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Obamacare Website Fixer Has Thing For Tax Havens

If you had to hire an outside company to run the Patient Protection and Affordable Care Act’s enrollment website, which would you rather have: a goody-two-shoes outfit that doesn’t know what it’s doing or a competent, well-known consulting firm that makes liberal use of offshore tax havens?

The best choice is neither, of course. Ideally, the U.S. government would set a good example and pick a skilled U.S. contractor that isn’t a poster child for clever tax shelters. Instead, the job of taking over construction of HealthCare.gov, which failed miserably when it debuted in October, is going to Accenture Plc, which switched its place of incorporation in 2009 to Ireland from Bermuda. It will replace Montreal-based CGI Group Inc., which got the blame for many of the website’s early problems.

It was only last May that the Senate Permanent Subcommittee on Investigations held hearings excoriating Apple Inc., which is based in Cupertino, California, over its use of Ireland as a tax haven. So it’s a bit surprising to see that hardly anyone is complaining about the Accenture hire. This may be an example of an orphan controversy. It’s sitting there waiting for someone to make a big deal of it, but there aren’t many politicians with an interest in doing so — even on a hot-button subject as politicized as Obamacare.

Democrats in Congress generally don’t want to be seen badmouthing the White House or the Affordable Care Act. Many Republican lawmakers (and plenty of Democrats, too) may be reluctant to criticize corporate tax dodges. For instance, Senator Rand Paul of Kentucky, a reliable Tea Party basher of Obamacare, spent much of his time at last year’s Senate hearing defending Apple’s use of offshore refuges to avoid U.S. taxes.

Accenture has endured so much criticism over the years for its use of tax havens that it even has a disclosure in its annual report warning investors to expect as much.

“Some companies that conduct substantial business in the United States but which have a parent domiciled in certain other jurisdictions have been criticized as improperly avoiding U.S. taxes or creating an unfair competitive advantage over other U.S. companies,” Accenture said. “Accenture never conducted business under a U.S. parent company and pays U.S. taxes on all of its U.S. operations. Nonetheless, we could be subject to criticism in connection with our incorporation in Ireland.”

That isn’t the whole story. Accenture got its start as part of the Chicago-based accounting firm Arthur Andersen. The firm’s consultants won an agreement in 1989 to form their own unit, Andersen Consulting, which remained affiliated with Arthur Andersen until 2000, when the two organizations severed ties. Andersen Consulting changed its name to Accenture in 2001 and went public the same year. Then, in 2002, Arthur Andersen imploded after being indicted in connection with its audit work for Enron Corp., the failed energy trader.

In other words, Accenture’s roots date back to a once-iconic American business, which helps explain why it’s gotten a lot of heat for incorporating in tax havens since spinning off.

In a 2002 report, the Government Accountability Office found that four of the 100 largest publicly traded federal contractors were incorporated in tax-haven countries. Accenture was one of them. The others were conglomerate Tyco International Ltd. and oil-services companies McDermott International Inc. and Foster Wheeler Ltd. Since then, Foster Wheeler and Tyco have switched locales to Switzerland from Bermuda. McDermott is still incorporated in Panama, while its executive offices are in Houston.

Plenty of other companies have drawn similar scrutiny. In 2008, the GAO released a report that looked at the 100 largest U.S.-based federal contractors that were publicly traded. It found that 63 of them had subsidiaries in tax havens. Citigroup Inc. had the most with 427, including 91 in Luxembourg, 90 in the Cayman Islands, 19 in Bermuda and 16 in Ireland.

All that said, if Accenture can make HealthCare.gov work properly, there probably won’t be many people criticizing it as a poor choice, model corporate citizen or not. The government doesn’t need angels for this job. It needs people who know how to build a good website.

(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter @JonathanWeil)

AFP Photo/Karen Bleier

Banks Demand Pity Party Over Volcker Rule Losses

Whatever successes might have been attained within the hundreds of pages of regulations implementing the Volcker Rule, our nation’s bureaucrats must have known they couldn’t do anything that would force banks to unearth any long-buried losses in their financial reports. Because then many bankers would feel victimized. They would demand that regulators rush to soothe their hurt feelings. And America would never be the same until the banks could keep those losses unrecognized again.

Yes, I’m kidding. But the banking lobby isn’t. This week, a Utah-based lender, Zions Bancorp, said it would have to take a charge to earnings in the neighborhood of $387 million because the new rules will force it to sell a bunch of collateralized debt obligations. Those CDOs declined in value a long time ago. But the accounting rules said Zions didn’t have to include those losses in its earnings. Now that Zions has to sell them, it can’t keep the losses buried and must count them on its income statement.

A few hundred other lenders may be in similar situations, though probably none as extreme as the one at Zions. Now the banking industry’s numerous lobbying groups are complaining to regulators and asking for clarification of the rule — footnote 1,861, if you care to look it up — which means they don’t like it and want it changed. They also have enlisted several U.S. senators to intervene with regulators on their behalf.

It generally isn’t a good idea for the government to pick winners and losers or to tell companies what investments they can’t keep. Surely there is money to be made somewhere buying up assets that banks aren’t allowed to own anymore. It’s hard to tell if the regulators intended the consequences in this instance or not, as part of the rules’ prohibitions against banks sponsoring or owning stakes in hedge funds and private- equity funds.

That said, the point of the Volcker Rule was to keep banks from gambling with depositors’ money. So it shouldn’t come as a surprise that banks face new restrictions on the types of investments they can make. At some point, after three years of hand-wringing, the banking regulators have to stop revising what they’ve passed and declare it final, which they happen to have done already this month. Whining from bankers about their sudden inability to paper over losses on old CDOs isn’t a sufficient reason to reopen the process all over again.

(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter @JonathanWeil)

Photo by “mlmdotcom” via Flickr

Book-Cooking Bank Gets To Keep Its Books Cooked

Dec. 6 (Bloomberg) — Here’s a not-so-comforting lesson for investors, courtesy of the Securities and Exchange Commission. Just because the SEC says a company’s earnings were fraudulent doesn’t mean the company will ever be required to correct them.

The SEC this week accused Fifth Third Bancorp of committing accounting fraud during the height of the 2008 financial crisis. The company agreed to pay a $6.5 million penalty to settle the agency’s claims.

The funny part: Fifth Third, which is Ohio’s largest bank, has never acknowledged to this day that its numbers were in error. The SEC isn’t requiring it to do so now. A Fifth Third spokesman, Larry Magnesen, said the company considered whether it needed to do a financial restatement and decided it didn’t.

Reasonable people might disagree about whether Fifth Third committed fraud. Per the usual protocol, Fifth Third neither admitted nor denied the SEC’s allegations. Yet it’s beyond belief that the company never had to set the record straight about its financial statements. Fifth Third first disclosed the SEC’s investigation in its 2010 annual report. So the bank has had a few years to revise its figures.

Surely an accounting error that is fraudulent also should be deemed material by SEC. Yet the agency isn’t treating it that way. An SEC spokesman, John Nester, declined to comment.

According to the SEC’s Dec. 4 administrative order, Fifth Third’s loss for the third quarter of 2008 would have been more than twice what it reported, had it complied with generally accepted accounting principles. The bank had been trying to sell some troubled commercial real-estate loans that had plunged in value. However, it continued to classify the loans as “held for investment” instead of “held for sale.” This let the bank avoid a $169 million writedown that quarter. Fifth Third reclassified the loans the following quarter. It sold most of the loans at issue in December 2008 and in 2009.

The SEC in its order said Fifth Third and its chief financial officer at the time, Daniel Poston, violated federal antifraud laws. (Poston, who will pay $100,000, also got a neither-admit-nor-deny deal.) Comment letters to the company from the SEC’s staff show the agency was asking Fifth Third about its loan accounting as far back as May 2010.

“It appears that the company should have restated in 2010,” says Don Whalen, general counsel and research director at Sutton, Massachusetts-based Audit Analytics, which tracks restatement data.

If nothing else, the Fifth Third case may help explain why restatements by U.S. banks declined after the financial crisis got started. Back in March 2011, I wrote a column that noted there were 133 banks that issued corrections from 2008 through 2010, according to Audit Analytics. That was down from 169 banks during the previous three-year period, before the crisis took off in earnest. That made no sense, considering the country had just experienced the greatest banking-industry meltdown since the Great Depression. The obvious conclusion was that the government had given lots of banks a free pass.

In at least this one instance, the SEC identified GAAP violations so egregious that they amounted to fraud — and never required a correction. Perhaps the moral of this story is that if a company drags out an accounting investigation long enough, it won’t have to admit any mistakes, because by then the matter will be ancient history.

(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter @JonathanWeil)

Photo via Wikimedia Commons

The JPMorgan Settlement Isn’t Justice

Nov. 22 (Bloomberg) — For years the public has vented about half-baked government settlements in which corporations and white-collar defendants “neither admit nor deny” the allegations against them. The Justice Department wasn’t about to go down that path when it unveiled its big, not-really-$13 billion deal this week with JPMorgan Chase & Co.

