Settlements and fines: Barclays and GSK

[wiggin]

As I'm sure most of you are aware, Barclays was recently given a $450 million fine from US and British regulators for their part in outright fraud in the setting of LIBOR rates. Investigations continue at a number of other large banks, and it seems likely other large fines will be levied. Most of the press has emphasized the unprecedented size of the fine/settlement, the scope of the investigation, and the likelihood of significant civil penalties in the ensuing lawsuits. The total market for LIBOR-linked debt is enormous, and it seems likely that the rate-fixers are on the hook for unknown civil penalties.

What struck me today, though, was that there was another record settlement in recent weeks over similar corporate shenanigans. GSK settled for $3 billion in a criminal fraud case dealing with off-label marketing (and other issues) of Paxil.

What's surprising to me is that scale of the settlements - large settlements are not uncommon in the pharma industry for fraudulent practices - in fact, I count at least 13 settlements of $500 million or more in the last couple decades in the US alone. Yet while this is seen as de rigueur in the pharma industry, the scale of the Barclays fine (and the likely subsequent fines at a dozen or so banks) seems to have shocked everyone.

So: is there something fundamentally different in the way regulation works in each industry that predisposes one to large fines and not another? How is the size of a settlement/fine determined? How should it be determined?

I don't think it can be said this is the result of the larger effects of the GSK fraud. In fact, GSK fraud affected a relatively small number of people, while the LIBOR fraud probably affected tens of millions or more. Both made the companies significant amounts of money, though I find it likely that is will be hard to put an exact dollar figure on either case. Both expose the companies to significant civil action in the future - GSK has already been sued by some 5,000 patients over this, and it's likely to increase, while Barclays et al are facing years of expensive and damaging court cases/class action suits given the fantastically large market in LIBOR-linked instruments (IIRC about $400 trillion?).

So why the difference?

I'm curious how the responsibility for these settlements is divided between the DoJ and the relevant regulators (in this case, CFTC/FSA vs. FDA), and how they determine the settlement amount. Does anyone have insight into this process?

(Also, I would plead with posters here to use this thread as an opportunity to talk about the issues raised here and not the broader failings of either the financial or pharma industries. Both committed significant fraud and are being punished for it. Let's leave it at that, eh?)

[Loki]

I have a feeling it's because lives are given a higher valuation, and any business practice that directly takes lives is going to get a bigger fine than financial malfeasance. Having said that, I do think large banks should be getting fined billions over this conspiracy (the fines can be spaced out to avoid affecting cashflow too much).

I would imagine there's also an element of the regulator/regulatee relationship. Bank regulators tend not to be as confrontational as pharma ones.

[wiggin]

I'm honestly not sure how many people died from the off-label marketing of Paxil, it was probably pretty small (bigger issues had to do with the fact it was habit forming and they claimed it wasn't and that it was not approved for kids but they promoted it for them). The sheer scale of the LIBOR-linked market makes me think the financial impact (including standard gov't valuations of lives) was probably similar if not much greater.


edit: I honestly think that settlements should be roughly determined by these criteria:
1. Figure out how much money the company made from the fraud/violation/etc.
2. Subtract a bit if they voluntarily came forward/cooperated.
3. Add some to put a bit of a sting into the punishment and deter future wrongdoing.

This is not linked to the human/market cost, really, since those should be determined by civil suits later, I would imagine. So perhaps this just means that banks didn't make as much money on LIBOR fraud as pharma companies do from off-label marketing? Perhaps so.

[Loki]

Adding "some" isn't deterrence unless the chance of getting caught is 100% (even then, the lower future value of money might make cheating attractive). For step 3, triple the amount in step 1.

[wiggin]

Fair enough. Then again, there's other costs associated with such a settlement that aren't figured into the actual dollar amount. Notably, the civil penalties can be extensive, and the damage to brand/etc. can also be significant. Furthermore, the most effective deterrent is firing people, and that often happens to the people involved (and executives in charge) after a significant settlement.

Certainly it would appear that given the number of continued cases of fraud in both the financial services and pharma industries that the deterrent is currently not enough.

[Loki]

The firing isn't a great deterrent due to the high turnover in executive positions. Either the executives won't be in charge of the company by the time it's caught, or they would have been fired anyway.

[RandBlade]

The firing isn't a great deterrent due to the high turnover in executive positions. Either the executives won't be in charge of the company by the time it's caught, or they would have been fired anyway.

Not sure about that, Bob Diamond had been with Barclays for 20 years I believe from memory and there was no expectation he'd be going in the near future had this not come to light.

Certain things should be held to a higher standard probably, anything that could involve a loss of life. That's the only reason I too can imagine pharmaceuticals getting fined more.

