Stephanie Pagni, Barclays plc
This is an extract from the third edition of GIR's The Practitioner’s Guide to Global Investigations. The whole publication is available here.
27.2 Commercial considerations for executive management
By the stage a resolution to an investigation is contemplated, the executive management will almost certainly have invested very significant time, resources and expense in ensuring the appropriate governance and oversight over the investigation preceding the settlement and will have taken a close interest in monitoring the findings to ensure appropriate and timely remedial action has been taken by the company. Having identified the salient issues and, having implemented any appropriate remedial steps, most executive management teams will have a strong desire to achieve closure through resolution to turn their attention back to the other important aspects of managing the company.
Whether the resolution will bring the requisite degree of finality or is merely a phase of resolution in a global investigation with the prospect of further phases is a key question executive management must address in determining the extent to which the proposed resolution is likely to be in the best interests of the company. The proposed terms and likely consequences of any resolution are obviously critical.
The factors for executive management to consider will almost certainly include:
- the potential impact on customers and the likely impact on business areas and the company’s ability for business operations to continue;
- the nature, extent and justifiability of factual and (if relevant) legal admissions required to be made as against the evidential record;
- the likely reputational damage to the company by factual or legal admissions;
- the proportionality of the monetary penalties by the authorities and the capacity of the company to absorb the impact;
- the extent to which the resolution and any consequent admissions are anticipated to result in enforcement action by other authorities in other jurisdictions not a party to the settlement;
- the potential for financial impacts beyond the original penalties as a result of follow-on litigation typically in the form of class action or group litigation lawsuits;
- the likely longer-term impact on the company of any non-monetary terms imposed, such as the installing of a monitor or probationary terms; and
- the extent to which the company considers it has already remediated the issues the subject of the resolution and whether this will be fairly reflected and acknowledged in any terms of settlement; the latter issue being particularly important for customer retention after a resolution.
A global resolution that is insufficiently comprehensive to achieve the desired certainty of outcome for the company may not be advisable. This may occur if enforcement agencies are working to a different timetable for resolution or otherwise refuse to coordinate in reaching an agreed and sufficiently conclusive enforcement outcome. This might also occur where the company faces a very substantial risk of new enforcement actions triggered by the facts and matters admitted pursuant to the terms of any initial resolution. Where there is significant risk to the company of future exposure which cannot be quantified with reasonable certainty, the evaluation of the benefits to the company of co-operation and an early resolution as against the downside risks of seeking to delay or avoid resolution at all can become a much more complex exercise. This may be particularly true for resolutions where the company, even though it has co-operated extensively in the investigation, runs the risk of being disproportionately singled out as a target by other agencies and for follow-on actions.
In summary, putting the company in a position to move forward having learned lessons from the past will usually constitute the desired outcome from the perspective of the executive management subject to a satisfactory degree of certainty that the outcome is reasonably foreseeable and will be proportionate in terms of the overall impact on the company.
When facing the question of whether to enter into a global settlement, an assessment of the commercial considerations relevant to the company would not be complete without reference to its shareholders. The shareholders, in common with the executive management, will also likely desire the certainty and closure brought by a resolution. They are also likely to require that the company has and continues to take all reasonable steps towards remediating the issues that were the subject of the resolution so that they can have confidence in the executive management’s future oversight of the company’s operations.
They will equally expect, however, that any settlement the company reaches will be appropriately calibrated in terms of its impact. Given the constitution of the shareholder base at the time of entering a global resolution is likely to be materially different to the shareholder base when the issues giving rise to the settlement arose, any shareholder holding an interest in the company today will be concerned to understand whether the impact of resolution is likely to represent a reasonable outcome in the circumstances and will not carry unwarranted risks for their investment. If the resolution does not strike the right balance in terms of censure and deterrence as far as impact on investors is concerned then other consequences may follow.
The European Systemic Risk Board (ESRB) has observed that the impact of the sequential, increasingly punitive and unpredictable nature of the global bank resolutions and the associated tail-end risks in recent years may have become a significant factor in flight from investment in the sector. Where there is widespread and sustained loss of investor confidence in a sector, given many investments will typically be held in pension funds and similar investment vehicles held for a wide class of beneficiaries, this may result in much broader detrimental impacts than originally anticipated.
The views of the wider workforce may often be inadvertently overlooked in contemplating the commercial impact of a resolution. Typically, companies need a well-motivated workforce to prosper. This, in turn, relies on the workforce having confidence in the company’s ability to resolve difficulties encountered in a responsible and proportionate way.