So the government made a few sly tweaks. The result is a mutant offspring of the no-admit genre that may be even less satisfying than the parent. JPMorgan didn’t have to admit to any violations of the law. And here’s the rub: The Justice Department didn’t allege any, either.

According to the settlement agreement, the bank will pay a civil penalty “pursuant to” a statute called the Financial Institutions Reform, Recovery and Enforcement Act. However, the Justice Department didn’t lodge any claims against JPMorgan for breaking that law or any other. This was an out-of-court settlement. The Justice Department didn’t file a complaint. No judge’s approval was needed.

The agreement did incorporate an 11-page statement of facts that explained in vague terms what JPMorgan did. Yet none of the acknowledgments by JPMorgan in that document hurt the bank. JPMorgan didn’t admit liability or even any mistakes. That’s no better than the old “neither admit nor deny” boilerplate.

This isn’t justice. It’s more like the greenmail that companies sometimes pay to corporate raiders who demand premium prices for their shares in exchange for going away. No individuals got pinched. We don’t know much about the details of what the Justice Department’s investigation found. It’s unclear why prosecutors didn’t accuse JPMorgan of fraud, although one possible explanation is that the government lacks proof.

The wording of the settlement agreement was awkward at times, too. It said the Justice Department had investigated the mortgage-bond operations of JPMorgan and two failing companies that it bought: Bear Stearns Cos. and Washington Mutual Inc. “Based on those investigations, the United States believes that there is an evidentiary basis to compromise potential legal claims by the United States against JPMorgan, Bear Stearns and Washington Mutual, for violation of federal laws,” the agreement said.

That line makes it seem like the U.S. doubted its own case, although perhaps it was just poorly drafted. The sentence would have made more sense if it said there was enough evidence to “bring” claims against JPMorgan, not “compromise” them. Maybe the prosecutors were trying to say they believed there was sufficient evidence to merit a settlement. But that doesn’t make much sense, either: The act of settling speaks for itself.

As an aside, it’s fitting that Massachusetts attorney general Martha Coakley took part in the same accord. Of the $13 billion headline figure — which combined the Justice Department’s $2 billion penalty with the amounts secured by several state and federal agencies — the settlement agreement earmarked about $34 million for Massachusetts.

In 2009, Coakley took a similar claim-free approach to squeeze money from Goldman Sachs Group Inc. Her office didn’t file a lawsuit or allege that Goldman Sachs violated any statutes or rules. Goldman Sachs didn’t admit anything, either. But it did pay $60 million to make the Massachusetts investigation go away. Coakley’s office had been looking into Goldman Sachs’ packaging of subprime mortgage bonds.

Surely some of the money that JPMorgan shells out will go to good use. Yet something important is lost when law-enforcement officials strike bargains with powerful corporations behind closed doors and fail to be transparent about what their investigations uncovered.

The Justice Department said this week that the settlement “does not absolve JPMorgan or its employees from facing any possible criminal charges.” By this point, though, it’s hard to take the Justice Department seriously when it says to stay tuned.

The department also said that “JPMorgan acknowledged it made serious misrepresentations to the public” as part of the agreed-upon statement of facts. Actually, it did no such thing. The document didn’t use the word “misrepresentation” or similar language to describe any of JPMorgan’s actions.

Usually when corporations settle with the Justice Department, they agree not to contradict the government’s assertions publicly. Yet on this occasion JPMorgan felt compelled to set the record straight. “We didn’t say that we acknowledge serious misrepresentation of the facts,” JPMorgan Chief Financial Officer Marianne Lake said during a Nov. 19 conference call.

She was right: The Justice Department overreached in its characterization. It isn’t a good sign when the company paying billions of dollars to resolve a government probe comes across as more believable than the government lawyers who cut the deal.

(Jonathan Weil is a Bloomberg View columnist.)

Photo via Wikimedia Commons

Eric Holder Finally Gets Tough On Banks

Oct. 25 (Bloomberg) — See if you can make sense of this. Somehow, in the space of seven months, U.S. Attorney General Eric Holder has gone from being:

1) The defeatist law-enforcement chief who told the Senate Judiciary Committee that some banks are too big to prosecute because of the economic damage that might ensue, to

2) The crackdown artist who presided over a meeting in which his team told JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon that the bank would need to enter a guilty plea in order to end a criminal investigation by prosecutors in California.

What gives? Maybe Holder will let JPMorgan skate once the probe is completed. Yet clearly a new approach is afoot. After that meeting, the Justice Department proposed that JPMorgan plead guilty to making false statements related to sales of defective mortgage bonds. The bank proposed a non-prosecution agreement, which Holder rejected, according to an Oct. 22 article by Bloomberg News.

Not long ago, large banks could be fairly confident they wouldn’t face criminal charges in the U.S. no matter what they got caught doing. Now the Justice Department is keeping the threat of such charges hanging over JPMorgan while the bank wraps up $13 billion in civil settlements with various government agencies.

Holder said in an interview that the department’s new aggressiveness on bank investigations was a top priority for both President Barack Obama and himself. (Holder didn’t talk about JPMorgan specifically.) Obama promised in his 2012 State of the Union address to hold banks accountable for their role in helping cause the worst recession since the Great Depression. A task force was set up, and it played a significant role in the pending JPMorgan deal.

Other important questions remain unanswered. For instance, what about before 2012? Why did the Justice Department do so little to go after banks during Obama’s first term?

Here is one way to look at it: For about five years, there were entire categories of wrongdoing by large financial-services companies that were all but deemed exempt from criminal prosecution. We’ve never gotten a satisfactory explanation from anyone in the government as to why.

But it wouldn’t be a surprise if someday we learned that a conscious policy decision was made during the Obama administration’s early days that aggressive investigations of too-big-to-fail banks and their senior executives would be contrary to the national interest because of the threat that prosecutions posed to financial stability and the economic recovery.

Even if this isn’t what happened, the White House and Justice Department must know this is the outward impression they created by their unexplained inaction. What’s more, the facade of trying to look tough while doing almost nothing was coming undone. In August, for example, the Justice Department admitted to grossly inflating how many mortgage-fraud prosecutions it had brought in years past.

A crucial difference between now and when Obama took office is that the stock market has rebounded and the financial-services industry has stabilized after much help from the government, especially the Federal Reserve. Even so, public anger over the lack of accountability has failed to subside, and cynicism about Wall Street’s pull in Washington has skyrocketed. The government didn’t want to be seen as giving the banking industry a pass.

So the administration had to come up with new, creative ways of holding the country’s banks to account. The largest ones seem healthy enough again to withstand government attacks. Yet the five-year statute of limitations for many fraud cases has elapsed. This, of course, presented a problem for the Justice Department, which had to be a bit more inventive than normal.

One of the department’s favorite new tools has been a once-obscure statute called the Financial Institutions Reform, Recovery and Enforcement Act of 1989, which was passed in response to the 1980s savings-and-loan crisis. Federal prosecutors in New York used the act, known as FIRREA, to win their jury verdict this week in a civil trial against Bank of America Corp.

The law, which has a 10-year statute of limitations, lets prosecutors file civil claims for violations of criminal mail-fraud and wire-fraud statutes that affect “a federally insured financial institution.” It is a strange creature that has led to some odd outcomes.

In the case against Bank of America, prosecutors accused the company of defrauding Fannie Mae and Freddie Mac. Those two entities don’t take federally insured deposits. Nonetheless, in an August ruling, U.S. District Judge Jed Rakoff said the case could proceed on the grounds that Bank of America is a federally insured financial institution and that any fraud it may have committed would have affected itself.

That reasoning may follow the letter of the statute, but it isn’t an intuitive basis for a lawsuit. Plus, if the government believes criminal laws were broken, why pursue only civil claims? Maybe it’s because even on their best days, prosecutors seem interested mainly in easy wins for which the burden of proof is low.

We have yet to see what violations the Justice Department will cite in its civil settlement with JPMorgan. Another FIRREA case may be possible. The Justice Department filed a second FIRREA lawsuit against Bank of America in August and, as Bloomberg News reported this week, Bank of America faces three other FIRREA probes across the country. Several other large banks, including Citigroup Inc. and Credit Suisse, are contending with FIRREA investigations, too.

Prosecutors also used FIRREA in their February lawsuit against Standard & Poor’s. In that case, the government alleged that Citigroup was duped by S&P credit ratings on subprime mortgage bonds that Citigroup itself created and sold. Bank of America, too, allegedly was “affected” by S&P’s ratings in the same way. The theory is bizarre at first glance. But for now, the law seems to be on the Justice Department’s side.

