Goodbye 2013 frauds; welcome 2014 abuses.
The financial crisis may be five years behind us, but there will never be a shortage in the ways in which the financial markets may be manipulated and abused.
Developments this past year are likely to affect future enforcement actions. For example, the Commodity Futures Trading Commission used the new antifraud rule authorized by the Dodd-Frank Act for the first time against JPMorgan Chase as part of the settlement over the “London whale” case. In that case, the agency accused the firm of using a “manipulative device” in its trading. This gives the agency a powerful tool to police trading in the huge financial futures markets.
The Securities and Exchange Commission unveiled a new policy in selected cases that required an admission of liability, rather than the old “neither admit nor deny” settlement. JPMorgan was the first company subjected to this policy shift by admitting violations related to reporting the London whale trades, coming shortly after a case in which the hedge fund manager Philip A. Falcone acknowledged wrongdoing in how he managed his firm.
This new approach comes after a United States district court judge in Manhattan, Jed S. Rakoff, refused to approve a settlement in 2012 between the S.E.C. and Citigroup because it did not require the bank to acknowledge wrongdoing. That case is now on appeal, but it has been nearly a year since the United States Court of Appeals for the Second Circuit heard the oral arguments. The appeals court’s decision may read much like yesterday’s newspaper now that the S.E.C. is willing to take a harder line in settling some cases.
So expect to see both the C.F.T.C. and the S.E.C. continue to apply their newfound muscle in investigating cases. In addition, there are three areas in which we are likely to see interesting developments in white-collar crime in 2014:
Insider Trading
Saying that insider trading will be a source of headlines in the coming year is like predicting that the New York Yankees will spend a lot of money on players for the baseball season.
You know it will happen; the question is, just how much? For insider trading, it is not whether there will be more cases, but who is next.
The United States attorney’s office in Manhattan has kept alive a streak of winning convictions through trials and guilty pleas since 2009 in cases growing out of what it called Operation Perfect Hedge. The target was hedge funds and expert networks that shared confidential corporate information used to get an “edge” on the markets.
By any measure, the crackdown has been a resounding success, with 77 convictions to date. But the last major target of the investigation remains uncharged – Steven A. Cohen, the founder and owner of SAC Capital Advisors. This continues to be a sore point among regulators, and perhaps 2014 may finally be the year that the Justice Department gets some traction.
The S.E.C. filed civil administrative charges against Mr. Cohen, accusing him of failing to supervise a number of SAC employees who engaged in insider trading. The case could result in an order barring him from investing money for outside investors, but that is unlikely to have much impact as the firm is now winding down its operations and shifting to a so-called family office that will manage Mr. Cohen’s prodigious personal wealth.
Building a criminal case looks to be the goal. As DealBook reported, investigators are scrutinizing trades in Weight Watchers, InterMune and Gymboree that may implicate Mr. Cohen. But suspicious trading alone, even in a number of different companies, is probably not enough to win a conviction.
Prosecutors will need someone who dealt directly with Mr. Cohen if they hope to convince a jury that he knowingly traded on inside information, a hurdle that has not been surmounted yet. But the recent jury conviction of Michael S. Steinberg, a former SAC trader, could finally give the government some leverage in getting an SAC trader to “flip” on Mr. Cohen. The big question is whether prosecutors will actually get a credible witness to testify. If that happens, prosecutors may finally bring criminal charges against one of the most prominent and successful hedge fund managers on Wall Street.
Crowdfunding
There will be an increase in so-called crowdfunding as a result of new S.E.C. rules made in response to the Jump-Start Our Business Start-Ups Act, or JOBS Act, adopted in 2012. The
new law permits small businesses to appeal directly to the general public to invest in their companies without having to deal with brokers or investment bankers. Instead, the investments are made through online
crowdfunding platforms, such as Kickstarter.
This new way for small investors to buy into developing companies is attractive because it is a chance to get a piece of the next great success story. But as the recently released movie “The Wolf of Wall Street” aptly demonstrates, where there is money to be made from investors looking to make the big score, there will be fraud.
That should not come as a surprise, because any investment vehicle can be misused. What may exacerbate the problem is that crowdfunding relies on word of mouth and social networks, and affinity fraud is among the most prevalent ways in which investors are duped. Think about how Bernard L. Madoff attracted so much money from individual investors.
The challenge for regulators, primarily the S.E.C., will be ferreting out fraud from those investments that are just risky. As the Deal Professor aptly noted “you will have better odds at the casino than investing in crowdfunded companies.” So just losing money is not necessarily a telltale sign of fraud because most will come out behind on crowdfunding investments.
The new rules limit the amounts that can be raised to $1 million in a 12-month period, so individual cases of fraud are likely to be small. As crowdfunding proliferates, the issue will be whether the S.E.C. has the resources to investigate a number of potential violations in which differentiating between fraud or excessive risk will be difficult.
Benchmark Manipulation
The manipulation of the London interbank offered rate, or Libor, and other benchmark rates has already netted a number of significant settlements from global banks. In 2012, Barclays paid about $450 million and UBS was fined about $1.5 billion, and more banks settled this past year.
2014 promises more cases, and we are likely to see the first resolutions involving American banks and the primary agencies in the United States involved in the cases, the Justice Department and the C.F.T.C. In the settlements with UBS and the Royal Bank of Scotland, federal prosecutors required that foreign subsidiaries enter guilty pleas to charges of wire fraud.
Whether the same will be demanded from banks like Citigroup and JPMorgan, which recently settled rate-manipulation charges with the European Commission, remains to be seen. The settlements will be a test of how stringently the Justice Department applies the law against American banks that engaged in conduct similar to foreign companies. If prosecutors demand a guilty plea, even from a foreign subsidiary, it will test whether any big banks really are “too big to jail” because of the potential collateral consequences.
A greater threat to global banks will be growing number of investigations of manipulation of other benchmark rates used in financial transactions. As DealBook reported, there is an expanding investigation of misreporting of foreign exchange rates by a group of traders who acquired the nickname “the cartel” from their instant messages.
The United States attorney general, Eric H. Holder Jr., said: “The manipulation we’ve seen so far may just be the tip of the iceberg.” Foreign exchange rates rely on self-reporting by market participants, making them particularly vulnerable to manipulation. Regulators throughout the world can be expected to look at any benchmark rate that can be gamed by traders.
The cases arising from these investigations may be a significant threat to banks because it is not just governments they have to worry about. Market participants cheated out of millions – and perhaps even billions – of dollars through manipulative trading can be expected to sue, and plaintiffs’ lawyers will see this as the next wave of class actions that can generate generous fees.
There are plenty of other potential sources of white-collar cases that can garner attention. Will there be a rogue trader who causes billions of dollars in losses at a firm, or a new vein of insider trading cases built on wiretaps? Who will be the focus of a tax-evasion investigation for using a Swiss bank account to hide assets, or what company will run afoul of the Foreign Corrupt Practices Act for paying bribes to foreign officials?