Recent revelations on traders’ behaviour in the Libor rigging case are worrisome not only as a sign of the rotten culture of financial operators, but also for the sense of legal impunity prevailing among them (Economist 2012). They suggest that bank CEOs and supervisors may have tolerated or encouraged rate rigging, or negligently lost control of banks’ operations, for years. They also indicate that law enforcement has been extremely weak in the realm of banking and finance. The recent allegations that some large UK banks have been involved in extensive money-laundering activities in favour of Mexican drug cartels and Iran reinforce this impression considerably.
In the light of these revelations, on 25 July the European Commission amended its proposal for a Regulation and a Directive on insider dealing and market manipulation to include criminal sanctions against that type of price fixing.1 Meanwhile, following a report by the FSA on the failure of the Royal Bank of Scotland, the UK Treasury had already opened a consultation on how to introduce criminal sanctions against failed banks’ directors, ranging from automatic debarment to full fledged prison for extreme reckless behaviour.2
The need for tougher sanctions is self-evident, as is the need to hold accountable negligent regulators. But are criminal sanctions a good remedy for financial misbehaviour? Wouldn’t it be better to substantially increase monetary fines? The question is warranted given that, with few exceptions, modern economists from Becker (1968) onwards regard monetary fines as a more efficient law enforcement instrument than non-monetary criminal sanctions (Polinski and Shavell 2000, Werder and Simon 1986).
The problem with monetary fines is that not always can wrongdoers be fined at a sufficient level to achieve deterrence. Wrongdoers may:
- Not have sufficient wealth, or may conceal it;
- Transfer fines to other parties (uninformed shareholders, directors’ insurance funds, etc.); or
- Be protected by limited liability (for corporate fines).3
In the remainder of this column, I will try to clarify why these problems are particularly acute for banks and in particular for bankers, intended as those individuals with inside information and control on the banks’ business (traders, directors, CEOs…). As we will see, the same reasons that for a long time have made banks 'special' for competition policy also ensure that to deter bankers' wrongdoing, non-monetary criminal sanctions are necessary.4
First allow me to note that I cannot be suspected of favouring criminal sanctions in general. Some years ago, when the European Commission considered the introduction of criminal sanctions in antitrust (Wils 2006, Cseres et al. 2006), I argued against that. The potential for high corporate fines, combined with leniency programmes that give amnesty to the first conspirator that collaborates – introduced in the last decades in antitrust – appeared far from being fully exploited in the EU. Antitrust fines were – and many think still are5 – too low to achieve cartel deterrence. We therefore suggested trying first to substantially increase antitrust fines, even at levels that could lead wrongdoing firms into financial distress. Selling a failing firm to new independent owners may be the best way to ensure it will change its course of action (see Buccirossi and Spagnolo 2006, 2007 for detailed discussions and some simulations).
For banks, however, this would not work. Banks are considered special because governments associate large, profitable banks with financial stability. For this reason, corporate fines on banks cannot be increased enough to discipline bankers. Fines of a sufficient size would weaken banks’ balance sheets, which is something nobody wants. The risk of destabilising banks will then either induce governments to keep fines low (something courts already do with non-financial firms in weak financial situations (Craycraft et al. 1997)); or, it will increase the likelihood that part of the fine will be paid by taxpayers through a higher risk of bailout or subsidised liquidity and deposit insurance.
Individual fines on wrongdoing bankers may help, but they are also unlikely to suffice:
- They can at least partly be hedged in the market and through directors' insurance.
- The less honest bankers (the individuals we want to deter more) are also often specialists in transferring and hiding money; they will likely react to large individual fines by transferring or hiding their wealth.
- Companies typically indemnify executives (reimburse their fines) if they acted to increase company profits. Therefore individual monetary fines are also likely to be at least partly transferred on uninformed shareholders and taxpayers.
For all these reasons, fines must be accompanied by individual non-monetary criminal sanctions on wrongdoing bankers.
It would also help if well-designed and well-run leniency programs (as present in antitrust) and whistleblower reward/protection schemes could accompany criminal sanctions. Indeed, most evidence on financial and corporate misbehaviour comes from whistleblowers, or from settlements in which lenient treatment is traded against important information.6 Recent research shows that leniency in exchange for cooperation works well if it is limited to the first cooperating wrongdoer and either (a) large rewards are paid out to whistleblowers (Bigoni et al. 2012a), or (b) sanctions are sufficiently tough to make people afraid of being betrayed by fellow wrongdoers (Bigoni et al. 2012b).
