“All things considered, I think I’d rather be a poor lawyer than a rich banker. At least the legal industry has ethical rules and disciplinary sanctions. Big Bankers have nothing. Money is their Holy Grail.” Anonymous (sort of….)
In reviewing several mission statements for Big Banks, the reoccurring theme seems to be that we are “Bigger, Better, Stronger.” Noticeably absent from any discussion of core institutional values are the words “morals” and “ethics.” And where these words are [rarely] found, the bank’s own conduct belies its statements. Let’s look at some prominent displays of the moral vacuity that exist at some of the Big Banks:
Sacking Sachs! Let’s start with a look at a recent story about one of Goldman Sachs’ former employees, Greg Smith. Mr. Smith (like Howard Beale in the 1976 movie “Network”) was “mad as hell, and wasn’t going to take it anymore.” So he decided to leave his position[1] at Goldman Sachs in a very public way; he published his resignation in a New York Times editorial piece entitled “Why I Am Leaving Goldman Sachs.” Herewith are some of the reasons for his departure[2]:
On the business environment at Goldman Sachs: “…I can honestly say that the environment now is as toxic[3]and destructive as I have ever seen.”
On respecting customers: “Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” [4] sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids [5]? No humility? I mean, come on. Integrity? It is eroding.”
On the money culture: “These days, the most common question I get from junior analysts about derivatives is, “How much money did we make off the client?” It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave.”
On firm culture, leadership and moral fiber: “When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.”
CACH This! Bank of America sold credit card receivables to CACH LLC, a subsidiary of SquareTwo Financial. Some were “legacy accounts” acquired from MBNA when it was purchased by B of A in 2006. Pricing of some receivables was as low as 1.8 cents on the dollar, testifying to the dubious quality of the paper being sold. This was an “AS-IS” sale in its most insidious sense. B of A disclaimed all “reps and warranties” about the accuracy or collectability of the accounts. Problem was, that before selling the paper, B of A had made no effort to “scrub” the accounts; some had already been paid off or discharged in bankruptcy. The result is that CACH has been wreaking havoc among consumers, some owing old credit card debt, and some not. It seems to make little difference to them.
CACH’s business model is to act merely as an aggregator of toxic waste; it doesn’t do the dirty work. Instead, it hires law firms around the country to sue people for collection on its dubious accounts. And for each questionable account that is sued upon and turned into a default judgment, in Oregon at least, that judgment remains good for ten years – long enough to keep collection agencies in the harassment business for a long time. And if they get tired of chasing down debtors, they can just re-sell the paper to another debt buyer to pick up the chase.
The Karen Stevens story is a good example: She paid nearly $1,900 to retire her delinquent credit card account to B of A. Nevertheless, the account was later sold for collection and Ms. Stevens spent the next three years trying to convince her pursuers that she had, in fact, paid the entire debt off. According to an American Banker article, “Neither a cancelled check or creditor’s letter stating that she’d fulfilled her obligations deterred the collectors.”
And reminiscent of the “robo-signing” scandals of the past years, when debtors contest the lawsuits, they are often confronted with company-generated “affidavits” swearing to the accuracy of the bank’s records. According to the American Banker article:
“In the case involving CACH in Duval County, Florida, a person described as B of A “Bank Officer” Michelle Samse swore in an affidavit that “There is due and payable from WENDY CODY as of 9/18/2009 the sum of $12266.83.” The Samse affidavit, typical of many others, went on to say “The statements made in this affidavit are based on the computerized and hard copy books and records of Bank of America, which are maintained in the ordinary course of business.” Attempts to contact Samse and Cody through Bank of America switchboards and public records searches were unsuccessful.”
Is this just a B of A problem? No! It appears to be standard industry practice. In 2008, JPMorgan Chase’s agreement to sell $200 million in credit card debt to Palisade Collection contained this dubious warranty/disclaimer: “Seller represents and warrants that documentation is available for no less than 50% of the Charged-off Accounts”. [For a related article about JPMorgan Chase’s dubious credit card business, go to the American Banker link here, about a recent whistle-blower lawsuit by former employee, Linda Almonte. – PCQ] In an apparent acknowledgment of the reputational damage it was suffering from the sale of its dubious credit card debt, JPMorgan Chase has quietly stopped its credit card collection lawsuits. [See American Banker article, here. – PCQ]
However, the sad fact is that the business of bad debt is an integral part of most Big Banks’ business model; they routinely enter into what are known as “Forward Flow Agreements” agreeing with debt buyers that over a certain period of time they will sell them old credit card accounts for pennies on the dollar.
