Fighting Financial Crime in the Global Economic Crisis

Nicholas Ryder, Umut Turksen, Sabine Hassler

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781317964360
• Edition: 1
• Topic: Law
• Subtopic: Financial Law
• Index: Law

Many commentators, regulatory agencies and politicians have blamed the risky behaviour of both financial institutions and their actors for the collapse of the United States sub-prime mortgage market which in turn precipitated the global 'Credit Crunch'. This edited volume explores how financial crime played a significant role in the global economic crisis.

The volume features contributions from internationally renowned academic and practitioner experts in the field who pinpoint some of the most important facets of financial crime which have emerged over recent years. Key subjects include: the possibility of criminalising reckless risk-taking on the financial markets; the duty of banks to prevent money-laundering and corruption; the growth of the Shadow Banking System; and the manipulation of LIBOR by banks. The book illustrates the global nature of financial crime, and highlights the complex relationships between regulatory bodies, law enforcement agencies and private actors in the attempt to limit the harmful effect of white collar crime on the stability of the financial sector.

This book will be of great use and interest to scholars, practitioners and students within the field of financial crime, banking and finance law, and international political economy.

1 Introduction

Nicholas Ryder, Umut Turksen and Sabine Hassler

DOI: 10.4324/9781315867663-1

The financial crisis: a brief review

The origins of the 2007 financial crisis can be traced to the lending practices in the US subprime mortgage markets. It has been well documented that such lending practices, amongst a magnitude of other factors, contributed towards the largest financial crisis since the Wall Street Crash and the Great Depression. The initial indication of the financial crisis arose in 2007, when one of the biggest US subprime lenders, New Century Financial, filed for bankruptcy protection. ¹ Other well-known ‘stalwarts’ of Wall Street that were adversely affected by the financial crisis include Lehman Brothers, American Insurance Group, Bear Stearns and JP Morgan. The initial response to the financial crisis was a reduction of interest rates and the granting of emergency funding by the Federal government. ² President George Bush responsed with the Economic Stimulus Act 2008 and the Emergency Economic Stabilisation Act 2008, which allowed the US government to acquire ‘troubled assets’ from failing financial institutions. The first legislative measure introduced by President Barack Obama was the American Recovery and Reinvestment Act 2009, and this was followed by the Dodd-Frank Wall Street Reform Act 2012. The impact of the financial crisis was felt in the European Union, where several firms reported record losses, and resulted in the introduction of several emergency funding measures between 2008 and 2011.

¹ See Cresswell, J., ‘Mortgage lender New Century Financial files for bankruptcy’, 2 April 2007, available from http://www.nytimes.com/2007/04/02/business/worldbusiness/02iht-loans.5.5118838.html, accessed 21 November 2012. ² Federal Reserve, ‘Term Securities Lending Facility’, n/d, available from http://www.federalreserve.gov/monetarypolicy/tslf.htm, accessed 8 August 2012.

The most infamous victim of the financial crisis in the UK was Northern Rock, which was saved from liquidation by emergency funding by the Bank of England, and the Banking (Special Provisions) Act 2008, which nationalised the failing financial institution. This was soon followed by the Banking Act 2009, which introduced a ‘Special Resolution Regime’ for failing banks, and established the bank insolvency order and a new bank administration order. Other financial institutions that struggled during the financial crisis were Bradford & Bingley, Lloyds TSB, HBOS and the Royal Bank of Scotland (RBS). In light of this, the Financial Services Act 2010 was enacted to provide the Financial Services Authority (FSA) with a new financial stability statutory objective and greater enforcement powers. These measures were amended by the Financial Services Act 2012, a Coalition government measure that resulted in the ‘rebranding’ of the FSA to the Financial Conduct Authority (FCA). Other significant regulatory reforms included the creation of the Prudential Regulation Authority (PRA) and the Financial Policy Committee (FPC), which is housed within the Bank of England.

What factors contributed towards the financial crisis?

The most significant question that has been discussed and answered on many occasions since the 2007 financial crisis is what factors contributed towards it? The contributory variables of the financial crisis included macroeconomic imbalances, the increasing complexity of the securitised credit model; rapid extension of credit with falling credit standards; property price booms; increasing leverage in the banking and shadow banking system; underestimation of bank and market liquidity risk, and a self-reinforcing cycle of irrational exuberance. Other factors included the breakdown in underwriting standards for subprime mortgages; a significant erosion of market discipline; flaws in credit rating agencies; risk management weaknesses at some large US banks; and weak regulatory policies. Other acknowledged factors include the subprime mortgage crisis, weak banking regulation, high levels of consumer debt, deregulation of banking legislation, weak credit regulation, deregulation of consumer credit legislation, self-regulation of credit rating agencies and the culture of banking practices.