To wrap up, our discussion suggests that:
a) Non-monetary criminal sanctions for individual misbehaving bankers are necessary.
b) Settlements involving only monetary payments from the banks, but no fines nor other criminal sanctions on the wrongdoing bankers, should be avoided. Such settlements should only be admitted if the information obtained in exchange are crucial to charge criminal sanctions against other wrongdoers, as in antitrust leniency programmes.
In the US, criminal sanctions are already present, also in antitrust, and will likely be used to send some of the Libor-rigging traders, and hopefully their negligent (or accomplice?) bosses, to jail. The US also introduced an amendment of the Dodd-Frank Act in 2011 that allows regulators to reward whistleblowers that denounce financial misbehaviour at the cost of their career. This is promising – let’s see how it will be administered.
In the EU there seems to be no intention to introduce effective leniency and whistleblower reward schemes. There is therefore only one option open: steeply increasing sanctions, including non-monetary criminal sanctions (debarment from the industry, and jail in worse cases) that are harder to hedge or transfer.
Criminal sanctions might even help with the Eurozone crisis. Suppose CEOs and directors of the Spanish banks in need of rescue could be fined individually and debarred from working again in the financial sector as a condition to access to the EU rescue plan. Isn’t it likely that the open complaint by 172 German economists against Ms Merkel’s willingness to save the Spanish bankers together with the Spanish banks would be withdrawn? After all, it is not Spanish banks that need to be held accountable, but the reckless Spanish bankers that continued to cash bonuses betting other people’s money on an obvious housing bubble that only bank-sponsored ‘experts’ could find the ‘courage’ to deny.
Becker, Gary S (1968), “Crime and Punishment: An Economic Approach”, Journal of Political Economy, 76(2):169-217.
Buccirossi, P and G Spagnolo (2006), "Optimal Fines in the Era of Whistleblowers", CEPR Discussion Paper No. 5465, published in V Goshal and J Stennek (eds.) The Political Economy of Antitrust, 2007, Elsevier: North Holland.
Buccirossi, P and G Spagnolo (2007), "Corporate Governance and Collusive Behaviour", CEPR Discussion Paper No. 6349, published in Dale W Collins (ed.) Issues in Competition Law and Policy, 2008, Antitrust Section, American Bar Association.
Craycraft, Catherine, Joseph L Craycraft, and Joseph C Gallo (1997), “Antitrust Sanctions and a Firm's Ability to Pay”, Review of Industrial Organization, 12(2):171-183.
Cseres, K J, M P Schinkel and F O W Vogelaar (eds.) (2006), Criminalisation of Competition Law Enforcement: Economic And Legal Implications For The EU Member States.
Bigoni, M, S-O Fridolfsson, C Le Coq, and G Spagnolo (2012a), “Fines, leniency, and rewards in antitrust”, The RAND Journal of Economics, 439(2):368-390.
Bigoni, M, S-O Fridolfsson, C Le Coq, and G Spagnolo (2012b), “Trust and Deterrence”, CEPR Discussion Paper No. 9002.
The Economist (2012), “The rotten heart of finance”, 7 July.
Polinski, A and S Shavell (2000), “The Economic Theory of Public Enforcement of Law”, Journal of Economic Literature, 38(1):45-76.
Werden and Simon (1986), “Why Price Fixers Should Go to Prison”, The Antitrust Bulletin 917.
Wils, W (2006), “Is Criminalization of EU Competition Law the Answer?”, European University Institute.
2 See here.
3 For example, US taxi companies seem to have strategically overborrowed to reduce their own liability for damages from car accidents. See e.g. Che and Spier (2008) and the literature therein.
4 Although recently published e-mail exchanges related to the HSCB money-laundering scandal involving bloody Mexican drug cartels make this need somewhat obvious. When challenged by the central compliance office, after the DoJ caught them, the responsible bankers apparently complained: “We didn’t go to jail! We merely signed a settlement with the Feds for $10 million!” See for example here.
5 See for example here.
6 This is a reason to blame banks that did not cooperate with authorities, like RBS which is controlled by the UK Treasury denied regulators some requested documentation, much more than Barclays, who at least chose to cooperate with law enforcers (although not entirely voluntarily).