignoring time-honoured banking rules

• US x-border WM: To be expected that Swiss banks would experience

difficulties to adapt their traditional wealth management to a dramatically tightened regulatory environment. UBS acted only with particular carelessness, but not fundamentally differently than the other banks

Fundamental question: Future positioning of UBS & CS? Binary choice between internationally oriented business model or retreat into the “Reduit” / Illusion: optimised regulation & supervision

Daniel Zuberbühler 8

Tougher

• ugher sanct

anctions ions for

• r mana

manager gers of

• f banks

banks wit ith h for

• rmal

mal or

• r fact

actual, ual, implicit implicit state e guar guarant anty? Cantonal bank executives: no personal moral hazard

• Tax payers react particularly sensitively & resentfully
• Against life experience that managers & politicians would

consciously expose themselves to such a purgatory

Large bank executives do not want a state bail-out

• Ideological horror to be nationalised and subject to state

interference with business orientation & salaries ! death penalty

• Social contempt dissuasive

Wrong incentive from expectation of customers, counter- parties, shareholders in state safety net! low risk premium

• Running systemic risks with minimal capital ! Root treatment:

more capital, resolvability, loss sharing of shareholders and creditors (bail-in)

Daniel Zuberbühler 9

2.2 2.2 UK UK Par arliament liamentar ary Commis

• mmission

ion on

• n Banking

anking Standar andards ds: : Changing hanging banking banking for

• r good,

good, 19.6.2013 19.6.2013 Recommendations adopted by UK Gov. & Parliament:

• Financial Services (Banking Reform) Act of 18.12.2013

Measures to enhance personal responsibility & sanctions

• Finding: Too many bankers, especially at most senior levels,
• perated in environment with insufficient personal responsibility
• Claiming ignorance
• Hiding behind collective decision-making in complex
• rganisations
• Corporate Governance as Potemkin villages: appearance of

effective control and oversight without the reality

• Objective: making individual responsibility a reality

Daniel Zuberbühler 10

UK: UK: Senior enior Per ersons

• ns regime

gime for

• r top
• p bank

banker ers All key responsibilities assigned to a specific, senior individual

• Senior Persons: BoD, GEB and some other key functions
• Detailed job description
• Handover certificate when relinquishing position: outline how

responsibilities were exercised and highlight critical issues for successor

• Responsibility remains with designated individual, even when

delegated or subject to collective decision-making

• Burden of proof reversed for supervisory sanctions:
• After successful enforcement against bank: Senior Persons must

demonstrate, that they took all reasonable steps to prevent / mitigate failing

• Reckless misconduct: entire remuneration recoverable

Doubts about fairness of formalised responsibility / bureaucracy

Daniel Zuberbühler 11

Sca cape pegoa goat idea idea reject ejected ed by by EBK K bef befor

• re

e cr cris isis is

Designate a senior for compliance

• Resignation in case of violation

" Sacrifice financially cushioned " After every accident new sacrificial lamb on ejector seat # Unsustainable & unfair

Daniel Zuberbühler 12

UK: UK: Licens Licensing ing regime gime for

• r ot
• ther

her bank bank emplo employees ees wit ith h pot potent ential ial for

• r ser

erious ious har harm m Objective: facilitate enforcement also against lower sinners

• Licensed Persons: bankers, whose behaviour could seriously

harm the bank, its reputation or its customers

• Contractual obligation to set of Banking Standards Rules
• Bank responsible for instruction and disciplinary actions
• No prior examination / approval by supervisors ! Bank

responsible alone

Single public register for Senior & Licensed Persons

• Swiss FIDLEG-project: professional skills examinations & duty to

register for all client advisors in financial sector ! bureaucracy

Daniel Zuberbühler 13

UK: UK: Criminal iminal of

• ffence

ence of

• f „r

„rec eckles kless mis misconduct conduct“ “ in in the he mana management gement of

• f a

a bank bank Prison sentence of up to 7 years for reckless misconduct of Senior Persons

• If the bank „failed“ due to their actions or omissions
• Insolvency, substantial costs to taxpayers, lasting consequences

for financial system or serious harm to customers

• If their behaviour was far below the standard, which could

reasonably be expected in their position

• Aware of risk that their behaviour could lead to failure of bank

Only for most serious of failings and primarily in large banks

• In smaller banks proving responsibility is easier and harm is much

lower

Daniel Zuberbühler 14

UK: UK: Remuner emuneration ion for

• r Senior

enior & Licens Licensed ed Per ersons

• ns:

: Incent ncentiv ives es for

• r bet

better er beha behaviour iour Remuneration Code: longer run balance of risks / rewards $

