Risk Management

Blind Justice

Why have so few bankers gone to jail for their part in the financial crisis?
Economist StaffMay 2, 2013

Crime sometimes pays unusual social dividends. In 2010 São Paulo’s museum of modern art hosted an exhibition of works that had been seized from a variety of crooks and drug traffickers. Some of the art had belonged to the founder of a Brazilian bank, Banco Santos, that had collapsed in 2005. After the bank’s liquidation Edemar Cid Ferreira lost his art collection and his home, was convicted of “crimes against the national financial system” and money-laundering, and sentenced to 21 years in jail.

For better or worse, many people would love to see more bankers behind bars for their role in blowing up the West’s financial system. In Britain not one senior banker has faced criminal charges relating to the failure of his institution. A handful have faced the lesser sanction of being barred from running another bank or company, or agreeing in settlements with regulators not to do so. (Policymakers have proposed introducing a “rebuttable presumption” that the directors of a failed bank should be automatically barred from running another unless they could prove they weren’t at fault.)

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In America the Federal Deposit Insurance Corporation has filed over 40 lawsuits against officers and directors of failed institutions since 2010; more actions are expected. But prosecutors have brought few criminal charges against high-profile bankers. The American government secured its first crisis-related conviction of a senior banker, a Credit Suisse employee charged with mismarking mortgage-backed securities, only in April; Kareem Serageldin will be sentenced in August.

The prosecutorial coyness of British and American authorities contrasts with the harder-charging approach taken by their predecessors and by authorities elsewhere. During America’s savings-and-loans (S&L) crisis in the 1980s more than 800 bankers were jailed. A decade later directors of Barings, a British bank that was felled by the rogue trader Nick Leeson, were barred from holding directorships despite having no direct connection to his wrongdoing. Other countries, such as Iceland and Germany, have taken a more muscular approach in this crisis (see table below).

Some of these differences seem to be down to political will. In America the federal government dedicated considerable resources to investigating fraud during the S&L crisis. William Black, a professor at the University of Missouri at Kansas City and a former bank regulator involved in charging S&L executives, has testified to lawmakers that regulators have given the FBI scant help during the current crisis.

Iceland managed to assemble a dedicated team of more than 100 investigators who have won convictions against executives in charge of Glitnir, a failed bank, and are bringing charges against other high-profile bankers and businessmen, including the bosses of Iceland’s other two big banks. In Spain the behavior of some 90 former bank executives and board members is under investigation. Dodgy deals with cronies, soft loans for themselves, allegedly irregular salary and pension packages, inflated golden handshakes and overgenerous fees for attending rubber-stamp meetings are all being scrutinized.

There are also differences in the laws that can be applied. The main reason that American and British regulators give for the paucity of prosecutions is that they have struggled to connect wrongdoing lower down in the bank, such as the LIBOR scandal, to those running it. Another is that it is generally not illegal to run a bank into the ground through incompetence (although British and German policymakers are consulting on the introduction of criminal sanctions for reckless management).

The threshold for getting bankers banged up is lower in some places than others, however. Germany, Switzerland and Austria, for instance, have an elastic concept called Untreue, or breach of trust, which is defined as a derogation of duty that causes real damage to the institution. Since the crisis German prosecutors have charged bankers at firms including WestLB, BayernLB, HSH Nordbank and Sal Oppenheim on offences including Untreue.

In Brazil, the law is stricter still. It holds banks’ executives and directors (and even their controlling shareholders) personally liable to repay the debts of failed banks even where no fault is proven. “The idea is really to put the management’s net worth at stake,” says José Luiz Homem de Mello of Pinheiro Neto, a São Paulo law firm.

Yet imposing stricter standards of liability has costs. It would overturn a tradition in English and American law in which courts avoid second-guessing business decisions that are honestly made but wrong. Heinrich Honsell, a law professor, sees the use of Untreue recently in commercial cases as a disturbing phenomenon. “It’s not right to criminalise negligent mistakes,” he says. “Very soon judges will be telling us how to manage risk.” Opponents of the idea of a law against reckless management warn that the effect would be to discourage risk-taking of any sort.

But if locking people up for incompetence goes too far, regulators could still get a lot tougher. Summary justice isn’t desirable. Some justice is.

© The Economist Newspaper Limited, London (May 4, 2013)

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