A defining feature of the 2008 financial crisis has been the dearth of criminal prosecutions. Rightly or wrongly, people have gotten the impression that the sheriff is asleep. The global Libor scandal has the potential to change that.
The investigation into the London interbank offered rate has already uncovered a wealth of evidence. From the facts provided by Barclays Plc in its settlements with U.S. and U.K. authorities, we know that its employees, and probably those of many other banks, submitted estimates of borrowing costs that they knew to be false. Those estimates were used to calculate a suite of benchmark interest rates that influence the value of hundreds of trillions of dollars in financial contracts worldwide.
The misbehavior went on from 2005 to 2009, possibly longer. Sometimes the employees lied at the behest of traders, who wanted to manipulate Libor to benefit their own positions. Sometimes -- specifically during the financial crisis -- they submitted artificially low rates on orders from managers, who wanted to conceal their banks’ funding troubles.
The order describing the Barclays settlement with the Commodity Futures Trading Commission offers a glimpse of the instant messages, e-mails and other exhibits prosecutors have at their disposal.
“We got a big position in 3m libor for the next 3 days,” wrote a New York trader to a rate submitter in London, in reference to three-month Libor. “Can we please keep the Libor fixing at 5.39.” In response to another trader’s request for a low Libor quote, a submitter wrote: “Done … for you big boy.” And here’s how a Libor submitter responded to a supervisor who ordered him to keep quotes low during the crisis: “I will be contributing rates which are nowhere near the clearing rates for unsecured cash and therefore will not be posting honest prices.”
There are various ways the traders’ efforts at manipulation for profit may have broken the law. Consider wire fraud, a U.S. statute that prohibits the use of any interstate or international communication in furtherance of an effort to deceive for personal gain. There’s also bank fraud, which applies to deceptions perpetrated against financial institutions -- the traders’ counterparties in many cases. Both statutes carry sentences of as much as 30 years in prison.
It’s important that prosecutors examine the entire chain of command. Given the length of time the misbehavior went on, it’s hard to imagine that executives were completely unaware. Reporting by Bloomberg News suggests that senior managers of at least one institution, Royal Bank of Scotland Plc, condoned and participated in the submission of false rates. If executives knew what traders were doing and encouraged it -- for example, by paying them bonuses -- that could be conspiracy to commit fraud, a crime that carries a prison term of as much as five years.
As regards the more systematic underreporting of Libor during the financial crisis, one could explore whether executives violated securities-fraud laws. It’s a crime to knowingly provide, or cause to be provided, false information that affects an investor’s assessment of the value of a security. A misreported cost of borrowing, for instance, can influence a bank’s stock price: Financial institutions depend heavily on borrowed money, so the interest rate they pay is an important indicator of their soundness and profitability.
At the state level, New York’s Martin Act offers prosecutors an easier standard. It’s similar to federal securities-fraud law, with the crucial difference that state prosecutors don’t need to prove fraudulent intent or the victim’s reliance on the false information. Former New York Attorney General Eliot Spitzer employed the Martin Act to great effect in his battles against Wall Street, though it hasn’t been used much to pursue criminal cases.
Some have argued that Libor manipulation isn’t a big deal in the grand scheme of things. True, it didn’t cause the financial crisis, and in some cases might even have helped homeowners by lowering mortgage payments. But the ease with which some in the financial community undermined one of the world’s most important financial benchmarks is of a piece with the actions that contributed to the crisis, and that erode trust in finance more broadly.
For markets to function effectively, such behavior cannot stand. The culture needs to change. Prosecutors have the power to make that clear.
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