Now who is most culpable in creating a business model that is patterned after nature’s carrion eaters? The debt seller or debt buyer? Obviously both. But remember how this started; the Big Banks issued their credit cards en masse to almost anyone who could fog a mirror. If and when these accounts went bad, the banks went into action. Forgetting that these folks were once their “valued customers”, they bundled the paper into a grab bag, and sold it to their peers farther down the food chain.
“Well, Well, Wells” Wells Fargo was in the news recently. This case involved force placed insurance, i.e. the insurance that Big Banks love to place on a defaulting borrowers’ homes, just to make sure that if there was ever a chance of curing the default, imposing a huge premium for force placed insurance will keep it from happening. The reason is that force placed insurance is far more expensive than the usual fire/casualty insurance homeowners normally pay. Well, now the screw is turning, and Wells may be getting the point.
In a closely watched case in Florida, entitled Williams, et. seq. v. Wells Fargo Bank N.A., et. al., a consumer lawsuit over force placed insurance was recently certified to move forward as a class action. For extensive discussion on the case and the dirty little secret of force placed insurance, see the excellent American Banker articles here and here. The gist of the problem is that the inflated premiums are not determined on any risk-based analysis, but rather by the number of pigs players at the trough, waiting to gobble up their share of the overpriced premium. Quoting an American Banker article on the Wells lawsuit:
“QBE [Wells’ affiliated force placed insurance company] pays out 40% of total force-placed premiums as commission to its subsidiaries and Wells Fargo, the Florida plaintiffs charge. And only 7.6 cents of every dollar of premium revenue QBE collects goes to paying claims, according to a plaintiffs’ analysis based on QBE data. Such a low payout ratio would be regarded as unacceptable in most states. Guidelines laid out by the National Association of Insurance Commissioners instruct insurers to aim for a payout of 60%.“
***
“Attorneys for the plaintiffs also attacked how QBE sets its rates. Camley Delach served as QBE’s lone actuary for force-place policies written on behalf of Wells Fargo in Florida, according to a deposition discussed at the class certification hearing. It was her job to gauge the financial risks the underwriter faced. But Delach said in a deposition that she works from her Pennsylvania home, performs no actuarial work to determine QBE’s prices, and has “no idea” why QBE prices its policies the way it does.” [Emphasis mine. – PCQ]
***
“Emails *** suggest that Wells employees themselves were uncomfortable with the high premiums QBE was charging Wells’ borrowers. Following an American Banker article alleging that force-placed insurers were charging as much as 10 times the cost of borrowers’ previous hazard insurance, an unnamed Wells executive allegedly told colleagues that the bank needed to rein QBE in.”
There is a saying: “If you can win on the law, argue the law. If you can win on the facts, argue the facts. If you can’t win on either the facts or the law, pound the table!” Wells not only pounded the table in the Williams case [arguing that the plaintiff’s attorneys had engaged in unethical conduct for “going public” with their claims – PCQ] but they also allegedly threatened some of the plaintiffs, which the Court did not take lightly in its written opinion granting class action status:
“The third category *** involves proposed class members who are in default on their mortgage loans. As argued by Wells Fargo, these individuals will not want to press the issue of whether the premiums they pay for force-placed insurance are excessive when to do so will subject them to foreclosure counterclaims on their mortgages – in other words, Wells Fargo will immediately initiate foreclosure proceedings on any homeowner in default if they choose to exercise their rights through this class action.
Wells Fargo has unabashedly set out its threats to retaliate against any homeowner seeking to avoid the alleged excessive and inflated force-placed insurance premiums through this litigation. Wells Fargo will not be permitted to create a conflict of interest, where none would otherwise exist, by establishing post-litigation, vindictive business practices. While it is unclear as to whether those homeowners would have a separate cause of action for the retaliatory actions of Wells Fargo, they will at least be permitted to proceed in this class action.”
“Trust Account? We Don’t Need No Stinkin’ Trust Account!” This piece isn’t exactly about Big Banks. It’s about MF Global which is a now bankrupt global financial derivatives broker.[6] But MF Global’s CEO, John Corzine, was a former Goldman Sachs CEO[proving that the apple doesn’t fall far from the tree], so there is a connection to the Big Banks and the business ethics of the leaders who run them. On October 31, 2011, MF Global filed for bankruptcy. It was the eighth largest in U.S. history.