There is no telling what great things U.S. prosecutors might have accomplished had Holder and his team been this determined and creative all along, before the biggest fraud cases of the financial crisis turned cold.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: ryanjreilly via Flickr

Not Too Early To Start Worrying About Banks Again

Sept. 20 (Bloomberg) — You don’t often see Washington regulators publicly raising alarms about banks’ accounting practices. That’s why a speech this week by the comptroller of the currency, Thomas Curry, deserves more attention.

The way Curry described the situation, you get the sense that some banks’ numbers may be too good to be true. He made clear he wasn’t warning about an imminent crisis. Yet he cautioned that some banks seemed to have been “scrimping on their allowances against their loan losses,” which is a fancy way of saying they may be fudging their numbers.

To understand better what he was referring to, here’s a brief accounting primer. Loan-loss allowances are the reserves that lenders set up on their balance sheets for perceived bad loans. Provisions are the expenses they record to boost those allowances. As losses are confirmed, lenders charge off the uncollectible amounts, reducing the allowances.

Sometimes lenders decide, in hindsight, that their allowances are too big. When this happens, they may undo some of the provisions they had previously booked. Bankers refer to this as “releasing reserves,” which boosts earnings and capital. This has been happening at several large U.S. banks lately, such as JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. Investors often refer to these gains as “low-quality earnings.”

Curry, who became comptroller in April 2012, said some reserve releases are to be expected as underwriting standards, loan performance and the economic climate improve. “But for some banks, the ease with which the allowance could be repurposed as earnings has proved habit-forming,” he said, without naming any companies. He noted that “this is happening despite loosening credit underwriting standards, which suggests that risks are increasing that may result in larger charge- offs.”

Loan-loss provisions and charge-offs have both been on the decline industrywide for a few years. Curry pointed out, though, that provisions have been falling at a faster rate — a signal that banks’ optimism about their loan quality might be outpacing reality. During the second quarter of this year, lenders regulated by his office recorded about $6.1 billion of provisions, equivalent to only 56.6 percent of their net charge-offs, according to data compiled by the agency. A year earlier, provisions were $10.4 billion, equivalent to 67.1 percent of net charge-offs.

One result is that recent surges in capital, which banks tout as a sign of resilience, may in part be illusory. An easy way for a bank to overstate its capital is to underestimate its losses. To find a period when banks’ provisions exceeded net charge-offs you would have to go back to the fourth quarter of 2009.

One good sign is that the banking industry’s loan-loss allowances are still more robust than they were during the years leading up to the financial crisis. Allowances at comptroller-regulated banks were equivalent to about 2.1 percent of total loans and leases, as of June 30. That percentage has been declining the past few years, after topping 4 percent in 2010. Back in early 2007, the figure was a mere 1.1 percent, which helped make banks look healthier and more profitable than they really were.

If banks are low-balling their provisions, accounting standards may be partly to blame. The way the rules stand now, lenders typically must meet two conditions before they can recognize loan losses. It must be “probable” that a loss has been incurred as of the balance-sheet date. The loss also must be reasonably estimable. Otherwise, no loss gets recorded.

These sorts of judgments and estimates can get extremely complex, especially for banks with millions of customers. The answers may be difficult for outsiders to challenge. Bankers who want to show lower losses can put on blinders, at least for a while, as many did during the financial crisis. Likewise, it may be tempting for some banks to overestimate losses and create excess reserves that they can dip into later like a cookie jar when they want to show higher earnings and capital.

Curry said he favors a proposal by the U.S. Financial Accounting Standards Board that would change the rules so that banks could recognize credit losses more quickly. Instead of having to decide whether it’s probable that a loss has been incurred, they could record “expected” losses. On paper, this should make it harder for banks to delay losses, because the threshold for recognizing them would be lower. (That is, if the banks do what the rules say.)

This has a possible downside, too. If Curry is worried about excessive reserve releases now, just wait to see what happens when banks get to book loan losses earlier and more often. Banks that were inclined to create cookie-jar reserves before could wind up having an easier time doing so.

Perhaps the best we can hope for is that the solution won’t be worse than the problem. To his credit, Curry is flagging the issue. Banking regulators didn’t emerge from the last crisis looking so good. This counts as progress.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

Photo: Steve Jurvetson via Wikimedia Commons

JPMorgan Investigations Are America’s New Pastime

Aug. 30 (Bloomberg) — Hardly a week goes by without a new report about a government investigation of JPMorgan Chase & Co. and how much money the bank might have to pay because of some alleged violation of the law.

The ritual is familiar by now. Details of the probe emerge, then settlement talks get leaked by one side or the other before the case is resolved, perhaps as a pressure tactic or to alert the market so that the final deal is barely news once it’s unveiled. And the outcome proves unsatisfying because the company doesn’t admit liability for breaking any specific laws.

The cases often present a bounty of ironies for a company that has reported $21.3 billion in legal fees and litigation costs since the start of 2008, which is almost as much as it paid in shareholder dividends. Sometimes the proceedings seem like bona fide attempts at law enforcement, notwithstanding that JPMorgan will always be afforded special treatment as a too-big-to-fail bank. Other times the payments look like a mere cost of doing business, with no moral judgment attached, even if the claim is something as serious as fraud.

A couple of recent examples: This week the Financial Times and other news organizations reported that the Federal Housing Finance Agency, which is the conservator for Fannie Mae and Freddie Mac, recently demanded a $6 billion settlement from JPMorgan in a lawsuit it filed two years ago over faulty mortgage bonds that Fannie and Freddie bought.

Some of those bonds were sold by JPMorgan. It’s also true that a large portion were sold by Washington Mutual Inc. and Bear Stearns Cos., which the government practically begged JPMorgan to buy in 2008 to keep the financial system from going kaput. JPMorgan assumed those companies’ liabilities, of course, and now finds itself facing some that perhaps it hadn’t counted on and weren’t of its own doing.

Separately, the Wall Street Journal reported this week that JPMorgan may pay as much as $600 million to resolve various investigations of the London Whale scandal, in which the bank lost control over some of its derivatives traders and wound up losing more than $6 billion. The Securities and Exchange Commission has insisted that JPMorgan admit wrongdoing — whatever that’s supposed to mean — as part of any civil settlement, according to news reports.

That doesn’t mean JPMorgan would have to admit legal liability. It probably won’t, based on precedent. So once again, the SEC would allow admissions of liability to be a sort of third rail that it refuses to require of settling defendants. Heaven forbid that other litigants might use it against the company in separate proceedings.

And who would a $600 million penalty hurt? In this case, the shareholders, of course. It’s debatable whether this is a just outcome. This isn’t like the $410 million that JPMorgan agreed to pay the Federal Energy Regulatory Commission last month for manipulating electricity markets. Shareholders deserved to be penalized in that instance, because they benefited from the company’s alleged misconduct in the form of extra profits. (This week, a Senate investigative panel sought records on that case, adding yet another headline to the company’s clip file.)

In the London Whale matter, investors were harmed by JPMorgan’s poor internal controls and inaccurate financial reports, not to mention the $6.2 billion trading loss. Fining the company arguably would penalize some shareholders twice — but not all of them. Those who bought the stock shortly after the scandal broke last year have done well because the price rebounded fabulously. The trading debacle is what created their buying opportunity. (JPMorgan shares were recently trading for about $50 after bottoming at $31 in June 2012.)

Another way of looking at this same case: Perhaps fines against the corporation are warranted — not because of any harm JPMorgan caused to its investors, but because of the risk the bank poses to the country were it to have a total meltdown in controls and tank the economy.

Meanwhile, two former JPMorgan traders have been criminally charged over their conduct in the London Whale affair. The prosecutors couldn’t find sufficient evidence on anybody higher up than them — such as the executives who created the incentives and the control environment in which they operated.

As for JPMorgan, it’s no secret that the government can’t enforce the law to its fullest extent. An indictment of the company, if one were ever warranted, could jeopardize the financial system and the economy. Both the Justice Department and the SEC in recent years have attached provisions to settlement agreements with JPMorgan in which the company agreed not to violate the law again. Those “obey-the-law” directives almost never get enforced against repeat offenders, and there’s scant reason to believe they would be against JPMorgan.

We simply don’t have a good way to punish big financial institutions for breaking the law. This, of course, encourages law-breaking. It’s hard to see this changing. Too many competing economic and political forces get in the way. If the government won’t let big banks fail, it isn’t about to try to kill them off. Still the prosecutors and regulators feel obligated to show they’re doing something.

JPMorgan’s shareholders are accustomed to the headlines. They can’t be pleased about them. In its latest quarterly report, the company disclosed six investigations by the Justice Department alone. This week we learned the Justice Department had joined another one: a bribery probe of the bank’s hiring practices in China. It could be years before the company gets its name out of the police blotter.

Jamie Dimon, JPMorgan’s chairman and chief executive officer, must be longing for the days when the big news about his bank was all the things it did right.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: Steve Jurvetson via Wikimedia Commons

Has Eric Holder Found Wall Street’s Nightmare?