I also suspect there's an issue of precedent involved. Fines often seem to be the largest previous fine plus a bit. If the previous biggest fine is say $100mn then going from that to $5bn barring extremely exceptional circumstances would be pretty extreme. OTOH if you're in an industry regularly getting fines in the hundreds of millions or billions then the precedent is there for a higher one.

[Loki]

Just because there are a handful of executives that stick around for a long time doesn't mean the average executive does. The average CEO gets fired after something like 3 years.

[RandBlade]

The average employee anywhere leaves after something like 3 years I believe.

[Loki]

That kind of supports my point about the prospect of being fired not being much of a threat, especially since executives who are fired tend to get pretty nice golden parachutes.

[Aimless]

If you split those 3 billion between the specific charges/violations then it might seem more reasonable. I personally hope that these fines also take into account past behaviour and that they're set high enough that they work as proper deterrents rather than being seen as part of "cost of doing business".

[Dreadnaught]

So: is there something fundamentally different in the way regulation works in each industry that predisposes one to large fines and not another? How is the size of a settlement/fine determined? How should it be determined?

Beyond the "lives at stake" issue, I think it has something to do with the amount of regulation in an industry. Healthcare and financial services are highly regulated industries, which means the cost/duration of litigation (and the potential penalties) justify large settlements.

I mean, has anyone ever heard of an ISP being forced to pay half a billion dollars for a screwup that wasn't part of a civil class-action lawsuit? I'm asking that as an open question, I can't think of any in recent memory but I am possibly/probably forgetting something.

[wiggin]

Beyond the "lives at stake" issue, I think it has something to do with the amount of regulation in an industry. Healthcare and financial services are highly regulated industries, which means the cost/duration of litigation (and the potential penalties) justify large settlements.

I mean, has anyone ever heard of an ISP being forced to pay half a billion dollars for a screwup that wasn't part of a civil class-action lawsuit? I'm asking that as an open question, I can't think of any in recent memory but I am possibly/probably forgetting something.

This is an interesting question you allude to.

What should settlements/fines be determined on? Using my aforementioned trial criteria, settlements/fines from the DoJ or a regulator are to force the company to lose money on the proposition. So, if they made a lot of money off of their bad behavior, they pay a larger fine (obviously with a deterrence premium) than if they made a pittance. This seems to be roughly the rules being applied here, which still leaves plenty of room for civil suits to recoup losses other people experienced as a result of the bad behavior.

Another way to look at it, though, is as a retroactive tax on their behavior to fix the problems they caused. Their fraud/whatever caused a negative externality, where the costs of their actions weren't priced into the actions, right? So the fine should not be calculated on the basis of their savings/profits, but rather on the basis of its negative economic impact on everyone else. It might seem like a somewhat unfair rubric to use (and should probably prejudice later civil settlements), but I'm not sure it's not a model sometimes used - aren't EPA fines often scaled to the estimated cost of cleanup/mitigation?

I'm not sure which idea makes more sense; if you choose just one or another, you might end up with suboptimal outcomes. Let's say that Barclays' fiddling with LIBOR didn't really have any significant effect on markets most of the time (because the top four and bottom four estimates are discarded anyways). I find this unlikely, but let's just say it for the purposes of argument. If we fine them on the basis of criteria #2, the fine would likely be quite small and just a slap on the wrist, obviously a poor deterrent. Yet what if Barclays' actions were actually the reverse - making them precious little actual profit but causing huge ripples throughout the financial industry? Then were we to just use deterrence-based calculations, they'd get a relatively small fine but leave regulators and the government (and consumers) holding the bag on a huge amount of losses.

[Dreadnaught]

I suppose the ultimate incentive would be to hold people personally liable. EG the government can hold individual employees personally criminally liable for Sarbanes-Oxley violations, which is why many large companies these days regularly ask employees to regularly self-certify (so the employees can be prosecuted if they goof).

But somehow I feel that undermines the whole point of a corporation. It also creates a somewhat adversarial relationship within a business venture, because suddenly it's up to a company and it's employees to separately monitor their compliance with byzantine laws.

Anyway, getting a bit closer to what you were talking about calculating these fines: Is it maybe just one of those gray areas of bureaucracy where the bureaucrats are semi-arbitrarily calculating fines? A lot of these fines are based on the premise of disgorging profits + paying some fees, but we all know some of these numbers are invented to some degree.

EG the Barclay's issue you brought up, where the profits were small but the fine is large. I guess in my fantasy land I would prefer a system where Barclay's could suffer real market punishment, such as not being allowed to have reported LIBOR rates and making their day-to-day borrowing that much more opaque, which in turn would increase their borrowing costs.

This would be a "fair" punishment, wouldn't it? They subverted the transparency of the market, so now they don't get the benefits of a transparent commercial paper market. Yet this could cause them to fall apart, which is the same damn systemic problem we've found with punishing banks over the past few years.