To fully understand how this happened, we have to understand the regulatory climate [or lack thereof – PCQ] that exists in this country. Regulation 1.25 of the Commodity Futures Trading Commission (“CFTC”) initially allowed futures brokers, like MF Global, to use money from their customers’ accounts to invest in certain approved, safe, highly liquid securities, such as U.S. Treasuries. However, at the request of MF Global and others, this Regulation was changed over the years (2000, 2004 and 2005) to allow firms to pledge their clients’ funds as security, as long as they were used for the purchase of “investment grade sovereign debt.” [From my more simplistic view of things, this sounds like purchasing stock on a margin account – except that the margin account was their customers’ money – not their own! – PCQ] Compliments of the “ever-vigilant” ratings shillsagencies, higher yielding distressed debt, “…such as Spain (AA) and Italy’s (A), were still listed as investment grade, according to columnist Barry Ritholtz in his Washington Post article, “The systemic risk revealed by MF Global’s collapse”.
By 2011, Mr. Corzine’s bet on the European sovereign debt was up to $11.5 Billion, at a reportedly leveraged ratio of 30:1 – but it was going south. In short, he apparently couldn’t meet the margin calls.
By August and September 2011, MF Global’s shares had fallen over 40% amid concerns about European financial instability. MF’s customers began pulling billions of dollars out of their accounts. On October 31, 2011 the company filed for bankruptcy protection. However, according to an article in the Huffington Post:
“On the morning of Oct. 28, three days before the bankruptcy filing, JPMorgan contacted MF Global about an overdraft in London. A Congressional memo circulated March 23, 2012, quoted an email from Vinay Mahajan, MF Global’s global treasurer. Vinay wrote JPMorgan was “holding up vital business in the U.S.” and called for funding “A.S.A.P.” Bloomberg News reported that on October 28, Edith O’Brien, an assistant treasurer for New York-based MF Global, wrote an email saying that a $200 million transfer of funds was “Per JC’s direct instructions.” It turns out that part of that money was customer money, and the transfer was impermissible. (“MF Global’s Corzine Ordered Funds Moved to JPMorgan, Memo Says,” by Phil Mattingly and Silla Brush, Bloomberg News, March 23, 2012.)”
JPMorgan officials, who probably feared later clawback lawsuits (Think: Bernie Madoff’s fraud) if MF Global failed, sought written assurances from Mr. Corzine that all “past, present and future” transfers complied with the law. Mr. Corzine invited them to “Send me the letter and we’ll have our people look at it.” Then he passed the written statement along to Edith O’Brien, the company’s assistant treasurer, to sign. She [wisely] refused.
Hmmm. Clients’ money being used as security to make bets at leveraged ratios of 30:1? And according to CFTC Reg. 125 that’s OK? Writing checks from customers’ money for $200 Million to cover a bounced check? How does that happen – regardless of whether it was authorized by the top brass or not? As we now know, far more than $200 Million is missing from MF Global’s customers’ accounts. The figure is closer to $1.6 Billion. ‘Well, By Golly, let’s hold some congressional hearings! We’re bound to learn the truth after a few preening U.S. Senators ask piercing questions ghost written for them by anonymous staffers.’
What’s wrong with this picture? How is it that an entire industry has no apparent regulation against using its customers’ funds to make billion dollar highly leveraged proprietary bets? How is it that a company’s funds can be commingled with client funds in the first place? To a lawyer, even the inadvertent act of “commingling” funds – even if it does not result in any loss to the client – can constitute a violation of state bar disciplinary rules. Not so in the financial services industry. This is what I mean when I speak of “ethical vacuity.” It’s like deep space….
Simple Math. Assume that you have $100 in your checking account, and that today you’ve used your debit card four times for the following sums in the following sequence: $10, $10, 10, and $110. Assume that you signed up for “overdraft protection” with your bank, so you figured you’d be OK. You might be surprised to learn that the “overdraft protection” is not protection from the OD charge itself, but from the embarrassment of having your debit transaction denied, say, as you’re picking up the tab for dinner with your newest Match.com date.
“OK,” you say to yourself, “I’ll take the hit – it was a great evening.” But the next day, when you check your account you learn that instead of having one OD charge, you have four. “How can this be?” you ask. It wasn’t the first three charges that overdrew me, it was the last one.”
The answer lies in some basic facts:
- Bank overdraft fees are big business;
- Banks learned years ago that they could make their OD business bigger if they simply changed the sorting order of their customers’ debit card transactions;
- So instead of debiting accounts based upon when the charge occurred, they debited them based upon amount of the charge – from the highest to the lowest;
- This little trick is called “Sort Order Optimization” and most of the Big Banks have – or will – pay dearly for it.