Aug. 23 (Bloomberg) — Why didn’t the U.S. Justice Department get someone like Leslie Caldwell years ago when it needed her?

Caldwell, a partner at the New York law firm Morgan Lewis & Bockius LLP, is the former prosecutor who led the Justice Department’s Enron Task Force from 2002 to 2004, which resulted in criminal prosecutions of 36 defendants after the Houston energy-trading company collapsed. She is now the lead candidate to become chief of the department’s criminal division, succeeding the rather passive Lanny Breuer, who left in March to return to the white-shoe law firm Covington & Burling LLP. Caldwell, 55, is in the final stages of the vetting process, Bloomberg News reported this week.

The Enron team’s record under Caldwell wasn’t perfect, of course. Yet when the country needed a seasoned prosecutor to bring tough cases and help restore investor confidence after a wave of accounting scandals, she and her squad performed admirably. Enron’s former chief financial officer, Andrew Fastow, pleaded guilty to fraud charges shortly before Caldwell stepped down as the task force’s director in March 2004. His testimony later helped prosecutors win guilty verdicts against former Enron Chief Executive Officers Jeffrey Skilling and Ken Lay.

In July 2002, after the telecommunications giant WorldCom Inc. imploded, President George W. Bush created a new corporate-fraud task force that went far beyond Enron. It resulted in almost 1,300 convictions, which included about 200 CEOs and corporate presidents and more than 50 CFOs.

That’s the type of response the U.S. needed to the 2007-2009 financial crisis. The country never got it. One of the central features of the crisis was how obvious it was that lots of big financial companies’ balance sheets were a farce. This helped cause the collapse in confidence that could only be restored with taxpayer backing. Yet no senior executive of a major financial institution was prosecuted.

Gretchen Morgenson and Louise Story of the New York Times nailed one of the crucial reasons in a landmark April 2011 article. In 1995, bank regulators made 1,837 criminal referrals to the Justice Department, according to data the Times reporters obtained from the Transactional Records Access Clearinghouse at Syracuse University. From 2007 to 2010, the average number of referrals for criminal prosecution was 72.

The plunge makes it seem like this must have been the result of a policy choice, perhaps motivated in part by a desire to promote financial stability. It’s as if the Justice Department simply forgot how to pursue serious financial-fraud cases — with the exception of Manhattan U.S. Attorney Preet Bharara’s campaign against insider trading at hedge funds. U.S. Attorney General Eric Holder told the Wall Street Journal this week that more cases spawned by the crisis may be unveiled in coming months. Yet some of the best opportunities may have been lost to time. The statute of limitations for many crisis-era fraud cases has passed or soon will.

Lehman Brothers Holdings Inc. wasn’t even under investigation when it filed for bankruptcy in September 2008. Recall that the night before it filed for Chapter 11, television reports showed Lehman employees streaming out of the building carrying boxes of documents — walking proof that the company hadn’t received subpoenas or been told by the government to preserve evidence. It’s no wonder nobody from Lehman was ever charged. The scene was cold by the time investigators arrived.

No senior executives were charged at American International Group Inc., Bear Stearns Cos., Citigroup Inc. or Merrill Lynch, to name a few. The Securities and Exchange Commission’s civil-trial win this month against former Goldman Sachs small fry Fabrice Tourre doesn’t count for much. Nor do all those SEC settlements where the defendants neither admitted nor denied anything.

Sure, corporate-fraud cases are complex and often hard to prove. In crises past, the government found a way to bring them and win. Caldwell certainly knows how, notwithstanding that the conviction of Enron’s accounting firm, Arthur Andersen LLP, was overturned on appeal.

That Holder is tapping her is a signal, if nothing else, that he is concerned about the relentless criticism the Justice Department has endured for its lack of criminal charges against Wall Street executives, as well as its habit of letting off corporate defendants with non-prosecution or deferred-prosecution deals. Those were the criminal division’s white-collar hallmark during Breuer’s four-year tenure.

Assuming Caldwell gets the post, we will have to see if she still has the same prosecutorial chops she did in 2002, when she took over the Enron investigation in Houston. (Before that, she served in the U.S. Attorney’s office in San Francisco, where she was chief of the criminal division and the securities-fraud section.) Sometimes white-collar defense work, like the kind she has done at Morgan Lewis, softens veteran prosecutors. For others, representing the other side only makes them better when they go back to government service.

So much time has passed since the financial crisis that the best we can hope for now is that the government regains its footing when it comes to prosecuting financial crimes. It clearly lost its way. If Leslie Caldwell has the same stuff she did when she led the charge against Enron’s bad boys, there is hope for things at the Justice Department to get better.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: The Aspen Institute via Flickr.com

If I Bribe City Hall, Can I Reduce My Mortgage?

Aug. 2 (Bloomberg) — Richmond, California, sent the securities and real estate industries into a tizzy this week. The city said it is moving ahead with plans to use its power of eminent domain to seize home mortgages and restructure them for residents who owe more money than their homes are worth.

This would be a first in the U.S. Normally when governments do things that upset Wall Street millionaires it’s a sign they’re going down the right path. There are exceptions, of course.

Here is another story about Richmond, a city of about 106,500 on the east side of San Francisco Bay. In May, its No. 2 administrator, Leslie Knight, stepped down. A corruption investigation, which started with a whistleblower complaint, found she had been using municipal offices and employees to run a personal gift-basket and party-favor business. She was also collecting a car allowance and using a city car at the same time. She later paid back $10,000 to the city, according to local news reports.

Knight wasn’t fired. The city manager gave her a warning and let her resign as assistant city manager and head of human resources, which meant she got to keep her pension. Protesters have picketed the district attorney’s office demanding that he prosecute her. (He declined.) The Contra Costa Times in June wrote that Richmond’s city attorney “stonewalled, trying to block public access to documents about the case” — which were released only after the newspaper brought in its own lawyer. The same city officials would oversee the new eminent-domain program in one fashion or another.

This is the nature of local government in much of the U.S. It tends to be corrupt. Or at least it has been that way everywhere I have lived, from Colorado and New Jersey to Texas, Florida and Arkansas. It’s easy to see how a plan to grab loans from their out-of-town owners would inspire graft. Supposedly city governments would have to pay them fair compensation, but you can be assured most would offer less. The losers mainly would be bondholders that own mortgage-backed securities.

Richmond has 4,600 underwater mortgages. It sent purchase offers this week to the owners of several hundred. Just wait till some nosy gadfly or enterprising journalist figures out that some of those borrowers are friends, relatives or patrons of local politicians — or on the city’s payroll themselves. It’s bound to happen, if not in Richmond then in other municipalities that try to follow its example. Then picture the recriminations as folks figure out who scratched whose back in exchange for getting their principal balance reduced by tens or hundreds of thousands of dollars. This could be the biggest wealth creator to hit some small towns since the invention of roadside speed traps.

Imagine what would ensue if a program like this were tried in some ethically challenged city such as New Orleans or Miami. Or Hoboken, New Jersey, the town I call home, where two of the last four mayors have gone to prison for taking bribes. Where I live, it’s amazing what people have managed to accomplish with brown paper bags of cash and by knowing the right people.

Some residents who receive help could be hurt worse. Like game-show contestants who win a new car and suddenly find they owe the Internal Revenue Service more money than they have, the lucky borrowers might face big tax bills if their loan reductions wind up counting as income. I suppose the city can dream up something magical to make those debts vanish, too.

Perhaps using eminent domain in this way is legal. The big lobbying groups for the financial-services industry say it’s unconstitutional. So do civil libertarians. The government conservator for mortgage giants Fannie Mae and Freddie Mac last year said it “has significant concerns about the use of eminent domain to revise existing financial contracts.” Litigation would be inevitable and drag on for years.

Cornell law school professor Robert Hockett, in a Federal Reserve Bank of New York paper published in June, explained how a system like this would work. In typical academic fashion, he made it all seem so smooth and sensible. I can’t fathom how it would be in practice.

For instance, we learned from the banking scandals a few years ago that many of the companies trying to foreclose on people’s homes can’t prove who owns the mortgages. The problem cuts both ways. What will a city do when it can’t verify ownership of a loan, especially when it discovers this only after buying one?

Cities usually use eminent domain to seize land and buildings. If they’re going to start seizing home mortgages, why stop there? In some states cars are subject to local property taxes. Why not seize auto loans, in the name of economic development and promoting the public good? Maybe next they could go for people’s past-due credit card debt. How could anyone stand by idly and not help local voters who are deemed deserving, right? Then watch city officials complain when banks charge all of their constituents more money for credit because of their ZIP code.

Legal or not, well intentioned or otherwise, this is a horrible idea. The mortgage market may be dysfunctional, but the status quo is better than letting city employees choose winners and losers. It isn’t often that I can say this, but this time when the banks win, they will deserve to.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: “BasicGov” via Flickr.com

Guy Walks Into Citigroup Branch, Loses $40,000

July 19 (Bloomberg) — Looking at the way that U.S. senators Elizabeth Warren and John McCain are pitching their proposal for a 21st-century version of the Glass-Steagall Act, I can’t help but wonder if they’re making a mistake.

