Wednesday’s news that the parent organizations of five of the world’s biggest banks will plead guilty to rigging global currency markets rattled the financial markets. But it also raised concerns about whether fines and settlements are effective deterrents to fraudulent behavior.

The five banks will pay the U.S. Justice Department and the Federal Reserve fines totaling $5.6 billion as they agreed to plead guilty to colluding to manipulate currency and interest rate markets. Yet, they could continue to do business as usual, thanks to settlement terms and waivers against stiffer actions from the Justice Department and the Securities and Exchange Commission (SEC). “For the banks, though, life as a felon is likely to carry more symbolic shame than practical problems,” a New York Times article noted, explaining that the banks secured exemptions, waivers and settlements from regulators to conduct business usual.

“People sometimes misunderstand how the law deters,” said Philip Nichols, Wharton professor of legal studies and business ethics. “In this case, the amounts that the banks were fined are trivial. The total fines, imposed for many years of criminal acts, represent one tenth of a percent of the daily volume of the forex market.”

“The senior bankers have obviously decided that it is in their financial interest to repeatedly violate the law,” said William K. Black, professor of law and economics at the University of Missouri-Kansas City and former executive director of the Institute for Fraud Prevention in Morgantown, West Virginia. He noted that at UBS, the latest case is the third act of rigging it has confessed to in the last five years. “The only thing that could save UBS is to have a crackdown by somebody external that gets rid of this assorted group of managers.”

The day before the guilty plea announcement, Black shared his thoughts on the bid-rigging cartel on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Plot Details

The investigations revealed that between 2007 and 2013, four banks or “The Cartel” — Citigroup, JPMorgan Chase, Barclays and Royal Bank of Scotland – colluded to rig euro and dollar markets. UBS, the fifth bank, was accused of manipulating foreign currency markets. Although no original charges were bought down on UBS under that accusation, it drove the Justice Department to withdraw an earlier non-prosecution agreement relating to UBS rigging the London Interbank Offered Rate (Libor) market.

“You are talking about hundreds of trillions of dollars of transactions that were affected by this bid rigging cartel.” –William K. Black

Here is a snapshot of what the four banks detailed in their plea agreements, according to a U.S. Justice Department press release: “Members of ‘The Cartel’ manipulated the euro-dollar exchange rate by agreeing to withhold bids or offers for euros or dollars to avoid moving the exchange rate in a direction adverse to open positions held by co-conspirators. By agreeing not to buy or sell at certain times, the traders protected each other’s trading positions by withholding supply of or demand for currency and suppressing competition in the FX market.”

According to Black, the foreign exchange and Libor bid-rigging cases individually are the largest cartels by three orders of magnitude in world financial history. “You are talking about hundreds of trillions of dollars of transactions that were affected by this bid rigging cartel,” he said.

Here is how the fines add up to $5.6 billion: The banks will pay $2.5 billion in criminal penalties for manipulating currency rates, plus another $1.6 billion in fines payable to the Federal Reserve. The remainder will come from penalties of $1.3 billion that Barclays will pay U.S. and British regulators and $203 million that UBS will pay for manipulating interest rates.

‘Extraordinary’ Temptation

The whiff of big money is a factor to think about for regulators, said Nichols. He noted that the amount of money that moves through the foreign exchange market in one day is almost twice the value of the economic output of the U.K. in one year. “The temptation to dip into that money must be extraordinary,” he said. “We should not regulate banks in the same way that we regulate manufacturing; the extraordinary temptations for misconduct must be recognized.

“What the law does in this case is strongly signal that this behavior is not at all acceptable,” Nichols added. “Often, that kind of a signal is accompanied by enough social disapprobation to effect a change in behavior.”

Here, Black faulted the practice of U.S. regulators protecting bankers from winding up in jail. Errant banks facing imminent action “negotiate in advance that a guilty plea will not be what a guilty plea would normally be,” he pointed out. The right to pursue a banking business is “a privilege,” he noted. “It is a privilege that is supposed to be limited to honest bankers.”