[/10AM hungover rant. I'm too old for Jello injector shots]

[Aimless]

But somehow I feel that undermines the whole point of a corporation. It also creates a somewhat adversarial relationship within a business venture, because suddenly it's up to a company and it's employees to separately monitor their compliance with byzantine laws.

I am a little puzzled by this remark. I thought this was about deliberate fraud (among other blatantly dodgy practices) rather than accidental semi-compliance with a murky or byzantine regulatory framework.

[Aimless]

Btw, the breakdown described here may perhaps help make sense of those 3 billion:

http://www.mondaq.com/unitedstates/x...es+Do+Business

GSK entered into a global settlement with criminal, civil and administrative components to resolve the pending investigations.

Criminal Plea: GSK pled guilty to three misdemeanor violations of the FDCA, including two counts of introducing misbranded drugs, Paxil and Wellbutrin, into interstate commerce and one count of failing to report safety data about Avandia to the FDA. Under the plea agreement, GSK will pay a criminal fine of $956.8 million and forfeit assets of $43.2 million. The plea agreement includes non-monetary compliance commitments and requires GSK's board of directors and its U.S. president to annually certify compliance with those commitments.

Civil Settlement: GSK also agreed to pay $2 billion ($1.5 billion to the federal government, $477.8 million to the states, and $20.2 million to certain public health entities) to resolve its civil liability for (1) promoting Paxil, Wellbutrin, Advair, Lamictal and Zofran for off-label uses and paying kickbacks to physicians to prescribe Advair, Flovent, Imitrex, Lotronex, Paxil, Wellbutrin and Valtrex, (2) making false and misleading statements concerning the safety of Avandia, and (3) reporting false drug prices and underpaying rebates owed under the Medicaid Drug Rebate Program. The off-label civil settlement also resolved four lawsuits pending in the District of Massachusetts under the qui tam provisions of the False Claims Act.

Administrative: GSK entered into a 5-year Corporate Integrity Agreement ("CIA") with the Office of the Inspector General of the Department of Health and Human Services.

[Khendraja'aro]

I think that article fits the discussion perfectly.

http://www.nytimes.com/2012/07/15/business/goldman-sachs-and-a-sale-gone-horribly-awry.html?pagewanted=1&_r=3&hpw

If the case goes to trial in Boston, as scheduled, on Nov. 6, the final argument that Goldman can be expected to make is that the bankers, as Mr. Wayner testified, gave the Bakers “great advice.”Mr. Berzofsky, too, testified in his deposition that the Goldman Four did a “great job.”
Even though Dragon lost everything?
“Yes,” Mr. Berzofsky said. He was given several opportunities to clarify. And then he was asked one more time — the fact that the Bakers and Dragon’s shareholders lost everything doesn’t affect your opinion?
“Correct,” Mr. Berzofsky responded. “We guided them to a completed transaction.”

With statements like these, you really have to wonder in what kind of world those guys live in.

[Dreadnaught]

I am a little puzzled by this remark. I thought this was about deliberate fraud (among other blatantly dodgy practices) rather than accidental semi-compliance with a murky or byzantine regulatory framework.

I think the idea is that it runs the gamut. The kinds of massive fines Wiggin is referring to also include a very large number of settlements, in which no fraud is admitted but the government is mainly paid to go away.

But those very byzantine regulations and complex commercial systems do often underpin these settlements. I think that is one reason companies are so willing to just pay for them to go away. The LIBOR probes may be a stretch to even be called fraud -- LIBOR involves banks submitting estimates of what each bank thinks they would pay to borrow in the interbank commercial paper market.

In other words, LIBOR is an estimate of a hypothetical borrowing rate. It's not really an average of actual borrowing; the scandal isn't an accounting fraud, it's "only" a violation of trust and a breakdown in a metric that is widely depended-upon. One could argue for months whether one can commit fraud when

1) Submitting an estimate of a hypothetical borrowing rate
2) To a non-profit, private banking consortium
3) That isn't a government entity, but is nonetheless relied-upon by a wide variety of organizations who aren't really paying BBA (the publishers of LIBOR) for the estimate.

Most banks and governments probably don't want to spend the money actually arguing that forever, because it's a highly murky issue. This won't stop the government from trying to prosecute, but they know they will probably just get a settlement and be able to declare victory.

I think that article fits the discussion perfectly.

http://www.nytimes.com/2012/07/15/business/goldman-sachs-and-a-sale-gone-horribly-awry.html?pagewanted=1&_r=3&hpw

With statements like these, you really have to wonder in what kind of world those guys live in.

It doesn't seem to be relevant at all. This seems to be an issue of contract law for a particular case. Though I remember trying out Dragon Naturally Speaking in 1999 or so, it's too bad to hear what happened to them.