Mostly they have promoted their new bill in terms of protecting taxpayers and the broader economy from a too-big-to-fail bank that might need another bailout. A lot of voters don’t get the connection between the problem and the solution being proposed, and it’s debatable if there is one. Here’s a better argument: The reason it’s a good idea to separate securities firms from commercial banks is to protect consumers from brokers selling schlock investments.

If the senators are going to persuade Congress to bring back Glass-Steagall, they should show examples of real, sympathetic people. This brings me to the story of Philip L. Ramatlhware, an immigrant from Botswana who went to a Citigroup Inc. branch in downtown Philadelphia one day five years ago to open a regular bank account.

He was 48 years old at the time and disabled, after being hurt in an accident as a passenger on a Greyhound bus. His English wasn’t good, he had no college education and his last job had been at a fast-food kiosk at the Philadelphia airport. In April 2008, he received $225,000 in a settlement for his injuries, part of which went to pay legal fees. He was holding the settlement check when he walked into the branch.

Immediately he was referred to a broker for a “financial consultation,” according to an arbitration claim he filed against Citigroup. The broker assured him the money would be invested in “guaranteed” funds and that he could have access to them whenever the need arose, the complaint said. Ramatlhware gave him $150,000 to invest. The broker put $5,000 into a bank certificate of deposit, bought a $133,000 variable annuity and invested the rest in a series of mutual funds.

Less than six months later, Ramatlhware had lost $40,000, according to the complaint. Citigroup settled the case in 2010 for $22,500, without admitting liability, according to a report on the case by the Financial Industry Regulatory Authority.

There are countless tales like this of banks cross-selling unsuitable investments to unsophisticated customers. For whatever reason, lots of people trust the advice they get from someone working in the lobby of their local retail bank branch, even if they normally would never set foot in a brokerage firm.

Here’s another example from Finra’s files, involving a Michigan couple, Alberto Ferrero and Qingwen Li, who filed a claim in 2010 against CCO Investment Services, a unit of Royal Bank of Scotland Group Plc. They sought $60,000, plus attorneys’ fees and other damages. They were awarded almost $72,000.

Their story began one day in April 2007 when they walked into their local bank, Charter One, also owned by RBS. Here’s how the arbitrator explained the November 2012 ruling in their favor:

“Claimants are recent immigrants to the United States, and they had very limited investment experience,” wrote James Graven, an attorney from Toledo, Ohio, who was the arbitration panel’s chairman. “Claimants went to their bank to roll over their CD. The bank directed them to a registered representative. Claimants’ primary objective was capital preservation.

“The broker recommended a solicited trade placing one third of claimants’ net worth in one speculative fund. The broker made material misrepresentations and omissions concerning risk. Claimants lost approximately 50 percent of their investment in 18 months. The broker invested claimants’ whole account into one high-risk junk municipal bond fund.”

The banking industry has a long history of preying on unsuspecting depositors by selling them garbage securities without regard to suitability. This was a big reason Glass- Steagall was originally enacted during the Great Depression. It has been a recurring problem ever since key portions of the act were repealed during President Bill Clinton’s administration.

There were $61 billion in settlements between large banks and the Securities and Exchange Commission over sales of auction-rate securities, the market for which crashed in 2008. At Wachovia Corp., for example, the SEC said bank employees helped recruit retail depositors for the investments. (Wachovia was bought by Wells Fargo & Co. in 2008.)

Most recently, according to a July 8 article in American Banker, the Office of the Comptroller of the Currency warned JPMorgan Chase & Co. early last year that the bank had wrongfully steered clients into in-house investment products. As a result of its findings, the OCC required the company to refund fees to an unknown number of customers. Unfortunately, we don’t know many more details because the examination findings are confidential (which should make this ripe for a congressional inquiry). American Banker said its source was a person with direct knowledge of the findings.

Now back to Senators Warren, a Democrat from Massachusetts, and McCain, the Arizona Republican. What they should do is canvass the country for the most gut-wrenching stories they can find about ordinary depositors who have been ripped off by their banks’ broker-dealer arms. Then invite them to testify before Congress and tell the country what happened, in their own words. The Senate Permanent Subcommittee on Investigations, where McCain is the ranking Republican, would be an ideal forum.

The best way to keep the sharks from preying on the customers in the bank lobby is to not let them in there in the first place. If this also helps make systemically dangerous banks smaller, that’s all the better.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: bruceg1001 via Flickr

S&P’s Public Relations Nightmare

July 12 (Bloomberg) — After the U.S. Justice Department accused Standard & Poor’s of fraud earlier this year, the credit rater had a choice.

It could make a courtroom argument that would torch its reputation, but might get the lawsuit thrown out.

Or, if S&P’s executives decided the harm would be too great in the court of public opinion, they could tell the lawyers to use another approach, even if it might be less likely to succeed in getting the case tossed.

In the end, the company went with the first option and lost. Now S&P is stuck with the damage.

The argument S&P made was that company statements extolling the objectivity, independence and integrity of its ratings are only “puffery” and that a reasonable investor wouldn’t depend on them. The Justice Department’s complaint alleged that such statements were false and part of a scheme to defraud investors. This week, in a preliminary ruling, the judge overseeing the suit rejected S&P’s defense, which at some level looks even worse than the government’s accusations. (Search “S&P puffery” on Google, and you will see what I mean.)

In April, after S&P filed its motion to dismiss the case, the Huffington Post ran this headline: “Standard & Poor’s Admits Its Claims of Objectivity, Integrity Are Mere ‘Puffery.’” In an article this week, Slate’s Matthew Yglesias wrote: “The law is the law, but this line of defense simply underscores that these agencies deserve to die.” His headline: “S&P Legal Defense — No Reasonable Investor Would Take Us Seriously.”

The defense has become part of S&P’s corporate image. After S&P cut Italy’s sovereign-debt rating this week, the website Zero Hedge posted a copy of the company’s report under the heading “Full ‘Puffery’ Statement.” Another blogger joked that S&P stands for “Snake-oil & Puffery.” These barbs have to hurt.

It’s one thing to blow your reputation by slapping AAA ratings on all sorts of garbage subprime-mortgage bonds, as S&P did during the housing bubble. It only makes it worse to go into court years later and argue that your most cherished values are, for legal purposes, a bunch of smoke.

Maybe S&P figured it had little to lose. The company gets paid by the issuers of securities that it rates or by other interested parties such as Wall Street underwriters. So even if credibility should be S&P’s most important asset, it’s not as if it hadn’t suffered self-inflicted harm already.

This is a classic dilemma for companies in crisis. The natural instinct for many litigators is to use every conceivable argument that might have even a remote shot at winning in court — and to severely restrict everyone else at the company from making public comments. The problem is that sound legal strategies sometimes create public-relations nightmares.

On the flip side, the most effective maneuvers from a communications standpoint — such as acknowledging errors and getting out all the worst facts quickly — can risk opening companies to more liability in court. Often PR and legal professionals end up pursuing conflicting agendas if they don’t work cooperatively.

In the motion to dismiss the case, signed by John Keker of the San Francisco law firm Keker & Van Nest LLP, S&P took the position that its ratings, in fact, “were objective, independent and uninfluenced by conflicts of interest,” but that such statements weren’t “actionable as fraud.” It was a tough needle to thread. The U.S. district judge hearing the case, David O. Carter in Santa Ana, California, didn’t buy the argument.

“S&P stands accused of fashioning a unified public image of trustworthiness backed by specific statements designed to induce consumers to rely on the objectivity of its ratings,” Carter said in the ruling, which he called tentative. “S&P’s statements were not a ‘general, subjective claim’ about the avoidance of conflicts of interest, but rather a promise that it had ‘established policies and procedures to address the conflicts of interest through a combination of internal controls and disclosure.’” The judge said he would take a closer look at the case before issuing a final ruling.

In hindsight, S&P shouldn’t have gone down this path. Yet it’s also understandable why it did. S&P’s parent, McGraw-Hill Financial Inc., prevailed before a federal appeals court last year using a similar puffery defense in a shareholder lawsuit. Judge Carter distinguished that ruling easily, noting that the Justice Department accused S&P and McGraw-Hill of defrauding investors who were the bond ratings’ end users. The pension fund that sued McGraw-Hill in its capacity as a shareholder had far different interests, he wrote.

There’s an old test that everyone in the public eye should use when making important decisions: How would this look if you read about it on the front page of a major newspaper or website? S&P must have known the answer in advance. It looks awful now. Other companies should learn from its example.

(Jonathan Weil is a Bloomberg View columnist.)