According to Nichols, banks that want special treatment “because they provide an invaluable public service” must staff themselves with people who will actually provide that service. “If banks want special treatment, then hold them to special standards,” he said. “If they do not want to be held to higher standards, then perhaps they should be treated like everyone else.”

Black felt that stronger action was warranted in the case of UBS. “[UBS] most assuredly should have long ago been banned for some years from doing banking in the U.S.,” he noted. Regulators should also have insisted that UBS clean up its top management and ensure it will not create further violations, he added.

Black took issue also with banks securing waivers against stern action. “The rule with large banks is that the SEC always waives – it doesn’t matter how bad [the violations are],” he said. “This is a serial recidivism.” He noted that one SEC commissioner is working to prevent routine waivers that the SEC grants.

“The senior bankers have obviously decided that it is in their financial interest to repeatedly violate the law.” –William K. Black

Receivership and Other Options

Black suggested one remedy would be “putting a fraudulently controlled bank through receivership,” or placing it under the control of a custodial entity. “Do it on a Friday and it reopens on Monday. It is in private-sector hands, but you have cleaned the sty of the fraudulent managers.” He noted that the industry has an adequate supply of honest bank managers who are unemployed because of the consolidation in the industry.

Nichols found some merit in the suggestion of putting errant banks in receivership. “It obviates the claim sometimes made by banks that they have to continue operating because only they can keep economic transactions moving,” he said. “It also resolves the tension between the claim that banks provide a public good in the form of providing liquid capital — which they do — and the claim that banks must serve their shareholders.”

However, receivership should probably be an option only for banks that seem irredeemable, and it might make more sense for most banks to just create a better internal culture, Nichols noted. Another remedy worth considering is to break up “repeatedly malfeasant banks” into smaller units and holding individuals accountable for poor decisions and for misconduct, he added.

“Banking is an industry that cries out for a competitor that can offer honest services,” said Nichols, adding that market forces cannot be a substitute for regulation and monitoring. “The emails coming out of some of these banks are ghastly – they describe clients in the most demeaning terms and talk openly about how wonderful it is to steal from them and to defraud them,” he noted. “If you ain’t cheating, you ain’t trying,” one trader at Barclays wrote in an online chat room where prosecutors say the price-fixing scheme was hatched, according to the New York Times report cited earlier.

Nichols compared banking regulations with the Foreign Corrupt Practices Act, pointing out that unlike with bribers, bankers do not face the risk of imprisonment. “Since 2008, virtually no individual associated with bank misbehavior has faced prosecution,” he said. He argued that if — as prosecutors sometimes claim — the laws are difficult to enforce as written, then changing those laws might help.

“The material rewards for violating the rules and the trust of clients are huge, while the risk is almost nonexistent,” Nichols noted. “While the fines imposed on banks are trivial … sending people to jail might change the way that people in positions to make decisions make those decisions.” He clarified that some banks have recently fired people that engage in misfeasance, “but those persons have rarely suffered financially.”

“The material rewards for violating the rules and the trust of clients are huge, while the risk is almost nonexistent.” –Philip Nichols

Change the Culture

“The real problem … is the culture inside the banks,” according to Nichols. “Somehow, within these venerated banks it has become a matter of pride among some people to cheat clients, to break rules and to lie, and money is the scorecard by which this behavior is measured.”

Black recalled the saying: “Fish rot from the head.” He noted that a bank’s CEO and chairman of the board create the strategic plan and the compensation system. “The reason you see recurrent fraud is because they created compensation systems that make people wealthy if they cheat,” he said.

Nichols cited a recent New York Times article to assert that the banks’ culture has not changed since the financial collapse of 2008. “We seem to be very skittish about doing anything that might cause a little pain to our economy today, but our forbearance risks calamity in the future,” he noted. “Something needs to be done about the culture.

“Although banks are the least trusted institutions in the United States, most people who work in banks are good and honest people,” he added. “It seems that a minority of people within banks contribute to the poor culture.”

Nichols warned of dire consequences if banks do not clean up their act soon. “I completely understand why banks want a world without fences, but it is not in anyone’s interest — including the banks — to have another failure,” he said. “If the next failure comes too soon, instead of bailouts there might be pitchforks and torches.”