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European financial institutions face stiffer regulation in the aftermath of the recent scandal involving allegations that British banking institution HSBC Holdings handled accounts for tax evaders and criminals. According to Wharton accounting professor Jennifer Blouin, the HSBC case sends warning signals to the U.S. financial services industry as well. “From a U.S. perspective, my worry is … what other institutions are out there [involved in illegal activities], and what are they doing?” Twitter she asked. “Who is facilitating black market criminal activity?”
William K. Black, a professor of economics and law at the University of Missouri-Kansas City noted that “there is hope” for regulators to clean up the banking industry. He cited the concept of “Gresham’s Dynamic,” which economist and Nobel laureate George Akerloff propounded in a 1970 paper. “The concept is that when you gain a competitive advantage by cheating, then markets will become perverse and bad ethics will drive good ethics out of the marketplace,” he said. “We can block those dynamics. That’s what our function is as competent regulators. We can recreate the rule of law so that honest bankers can prevail.”
Blouin and Black discussed the likely fallout of the HSBC scandal on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
Earlier this month, the Washington, D.C.-based International Consortium of Investigative Journalists published a report that showed how the Swiss unit of HSBC helped wealthy and well-known people, including senior government officials, skirt a European Union law on withholding taxes. Essentially, HSBC stands accused of helping select customers exploit a loophole in the law, which is applicable only to individual deposits and not on corporate profits or deposits.
“From a U.S. perspective, my worry is … what other institutions are out there [involved in illegal activities], and what are they doing?”–Jennifer Blouin
Invitation to Tax Evasion
“[HSBC] became active in the creation of corporate entities for families to hide their assets,” said Blouin, explaining that the U.K. residents involved in the incident legally classified themselves as non-domiciles by ensuring that their income and assets are outside the U.K. Swiss secrecy laws and HSBC facilitated all that, she added. “That is the point at which we get concerned as to the governance of this massive financial institution.”
“In the U.K., the non-domiciliary nature of taxes is almost an invitation to tax evasion if you are wealthy and sophisticated,” said Black. “Regular people of course don’t get to do this — and this drives home further not only the actual inequality but the feeling of inequality that the typical Brit in the street feels.”
Blouin noted that the regulation of U.S. financial institutions has been relatively stronger after the 2008 financial crisis. “We have had some serious controversies come to the banking industry, but we also have to recognize that in terms of soundness, we have a pretty good system.” In any event, she advised bank customers to be better informed about the products and services they buy. Bank customers have the misconception that every financial product they buy is safe, but that is not the case, she explained.
In an earlier development in 2008, a whistleblower named Herve Falciani had stolen client account details from HSBC’s Geneva offices. He handed them over to Christine Lagarde, then France’s finance minister and currently chairperson of the International Monetary Fund, who then tipped off several governments with the information. However, after those disclosures, many governments “overwhelmingly sat on the information,” said Black. “One of the purposes of not acting, of course, is these governments are letting the statute of limitations run and [then] they can turn around and say, ‘Well, what can we do?'”
“We can recreate the rule of law so that honest bankers can prevail.”–William Black
In the U.S., Blouin added “the most disconcerting thing” was that a tax amnesty program in 2008 allowed some 3,600 individuals named for not reporting bank accounts or assets held overseas to get away by paying some of what they owed. “The tax amnesty program does not, of course, pay all the money these people owed with all the penalties,” said Black. “Sometimes, it’s close to a pittance.”
A Troubling Legacy
Black noted that HSBC has had a history of scandals involving crime. “Many of them are felonies that aid and abet a crime, and enormous numbers of them involve drug smugglers, murderers and just the most horrific things in the world,” he said. “It’s pretty much a complete death of ethics at HSBC.” He pointed to a $1.9 billion settlement HSBC reached with U.S. authorities in late 2012 for processing cash for Mexico’s Sinaloa drug cartel. At the time, HSBC said it was “profoundly sorry” and later claimed to have cleaned up its internal systems. Black said HSBC had been involved also in “massive abuses” in the U.K. for insurance products they sold individual customers and “complicated swaps” they sold small business borrowers.
“It’s pretty much a complete death of ethics at HSBC.”–William Black
Black said the disclosures also did not lead to too many prosecutions. “In the U.K., exactly one person has been prosecuted. In Switzerland, the only person they are eager to prosecute is the whistleblower. There have been virtually no prosecutions in the U.S.,” he said. Blouin added that she did not expect the U.S. authorities to now bring up the 2008 case and prosecute people. To them, “it’s water under the bridge,” she said.
Even as regulatory reforms in the U.K. will now focus on the non-domicile law, Black said it is set against the backdrop of larger banking scandals. According to him, HSBC, Standard Chartered, UBS and Credit Suisse “were not passive — they actively assisted frauds.” He noted that Standard Chartered actually had training manuals for its staff on how to remove information.
As for the U.S., both Blouin and Black felt the “back story” of the events leading up to the 2012 HSBC settlement must be made public. They also faulted the U.S. for not prosecuting HSBC at the time. “The great fault is that when you don’t prosecute, when you don’t get real admissions of facts … then you don’t have the ability to make policy decisions, or even judgments as a lay person as to what in God’s name is really happening,” said Black.