In most cases, the majority of employees of the company will likely have no knowledge of the issues giving rise to the settlement beyond the announcement of the settlement itself but will be impacted by it in a variety of ways in monetary and non-monetary terms. Consequently, settlements that do not differentiate sufficiently those within the company who are responsible for any wrongdoing from the wider employee population and that fail to underscore in a sufficiently balanced way the extent to which the company has succeeded in corrective action can have disproportionately negative impacts on employee morale.
A resolution that imposes monetary penalties and public censure can be an effective tool in deterring others within the company from similar wrongdoing. However, the right balance between deterrence and prevention must be sought. An industry seeking long-term cultural reform needs a well-motivated values-driven workforce to help bring about such change through a committed focus on behavioural adjustment and the implementation of enhanced prevention and compliance programmes. If a resolution is not appropriately calibrated to recognise the ongoing efforts of the wider employee population as against the wrongdoing of a few, it may present long-term attrition risks to the company or the industry more broadly with an accompanying flight of good citizens, significantly hampering the company’s attempts (and where applicable the industry more broadly) to bring about the desired change for the better.
27.5 Enforcement agencies
In a global settlement, monetary penalties are very often a key, if not in recent times the key, component in the pursuit of credible deterrence strategies by enforcement agencies. The severity of monetary penalties imposed with accompanying public censure can be effective in dissuading others (within the institution or more broadly in the industry) from engaging in similar wrongdoing. However, in instances where penalties are continually levied on an institution (and its shareholders) at the expense of holding individuals responsible, this may create a risk of an imbalance of accountability as between a company and individual employees within the company who are principally responsible for the wrongdoing. Where penalties and censure are borne disproportionately by the corporate entity and its wider associated stakeholders, this may in fact undermine rather than reinforce credible deterrence policies.
In principle, enforcement agencies’ policy objective of credible deterrence should be free of commercial considerations. As a matter of practical reality, however, most enforcement arms and prosecuting authorities will need to justify decisions to balance limited resources to cases with outcomes and will need to demonstrate how funding has been allocated to pursue cases to meet their overriding credible deterrence objective. The pressure for an acceptable outcome comprising a material monetary component may therefore increase particularly in circumstances where the agency has expended very significant resources pursuing a global investigation over a long period. Equally, where there is a high degree of political pressure to achieve or match equivalent penalties in other jurisdictions, the decision to impose ever greater monetary penalties in substitution for other credible deterrence measures may also increase.
Some commentators have opined that the high levels of regulatory fines resulting from enforcement actions against the major banks in the last few years may have in part been driven by a policy objective to drive banks to restructure and become smaller, simpler and less complex. Others have noted that high monetary penalties may be a response to political pressure as, in the United States at least, high-profile bankers had not faced criminal prosecution and sentencing. The Economist has observed that many enforcement outcomes are opaque and hard for the public to understand; without full understanding as to the specific circumstances or wrongdoing, public attention often settles on the fine. The Economist has also noted that regulators and prosecutors – some of whom have to stand for election – often encourage the media to focus on such outcomes. A similar conclusion was reached in a report by Thomson Reuters into the rising costs of non-compliance by financial institutions. The report noted that ‘regulators have been under immense political and public pressure to hold those responsible [for misconduct] to account’ and that ‘widespread and persistent negative media coverage has been responsible, at least in part, for driving up the levels of monetary fines. Firms needed to be seen to be punished and headlines covering ever-bigger fines were a predictable regulatory response’. Whatever the reasons for the very significant increase in monetary penalties, it is clear that the associated revenues have resulted in a range of collateral benefits.
- The New York Department of Financial Services budget for 2015 and 2016 allocated over US$7 billion received from bank settlements, including US$4.6 billion for one-off capital projects to support economic development and infrastructure investments in the State of New York. Examples of such expenditure include replacing a major bridge across the Hudson River and improving broadband access, projects entirely removed from the misconduct that is the subject of the settlements, prompting questions among some commentators about governance and oversight.
- A significant portion of bank settlement payments made to the Financial Conduct Authority (FCA) are paid to HM Treasury. FCA fines relating to LIBOR, which amounted to more than £500 million, were allocated by the then Chancellor in budget speeches for various good causes, including the NHS, charities and emergency services, often attracting positive media coverage.