[wiggin]

I suppose the ultimate incentive would be to hold people personally liable. EG the government can hold individual employees personally criminally liable for Sarbanes-Oxley violations, which is why many large companies these days regularly ask employees to regularly self-certify (so the employees can be prosecuted if they goof).

But somehow I feel that undermines the whole point of a corporation. It also creates a somewhat adversarial relationship within a business venture, because suddenly it's up to a company and it's employees to separately monitor their compliance with byzantine laws.

Employees should be held separately liable, but corporations are separate entities that do have responsibilities. When they fail to adequately control/police their employees (or, worse, actively encourage fraud), the corporation is also at fault and should also be considered as liable. IMO.

Anyway, getting a bit closer to what you were talking about calculating these fines: Is it maybe just one of those gray areas of bureaucracy where the bureaucrats are semi-arbitrarily calculating fines? A lot of these fines are based on the premise of disgorging profits + paying some fees, but we all know some of these numbers are invented to some degree.

I think it's not arbitrary, but it certainly seems to be opaque. I'm frankly not well versed in the underlying theory at the DoJ in how they come up with the numbers.

EG the Barclay's issue you brought up, where the profits were small but the fine is large. I guess in my fantasy land I would prefer a system where Barclay's could suffer real market punishment, such as not being allowed to have reported LIBOR rates and making their day-to-day borrowing that much more opaque, which in turn would increase their borrowing costs.

This would be a "fair" punishment, wouldn't it? They subverted the transparency of the market, so now they don't get the benefits of a transparent commercial paper market. Yet this could cause them to fall apart, which is the same damn systemic problem we've found with punishing banks over the past few years.

Hmm. I'm not sure whether you need to report LIBOR to have access to the commercial paper/interbank market. I mean, obviously plenty of banks aren't used for figuring LIBOR, but equally obviously the published LIBOR submissions give people a very clear benchmark for the company at hand. That being said, I find it unlikely Barclays would be hurt by the markets for this anywhere near as much as they'll be hurt by legal action (and the effect on their share price from said legal action).

Btw, the breakdown described here may perhaps help make sense of those 3 billion:

http://www.mondaq.com/unitedstates/x...es+Do+Business

As far as I can tell, it doesn't really give any insight into how the amounts were calculated, just where they are going. If I'm reading it right, though, it would seem to preclude more individuals from seeking civil claims against GSK, which the LIBOR settlement definitely does not prejudice.

[Aimless]

One could argue for months whether one can commit fraud when

1) Submitting an estimate of a hypothetical borrowing rate
2) To a non-profit, private banking consortium
3) That isn't a government entity, but is nonetheless relied-upon by a wide variety of organizations who aren't really paying BBA (the publishers of LIBOR) for the estimate.

Er, when deliberately serving a fraudulent estimate--ie. not an estimate at all--with the clear intent of manipulating others, never mind the collusion and the insider info abuse. Fraud isn't strictly limited to accounting is it?

[wiggin]

Yeah, Dread, I think it's pretty clear from the emails at Barclays that this was outright fraud. It's true that LIBOR is not always representative of actual interbank transactions because it's not a very liquid market, but the idea of LIBOR is that they're supposed to be honest estimates. The emails clearly show traders colluding with the guys making the LIBOR estimate to 'fix' the reported LIBOR estimate higher or lower than they would have otherwise. This is definitely fraudulent, especially because they were using it to bilk the market out of large amounts of money (millions of dollars for each fix, reportedly).

I think it's a much murkier question about how liable they are for civil claims - i.e. if they were not party to specific LIBOR-indexed transactions, are they still liable for the losses accrued from the fix? It's obvious that they're liable for the added profits from transactions their traders actually made, but it's much less clear they are legally liable for third-party transaction. (That being said, I think a decent case could be made in court; we'll have to see what happens in the years to come.)

[Dreadnaught]

I see the issue completely the other way around. I think proving a criminal case is probably pretty tough, but there is a lot of potential civil action.

From the criminal side-- The BBA (which calculates and publishes LIBOR) isn't a government or regulatory agency. Unless the government has laws which make employees personally liable for criminal fraud if they submit deliberately bullshit hypothetical numbers to non-profit aggregator of hypothetical banking numbers...proving criminal fraud at the personal employee level is going to be tough.

It's a semi-fake metric. And everyone's always known that, which is why the head of the Bank of England kinda-sorta nudged Barclay's to massage the numbers; because they are so damn easy to massage, it's barely considered lying. The issue isn't that LIBOR "is not always representative of actual interbank transactions" -- it's that LIBOR is not representative of transactions at all.

This is rather like the Goldman Abacus case. The transaction was terrible for Goldman's credibility and possibly totally unethical. But everyone preferred to settle, as it wasn't clear any real laws were broken. But Goldman wasn't willing to let its e-mails be leaked by prosecutors for years to come, and the government was happy to declare victory while not having to litigate something for years on end.

