Foreign Exchange Settlement Shows the Lessons Banks Have Learned

The settlements by five global banks for manipulating the foreign currency markets show a strategy based on strength in numbers: The more banks that are disciplined, the less any one of them will be the focus of public attention for their violations. The total fine of $4.25 billion imposed by British, American and Swiss regulators sounds like a lot of money, but no one bank has to bear the brunt of the bad publicity.

This is really a “settlement light,” though, because much like the beer, it is not fully satisfying until the criminal investigation for the manipulative conduct is resolved. The Justice Department is sure to seek additional fines as part of deferred prosecution agreements that can also be expected to impose new monitoring costs on the banks to avoid future violations.

So why would UBS, HSBC, Royal Bank of Scotland, JPMorgan Chase, and Citigroup agree to settle the civil cases rather than try to wrap up the entire case at once? The reason reflects an evolving strategy by the banks as they learn to navigate among regulators and prosecutors spread across the globe to minimize the impact of the settlements. The goal is to have the markets react positively to the resolution of a case while ensuring that their bottom lines are not harmed too much by the monetary penalties.

To understand the strategy, we need to look at how Goldman Sachs and Barclays handled government investigations, and the lessons that can be drawn from their cases.

In April 2010, the Securities and Exchange Commission sued Goldman for fraud related to its sale of a collateralized debt obligation tied to subprime mortgages right before the collapse of the housing market. The firm had been notified months earlier by the S.E.C.’s enforcement division that it was considering filing charges, but Goldman made no specific public disclosure that a lawsuit could be filed against it. When the regulators finally acted, the charges drew wide attention and Goldman’s stock price dropped by 13 percent that day, wiping out over $10 billion in market value.

Lesson No. 1: Let the market know in advance if your company is going to be the subject of some type of government proceeding so that investors and analysts are not surprised when it comes out.

In June 2012, Barclays was the first global bank to settle charges related to manipulation of the London Interbank Offered Rate, or Libor, paying about $450 million in civil and criminal penalties.

As the first bank to settle a case for this type of violation, Barclays got what it no doubt thought was a good deal: a lower payment along with a pat on the back from the Justice Department for what was described as “a significant step toward accepting responsibility for its conduct by being the first institution to provide extensive and meaningful cooperation to the government.”

But within days of the announcement, after the bank was vilified for its conduct, three executives — including its chief executive and board chairman — abruptly resigned. Other banks later reached settlements requiring much higher penalties for Libor manipulation, but none took the public relations hit that Barclays did.

Lesson No. 2: Don’t be the first one to settle when others in the same position are still out there.

The banks have learned their lessons well in dealing with the foreign currency exchange investigations. Over the last few weeks, they conditioned the market to the impending settlement by disclosing reserves to pay the likely penalties, letting investors digest the news in advance. And by acting together, no one bank bears the brunt of the regulators’ criticism, including the usual array of embarrassing chat session comments.

The settlements on Wednesday leave the criminal investigations to be resolved. But even here, I think we can see the approach the banks are taking to minimize the damage. About 30 traders involved in the manipulation have been fired or suspended over the past year by the banks, which have kept quiet about the reasons beyond vague acknowledgements that they would not comment during a pending investigation. We can expect to see some of those traders prosecuted for manipulation, and the banks are certain to show that they are cooperating with the Justice Department by providing incriminating information and removing the traders from their positions.

Thus, I expect the next wave of cases to be criminal charges against individuals and deferred prosecution agreements with the banks. Their cooperation will be extolled as the reason the Justice Department is not demanding a guilty plea, as seen in other recent cases involving BNP Paribas and Credit Suisse. Additional fines will be assessed to the banks, but those amounts are unlikely to exceed the total of $4.25 billion paid out in the current settlement. The individual traders are more likely to be the focus of attention when the criminal cases come out because the banks will be an old story by then.

This will lead to a third lesson for banks in this settlement: Sacrifice former employees to ensure that the government views the company as cooperative.

One bank that backed out of the settlement at the last moment is Barclays. DealBook reported that the bank was concerned about the collateral consequences of the resolution, especially the potential impact on the investigation by the New York State Department of Financial Services. In a statement about why it was not joining the settlement, the bank said it concluded “that it is in the interests of the company to seek a more general coordinated settlement.” But it could also fear joining in the first settlement, having been burned in the Libor case. Regardless of the reason, Barclays will have to join the party at some point by settling, and risk being the focus of significant public attention once again.

The settlement on Wednesday comes with the usual promises of reform from the banks and warnings from regulators about the need to change corporate cultures. Perhaps the biggest lesson from the settlement is the one we have seen in other cases involving big fines — that there will be little real change in how global banks act, even as they figure out how to limit the damage after they get caught.