It was just reported that JPMorgan Chase agreed to pay $110 Million for its overdraft trickery.
Wells Fargo, experienced the ignominy of having some of its internal memos made public as a result of class action litigation over Sort Order Optimization. In a 2010 ProPublica article, we learned the following:
“We are currently analyzing the change in frequency of overdrafts,” Wells Fargo Executive Vice President Ken Zimmerman wrote in an April 2005 e-mail. The cause for concern at the time? An unexplained decline in revenue from overdrafts.”
***
“Given our dependence on a small set of OD consumers (4% generate 40% of total OD/NSF revenue),” Zimmerman wrote, “a small change in behavior within this group can cause a large change in revenue.”
***
“In a 90-page ruling against Wells Fargo, he [U.S. District Judge William Alsip] said the bank had acted in bad faith and that its “true motives” for re-engineering its processing of transactions were “gouging and profiteering.” The ruling came down on August 10—the same day Wells Fargo told investors that the Fed’s new rules on overdrafts would cost the company $500 million in fee revenue.”
But Wells Fargo is not alone. According to a January 20, 2012 American Banker article, “Bank of the West is on the brink of settling a lawsuit targeting its overdraft fee practices, making it the tenth bank to buy its way out of a massive Florida class action case.”
***
“The defendants in the [Florida class action] case have generally not fared well. Bank of America was the first to settle, agreeing to a $410 million settlement last year that accounted for slightly under 10% of the overdraft fees it is alleged to have wrongfully charged. Subsequent settlements have recovered a higher portion of alleged damages. For example, the $83.5 billion asset Union Bank has agreed to a $35 million settlement, roughly 40% of alleged damages.”
Union Bank of California, a unit of Mitsubishi UFJ Financial Group, has similarly experienced the unpleasantness of public disclosure of its internal emails discussing the pros and cons of high-to-low debit transaction processing. On September 26, 2011, American Banker reported the following:
“Bank documents turned over to plaintiff attorneys during discovery indicate Union Bank agreed that CAST would receive 20% of any extra overdraft charges generated under its high-to-low system. Union Bank employees also discussed how to hide the bank’s policy from customers, even as it was costing them tens of millions of dollars, internal emails show.”
***
“By design, the details of what happens inside the bank when an overdraft occurs were never intended to be communicated to the public,” a Union Bank employee wrote to a colleague in an email cited in the suit.”
***
“CAST [the company processing vendor] seems to believe it had seven-figure opportunities and given we are drifting way behind budget I’d like to see if this was ever implemented,” [chief marketing officer Greta] Ryan said in a May 21, 2003 email. In a followup (sic) email a month later, she acknowleged (sic) her colleagues’ distaste for high to low but advocated moving forward anyway. “We are not taking any of these concerns lightly but obviously with $1.0mm a month at stake we want to try to work them through to … let the risks be weighted (sic) against the rewards,” Ryan wrote in an email to colleagues that is disclosed in the Florida class action.” [Underscore mine. – PCQ]
_________________________________________
So in a genuine effort to assist Big Banks [and other members in the financial services industry] in developing a moral and ethical fabric, I’ve set forth the following three Ethical Rules, with more to come later, once we’ve made progress with these. And guys, don’t expect success the first time around. It will take time, patience, and practice. Remember, just baby steps at first….
ETHICAL RULE NO. 1
“Use kindness as a business strategy.”[7]
ETHICAL RULE NO. 2
“Let your conscience be your guide.”[8]
ETHICAL RULE NO. 3
“Do unto others as you would have them do unto you.”[9]
[1] He was an executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa.
[2] It is important to note that Mr. Smith expressly stated that he did not ever see anything “illegal” going on.
[3] For a hilarious depiction of just how “toxic,” go to the Huffington Post link here, and view the NMA.tv animated version of the Greg Smith story.
[4] For the “muppets,” go to the Huffington Post link here.
[5] For the “vampire squids,” go to the Huffington Post link here.
[6] I have no idea what this means. According to Wikipedia, “MF Global provided exchange-traded derivatives, such as futures and options as well as over-the-counter products such as contracts for difference (“CFDs”), foreign exchangeand spread betting. MF Global was also a primary dealer in United States Treasury securities.”
[7]Jeffrey F. Rayport Operating Partner at Castanea Partners, in a Harvard Business Review article well worth reading here.
[8]Jiminy Cricket, Pinnochio, 1940.
[9] The Golden Rule, Mathew 7:12 and virtually every other major religion in the world!