From the civil side, I can see plenty of avenues for litigation. BBA could sue Barclay's for manipulating them and undermining their credibility, or perhaps breaking some terms BBA and Barclay's may have had between them.

And I'm sure a few hundred trial lawyers are figuring out how they can put together a class-action of people whose mortgage rates were "too high" because Barclay's was manipulating the baseline LIBOR. Even if it's not remotely clear that Barclay's was even successful at moving the metric.

***

Getting back to the larger point of this thread -- I think the fact that there is disagreement here sorta gets at what I was saying before about how highly-regulated industries with very complex transactions can lead to this kind of opacity and massive fines.

[wiggin]

From the criminal side-- The BBA (which calculates and publishes LIBOR) isn't a government or regulatory agency. Unless the government has laws which make employees personally liable for criminal fraud if they submit deliberately bullshit hypothetical numbers to non-profit aggregator of hypothetical banking numbers...proving criminal fraud at the personal employee level is going to be tough.

It's a semi-fake metric. And everyone's always known that, which is why the head of the Bank of England kinda-sorta nudged Barclay's to massage the numbers; because they are so damn easy to massage, it's barely considered lying. The issue isn't that LIBOR "is not always representative of actual interbank transactions" -- it's that LIBOR is not representative of transactions at all.

I don't get this logic at all. It doesn't matter whether the numbers are anchored in a real average interbank market. It matters if the numbers were intentionally nudged upwards or downwards from what they would have normally reported (by whatever methodology that is) in order to make a profit. (Let's ignore the second charges of fraud stemming from the 2008 crisis when Barclays may or may not have gotten a green light from the BoE to systematically lie to make their bank look more solvent; this is much murkier wrt criminal charges.)

This is rather like the Goldman Abacus case. The transaction was terrible for Goldman's credibility and possibly totally unethical. But everyone preferred to settle, as it wasn't clear any real laws were broken. But Goldman wasn't willing to let its e-mails be leaked by prosecutors for years to come, and the government was happy to declare victory while not having to litigate something for years on end.

Completely different. The major problem in the Abacus case was errors of omission rather than commission - they failed to tell investors something (about Paulsen's hedge, essentially), rather than reporting that the CDO was rated AAA when in fact it was rated AA or whatever. If they had misrepresented the credit rating given Moody's - or colluded with Moody's to give it an artificially high credit rating - that would be much closer to the Barclay's case. In such an instance, the credit rating is again essentially a guess, although it is based on some methodology/metric. People use the rating to make financial decisions, and lying on the rating to make a profit is definitely criminal fraud.

But Goldman didn't do that in Abacus, and that's why it was a weaker case.

From the civil side, I can see plenty of avenues for litigation. BBA could sue Barclay's for manipulating them and undermining their credibility, or perhaps breaking some terms BBA and Barclay's may have had between them.

I agree that this is a valid civil suit, as are suits from people who were party to LIBOR-linked transactions with Barclays.

What I don't agree with is that the broader class-action suits vis-a-vis third-party transactions using LIBOR-linked debt will be able to get much money from Barclays. That's because Barclays didn't specifically benefit from those transactions/fraud, and I think it would be a legal precedent to make them liable for such 3rd party transactions (though IANAL). I'm sure people will try it, but I'm skeptical it will hold much water in court.

Getting back to the larger point of this thread -- I think the fact that there is disagreement here sorta gets at what I was saying before about how highly-regulated industries with very complex transactions can lead to this kind of opacity and massive fines.

How would you simplify regulation to avoid this particular problem? I don't really see this is as a fault of regulation, but of egregious and systematic fraud by a large player in the market.

[Dreadnaught]

The thing is the "methodology" is mostly fluid. It's a self-reported hypothetical borrowing rate, which is reported to a non-government, non-regulatory organization. Sure, it's a error of commission. But it's also not a misrepresentation of actual events.

I am comparing it to Abacus rather narrowly -- what I'm saying is there was a settlement because the path to criminal prosecution is not very clear-cut and litigation is costly, so everyone agreed to settle. Which begat these massive fines, which is what (I thought) this thread was about.

But if you think Barclay's was criminally fraudulent, that's fine. Correct me if I'm wrong, but it seems your position on this has hardened a bit. You started by expressing some curiosity at how the Barclay's fines were calculated/justified, but also saying you thought civil cases were a near-certainty. You seem to be shifting towards being nonplussed about the fines, but questioning civil action.

I'm not trying to play "gotcha" here, but it seems like your views on this are fluid. Which is fine, like I said, I'm not playing "gotcha". Are there other examples you have noticed where the fines/penalties seemed shocking or somehow opaque?