- It was reported in March 2016 that over US$110 billion in bank fines had been levied in connection with retail mortgage-backed securities losses since the financial crisis of which it is estimated that less than half had been allocated for ‘consumer-relief’ with the remaining funds being received by the US Treasury, various US state attorneys general and the prosecutors that led most of the negotiations.
Where economic, commercial and even political benefits accrue that significantly exceed those required by the relevant agency to justify its expenditure to meet credible deterrence objectives and to meet compensation requirements for those harmed by any wrongdoing, there is a risk that such collateral benefits could be perceived to influence the determination as to the manner in which cases are pursued. As a consequence, other important and more sustainable credible deterrence policy tools such as coordination in the investment of prevention and compliance programmes may become subordinate to revenue-generating considerations and other collateral benefits accruing to the agencies involved. Where this occurs, then aside from the other consequences already explored in this chapter, such action may in the longer term inadvertently undermine rather than reinforce credible deterrence measures.
27.6 Other stakeholders
Over time, and if global settlements are sufficiently punitive or perceived as such, an economically rational risk management response by a company (and indeed in more extreme scenarios, an entire sector or industry) may be wholesale withdrawal or retrenchment from the activity where the compliance costs and risks associated with the activity are, or are perceived as being, disproportionately high and economically unsustainable. The phenomenon of withdrawing from geographical and business lines deemed to be high risk is known as ‘de-risking’ and can be seen to have impacted the servicing of certain customer segments and activities following the series of banking fines (for example, withdrawal from support for the money services business sector).
De-risking should be seen as a negative effect when it results in the wholesale withdrawal of legitimate services and activity because of a general concern that highly punitive sanctions may be imposed in the event of any incidence of non-compliance. The consequences of de-risking may take time to manifest themselves, but may include adverse socioeconomic impacts on financial infrastructures of developing economies and the exacerbation of financial exclusion. Where this occurs, there may be compounding effects on categories of stakeholder beyond those already described in this chapter including end users and the economy more broadly. Aside from the scale, frequency and unpredictability of enforcement actions affecting the major banks, the other crucial factor that appears to have resulted in unintended consequences is the vital role performed by banks to the proper functioning of global financial markets. By 2013, 85 per cent of all the major fines had been made against the most globally systemically important banks resulting in concentration risk. The ESRB has observed that there may be factors that render the banking sector (as compared to other companies or sectors) more susceptible to risks that could result in the unintended imposition of costs on end users of the financial system (as a result of depletion of bank capital and the associated reduction of lending and other financial service activities affecting end users and the wider economy).
Given that end users of the impacted products or services will often be the stakeholders that the enforcement agencies seeking settlement intend to convey some measure of protection or redress, it is likely to become increasingly important in evaluating the potential impact of a global settlement for agencies to consider any longer term unintended consequences for this wider group of stakeholders.
One obvious route to avoiding some of the potential downsides and collateral consequences explored above is to place greater emphasis on prevention. The most effective compliance programmes employ preventive measures to detect early issues before they become large enough to warrant major enforcement action. Such steps can help avoid some of the costs associated with penalties and can help supervisors and policymakers to focus resources toward more proactive, forward-thinking preventive solutions as opposed to after the event enforcement outcomes. Proactive market studies and industry-led cultural change initiatives, such as those exemplified by the Fair and Effective Markets Review through the Banking Standards Board, can also be highly effective in bringing about transformational change impacting complex market infrastructures.
Even with better prevention measures, in some cases, enforcement action accompanied by monetary penalties will be necessary and appropriate to deploy both as a punitive and credible deterrence tool. In such instances, however, more can and arguably should be done to coordinate enforcement outcomes to bring greater certainty and predictability to mitigate some of the risks explored in this chapter. While many of these risks may be unique to the banking sector because banks are subject to multiple regimes across multiple jurisdictions, given the essential role played by such institutions to the global economy, there ought to exist a mechanism among the various enforcement agencies to coordinate enforcement to ensure better overall proportionality and fewer collateral effects. In an increasingly complex globally interconnected world economy, given that action taken in one market or geography can quickly have an impact on another, this seems a necessary principle that should underpin all policy objectives.
Subscribe here for related content, breaking news and market analysis from Global Investigations Review.
Global Investigations Review provides exclusive news and analysis and other thought-provoking content for those who specialise in investigating and resolving suspected corporate wrongdoing.