Deutsche Bank Directors Indicted for LIBOR Fraud

June 6, 2016

When it comes to authoring content for the Blog, I've never made any pretense of being objective or impartial.  To my credit, I try to highlight and make clear my biases, prejudices, and scorn for much of what passes for the purported regulation of the financial industry. As I see it -- as I too often see it -- we frequently entrust the inept and the inefficient with the task of policing our financial markets. In fairness, that's not an abject, blanket statement. There are many men and women who sincerely and credibly discharge their regulatory duties at any number of prosecutorial and regulatory organizations around the world. The blame falls less upon the grunts in the trenches than on those planning the strategy and tactics of battles.  The agenda of too many of those in charge seems more designed to garner headlines for regulatory bosses looking to pad a resume or move higher up the ladder than to win the war against financial fraud.  

Laborious LIBOR Prosecutions

Against that cynical and pessimistic view, we consider the ongoing civil and criminal lawsuits arising from the efforts of the London-based British Bankers' Association, which represents about 200 banks from over 60 countries, to promulgate the benchmark interest rate known as LIBOR or the London Interbank Offered RateAs explained in "Two Former Deutsche Bank Employees Indicted on Fraud Charges in Connection with Long-Running Manipulation of Libor" (Press Release, United States Department of Justice, June 2, 2016) (the "DOJ Press Release"):

In April 2015, Deutsche Bank entered into a deferred prosecution agreement to resolve wire fraud and antitrust charges and Deutsche Bank Group Services (UK) Limited pleaded guilty to one count of wire fraud, collectively agreeing to pay a $775 million fine, for the bank's role in engaging in a scheme to defraud counterparties to interest rate derivatives trades by secretly manipulating USD LIBOR and other currencies submissions. 

The Justice Department has previously announced resolutions with five other banks for their roles in manipulation of benchmark interest rates, including Barclays Bank PLC, UBS AG, The Royal Bank of Scotland plc, Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A. and Lloyds Banking Group plc. 

The DOJ Press Release sure as hell got one thing right: the alleged LIBOR manipulation was "long-running." 

The thing about protracted frauds in the financial markets is that participants in manipulated markets seem to be aware of fraud way before those who are the purported regulators of those markets.  Then you have that frustrating phenomenon that as the red flags start waving, as the flares start to light up the skies, as the alarms awaken those who slumber, regulators are slow to respond. Inevitably, there is an investigation. If the targets of the investigation are the powerful, the investigation is protracted, laborious, and consumed by inquiries. reviews, and admonitions from the upper echelons of the regulatory organizations. The public is told that the reason for the delays is to get it right. To protect the markets from false rumors. To protect the investors. To ensure that justice is done. 

Funny, isn't it, that when it's the small fry that come within the regulators' cross-hairs that we just don't see the same heightened concerns and slower paced cadence of regulation. When it's a human being defendant, the tone is often that there is a need to "send a message" and to quickly nip the fraud in the bud.  Even the pace of settlement discussions take on a different hue depending upon the stature of the potential defendants. The big fish seem to engage in, how did the DOJ Press Release phrase it . . . oh, yeah, "long running" negotiations that end with a check being cut against the account of a publicly traded company (in essence the public shareholders get stuck with the bill). With a human being that's the target, we get the Perp Walk, we get the lurid details of personal missteps, we get threats of settle immediately or we unleash every weapon in our armory. 

Don't misunderstand me: I'm not shedding any tears for anyone who engages in fraud in the financial markets. Moreover, I am not blind to the fact that even "Directors" and "Managers" at big banks are making princely sums and have often ignited their own bonfires of the vanities. My point is that there is rarely an even-handed treatment of too-big-to-fail-institutions and the men and women that work there -- and don't get me started, yet again, about comparing the two worlds of the big boys and little guys on Wall Street.

The Connolly and Black Indictment

So here we are in 2016 and DOJ has unsealed an Indictment dated May 31, 2016, in which two human beings are each charged with one count of Conspiracy to Commit Wire Fraud and Bank Fraud, and nine counts of Wire Fraud. United States of America v. Matthew Connolly and Gavin Campbell Black (Indictment, 16-CR-370, SDNY / May 31, 2016). As explained in DOJ's June 2, 2016 Press Release:

According to allegations in the indictment, Connolly was Deutsche Bank's director of the Pool Trading Desk in New York, where he supervised traders who traded USD LIBOR-based derivative products.  Black was a director on Deutsche Bank's MMD Desk in London, who also traded USD LIBOR-based derivative products.  In order to increase Deutsche Bank's profits on derivatives contracts tied to the USD LIBOR, Connolly allegedly directed his subordinates, and Black allegedly asked Curtler and others at Deutsche Bank, to submit false and fraudulent LIBOR contributions consistent with the traders' or the bank's financial interests rather than the honest and unbiased costs of borrowing. 