The financial crisis and white collar crime

The relationship between the 2007 financial crisis and white-collar crime has been increasingly highlighted by several commentators. ³ The term ‘white-collar crime’ was famously defined by Edwin Sutherland as: This interpretation has attracted a great deal of criticism and has been described as inflexible ⁵ and out of date. ⁶ It is not the intention of this edited collection to provide a definitive guide on definitions or the terminology used but rather as an indicator that within the area there is a great deal of confusion about, and even disagreement on, their scope and use. The association between the financial crisis and white collar crime is clearly illustrated by an increase in the related enforcement actions of both regulatory bodies and law enforcement agencies including the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Federal Bureau of Investigation, the Department of Justice, the FSA and the FCA.

³ See for example Huisman, Q., ‘Corporate crime and crisis: causation scenarios’ in Deflem, M. (ed), Economic Crisis and Crime (Emerald: Bingley, 2011); Nguyen, T. and Pontell, H., ‘Mortgage origination fraud and the global economic crisis’, 9(3) (2010) Criminology & Public Policy 591–612; and Ryder, N., The Financial Crisis and White Collar Crime: The Perfect Storm? (Edward Elgar: Cheltenham, 2014). ⁴ Sutherland, E., White Collar Crime (Dryden: New York, 1949) 9. Also see Benson, M.L. and Simpson, S.S., White-Collar Crime: An Opportunity Perspective, Criminology and Justice Series (Routledge: New York, 2009). ⁵ Bookman, Z., ‘Convergences and omissions in reporting corporate and white collar crime’, 6 (2008) DePaul Business & Commercial Law Journal 347–92, at 355. ⁶ Brody, R. and Kiehl, K. ‘From white-collar crime to red-collar crime’ 17(3) (2010) Journal of Financial Crime 351–64, at 351.

a crime committed by a person of respectability and high social status in the course of his occupation . . . The present-day white-collar criminals, who are more suave and deceptive than the ‘robber barons’, are represented . . . many other merchant princes and captains of finance and industry, and by a host of lesser followers. Their criminality has been demonstrated again and again in the investigations of land offices, railways, insurance, munitions, banking, public utilities, stock exchanges, the oil industry, real estate, reorganization committees, receiverships, bankruptcies, and politics. ⁴

Contents overview

Chapter 2 is written by Professor Jonathan Fisher QC and is entitled ‘Risk, recklessness and policing the financial markets’. In this contribution, Fisher noted that prosecuting authorities in both the US and the UK have attracted a great deal of criticism for failing to prosecute market participants whose actions precipitated or contributed to the 2007 financial crisis. Although characterised by egregious instances of non-disclosure and false valuations, enforcement agencies have been reluctant to initiate criminal prosecutions where it is necessary to prove that a market participant acted dishonestly, intending to cause financial loss to investors and transaction counterparties. Whether reckless risk-taking on the financial markets constitutes dishonest conduct is debatable, and the creation of a new criminal offence has been mooted. However, the taking of risk is inherent in the capitalist system, and if market participants are unduly constrained at a national level, it will encourage financial business to relocate. This chapter explores the tension between calculated risk-taking and reckless risk-taking, and whether the creation of a new criminal offence is necessary. If so, what form should it take and how can legislators maintain the balance between investor protection and the interests of the free market?

In the third chapter for this collection, ‘Credible deterrence and consumer protection through the imposition of financial penalties: lessons for the Financial Conduct Authority’, Professor Peter Cartwright examines deterrence in theory and practice, assessing in particular the FSA’s move towards ‘credible deterrence’ and considering what it would take to create a sanctioning regime which protected consumers by effectively deterring misconduct.

Dr Robert Stokes considers the impact of the LIBOR scandal in Chapter 4, entitled ‘LIBOR manipulation: the limits and potential of corporate criminal liability’. Stokes argues that one of the significant effects of the financial crisis has been to reveal the ‘naked swimmers’ and their flotilla of misdemeanours. The chapter argued that some of such activities were due to poor management and weak compliance infrastructure, others in straightforward criminality. Stokes contends that the manipulation of LIBOR by Barclays Bank Plc is one of the potentially most damaging practices recently revealed by the receding tide. The chapter analyses the activities of Barclays Bank which culminated in the FSA imposing a penalty of £59.5m in June 2012 for various breaches of the Principles of Business Handbook. In particular it considers to what extent the matter is appropriate for regulatory sanction or whether it ought to be dealt with as an act of criminality. If the latter, this raises many interesting questions including what criminal offence has been committed, by whom and what are the penalties applicable if convicted.