• Deferred compensation: much higher proportion and for much

longer periods of up to 10 years

• Favour long-term performance and soundness of firm ! bail-in

bonds / CoCos

• No reliance on narrow measures for profitability: ! RoE
• Cancellation of deferred remuneration in light of individual or

wider misconduct or downturn in performance of bank or business area

• Direct taxpayer support: cancellation of deferred remuneration,

unvested pension rights and severance payments

• ≈ Lex UBS (Art. 10a BankL): Prohibition of variable compensation /

adaptation of remuneration system ! contractual provision

Daniel Zuberbühler 15

2.3 2.3 Ger Germany many: : § § 54a 54a cr criminal iminal of

• ffence

ence in in Kr Kredit editwes esenges engeset etz

§ 25c Abs. 4a KWG: Risk management duties of bank executives as part of adequate organisation §54a KWG: Prison sentence of up to 5 years for top managers

• Violation of risk management duties
• Threat to existence for bank or banking group
• Only punishable in case of prior BaFin order to remediate violation and

if such an enforceable order is disregarded

• Criticism by German lawyers: against principle of clarity and

segregation of powers if BaFin determines punishability

Problem: BaFin-order only feasible, if failings in RM detected

• Supervisors did not see risk management failings prior to crisis (incl. UBS)
• More appropriate: order remediation under threat of withdrawal of

license / removal of delinquent managers

Daniel Zuberbühler 16

3.

• 3. Sanct

anctions ions agains gainst banks banks as as ent enter erpr pris ises es 3.1 3.1 Criminal iminal law law Swiss corporate criminal liability (102 StGB): symbolic instead of practical ! at least no overkill More worrying: US criminal indictments against enterprises life-threatening. Reason for

• FINMA-rescue of UBS on18.2.09: customer-data passed to DoJ
• US Tax Program of DoJ for other Swiss banks
• Wegelin case: gave up banking activity before court decision, because

it would have run out of steam

• Arthur Andersen: acquitted 3 years after indictment

US criminal threat very efficient, but disproportionate and legally highly questionable weapon: death by starvation

Daniel Zuberbühler 18

3.2 3.2 Monet

• netar

ary sanct anctions ions ar arms ms race ace agains gainst lar large ge financial inancial ins instit itut utions ions – – wit ithout hout for

• rmal

mal indict indictment ment 1 1 Multi-billion fines against banks for sins committed before

• r during the financial crisis:
• End phase of crisis management: a posteriori redistribution of

crisis-losses from state or investors to banks, combined with civil- law actions for damages

• Crisis winners subsequently become losers:
• Sale of toxic subprime papers and avoiding losses on trading assets

before market collapse ! Accusation of defrauding „ignorant“ market participants

• Paying also for sins of insolvent banks taken over at crisis peak
• Fannie Mae & Freddy Mac: Federal Housing Finance Agency sues 18

banks for 200 bn. USD for losses of mortgage GSEs; crisis victim UBS pays 885 m. USD; Credit Suisse pays same amount.

Daniel Zuberbühler 19

3.2 3.2 Monet

• netar

ary sanct anctions ions ar arms ms race ace agains gainst lar large ge financial inancial ins instit itut utions ions for

• r compliance

compliance viola iolations ions 2 2 Billions in fines, disgorgements of profits, indemnifications, not only for subprime mortgage securitisations

• OFAC sanctions, corruption, money laundering, competition law,

distribution of useless products, rigging of interest rates (LIBOR etc.) and soon also rigging of forex prices

• J.P. Morgan in 2013 paid total of 22 bn. USD for settlement of law

suites, but still made a net profit of 18 bn. USD

• f which 920 m. USD to UK and US authorities for control

deficiencies in risky derivatives trades of „Whale of London“ with loss of 6.2 bn. USD

• UBS paid for LIBOR-scandal total of 1.4 bn. CHF to US, UK and CH

authorities, of which1.2 bn. USD to US authorities; escaped fine of 2.5

• bn. € for EU competition law only due to whistleblower rule
• EU Commission in Libor case fined 8 banks with 1.7 bn. € for

competition law violations, of which Deutsche Bank with 725 m. €

Daniel Zuberbühler 21

3.2 3.2 Monet

• netar

ary sanct anctions ions ar arms ms race ace agains gainst lar large ge financial inancial ins instit itut utions ions – – pr proces

• cess and

and mot motiv ives es 3 3 Arms race of supervisors and prosecutors for ever higher monetary sanctions by settlement

• Internationally coordinated process: alignment of investigations

and communication of closure of procedure, but

• overlapping material & geographic competences lead to

cumulative punishment, esp. in competition among many US authorities ! mark turf & secure part of prey within pack

Motives for arms race

• Stated objective: punishment and deterrence against future

misconduct / monetary incentive for preventive measures of top management (get the attention from boards and CEOs)

• Public expectation: „Main Street vs. Wall Street“

Daniel Zuberbühler 22

3.2 3.2 Monet

• netar

ary sanct anctions ions ar arms ms race ace agains gainst lar large ge financial inancial ins instit itut utions ions – – mot motiv ives es of

• f aut

author horit ities ies 4 4

Headline-grabbing fines: WIN-WIN for authorities

• Reputation as tough supervisor ! compensate reproach of

earlier laxity or regulatory capture

• Promote career of senior officials and prosecutors if
• politically appointed or aspiring for private sector