[wiggin]

The thing is the "methodology" is mostly fluid. It's a self-reported hypothetical borrowing rate, which is reported to a non-government, non-regulatory organization. Sure, it's a error of commission. But it's also not a misrepresentation of actual events.

I am comparing it to Abacus rather narrowly -- what I'm saying is there was a settlement because the path to criminal prosecution is not very clear-cut and litigation is costly, so everyone agreed to settle. Which begat these massive fines, which is what (I thought) this thread was about.

But if you think Barclay's was criminally fraudulent, that's fine. Correct me if I'm wrong, but it seems your position on this has hardened a bit. You started by expressing some curiosity at how the Barclay's fines were calculated/justified, but also saying you thought civil cases were a near-certainty. You seem to be shifting towards being nonplussed about the fines, but questioning civil action.

I'm not trying to play "gotcha" here, but it seems like your views on this are fluid. Which is fine, like I said, I'm not playing "gotcha". Are there other examples you have noticed where the fines/penalties seemed shocking or somehow opaque?

I don't think the methodology for LIBOR is fluid. It's an estimate, yes, but it's supposed to be an honest one. When the estimate is intentionally manipulated from an 'honest' estimate in order to make a profit, that's criminal fraud. (I don't think that it matters whether the BBA is regulatory/government or not.)

The reason I started the thread wasn't surprise at the size of the Barclays fine, but surprise at the shock by others at the size of the fine. I thought given the broad exposure from this fraud, a large fine should have been expected (especially given my knowledge of pharma/etc. settlements), so I was surprised people thought the Barclays fine was crazy huge.

What has indeed shifted is my assessment of the likely success of some civil cases. I still think Barclays (and the other as-yet unnamed banks in on the LIBOR fix) is exposed to a huge potential civil liability, but after further reading/consideration I find it unlikely that they are exposed to the entire LIBOR-linked market, but rather just those transactions to which they were party. That's still a huge liability, but nowhere near the exposure they'd have if the entire market could sue them and expect to win. That being said, I'm sure the lawsuits will still happen, they just won't necessarily succeed.


In general, I don't really understand how any of these settlement amounts are calculated; to my knowledge they're cooked up by the DoJ, and if they're palatably low enough compared to their future civil/criminal liability, a company will take the terms. Obviously the DoJ might need to provide some justification for their numbers to a judge, so I assume settlements can't be too big or too small. What I was trying to understand is what 'too big' and 'too small' really mean - i.e. what specifically are we trying to achieve with a settlement/fine? I've done some reading and haven't yet found a really satisfactory answer. I probably just need to spend some time talking to lawyers in this field to get a feel for it, I guess.

[wiggin]

I was reading this week's Economist and ran across this interesting piece on the issue from Free Exchange. It does indeed seem like fines are not currently high enough, if their assumptions are even remotely correct.

Fine and punishment
The economics of crime suggests that corporate fines should be even higher
Jul 21st 2012 | from the print edition

IT HAS been a bumper summer for corporate fines and settlements. In the past three months alone firms in Britain and America have agreed to pay out over $10 billion because of wrongdoing. But the economics of crime suggests that fines imposed by regulators may need to rise still further if they are to offset the rewards from lawbreaking.

The latest allegations of bad behaviour are a familiar brew of overcharging, mis-selling and price-fixing. Banks have been the worst offenders. Barclays was fined $450m for its part in a price-fixing scandal; others will follow. HSBC is expected to receive a hefty fine for allegedly flouting money-laundering regulations. Two pharmaceuticals firms, GlaxoSmithKline and Abbott Laboratories, have been stung for illegal marketing.

That some firms behave badly is nothing new, but the response of the authorities has changed recently. Take cartels. Internationally, fines rose by a factor of one thousand between the 1990s and 2000s. Data from America suggest this is not because there are more cartel cases, which have shown no upward trend since the late 1980s. Rather, the average level of fines has risen (see left-hand chart). Recent penalties have smashed records. The Barclays fine includes the largest ever levied by Britain’s financial regulator and America’s Commodity Futures Trading Commission, for instance. Even so, are fines high enough to work?

The economics of crime prevention starts with a depressing assumption: executives simply weigh up all their options, including the illegal ones. Given a risk-free opportunity to mis-sell a product, or form a cartel, they will grab it. Most businesspeople are not this calculating, of course, but the assumption of harsh rationality is a useful way to work out how to deter rule-breakers.

In an influential 1968 paper* on the economics of crime, Gary Becker of the University of Chicago set out a framework in which criminals weigh up the expected costs and benefits of breaking the law. The expected cost of lawless behaviour is the product of two things: the chance of being caught and the severity of the punishment if caught. This framework can be used to examine the appropriate level of fines, and to see if there are ever reasons to exempt companies from fines.


