LONDON -- This week is crunch time at Standard Chartered (LSE: STAN.L ) . Since being threatened with the loss of its New York banking license last Tuesday, its shares initially dropped 25% and have since recovered 10%.
The outcome of Wednesday's meeting with the New York regulator might see that partial recovery evaporate, or else Standard Chartered's premium rating return. Or neither.
New York State Department of Financial Services regulator Benjamin Lawsky's 27-page dossier reads more like a Batman comic than a legal document: Standard Chartered is a "rogue institution" that "engaged in deceptive and fraudulent misconduct" to move $250 billion through its New York branch for Iranians clients leaving "the US financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes." Lawsky's team of caped crusaders trawled through 30,000 pages of documents to unearth this evil.
There's a good deal of politicking behind this hyperbole, of course. You can take your pick as to whether it's U.S. vs. U.K., state regulator vs. federal, Democrat vs. Republican, or just plain grandstanding.
Where there's smoke...
But the bluster of the ready-made sound bites occludes some really hard questions for Standard Chartered.
The bank has come out fighting. It claims that more than 99.9% of transactions complied with regulations and less than $14 million worth were at fault. It says the state regulator is wrong about the law, and wants to negotiate a settlement together with the federal regulators. Five banks including Barclays and Lloyds have already settled fines totaling $1.8 billion in relation to sanctions violations.
Standard Chartered has also taken legal advice on whether it can sue for damage to its reputation.
At the heart of the allegations are the so-called U-turn regulations, which allowed dollars from Iran's oil industry to be cleared through the U.S. provided they were routed via a non-Iranian bank. The crux is whether banks could legitimately strip client details from these transfers before sending them to the U.S.
Lawson's document makes clear that Standard Chartered knew it was on thin ice. RBS (LSE: RBS.L ) shareholders might be a little miffed at a 1995 memo from Standard Chartered's internal lawyer recommending that it "should use e.g. [National Westminster Bank] who in processing the transaction would breach OFAC regulations and would expose themselves to a penalty." It was certainly aware of the reputational risk, too.
The worst-case scenario is that the bank loses its New York license. That would have a devastating impact on its business processing, its reputation and its share price.
Mutually assured destruction
But the bank won't take such a big hit without a big fight. It might have grounds for legal action. And it has powerful friends, not just in the West but throughout the developing world. By jumping the gun ahead of federal regulators, Lawsky has possibly made himself vulnerable.
What happens when two sides both have a nuclear option? Of course, the threat of using it is enough to ensure negotiation of a peaceful settlement.
So I believe Standard Chartered's license is safe. But the outcome will cost it dearly, allowing Lawsky his victory. It will be hit three ways:
- A substantial fine, maybe $0.5 billion to $1 billion.
- Management resignations. The regulator might call for the resignation of finance director Richard Meddings, who is indirectly named in the document, but the chairman and chief executive could also be vulnerable.
- A trashed reputation. Management's hubris over the travails of other banks has turned to nemesis.
What does that mean for the share price? Retaining the New York license should protect investors from any catastrophic downside. But there is unlikely to be much of a bounce-back. Standard Chartered's premium rating has slipped permanently as the bank has lost its reputation for walking on water. I suspect current levels are the new reality.
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