Hit 'em again? Is LIBOR still being rigged?

When CFTC Chairman Gary Gensler spoke to the annual meeting of the Institute of International Bankers held in Washington on March 4, he discussed, among other timely topics, the continued reliance of the credit markets on the London Interbank Offered Rate (LIBOR), which he correctly asserted is ill-advised.  He mentioned that in 2012 LIBOR was dramatically more stable than comparable measures of volatility.  According to Chairman Gensler, for more than 115 straight trading days the LIBOR three month U.S. dollar rate did not change. 

Perhaps it is time to investigate LIBOR once more, starting where the recent settlements left off.  The marvels of modern word processing could make the burden of issuing new subpoenas a matter of minutes.  The attorneys and investigators that first snagged the liars now have a learning curve behind them.  It could be a perfect example of doing more with less.  And if this unbelievable stability is a sign of unbelievable stupidity or hubris, doesn't it cry out for continued redress?  Perhaps the tuition was too low for the last lesson in civic responsibility. 

Chairman Gensler's public expression of skepticism about this remarkable turn of events implies that his staff likely shares his doubts.  Hopefully, enforcement officials will be able to head off any corps of bankers hammering away at the "delete" buttons on their keyboards and running red-hot shredders.    

Agencies need leadership

As the second Obama Administration is being prepared, we have numerous qualified candidates to assume direction of our critical financial regulatory agencies.  I hope that when these candidates are vetted, however, their ability to supply internal leadership to the agencies they will join is carefully considered.  We are fairly well aware of the qualifications needed regarding a candidate's ability to contribute publicly to the agencies' missions.  But the agencies themselves are in a high degree of flux and their effectiveness, especially in times of uncertain budgetary support, turns largely on the culture instilled by top management.

Many of the agencies have had their authority vastly expanded in the last several years, and some of them did not even exist until recently.  Bidding against the private sector for top talent will make recruiting and retaining high quality staff extremely difficult.  Maintaining morale and a sense of purpose is difficult when constricted budgets limit even the most basic support --travel and continuing education, for example.  Being a public advocate for the mission of an agency while also leading agency personnel is a huge challenge -- probably too great for all but the most exceptional leaders.  But good leaders are also good at choosing capable lieutenants, giving them scope to operate, and holding them accountable for results. 

I suggest that those who judge the potential of our incoming crop of agency officials will ask probing questions about how the candidates will instill and maintain a commitment to the agency mission by those in the ranks who will do the most to accomplish it.

Update:  Concerning my post of October 7, discussing the need for more flexible remedies for violations of the law, the University of Maryland Carey Law School has posted video of its recent, superb 2012 Ward Kershaw Symposium, "Too Big to Jail: Roadblocks to Regulatory Enforcement," available at this link.

What is the value of internal compliance systems?

Internal systems of compliance monitoring have recently presented us with an alarming collection of spectacular failures.  For one example among many, the compliance office at Barclays was alerted to irregularities in the Bank's submissions to the calculation of LIBOR, and a senior compliance officer promised to raise the issue with senior management, but did not do so. 

Internal compliance systems suffer from intrinsic conflicts of interest.  Like the Chancellor of England, who served as the "King's conscience," compliance officers serve as the conscience of the company.  But the King could, and sometimes did, behead the Chancellor -- a lesson that is not lost on modern compliance officers.  On the other hand, truly independent monitors of corporate probity are cumbersome, expensive, and may lack expertise and inside knowledge of the corporation. 

Until corporate incentives -- mainly, but not exclusively, executive compensation -- are more closely aligned with ethical practices and legal constraints, the role of the corporate compliance program will be relegated to overseeing routine technical matters and correction of lower-level ethical lapses.  Stronger protections for whistleblowers, carefully targeted criminal prosecutions, meaningful statutory revisions to the financial system, and similar techniques, must all be brought to bear in a coordinated manner if these incentives are to be changed in an effective way.  It remains to be seen if recent efforts in these areas are sufficient and sufficiently timely.  

It is not in the nature of organizational compliance programs to be crowns of laurels, but neither can we tolerate them being corporate fig leaves.         

More imaginative penalties are needed

Constructing appropriate penalties for violation of the commodities laws in no easy undertaking.  Entities that can do the most damage to the economy are often "too big to fail/too big to jail."  Fines in the hundreds of millions of dollars may be the equivalent of a traffic ticket -- as U.S. District Judge Jed Rakoff has noted.  On the other hand, fines of a ruinous amount inflict punishment on a broad swath of the investing public and could have adverse impacts on entire markets.  But to limit the range of possible sanctions to monetary penalties takes too narrow an approach in my view.

The law of equity has a wide range of remedies, developed over centuries of dealing with novel situations.  At the top end of the spectrum is the imposition of a receivership.  This is a truly draconian step, in which the receiver -- an officer of the court -- actually takes control of the entity in question.  This remedy is unlikely to be feasible when a wrongdoer is still a going concern, but has, of course, been widely used when the entity has failed.  Less aggressive measures include the appointment of a party with special powers tailored to the problems to be corrected.  These parties are often referred to as private inspectors general, monitors, or consultants.  Such a party might be empowered to conduct periodic audits of financial transactions, review the structure of an organization and recommend changes, assure compliance with court-ordered conditions, make reports to parties in interest, and the like.  At the lower end of the spectrum, a wrongdoer might agree to the use of a third party simply to verify its compliance with the conditions of a settlement.

The use of flexible, third-party involvement in the operation of a company or in assuring compliance with the requirements of a court order or settlement agreement is not novel -- the Department of Justice has used mechanisms of this sort for years in the criminal prosecution of corporations.  The key is to assure that the scope of the powers of the third party is sufficiently broad to give the monitorship real teeth and yet not so intrusive as to be counterproductive.

Use of a sanction of this type would help address the chronic lack of resources available to regulators, because the wrongdoer bears the expense of the monitor.  Non-monetary sanctions are also rebarbative to entities who must host the third party and so may incentivize them to more carefully obey the law.

These suggestions are just that -- the ultimate point is that monetary sanctions, by themselves, are not adequate to deal with the complexities of modern market regulation.  Regulators should use a much broader range of remedies if they are to make any meaningful progress in policing the commodities markets.  Your further suggestions would be greatly appreciated.