In thinking about how to set fines, it helps to start from the extremes. One option is to have no fines at all for corporate wrongdoing, and to rely instead on market forces to impose the costs that keep firms in line. The market-based approach to antitrust regulation, popularised by Aaron Director of the University of Chicago, holds that antitrust violations must be ripping someone off, whether a customer or a supplier. The same is true of mis-selling cases. In time a firm acting in this way will lose business, meaning that crime will not pay.

The problem with this view is that frictions—the costs to customers of switching, say, or the barriers to entry for competitors—can allow exploitative firms to escape punishment. Market constraints alone are not always enough to ensure good behaviour. In a 2007 paper, John Connor and Gustav Helmers of Purdue University examined 283 international cartels that operated between 1990 and 2005. The aggregate revenue increase these cartels achieved by acting as they did was over $300 billion.

At the other extreme is a system of very high fines. Indeed, Mr Becker’s crime calculus might lead to the conclusion that fines should be as draconian as possible—seizing all a wrongdoer’s assets, for example. Anything lower reduces the expected cost of criminality, without doing anything to improve the probability of detection. (Treating whistleblowers leniently is consistent with this logic: letting them off punishment raises the odds of truth-telling, and therefore of detection.) There are plenty of arguments against ultra-high fines, however. One is that false convictions carry too high a cost. Another is that fines of this sort could cripple firms, reducing competition.

A middle way might be for regulators to levy penalties that offset the benefits of crime. Data on cartels supply useful guidance on how to go about calculating these fines. The first step is to measure the expected gain from crime which fines need to offset. In the study by Messrs Connor and Helmers, the median amount that cartel members overcharged was just over 20% of revenue in affected markets. Next, you need an assumption about the chances of being found out: a detection rate of one cartel in three would mean trustbusters were doing well. In this example, that would mean a fine of 60% of revenue is needed to offset an expected benefit of 20% of revenue—far higher than the fines in the study, which were between 1.4% and 4.9%.

The calculus of crime

Assessed against this methodology, even apparently hefty fines look pretty weak. Recent big penalties (see right-hand chart) have been far lower than a crime calculus of this sort would suggest is needed, even allowing for the fact that some firms, like Barclays, get discounts for co-operating with the authorities. Britain looks particularly lenient. Its antitrust laws impose fines of up to 10% of revenues; American regulators levy penalties of up to 40%, and the European Commission goes up to 30%.

Disgruntled customers may later bring private lawsuits, which can further raise the cost of crime. Here crime economics would suggest the American “class action” system, bunching many customers’ complaints into a single lawsuit, is an asset Europe lacks. MasterCard and Visa this month agreed to a $7.3 billion settlement to resolve retailers’ lawsuits alleging collusion (which the two firms deny) over credit-card fees. Criminal charges against individuals can also focus minds. Yet litigation and criminal charges tend to take years to emerge; many wrongdoers are able to avoid court. To deter bad behaviour fines need to rise. The watchdogs are biting, but some need sharper teeth.

http://www.economist.com/node/21559315

[Dreadnaught]

"Assessed against this methodology" that fines should be crippling, yes, these fines look weak.

But seriously, this only seems to support the idea that:

1) Many of these settlements are for opaque issues where guilt is not clear-cut at all (despite what the newspapers like us to think).

2) Profit disgorgement is a standard calculus behind these kinds of fines. But clearly, either the level of fraud is much lower than the media likes us to think, or the issues are opaque enough that it's difficult to establish an actual value to the alleged wrongdoing (along with wrongdoing itself).

[Loki]

Or the politicians and regulators don't want to severely damage any firm, regardless of wrongdoing, for reasons that have little to do with the crimes committed.

[GGT]

snip

I'm curious how the responsibility for these settlements is divided between the DoJ and the relevant regulators (in this case, CFTC/FSA vs. FDA), and how they determine the settlement amount. Does anyone have insight into this process?

(Also, I would plead with posters here to use this thread as an opportunity to talk about the issues raised here and not the broader failings of either the financial or pharma industries. Both committed significant fraud and are being punished for it. Let's leave it at that, eh?)

snip

Getting back to the larger point of this thread -- I think the fact that there is disagreement here sorta gets at what I was saying before about how highly-regulated industries with very complex transactions can lead to this kind of opacity and massive fines.

Or the politicians and regulators don't want to severely damage any firm, regardless of wrongdoing, for reasons that have little to do with the crimes committed.

The financial industry has a Revolving Door that moves both ways, between regulators and legislators, bankers and financiers, private and public. Just look at their job histories and CV, with common connections between top banks and/or investment firms.

