Prosecutors, Shifting Strategy, Build New Wall Street Cases
Criticized for letting Wall Street off the hook after the financial crisis, the Justice Department is building a new model for prosecuting big banks.
In a recent round of actions that shook the financial industry, the government pushed for guilty pleas, rather than just the usual fines and reforms. Prosecutors now aim to apply the approach broadly to financial fraud cases, according to officials involved in the investigations.
Lawyers for several big banks, who spoke on the condition of anonymity, said they were already adjusting their defenses and urging banks to fire employees suspected of wrongdoing in the hope of appeasing authorities.
But critics question whether the new strategy amounts to a symbolic reprimand rather than a sweeping rebuke. So far, the Justice Department has extracted guilty pleas only from remote subsidiaries of big foreign banks, a move that has inflicted reputational damage but little else.
The new strategy first materialized in recent settlements with UBS and the Royal Bank of Scotland, which were accused of manipulating interest rates to bolster profit. As part of a broader deal, the banks' Japanese subsidiaries pleaded guilty to felony wire fraud.
The settlements present a significant shift. Authorities have long avoided guilty pleas over fears they will destroy the banks and imperil the broader economy. By going after a subsidiary, prosecutors shield the parent company from losing its license, but still send a warning to the financial industry.
The Justice Department plans to continue the campaign as it pursues guilty pleas from other bank subsidiaries suspected of reporting false interest rates, according to the prosecutors and the lawyers who requested anonymity to discuss the cases. Authorities are scrutinizing Citigroup, whose Japanese unit is suspected of rate manipulation, and prosecutors recently accused one former trader there of colluding with other banks in a vast rate-rigging conspiracy.
Prosecutors want the rate-rigging investigation to serve as a template for other financial fraud cases. Two officials, who spoke on condition of anonymity, described a plan to eventually wring an admission of guilt from an entire bank.
"This Department of Justice will continue to hold financial institutions that break the law criminally responsible," Lanny A. Breuer, the departing head of the agency's criminal division, said in an interview.
The strategy will face significant roadblocks.
For one, banking regulators are likely to sound alarms about the economy. HSBC avoided charges in a money laundering case last year after concerns arose that an indictment could put the bank out of business. In the first interest rate-rigging case, prosecutors briefly considered criminal charges against an arm of Barclays, but they hesitated given the bank's cooperation and its importance to the financial system, two people close to the case said.
The Justice Department will also face resistance from Wall Street. In meetings with authorities, banks are trying to distinguish their activities from the bad behavior at UBS and Barclays, according to the industry lawyers. One lawyer who represents Deutsche Bank acknowledged that Wall Street was girding for battle over the push for guilty pleas.
Some lawyers posit that the new approach amounts to a government shakedown, because institutions may plead guilty to dodge an indictment. "I think it's a step in the wrong direction," said James R. Copland, the director of the Center for Legal Policy at the Manhattan Institute.
Complicating matters, lawmakers and consumer advocates will continue to complain that banks get off too easily. In the rate manipulation cases, critics have clamored for more potent penalties, seeking convictions against parent companies.
The problems "should provide motivation to prosecutors, regulators and Congress to do more to ensure that this type of behavior is stopped, and that banks and their executives who manipulate markets are held accountable," said Senator Carl Levin, Democrat of Michigan.
Critics point to the UBS case. Before UBS signed the deal, Japanese authorities assured the bank that a guilty plea would not cost the subsidiary its license, a person involved in the case said. While the case has weighed on the stock price, the subsidiary is operating normally and clients have stayed put, according to people with direct knowledge of the case.
Prosecutors defend their effort, saying it was born from painful experiences over the last decade.
After Arthur Andersen was convicted in 2002, the accounting firm went out of business, taking 28,000 jobs with it. The Supreme Court later overturned the case, prompting the government to alter its approach.
Prosecutors then turned to deferred-prosecution agreements, which suspend charges against corporations in exchange for certain concessions and a promise to behave. But the Justice Department took heat for prosecuting few top bank executives after the financial crisis. A recent "Frontline" documentary portrayed prosecutors as Wall Street apologists.
So the government is seeking a balanced approach, aiming to hold banks accountable without shutting them down. Prosecutors consulted federal policies that required them to weigh action with "collateral consequences" like job losses. Mr. Breuer also collected input from staff, including the head of his fraud unit, Denis J. McInerney, a former defense lawyer who represented Arthur Andersen.
Mr. Breuer eventually deployed a strategy built on guilty pleas for subsidiaries. He imported the model, in part, from his foreign bribery actions and pharmaceutical cases.
"Extracting a guilty plea from a wholly owned subsidiary finally enables the Justice Department to look tough on financial institutions while sparing them from the corporate death penalty," said Evan T. Barr, a former federal prosecutor who now defends white-collar cases as a partner at Steptoe & Johnson.
As the Arthur Andersen cases fades from memory, some prosecutors say their new approach will lay the groundwork for parent companies to plead guilty.
But first, officials say, they are testing the strategy in the interest rate-rigging case. Authorities suspect that more than a dozen banks falsified reports to influence benchmark interest rates like the London interbank offered rate, or Libor, which underpins the costs for trillions of dollars in financial products like mortgages and credit cards.
Prosecutors focused on Japanese units because e-mail traffic exposed how traders there had routinely manipulated rates to increase profits, officials say. The units also have few ties to American arms of the banks, containing any threat to the economy.
After the Barclays case, authorities shifted to UBS, given the scope of the evidence and the bank's past brushes with authorities, according to officials. The bank's Japanese subsidiary was also a hub of rate-rigging activity. "The Justice Department had a clear view on the past of this institution," said one executive who met with government officials.
Along with paying $1.5 billion in fines, the bank agreed to bolster its controls and have its Japanese unit plead guilty. It was the first big global bank subsidiary to plead guilty in more than two decades.
The Royal Bank of Scotland met a similar fate. The bank's conduct was less severe than the actions of UBS, but it too had a rogue Japanese subsidiary. The bank announced a $612 million settlement with authorities this month, including a guilty plea in Japan.
Using the settlements as a template, prosecutors are building cases against other banks ensnared in the investigation, people involved in the case said, and guilty pleas are likely. Deutsche Bank is expected to settle with authorities by late 2013, the people said.
American regulators may warn that extending the campaign to Citigroup would threaten the company's stock and prompt an exodus of clients. Japan's regulators, some feeling upstaged by the recent actions, might raise similar concerns. Citigroup's lawyers will also push back, people involved in the case said, citing the bank's cooperation with investigators and emphasizing that wrongdoing never reached upper levels of management. The bank fired the trader recently charged by the Justice Department.
Authorities could counter that Citigroup's Japanese unit is a repeat offender. It butted heads with Japanese regulators three times over the last decade.
"This is hard-nosed negotiation," said Samuel W. Buell, a former prosecutor who is now a professor at Duke Law School. "It's a game of chicken."
—Mark Scott contributed reporting from London and Hiroko Tabuchi from Tokyo.