The charges in the indictment are merely accusations, and the defendants are presumed innocent unless and until proven guilty beyond a reasonable doubt in a court of law.

My oh my, we're finally getting around to naming names of human beings. No more deferred prosecution agreements with financial institutions. No more checkbook regulation involving major banks. No . . . this time we're threatening to throw some folks into jail for their role in the alleged LIBOR fraud. Funny, though, once again it's a flyby of the C-Suites. Not that politics or influence had anything whatsoever to do with this result. In any event, according to the Indictment

26. From at least in or about 2005 through at least in or about 2011, CONNOLLY and BLACK, the defendants . . . and other known and unknown to the Grand Jury . . . engaged in a scheme to obtain money and property by making false and fraudulent USD LIBOR submissions to the BBA for inclusion in the calculation of USD LIBOR representing that the rates submitted were an unbiased and honest estimate of the bank's borrowing costs when in fact the submissions reflected rates that were designed to benefit their trading positions .  . .

Did you catch the relevant dates in the Indictment? 2005. 2006. 2007. 2008. 2009. 2010. 2011. Like the DOJ Press Release said: That's a "long running" fraud.

So . . . what the hell took DOJ so long to get the whiff, to follow the smell, to come across the stink, and to do something to clean up the mess?  Was it for lack of warning or rumors? Not at all. By way of making that point, for example, consider this nearly eight-year-old article by my colleague Shah Gilani: "Fears of Mortgage Rate Re-Sets May Fuel LIBOR Manipulation and Mask Deeper Banking System Problems"(By Shah Gilani, Capital Wave Strategist, Money Morning / October 23, 2008); note Gilani's opening paragraphs:

It's panic time for U.S. legislators, regulators, banks and lenders. More than $24 billion worth of adjustable-rate mortgages (ARMs) are expected to "re-set" to higher interest rates in November - boosting the likelihood of further home foreclosures.

And it gets worse. That increase in borrowing costs will spread to other parts of the global debt market, representing an across-the board threat to corporate, institutional and sovereign borrowers. If interest rates remain high and interbank lending remains tight, the credit crisis is not likely to recede.

This raises two key questions. Are desperate times prompting desperate measures? Is LIBOR being manipulated by banks that are trying to make their financial positions appear better than they really are?

If that's the case, it's one more reason the credit crisis will fester and spread undetected: The artificially low interbank lending rates removed a key "early warning" indicator, leading investors to believe the credit market was healthy when it actually wasn't.

In anticipation of some readers' complaints, you might argue that Gilani's remarks are somewhat amorphous and more patterned along questions that assertions. On the other hand, consider the points he raised in concluding his 2008 article:

No bank wants to admit it is being charged a premium to borrow: That sends a bad signal. If a reporting bank submits data that shows its own borrowing costs are higher than average, it will very likely raise questions about that institution's financial strength and stability - the kind of uncertainty that recently brought down such financial institutions as The Bear Stearns Cos. [now part of JP Morgan Chase & Co. (JPM)], and Lehman Brothers Holdings Inc. (LEHMQ).

So what might that bank do? Since the submitting banks providing data to Reuters are on the "honor system," maybe this institution has an incentive to not submit its actual borrowing costs? Maybe this bank submits rates at which it could borrow - which it is permitted to do, by definition, under the submitting rules - if those rates are lower by virtue of only being a quote it received?

Maybe this bank - and the rest of its brethren - would like to keep LIBOR lower than the interbank rate should actually be, realizing that if rates rise, bad-loan exposure increases. And if bad-loan exposure increases, derivative exposure will escalate, too. What if U.S. ARM re-sets (based on LIBOR) bump up the interest-rate charges that already-strapped homeowners have to pay? What will more foreclosures do to already-battered bank balance sheets?

We already know the answers to those questions.

Bill Singer's Comment

I'm truly quite tired of the ongoing saga of the LIBOR cases in the UK and USA and, as such, will direct my readers to the Indictment and DOJ Press Release for all the gory details. What jumps out at me is the age of the alleged fraud, which the Department of Justice pegs as early as 2005 (over a decade ago) and the bulk of the charged conduct seems to have taken place in 2007 and 2008, dates that are only a tad less than a decade.  

Go ahead and read the 27 page Indictment; for whatever it's worth, it's well written. You can see the smoking guns in the form of electronic messages. You can follow the dots as the federal prosecutors connect them from the alleged conspiracies to the alleged accomplished fraud. When you finally look up at the name on the mailbox where this message of an indictment is delivered, note that their is no "Chief" from a C-Suite named as a Defendant. And that's just the way it is folks. Just the way it is.