Sure, the pharmaceutical industry has policy preferences, and may want to hire a previous lawmaker (especially one who served on any health-related committee) as their lobbyist. But executives from Glaxo, or Lily or whatever, don't routinely end up heading the FDA, or being 'embedded' as internal regulators in that industry. Unlike the CFTC/FSA, SEC, Treasury or Federal Reserve...where everyone comes from within the financial industry.

[Dreadnaught]

Was going to post about the random Google/Safari fine, but couldn't avoid noting this one...

S.E.C. and Justice Dept. End Mortgage Investigations Into Goldman
BY BEN PROTESS AND AZAM AHMED
9:06 p.m. | Updated

Federal authorities ended two investigations into the actions of Goldman Sachs during the financial crisis, handing a quiet victory to the bank after years of public scrutiny.

In a rare statement late Thursday, the Justice Department said there was “not a viable basis to bring a criminal prosecution” against Goldman or its employees after a Congressional committee asked prosecutors to investigate several mortgage deals at the bank. Federal prosecutors are typically loath to acknowledge the closing of a case, doing so publicly in only a handful of instances over the last several years.

The Senate’s Permanent Subcommittee on Investigations had examined troubled mortgage securities that Goldman sold to investors, who later sustained steep losses during the crisis. The subcommittee also suggested prosecutors investigate whether the chief executive of the bank, Lloyd Blankfein, had misled lawmakers during public testimony.


Separately, Goldman Sachs announced early Thursday that the Securities and Exchange Commission had ended an investigation into a $1.3 billion subprime mortgage deal, taking no action. The move was an about-face for the commission, which notified the bank in February that it planned to pursue a civil action.

“We are pleased that this matter is behind us,” a bank spokesman said Thursday.

The moves closed a difficult chapter for the bank, whose missteps became emblematic of Wall Street’s excess. But for all the public criticism of the bank, the only law enforcement case to have surfaced against Goldman was a civil case that the bank settled for $550 million in 2010 over a mortgage investment that investigators said had been intended to collapse.

The announcements were also the latest indication that federal investigations into the financial crisis were petering out as the deadline to file cases approached. While the S.E.C. has brought more than 100 financial crisis-related cases, the agency was looking to take on a big case aimed at punishing Wall Street for its role in the crisis.

After President Obama announced the creation of a special task force in January to investigate the residential mortgage mess, the S.E.C. and other authorities vowed to hold the banks accountable. Wall Street packaged and sold subprime mortgages, including to the government-owned mortgage finance giants Fannie Mae and Freddie Mac, that suffered billions of dollars in losses.

The subcommittee, led by Senator Carl Levin of Michigan, focused on a group of mortgage deals that Goldman had arranged and sold. Mr. Levin further suggested that Mr. Blankfein might have misled lawmakers when testifying about the deals.

But in a statement on Thursday, the Justice Department said it “ultimately concluded that the burden of proof to bring a criminal case could not be met based on the law and facts as they exist at this time.” The agency said it would pursue the case again if new evidence emerged.

The S.E.C.’s inquiry into Goldman involved a package of subprime mortgages in Fremont, Calif., that the bank sold to investors in 2006. The S.E.C. was examining whether Goldman had misled investors into believing that the mortgage securities were a safe bet.

The S.E.C. in February sent the bank a so-called Wells notice, indicating that the agency ’s enforcement team planned to recommend an action against the bank. At the time, Goldman said it would fight to convince regulators that they were mistaken.

On Monday, the bank learned that it was successful. Goldman was “notified by the S.E.C. staff that the investigation into this offering has been completed,” the bank said In a quarterly filing released on Thursday Goldman said the agency’s “staff does not intend to recommend any enforcement action.”

Goldman’s Fremont deal, known as Fremont Home Loan Trust 2006-E, was one piece of a broader investigation into the mortgage-backed securities. Wells Fargo and JPMorgan Chase have also received warnings of potential action by the S.E.C.

“Mortgage products were in many ways ground zero in the financial crisis,” Robert Khuzami, the agency’s enforcement director, said at a news conference for the task force.

The agency, along with other federal regulators and the Justice Department, is also pursuing an array of other cases stemming from the financial crisis. And Goldman is not yet off the hook for its part in the Fremont deal.

Last year, the regulator overseeing Fannie and Freddie filed suits against 17 financial firms that sold the mortgage giants nearly $200 billion in mortgage-backed securities that later soured. In its action against Goldman, the Federal Housing Finance Agency cited the Fremont investment.

Still, the announcement on Thursday is welcome news for Goldman, allowing the bank to avoid another major battle with the S.E.C. over the mortgage crisis. In 2010, Goldman paid $550 million to settle accusations that it sold a mortgage investment that was intended to collapse. The bank, the S.E.C. said, failed to disclose to investors that the hedge fund manager John Paulson had helped create — and bet against — the deal.

http://dealbook.nytimes.com/2012/08/...investigation/