Photo via Wikimedia Commons

Where Are The LIBOR Cases Against U.S. Banks?

citibank

June 28 (Bloomberg) — It would look awfully strange if the U.S. government wound up targeting only foreign banks as part of its investigation into the manipulation of the London InterBank Offered Rate. It’s too soon to say if that will be the end result. But time is marching quickly.

A year ago this week, London-based Barclays Plc cut a $160 million nonprosecution agreement with the U.S. Justice Department and became the first bank to admit to falsifying its LIBOR submissions. Two other European banks — Zurich-based UBS AG and Edinburgh-based Royal Bank of Scotland Group Plc — have reached LIBOR-related settlements with U.S. prosecutors since then, each with much harsher penalties than Barclays got.

LIBOR is the interest-rate benchmark used in hundreds of trillions of dollars’ worth of financial contracts, from derivatives to mortgage loans. It is based on daily surveys of large banks about their borrowing costs. That it was rigged for years by large banks is well established. Still unclear is which other lenders will be held accountable, or when.

Will the feds go after any U.S. banks? Last week’s criminal charges in the UK against Tom Hayes, a former derivatives trader at UBS and Citigroup Inc., only add to the curiosity. They came six months after U.S. prosecutors filed their own criminal complaint against Hayes and another former UBS trader. A comparison of the allegations in the two cases yields some noteworthy differences.

The eight criminal counts filed by UK prosecutors include the period of time that Hayes worked for Citigroup in late 2009 and into 2010, as well as the three years he worked at UBS before then. UK officials said he conspired with employees of at least five other banks and three interdealer brokers to manipulate yen LIBOR rates. The UK court documents identified all the companies allegedly involved, including JPMorgan Chase & Co. (Hayes, 33, appeared in a London court last week and hasn’t indicated how he will plead.)

In the U.S., by comparison, the complaint against Hayes listed three criminal counts, the timeline for which ended in September 2009, when Hayes left UBS. The complaint cited UBS by name but not Citigroup or other companies.

Put another way, the criminal counts against Hayes in the UK include conduct while he worked at both UBS and Citigroup. The three counts against him in the U.S. refer to the time he worked at UBS but not at Citigroup.

A separate section in the U.S. complaint does cite illegal acts that Hayes allegedly committed in 2010, when he was a Citigroup employee. However, those weren’t referred to in the fraud, conspiracy and antitrust counts that Hayes was specifically charged with. The Justice Department’s Dec. 19 news release about the charges against Hayes didn’t mention Citigroup, either.

Might U.S. officials have carefully crafted the counts against Hayes to avoid calling attention to Citigroup? There’s no way to know from the outside looking in. A Citigroup spokeswoman, Shannon Bell, declined to comment. So did a Justice Department spokesman, Michael Passman.

The U.S. complaint against Hayes was unsealed on the same day as a $1.5 billion settlement with UBS, under which its Japanese subsidiary pleaded guilty in the U.S. to wire fraud. The allegations against the company and the individuals went hand in hand. That UBS admitted to criminal behavior was consistent with charges that certain UBS employees broke the law, too.

On the flip side, the notion that Citigroup didn’t violate U.S. laws makes more sense if the criminal counts against Hayes don’t mention any conduct while he worked there. It’s also possible, of course, that prosecutors had other, perfectly good reasons for structuring the complaint against Hayes as they did.

You won’t find much useful information about the probes in the companies’ disclosures. JPMorgan and Citigroup noted the existence of the Justice Department’s LIBOR investigation in recent securities filings. However, neither company specified whether the probe is civil or criminal in nature — even though it’s pretty clearly the latter.

There are indications that foreign corporations may face stricter penalties than domestic companies have in U.S. criminal cases. Brandon Garrett, a law professor at the University of Virginia who is working on a book about corporate prosecutions, said he examined more than 2,250 corporate convictions and criminal settlements from 2001 to 2012 and found that foreign firms were fined an average of $35 million, compared with $4.7 million for domestic firms.

Even when Garrett made adjustments to control for the type of crime and whether a company was publicly held, foreign corporations still paid far larger fines on average. To be sure, the numbers don’t tell us whether prosecutors unfairly single out foreign companies, Garrett said.

In a speech last month, Mythili Raman, the acting head of the Justice Department’s criminal division, said U.S. authorities aren’t done with their LIBOR probe, which also resulted in a guilty plea to wire fraud by Royal Bank of Scotland’s Japanese unit. “Banks will be held to account through public admissions of guilt, payment of significant monetary penalties and, as seen with RBS and UBS, criminal convictions,” she said.

Whether those include U.S. banks remains to be seen.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: bruceg1001 via Flickr.com

Bank Of America’s Foreclosure Frenzy

June 21 (Bloomberg) — In one corner, we have five former Bank of America Corp. employees who told a federal court they were instructed to mislead customers on the verge of losing their homes and stall their applications for loan modifications.

In another corner, we have Bank of America, which says nothing could be further from the truth.

Who’s right? If anything, the bank’s strident denials make me more inclined to believe the workers’ claims. “These allegations are absurd, patently false and contrary to Bank of America’s long-standing policy only to foreclose as a last resort when other available options to help keep people in their home have been exhausted,” Jumana Bauwens, a Bank of America spokeswoman, told Bloomberg News in an email this week.

Perhaps some of the allegations may be wrong. But to say all of them are obviously false? You have to wonder. A lot of the former employees’ claims make sense.

We have known for years that the U.S. Treasury Department’s Home Affordable Modification Program failed miserably at its stated goal of helping struggling homeowners. In part, that’s because companies and divisions of major banks that service mortgage loans often can make more money from foreclosures than from loan modifications.

It didn’t bother the banking industry’s “robo-signers” that they risked committing perjury when they signed false affidavits filed in courthouses across the country to speed foreclosures along. Now, Bank of America would have us believe that all of these former employees were making things up under penalty of perjury when they came forward and told their stories.

The former employees’ statements were filed with a federal court in Boston as part of a lawsuit against Bank of America by homeowners who say they were improperly denied permanent loan modifications. Bank of America says it will respond to the statements in greater detail in a court filing.

The workers gave horrific accounts about Bank of America’s compliance with the Home Affordable Modification Program. One consistent theme was that they said they were told to deceive borrowers about the status of their applications.

“My colleagues and I were instructed to inform homeowners that modification documents were not received on time, not received at all, or that documents were missing, even when, in fact, all documents were received in full and on time,” said Theresa Terrelonge of Grand Prairie, TX, who worked at Bank of America from 2009 to 2010 as a loan-servicing representative. She said workers “were awarded incentives such as $25 in cash, or as a restaurant gift card” based on “how many applications for loan modifications they could decline.”

Simone Gordon of Orange, NJ, who left Bank of America in 2012, gave a similar account. “Employees were rewarded by meeting a quota of placing a specific number of accounts into foreclosure, including accounts in which the borrower fulfilled a HAMP trial period,” Gordon said. “For example, a collector who placed ten or more accounts into foreclosure in a given month received a $500 bonus.” Other rewards for placing accounts into foreclosure included gift cards to Target or Bed, Bath & Beyond.

“We were regularly drilled that it was our job to maximize fees for the bank by fostering and extending delay of the HAMP modification process by any means we could — this included by lying to customers,” Gordon said.

William Wilson, a Bank of America underwriter and manager in Charlotte, NC from 2010 to 2012, described what he said was called a “blitz.” About twice a month, he said, Bank of America would order case managers and underwriters to clean out the backlog of HAMP applications by rejecting any file in which the documents were more than 60 days old. Employees were instructed to “enter a reason that would justify declining the modification to the Treasury Department,” Wilson said.

“Justifications commonly included claiming that the homeowner had failed to return requested documents or had failed to make payments,” he said. “In reality these justifications were untrue. I personally reviewed hundreds of files in which the computer systems showed that the homeowner had fulfilled a trial period plan and was entitled to a permanent loan modification,” but was nevertheless declined during a blitz.

“On many occasions, homeowners who did not receive the permanent modification that they were entitled to ultimately lost their homes to foreclosure,” he said.

After Bloomberg wrote last week about the former employees’ statements, the top Democrat on the House Financial Services Committee, Maxine Waters, sent a letter to Christy Romero, the special inspector general of the Troubled Asset Relief Program, asking that her office investigate. Yet it’s hard to get one’s hopes up about the government’s desire to get at the truth.

There already has been a $25 billion nationwide whitewash of a settlement between regulators and big banks over improper foreclosure practices, along with billion-dollar payments under a different settlement to consultants who were hired to review those practices. Nobody was prosecuted, much less wrist-slapped.

This week, the court-appointed monitor overseeing compliance with the terms of the national mortgage settlement said he found “more work needs to be done” by big mortgage servicers to improve their treatment of customers. But neither he nor the regulators have ever reported anything as dubious as the conduct described in the former Bank of America employees’ court declarations. Perhaps they just missed a bunch of stuff.