(revolving door)

• Contribution to empty state coffers
• Settlement limits burden and procedural risks for

understaffed authorities; no cumbersome search for individual culprits

• Settlement avoids overkill of criminal indictment

" But: egoistic motives undermine moral justification

Daniel Zuberbühler 23

3.2 3.2 Monet

• netar

ary sanct anctions ions ar arms ms race ace agains gainst lar large ge financial inancial ins instit itut utions ions – – doubt doubts on

• n ef

efficac icacy 5 5 Focus on enterprise weakens individual responsibility

• Resolving legacy: convenient for actual management ! blame

predecessors; lessons learned, but if repeated

• Suspicion: today‘s ordinary profits will become legacy

tomorrow ! Successors will also exclude them as extraordinary losses / special factors; „adjusted“ results = whitewashing ! Operational risks from breaches of rules & exorbitant sanctions become normality (cost of doing business)

• Justification of bonuses by blending out sanctions as extraordinary

factors, even in case of accounting net loss

• Tax deduction as commercially justified expenditure: for fines

controversial, but admitted for settlement without admission of guilt

• US excesses at cost of Swiss taxpayers; in addition no corporate

income tax paid due to deferred tax assets from crisis losses

Daniel Zuberbühler 24

3.2 3.2 Monet

• netar

ary sanct anctions ions ar arms ms race ace agains gainst lar large ge financial inancial ins instit itut utions ions – – doubt doubts on

• n ef

efficac icacy 6 6

• Dose of fines must be increased constantly to achieve effect on

firms and public ≈ drug consumption

• Costs borne by shareholders:
• Unjust against passive investors without influence on behaviour
• Against prudential interest in strong capitalisation to withdraw own

funds from bank or make its shares unattractive investment

Gross violation of proportionality

• Guiding principle for sanctions: violations should not pay !

Orientation on realised profit + some risk of loss + costs of procedure and defence + remediation program

• Fines far above: mostly low-profitability activities
• Positive example: FINMA disgorgement of profits in UBS-LIBOR

% No competence for FINMA to impose heavy monetary sanctions

Daniel Zuberbühler 25

4.

• 4. Prudent

udential ial alt alter erna nativ ives es to

• indiv

individual idual or

• r monet

monetar ary sanct anctions ions No need for tougher sanctions for small / medium-sized banks or lower employees in large banks

• Discussion rightly focussed on large, complex and mostly

internationally active banks and their top managers

Approaches discussed either ineffectual, bureaucratically burdensome, unjust, legally questionable or simply disproportionate More realistic approach: preventive prudential measures to ensure that

• 1. Large losses can be absorbed by banks without endangering

creditors or the financial system, and

• 2. Risk of severe mistakes is reduced by simplifying complex
• rganisations

Daniel Zuberbühler 26

4.1 4.1 Muc uch h mor more e CET1 1 & Capit pital al Punis unishment hment ins instead ead

• f
• f fines

ines Doubling Leverage Ratio to at least 7- 8% of total exposure, with hard common equity ! Review of Swiss Too big to fail- regime in spring 2015 Capital Punishment instead of fines

• Supervisory capital surcharge for losses and severe compliance

failures ! Instead of weakening bank by withdrawal of funds , strengthen loss absorption capacity by increasing capital or reducing risky activities

• No penalty or guilt issue: factual proof that bank does not master

its risks ! need for higher safety cushion

• FINMA version: capital surcharge of 50% for operational risks

from legal and compliance issues of UBS ! correction of inadequate internal model (AMA) = close combat against galloping consumption of risk-weighted assets from internal models

cutting through complexity

Daniel Zuberbühler 28

4.2 4.2 Or Organis ganisational ional simplif implifica ication ion / reduct eduction ion of

• f

comple complexit xity

No „culprits“ for failures found among top managers ! complex behemoths no longer manageable or controllable

• Too large and complex to be managed by group executive board, to be
• verviewed by BoD and to be supervised by regulators
• Instead of formalistic or causal-like liability, organisational simplification

and compartmentalisation of group structures

• Improved resolvability of G-SIBs requires preventive structural

interventions: ring-fencing systemic functions from risky trading of investment banks; prohibition of proprietary trading (Volcker rule); subsidiarisation of local units by host countries

• Side benefit: business areas and legal entities better overlooked and

easier manageable & controllable; investment bank reined in by Basel III and requirement for auto-financing

• Ring-fencing doctrine maybe only temporary fashion ! If experiment

fails ! More radical conclusion: break up because simply too big ! hence trial and error in financial market regulation

Daniel Zuberbühler Sonnenbergstrasse 3 3013 Berne Switzerland Mobile: +41 78 710 48 74 d.zuberbuehler@hispeed.ch

Full version in German: Banker an den Galgen? Erwartungen und Realitäten, in Jusletter 24. März 2014, http://jusletter.weblaw.ch/_750? current=1