Organised irresponsibility? How lawyers can make it worse

This morning the too big to manage arguments about HSBC again hitting the newspapers. Robert Jenkins, a former banker and member of the Bank of England’s Financial Policy Committee and now a senior fellow at the Better Markets lobby group has called on the Chairman of HSBC to resign in the FT.  The too big to manage argument always strikes me as a bit of an odd one.  If there is a problem in a sub-part of an organisation, selling off that sub-part will not make it better managed, it will just distance the parent from the problem. And if the parent cannot manage its sub-parts, it is not immediately obvious why getting rid of one bit of it will help.  True, it may reduce the load, so a board required to scrutinise (say) 23 sub-parts only has to scrutinise (say) 22 next time – but the more pressing issue is the quality of risk, compliance and audit functions.  The responsibility and integrity of those have to be right at every level of the organisation.  Without that the divisions of labour inherent in corporate life operate, deliberately or accidentally, as a form of organised irresponsibility.

Lawyer’s role in these processes can sometimes be acute and they sometimes contribute to organisational irresponsibility.  The way General Motors dealt with claims related to their faulty ignitions may be a case in point.  Standard Chartered Bank is an example where the role of the lawyers deserves some scrutiny.  The following account is gleaned from the Order of the US regulator/prosecutor that investigated the matter.  In that case SCB want to take Iranian Transactions and process them quickly into dollars.  US sanctions law was a problem but they formed the view that the transactions were not banned if they qualified as U-turn transactions.  As I understand it, US law required due diligence on such transactions be done in the US.  SCB did not want to do that because it slowed things down.  Why due diligence in the US would be slower than due diligence outside the US is not immediately obvious.  They formed a plan to do due diligence outside US and then strip the transactions of Iranian identifiers. Internal lawyers advised on ‘enforcement proofing’ this approach.  The Prosecutor’s Order put it like this:

As early as 1995, soon after President Clinton issued two Executive Orders announcing U.S. economic sanctions against Iran, SCB’s General Counsel embraced a  framework for regulatory evasion. He strategized with SCB’s regulatory compliance staff by advising that “if SCB London were to ignore OFACs regulations AND SCB NY were not involved in any way & (2) had no knowledge of SCB Londons [sic] activities & (3) could not be said to be in a position to control SCB London, then IF OFAC discovered SCBLondons [sic] breach, there is nothing they could do against SCB London, or more importantly against SCBNY.” He also instructed that a memorandum containing this plan was “highly confidential & MUST NOT be sent to the US.”10 (emphasis in original)

Part of the plan included advising that they get another (competitor) bank to clear the funds into the US.  The Order quotes:

Email from SCB’s General Counsel to SCB’s Group Compliance Manager dated June 1, 1995, SCB- 00038523 (emphasis in original). SCB’s General Counsel added that “when dealing with OFAC countries that are not on the UK’s list SCB London should use another US Dollar clearer in NY. It should not in any event use SCB NY.” In fairly mercenary terms, he recommended that “SCB should use eg [National Westminister Bank] who in processing the transactions would breach OFAC regulations & would expose themselves to a penalty.”

SCB staff outside of the US were told explicitly not to let SCB in the USA know of the plan: if they were aware of the plan or the fact that any of the transactions came from Iran, then SCB in New York could be enforced against.  SCB’s head of Legal and Compliance Wholesale Bank, UK/Europe, commented to other legal and compliance staff by email that the document, “read in isolation, is clearly . . . designed to hide, deliberately, the Iranian connection of payments.”  The Bank also got advice from outside counsel who advised that the scheme “did not comport with the law or spirit of the law”.

So much so very interesting.  Perhaps there was a legitimate and tenable difference of view about the legality of the scheme, but in the context of the debate about oversight at HSBC, whilst teaching the SCB case to my students this week I noticed this very interesting passage in the Prosecutor’s Order.

A 2006 memorandum from SCB’s General Counsel advising SCB’s Audit and Risk Committee that “certain US$ clearing transactions handled in London were processed with the name of the Iranian Bank excluded or removed from the ‘remitter field’” despite the “requirement that due diligence in respect of ‘U-turn’ payments should be undertaken by our office in New York.” SCB’s chief legal counsel strategized, much as he had in 1995, that “it is reasonable to undertake due diligence on behalf of New York outside the US” even though “we are potentially placing our SCB New York office and the Bank at risk if our due diligence procedures are not fully effective.”

The presentation of the wire-stripping strategy  states the legal requirement.  In this sense the risk committee are seized of the risk, yet the legal requirement (which outside counsel is clear is violated) is reshaped as a question of reasonableness and a question about the quality of the due diligence process.  The point being made may be that it is unlawful, but reasonable, to do due diligence outside the US and we may not get into trouble because our (non compliant) due diligence system is good.  It is like a magicians trick, diverting attention from the relevant to the irrelevant.  Arguments are being reshaped as facts and those facts are of questionable relevance to the legal risk in question.  The lawyers may have begun to believe their own hype or the work of organised irresponsibility may have been forgotten in the time from strategy formulation to review all those years later.

Whether I am right in that analysis or not there is a further uncomfortable fact for all those involved in design, approval and maintenance of SCB wire-stripping .  There were doubts about the extent to which the transactions being cleared in this way were in fact U-turn transactions – due diligence (no matter where it was conducted) could not solve the problems of all these transactions:

An executive SCB compliance attorney made the point more sharply, observing that SCB’s London staff believed “that any payment that could conceivably give rise to an OFAC problem should always be dealt with [in a way to avoid detection].”

The prosecutor was even blunter in his assessment:

Consistent with its historical views, SCB apparently decided that regulatory compliance would impede any such business expansion. Summarizing the bank’s linchpin consideration, SCB’s chief legal and compliance officer for its wholesale banking business explained that SCB wire stripped because “there would be a delay in the OFAC que [sic] if an Iranian name was spotted by the OFAC filter in New York and the payment would get held up.” Any such delay, he concluded, would be “a deal-breaker” in SCB’s efforts to develop new business.

To avoid such deal-breakers, SCB instituted a system of so-called “offshore OFAC due diligence.” The entire concept was a sham. Any off-shore substitute for OFAC compliance would have necessarily caused the exact delay threatened by OFAC compliance at the New York branch. Under the law governing at the time, any legitimate due diligence was premised on investigative delay. SCB undertook its off shore due diligence program, however, specifically to escape OFAC’s watchful eye, not to be examined by it.

SCB’s overseas due diligence staff members were responsible for both SCB’s UTurn “repair procedures” and OFAC “compliance” – a paradoxical task to say the least. These staff members did not know the elements of a lawful U-Turn transaction other than that the payment “had to be offshore to offshore,” and they were not trained to determine whether the underlying transactions were valid according to the Iranian Trade Regulations.

In fact, as late as August, 2006, SCB’s operations staff still “resolve[d] ‘hits’ on sanctioned names directly with the customer” – a method ill-designed to detect client misconduct. (emphasis added).

Yet senior SCB management knowingly embraced the bank’s fraudulent U-Turn procedures.

Of course we cannot be sure that the Prosecutor’s account is an entirely fair or balanced one.  It is though based in large part on documented sources (emails and the like), and -at the very least – it provides an interesting insight into how lawyers can contribute to, manage even, organisational irresponsibility in an attempt to be ‘reasonable’ when dealing with legal risk.

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