If there was a good reason to believe that the government’s priority is to investigate big banks rather than protect them, maybe Bank of America’s blanket denial would seem more credible.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: thecloverhunter via Flickr.com

Cocaine Cowboys Always Know Best Places To Bank

To grow up in South Florida during the 1970s and 1980s, as I did, wasn’t your typical American childhood experience. Back then the area was known as the most dangerous place in the country.

Carnage from the drug wars filled the local news long before “Miami Vice” became a hit TV show. By elementary school, my friends and I knew some of the lingo. A Colombian necktie wasn’t a piece of clothing, but a gruesome execution method. When I was 7 years old my barber was murdered in his shop, apparently over a drug deal.

It had been a long time since I thought much about those days. By chance I recently came across a fabulous documentary, “Cocaine Cowboys,” by Miami filmmaker Billy Corben. Then last month a Senate panel held a hearing on the U.K. bank HSBC Holdings Plc and its ties to drug lords, money laundering, al- Qaeda and rogue nations such as Iran and North Korea.

Here’s a bank with $2.7 trillion of assets that flouted U.S. laws for a decade, according to the July 17 report by the Senate Permanent Subcommittee on Investigations. HSBC turned a blind eye to organized crime, Mexican drug cartels and overseas terrorism financiers, and gave them access to the U.S. banking system. HSBC’s main U.S. regulator, the Office of the Comptroller of the Currency, for years tolerated its violations of anti-money laundering laws.

For this, HSBC and the OCC apologized. Justice Department fines are likely. It’s an outrage HSBC hasn’t had its U.S. banking licenses revoked, assuming the Senate panel’s report is accurate — and there’s no reason to believe it isn’t.

Let’s try out a novel idea: Banks that help drug cartels launder money and give cover to those tied to terrorism should be put out of business. Is that really so hard for everyone to agree on? Free markets have worked in the U.S. because we have the rule of law. It’s why so many investors from other countries want to do business here. When contracts are breached, courts can be accessed to enforce them. When individuals or companies commit crimes, they’re supposed to be prosecuted and punished.

Except we have this mutant species of corporation called too-big-to-fail banks whose collapse might wreck the global economy. No financial institution in the U.S. can survive a felony indictment. So these companies have become un-indictable, creating a perverse nonchalance regarding financial crimes. In 2010, Wachovia paid $160 million to settle criminal allegations of laundering Mexican drug money. By then the bank had been bought by Wells Fargo & Co., and the Justice Department let it off with a deferred-prosecution deal. Usually the most that happens to management is someone resigns, as HSBC’s head of compliance, David Bagley, said he would at last month’s Senate hearing.

What would it take for the government to really crack down on wrongdoing in the financial-services industry? What finally prompted the feds to do something about cocaine smuggling into South Florida long ago was the epidemic of violence it spawned.

A defining moment came in July 1979, when drug traffickers went on a shooting spree in broad daylight at the Dadeland Mall in Kendall, southwest of Miami. This was unprecedented. The gunmen arrived in a delivery van that had been converted into an armored personnel carrier. Two people were killed. Bystanders dove for cover. Cars in the parking lot were riddled with bullets from machine-gun fire.

Attacks like that became frequent over the next few years. In 1979 there were 349 murders in South Florida, according to the Justice Department, triple the number of two years earlier. By 1981 murders had climbed to 621. The local police were outgunned, outnumbered, easily corrupted and often stoned. Finally in 1982 President Ronald Reagan formed a task force and devoted hundreds of additional federal agents to South Florida to restore law and order.

Back then, too, the cartels’ enablers included dirty banks. As Corben’s film noted, in 1979 the Federal Reserve’s Miami branch reported a $5 billion cash surplus — more than the country’s other Federal Reserve banks combined. One crucial difference, compared with today, was the drug banks in those days were relatively small. When an outfit such as Sunshine State Bank got busted, it didn’t threaten the economy.

In terms of stray bullets, Miami is a much safer place today. But mainly what the U.S. did was drive the cartels, the turf battles and the killings into Mexico, where the violence is out of mind for most Americans even while much of that country has turned into a narco-state.

Maybe if the bankers were the ones spraying machine-gun fire in the streets, that might spur the U.S. government to take meaningful, punitive action. Short of that, you have to wonder if anything would. Too-big-to-fail isn’t merely an economic problem. It is a great moral failing of our society that poisons our democracy. Something has to give.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

Always Ask A Banker To Put The Lie In Writing

July 13 (Bloomberg) — If we take Bob Diamond and Paul Tucker at their word, part of the Libor scandal at Barclays Plc can be chalked up to a series of comic misunderstandings, like a children’s game of telephone. It’s a bit much to swallow, but the spectacle sure has been fun to watch.

Both men agree that on Oct. 29, 2008, while the financial system was on the brink, Tucker, who is the Bank of England’s deputy governor, called Diamond on the phone. Diamond, who resigned last week as Barclays’s chief executive officer, was head of the company’s investment-banking business at the time.

In Diamond’s version, Tucker told him “he had received calls from a number of senior” U.K. government officials asking “why Barclays was always toward the top end of the Libor pricing,” according to a file note Diamond wrote that day. Tucker said “while he was certain we did not need advice, that it did not always need to be the case that we appeared as high as we have recently,” according to Diamond’s memo.

Tucker, testifying before a U.K. parliamentary panel this week, said that last sentence of Diamond’s note “gives the wrong impression.” He wasn’t nudging Barclays to underreport its Libor submissions, he said.

Rather, Tucker said he was expressing concern that Barclays was paying too much to borrow money — and sending signals to the markets that it was desperate for funding, at a time when Barclays was widely viewed as the next big U.K. bank to need a government bailout. Tucker said he didn’t make any record of the talk, in spite of the Bank of England’s policy to make notes of important phone calls. He said he was too busy.

Libor, or the London interbank offered rate, is the now- infamous interest-rate benchmark used in hundreds of trillions of dollars of transactions globally, from loans to derivative contracts. Each day, in surveys overseen by the British Bankers’ Association, major banks estimate their borrowing costs. It has been an open secret for years that banks routinely misstated their numbers. A Barclays Capital strategist, Tim Bond, even said so in a May 2008 interview.

Last month, Barclays agreed to pay $453 million to settle U.S. and U.K. claims that it manipulated its Libor submissions as far back as 2005 — years before the phone call in question. Sometimes the bank low-balled its costs to make itself look healthier. Other times, it filed false rates to make trading positions more profitable. On some occasions, its traders colluded with other banks, Barclays admitted.

Diamond told the same parliamentary panel last week that he didn’t interpret Tucker’s comments as an instruction to lower Barclays’s Libor submissions. Another top executive did perceive them that way, however, after receiving Diamond’s memo and passed down orders to that effect to the bank’s submitters. That person, Jerry del Missier, resigned as Barclays’s chief operating officer July 3.

The supposed misunderstandings don’t end there. In his October 2008 file note, Diamond wrote that he asked Tucker “if he could relay the reality, that not all banks were providing quotes at the levels that represented real transactions.”

Tucker told members of Parliament’s Treasury Committee that he didn’t take that statement to mean there was cheating going on. He said he thought it meant that “when they come to do real transactions, they will find they are paying a higher rate than they are judging they would need to pay.”

Tucker also was asked about a 2007 meeting with banking- industry members of a Bank of England liaison group. Minutes show “several group members thought that Libor fixings had been lower than actual traded interbank rates.” Tucker, who chaired the meeting, said “it did not set alarm bells ringing.”

“This doesn’t look good, Mr. Tucker,” the committee’s chairman, Andrew Tyrie, said. “It doesn’t look good that we have in the minutes on the 15th of November 2007, what appears to any reasonable person to be a clear indication of low- balling, about which nothing was done.” Tucker replied: “We thought it was a malfunctioning market, not a dishonest market.”

Diamond’s credibility doesn’t look any better. This week, Barclays’s departing chairman, Marcus Agius, released an April 10 letter from the chairman of the U.K.’s Financial Services Authority, Adair Turner, expressing doubts that Barclays could be trusted. At last week’s hearing, Diamond said the FSA had been happy with the bank’s “tone at the top.” He downplayed the FSA’s concerns as mere “cultural issues,” even when asked about the letter, which hadn’t been released publicly yet when he testified. It’s hard to know whom to believe less.

There’s no mystery why Tucker’s 2008 phone call to Diamond is receiving so much attention. The notion that a central banker may have prodded a big bank to lie about its numbers rings true. Many times over the past five years, in Europe and the U.S., bank regulators and other government officials have seemed to be in cahoots with the industry they oversee.

In May 2008, for example, the U.S. Office of Thrift Supervision let IndyMac Bancorp Inc. backdate a capital contribution so it would appear on its books in the prior quarter. IndyMac failed two months later, costing the Federal Deposit Insurance Corp. almost $11 billion. When banks were teetering in 2008 and 2009, regulators and lawmakers in Europe and the U.S. browbeat accounting-standard setters into making emergency rule tweaks so banks could show smaller losses.

