This week two different approaches to embedding restraint began to take shape as London headquartered banks reflect 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 to the Department of Justice a pool of three suitably qualified candidates to the position of Independent Compliance Monitor, 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 in August without the imposition of an external monitor, 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 stated interest in and 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 the 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' (the theme of this year's upcoming Australian Securities and Investments Commission Annual Forum on regulatory developments).
At its core this involves an adjudication of what constitutes the appropriate level of external oversight over ongoing corporate practice. As such it extends far beyond narrow issues of capitalisation. It focuses attention instead on the critical questions of how to ensure warranted trust in the operation of free markets while balancing more intrusive supervision with requisite levels of both expertise and accountability.
The chairman of ASIC, 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 marginalized.
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 one 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 ninety calendar days of the appointment, which itself is mandated within sixty 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, however, 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 Justices 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 as they relate to HSBC 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. On an ongoing basis 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 if in the course of the Monitor's investigation of the efficacy of internal controls, policies and procedures improper conduct or a material violation of the law is uncovered as well as reporting such activity directly to the bank's Chief Legal Officer. 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 recognizing that the information contained in the Compliance Monitors reports may include 'proprietary, financial, confidential, and business information' has agreed, in principle, to keep the reports classified. 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 unparalleled 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 Behavior 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.