"If a graduating MBA student were to ask me, 'How do I get rich in a hurry?' I would not respond with quotations from Ben Franklin or Horatio Alger, but would instead hold my nose with one hand and point with the other toward Wall Street." -- Warren Buffett
There will come a time in the not-too-distant future when Wall Street banks won't be regularly chastised for ripping off customers, defrauding the federal and state governments, facilitating tax evasion, laundering money for sworn enemies of the United States, and manipulating bond, interest rate, foreign-exchange, and energy markets. When this time comes, however, it shouldn't be interpreted as a sign that things have changed.
The reality is that corruption is endemic on Wall Street. It was in the 1800s when Daniel Drew and Cornelius Vanderbilt cornered railroad stocks and enriched themselves on inside information. It was in the 1920s when the predecessor to Citigroup (NYSE:C) flooded the country with toxic Peruvian bonds. It was at the turn of the century when analysts touted companies like Enron. And it is today. Indeed, perhaps the only thing that's shocking about the financial industry's misdeeds is that we continue to be shocked by them.
Wall Street's latest brush with the law
The latest multibillion-dollar settlement serves as a case in point. On Wednesday, six major banks -- Citigroup, JPMorgan Chase (NYSE:JPM), UBS, The Royal Bank of Scotland, HSBC, and Bank of America (NYSE:BAC) -- agreed to pay a combined $4.3 billion to settle allegations that traders within their investment banking divisions conspired to manipulate foreign exchange rates.
This is bad in and of itself; but what makes it worse is the fact that the banks were doing so in order to take advantage of their own clients. According to the Financial Conduct Authority, a financial regulator in the United Kingdom:
Traders shared information obtained [in Internet chat rooms] to help them work out their trading strategies. They then attempted to manipulate fix rates and trigger client "stop loss" orders (which are designed to limit the losses a client could face if exposed to adverse currency rate movements). This involved traders attempting to manipulate the relevant currency rate in the market, for example, to ensure that the rate at which the bank had agreed to sell a particular currency to its clients was higher than the average rate it had bought that currency for in the market. If successful, the bank would profit.
Of course, the banks argue that these were the acts of a handful of rogue agents, and that the indiscretions don't reflect the official policies and practices of the companies themselves. Take the following responses from JPMorgan Chase and Citigroup:
The trader conduct described in today's settlements is unacceptable. In addition to making significant improvements to our systems and controls, we have spent a lot of time reinforcing the high standards of conduct expected of our people. Although the settlements acknowledge our progress, further training and enhancements are ongoing and will remain a priority.
Citigroup acted quickly upon becoming aware of issues in our foreign exchange business and we have already made changes to our systems, controls and monitoring processes to better guard against improper behavior. While today's settlements resolve significant investigations into Citi's foreign exchange business, as we have previously disclosed, several additional regulatory agencies and enforcement bodies are conducting investigations and making inquiries into this business. We continue to fully cooperate with these investigations and inquiries.
A pattern of unsavory behavior
I doubt the employee manuals at these firms instruct traders to manipulate markets and exploit clients. But the problem is that this isn't the first time allegations like these have triggered fines or settlements at the same banks:
- Between 2012 and 2013, eight banks -- UBS, The Royal Bank of Scotland, Rabobank, Deutsche Bank, Societe Generale, Barclays, JPMorgan Chase, and Citigroup -- paid $6 billion to settle allegations that they manipulated the London interbank offered rate benchmark, one of the most widely tracked interest rate indexes in the world.
- In 2013, JPMorgan Chase paid $410 million in penalties and disgorgement for rigging electricity markets in California and the Midwest.
- Also in 2013, more than a dozen major banks paid a combined $9.3 billion to make amends for systematically submitting fraudulent documents to courts in foreclosure proceedings.
- In 2010, Bank of America paid $137 million to settle charges of securities fraud for rigging bids in the municipal bond market -- and just for the record, the North Carolina-based bank was joined by the usual cast of characters, including JPMorgan Chase and UBS, among others.
- Also in 2010, Goldman Sachs was hauled before Congress to answer for its role in constructing toxic derivatives that it then sold to unwitting clients just as the subprime mortgage market started to buckle -- here's a revealing portrait of virtually identical conduct at JPMorgan Chase.
Thus, the question is whether these practices are indeed isolated incidences of employee misconduct, as the banks would like us to believe, or instead whether they're indicative of a pattern of behavior that's endemic on Wall Street. I suspect it's the latter. And, for what it's worth, so does Daniel Tarullo, the Federal Reserve's chief enforcement officer:
The hypothesis that this is all the result of "a few bad apples," an explanation I heard with exasperating frequency a year or two ago, has I think given way to a realization within many large financial firms that they have not taken steps sufficient to ensure that the activities of their employees remain within the law and, more broadly, accord with the values of probity, customer service, and ethical conduct that most of them espouse on their websites and in their television commercials.
And here's William Dudley, a former partner at Goldman Sachs and the current president of the Federal Reserve Bank of New York, echoing a similar message:
There is evidence of deep-seated cultural and ethical failures at many large financial institutions. Whether this is due to size and complexity, bad incentives or some other issues is difficult to judge, but it is another critical problem that needs to be addressed. Tough enforcement and high penalties will certainly help focus management's attention on this issue. But I am also hopeful that ending too big to fail and shifting the emphasis to longer-term sustainability will encourage the needed cultural shift necessary to restore public trust in the industry.
Fool me once, shame on you. Fool me twice...
Of course, it's impossible to forensically prove that corruption is woven into the fabric of Wall Street banks -- and, specifically, at companies with significant trading operations where the temptation to skirt the rules seems to be greatest. That's certainly what history suggests. And it's also what the ongoing regulatory assault on the industry implies. But, again, there is no way to quantitatively demonstrate this.
But what we can say is that there is a noxious air of impropriety that has enveloped these operations. And, rightly or wrongly, this reputational baggage subjects shareholders of these banks to more risk than, at least in my opinion, is warranted by any reasonable estimate of future returns. It's for this reason, in turn, that I believe individual investors would be smart to avoid universal lenders like JPMorgan Chase, Bank of America, and Citigroup in favor of their smaller, simpler counterparts in the regional banking space.