After American International Group Inc.’s 2008 government bailout, officials at the Federal Reserve Bank of New York pressured AIG executives not to disclose details of how the company had paid its counterparties 100 cents on the dollar using taxpayer money. Now it turns out the New York Fed says it received “occasional anecdotal reports from Barclays of problems with Libor” in 2007, according to a statement it released July 10. The district bank wasn’t a party to Barclays’s settlement.

Here’s one lesson that hopefully has been learned from all this: If you ever think someone in business is telling you to lie, ask that person to put it in writing.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

The Bank That Bought The Remains Of Lehman Brothers Finally Faces The Music

(Bloomberg) — If Barclays Plc would lie about its borrowing costs, what else would it lie about?

That question gets to the heart of the damage Barclays did to itself by submitting false numbers for years to the British Bankers’ Association as part of the surveys used to set the London interbank offered rate, the benchmark for $360 trillion of financial instruments globally. The most important asset any bank has is trust — especially when it comes to the figures on its own financial statements. Whatever credibility Barclays had, it’s been poured down the drain like last night’s suds.

Andrea Leadsom, a member of the U.K. parliamentary committee that grilled former Barclays Chief Executive Officer Robert Diamond at a hearing two days ago, framed the issue well when she asked Diamond: “In light of the fact that your audit failed to notice for several years that there was fraud and corruption going on under your noses and very openly, have you now looked at other areas of the bank to see whether something like that has been going on there for years, too?”

Diamond, who resigned July 3, replied: “Of course.” His terse response came off as less than credible. Later he said: “The way to do that is to start by going through our processes and our controls and our audit reports. And if someone wasn’t happy with those and made suggestions that there were other places to look, of course we would do it.” So, perhaps Barclays made such an inquiry. Or maybe it would, if someone became unhappy. It’s hard to tell.

The trust deficit is evident in Barclays’s market value. At 20.6 billion pounds ($32 billion), Barclays trades for a mere 37 percent of its common shareholder equity, which shows that investors believe most of its 55.6 billion pounds of book value is fictional. The price-to-book discount also can be explained partly by the soft nature of some of the bank’s assets.

Barclays showed 7.8 billion pounds of intangibles as of Dec. 31 — things like goodwill and customer lists — as well as 3 billion pounds of deferred tax assets. Such items would be useless in a crisis. (Barclays discloses full financial statements twice a year and has yet to provide results for the first half of 2012.)

Additionally, in the footnotes to its annual report, the company said the fair market value of its loans was 14.6 billion pounds less than their carrying value on its books. The bank also said about 32 billion pounds of its financial assets were of the Level 3 variety, which means their values depended on data that weren’t observable in the marketplace, making them easy to fudge. The less investors trust Barclays, the less they will trust these kinds of subjective estimates.

Barclays shares fell 16 percent after news broke last week that the company had been fined $453 million by U.S. and U.K. authorities. Clearly, Diamond and Barclays’s outgoing chairman, Marcus Agius, who will leave after helping find Diamond’s successor, had to step aside to show the company cared about its reputation. (The company’s chief operating officer, Jerry Del Missier, also resigned.)

It must do more. For instance, the head of Barclays’s audit committee, Michael Rake, was the chairman of the accounting giant KPMG International when its U.S. affiliate, KPMG LLP, was caught selling fraudulent tax shelters to hundreds of wealthy Americans. That resulted in $456 million of fines by the Justice Department in 2005 and an admission of criminal wrongdoing by the U.S. firm. Although Rake wasn’t implicated in any way, his promotion this week to deputy chairman of Barclays looks like an obvious case of the wrong person for the job at a time when appearances are everything.

Barclays’s auditor, PricewaterhouseCoopers, looks more like a public-relations firm than a skeptical watchdog. Last year, as part of its annual “Building Public Trust Awards,” it gave Barclays two runner-up accolades, including one in the category of “tax reporting,” according to the firm’s website.

Talk about a gaffe: Last month a Milan judge ordered 20 bankers and former managers of Barclays and the Italian bank UniCredit SpA to stand trial on tax-fraud charges. The tax probe was linked to a complex investment plan arranged by Barclays known as Brontos, where interest payments on deposit accounts allegedly were made to look like dividends, which were taxed at lower rates, according to a June 5 article by Bloomberg News.

Barclays in a statement last month said it didn’t violate any laws. Members of Parliament at this week’s hearing also noted that Barclays’s accounting practices have come under regulatory scrutiny before — particularly the bank’s use of a Cayman Islands company called Protium in 2009 to transfer several billion pounds of troubled assets off its balance sheet.

What’s truly depressing is the thought that Barclays is only the first bank to settle with regulators over the Libor affair. Eventually, when others reach their own accords, similar inquiries will be made of their top officers.

Enforcing the law may be destabilizing at times. It also is necessary. Hopefully banking regulators now are waking up to this realization for good. A proper reckoning for the industry has been a long time coming.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

Who Stole The Global Economy From The Cookie Jar?

June 15 (Bloomberg) — Only a few years ago, Spain’s banks were seen in some policy-making circles as a model for the rest of the world. This may be hard to fathom now, considering that Spain is seeking $125 billion to bail out its ailing lenders.

But back in 2008 and early 2009, Spanish regulators were riding high after their country’s banks seemed to have dodged the financial crisis with minimal losses. A big reason for their success, the regulators said, was an accounting technique called dynamic provisioning.

By this, they meant that Spain’s banks had set aside rainy- day loan-loss reserves on their books during boom years. The purpose, they said, was to build up a buffer in good times for use in bad times.

This isn’t the way accounting standards usually work. Normally the rules say companies can record losses, or provisions, only when bad loans are specifically identified. Spanish regulators said they were trying to be countercyclical, so that any declines in lending and the broader economy would be less severe.
What’s now obvious is that Spain’s banks weren’t reporting all of their losses when they should have, dynamically or otherwise. One of the catalysts for last weekend’s bailout request was the decision last month by the Bankia group, Spain’s third-largest lender, to restate its 2011 results to show a 3.3 billion-euro ($4.2 billion) loss rather than a 40.9 million-euro profit. Looking back, we probably should have known Spain’s banks would end up this way, and that their reported financial results bore no relation to reality.

Dynamic provisioning is a euphemism for an old balance- sheet trick called cookie-jar accounting. The point of the technique is to understate past profits and shift them into later periods, so that companies can mask volatility and bury future losses. Spain’s banks began using the method in 2000 because their regulator, the Bank of Spain, required them to.

“Dynamic loan loss provisions can help deal with procyclicality in banking,” Bank of Spain’s director of financial stability, Jesus Saurina, wrote in a July 2009 paper published by the World Bank. “Their anticyclical nature enhances the resilience of both individual banks and the banking system as a whole. While there is no guarantee that they will be enough to cope with all the credit losses of a downturn, dynamic provisions have proved useful in Spain during the current financial crisis.”

The danger with the technique is it can make companies look healthy when they are actually quite ill, sometimes for years, until they finally deplete their excess reserves and crash. The practice also clashed with International Financial Reporting Standards, which Spain adopted several years ago along with the rest of Europe. European Union officials knew this and let Spain proceed with its own brand of accounting anyway.

One of the more candid advocates of Spain’s approach was Charlie McCreevy, the EU’s commissioner for financial services from 2004 to 2010, who previously had been Ireland’s finance minister. During an April 2009 meeting of the monitoring board that oversees the International Accounting Standards Board’s trustees, McCreevy said he knew Spain’s banks were violating the board’s rules. This was fine with him, he said.

“They didn’t implement IFRS, and our regulations said from the 1st January 2005 all publicly listed companies had to implement IFRS,” McCreevy said, according to a transcript of the meeting on the monitoring board’s website. “The Spanish regulator did not do that, and he survived this. His banks have survived this crisis better than anybody else to date.”

McCreevy, who at the time was the chief enforcer of EU laws affecting banking and markets, went on: “The rules did not allow the dynamic provisioning that the Spanish banks did, and the Spanish banking regulator insisted that they still have the dynamic provisioning. And they did so, but I strictly speaking should have taken action against them.”

Why didn’t he take action? McCreevy said he was a fan of dynamic provisioning. “Why am I like that? Well, I’m old enough to remember when I was a young student that in my country that I know best, banks weren’t allowed to publish their results in detail,” he said. “Why? Because we felt if everybody saw the reserves, etc., it would create maybe a run on the banks.”

So to sum up this way of thinking: The best system is one that lets banks hide their financial condition from the public. Barring that, it’s perfectly acceptable for banks to violate accounting standards, if that’s what it takes to navigate a crisis. The proof is that Spain’s banks survived the financial meltdown of 2008 better than most others.

Except now we know they didn’t. They merely postponed their reckoning, making it inevitably more expensive. Someday maybe the world’s leaders will learn that masking losses undermines investor confidence and makes crises worse. We can only hope they don’t manage to blow up the whole financial system first.