Dr Umut Turksen in Chapter 5, ‘Implications of anti-money laundering law for accountancy in the European Union – a comparative study’ examines the role of accountants in relation to anti-money laundering (AML) legislation in the European Union and provides a comparative study and literature review of AML legislative preventative measures. National legislation in these jurisdictions will be critiqued against the Third Money Laundering Directive requirements and Financial Action Task Force recommendations as well as the proposed fourth EU anti-money laundering legislation. The scope of the chapter includes, inter alia, the criminalisation of money laundering, recording and reporting obligations for accountants, and the enforcement and sanctions mechanisms within selected AML regimes. In order to enhance the effectiveness and efficiency of the AML within the EU, it is important for the government authorities to coordinate their efforts with the relevant accountancy regulatory bodies and provide a secure environment in which suspicious activities can be reported effectively. This chapter also comments on whether a well-established dialogue and coordination exist between accountancy regulatory bodies and law enforcement agencies.

In Chapter 6, ‘Solicitors and complying with the anti-money laundering framework: reporting suspicions, applying for consent and tipping-off’, Professor Andrew Campbell and Elise Campbell review the tipping-off offence under the Proceeds of Crime Act 2002 and argue that it causes great inconvenience and problems for the regulated sector. The authors argue that the most frequently mentioned problem for banks and other financial institutions, as well as solicitors, is the period immediately after a suspicious activity report has been made and the person who made the report has instructions from the customer/client to immediately undertake a transaction. The chapter concludes that the tipping-off offence is in need of reform and it uniquely considers the possible alternatives to the current provision.

In Chapter 7, ‘The good, the bad and the fraud: securitisation and financial crime in light of the global financial crisis’, Dr Anastasia Nesvetailova and Andrei Sandu consider the relationship between the ‘shadow banking system’ and the 2007 financial crisis. The chapter defines ‘shadow banking’, discusses the emergent analyses of the phenomenon of shadow banking and concurs that it is regulatory arbitrage that is the main factor behind the expanding chain of units and functions of shadow banking and problematises the extreme opacity that this phenomenon brings to the operation and governance of the global financial system. The chapter aims to go beyond the regulatory arbitrage set of explanations for the existence and reach of shadow banking, and enquires into the structural origins of this phenomenon. Drawing on post-Keynesian theories of asset inflation and financial innovation, this chapter offers a conceptualisation of the shadow banking system as an organic and irrevocable foundation of risk-based finance. In this vision, shadow banking provides crucial inter-temporal, legal and spatial pillars to the process of financial innovation, or what is commonly described as financialisation. Policy-wise, this analysis suggests that the calls for a financial reform underestimate the importance of shadow banking in the overall functioning of the global financial system.

Chapter 8 is co-authored by Professor Indira Carr and Rob Jago and is en-titled ‘Corruption, money laundering, secrecy and societal responsibility of banks’. This chapter focuses on the link between corruption and money laundering and explores the extent to which the anti-money laundering framework has the potential to prevent corruption. The chapter considers the anti-corruption conventions and how they accommodate the anti-money laundering discourse within their overall framework. It is followed with an examination of due diligence procedures including those in relation to Politically Exposed Persons that banks are expected to follow to counter money laundering. The chapter argues that anti-money laundering legislative measures are of limited use only since they are dependent on rigorous application by the banks. To improve the contribution of anti-money laundering measures to combat corruption, the chapter argues that banks, which in some instances encourage this activity through their commitment to bank secrecy, should not be solely profit-seeking entities but should see themselves as having societal responsibility, both at the local and global level.

In Chapter 9, ‘Virtual currency in a virtual world: virtually unstoppable?’, Alan Reid looks at the rising interest in, incidence of and attempts at regulation of virtual currencies. As more and more commercial activities are instituted, organised and concluded online, both lawful and unlawful, the need for a corresponding method of online regulation becomes imperative. The growth of lives lived virtually necessitates close regulation of the cyberspace.

Finally, in Chapter 10 Henry Hillman undertakes a comparative analysis of the enforcement mechanisms adopted in the United States of America and the United Kingdom towards directors of failing banks. The chapter is divided into several sections and concentrates on a wide range of issues including the use of financial sanctions, the disqualification of directors, the imposition of custodial sentences and lesser measures such as the revocation of banking licences.

Table of contents

• Cover
• Halftitle Page
• Series Page
• Title Page
• Copyright Page
• Contents
• Notes on Contributors
• Foreword
• 1 Introduction
• 2 Risk, recklessness and policing the financial markets
• 3 Credible deterrence and consumer protection through the imposition of financial penalties: lessons for the Financial Conduct Authority
• 4 LIBOR manipulation: the limits and potential of corporate criminal liability
• 5 Implications of anti-money laundering law for accountancy in the European Union – a comparative study
• 6 Solicitors and complying with the anti-money laundering framework: reporting suspicions, applying for consent and tipping-off
• 7 The good, the bad and the fraud: securitisation and financial crime in light of the global fi nancial crisis
• 8 Corruption, money laundering, secrecy and societal responsibility of banks
• 9 Virtual currency in a virtual world: virtually unstoppable?
• 10 Are the current laws and potential enforcement measures effective in achieving the accountability of bank directors for their actions, or the actions of the banks they manage? A comparison of UK and US approaches
• Index