Bank Lawyer's Blog

Rebuilding A Broken Culture

I stand with Livy, who at the final hardening of Rome's republican arteries, wrote that the study of his land's history was the rise and fall of moral strength, with duty and severity giving way to ambition, avarice, and license, till his fellow Romans "sank lower and lower, and finally began the downward plunge which has brought us to the present time, when we can endure neither the vices not their cure."
--Anthony Esolen, "Out of the Ashes: Rebuilding American Culture"

This past week in London, president of the Federal Reserve Bank of New York, William Dudley, delivered a speech entitled "Reforming Culture for the Long Term," in which he sought to apply lessons learned from the Wells Fargo fraudulent account fiasco to the banking world at large. Housing Wire's Ben Lane provides a decent summary of the speech.

"As I have argued before, incentives shape behavior, and behavior drives culture. If you want a culture that will support your long-term business strategy, you need to align incentives with the behaviors that will sustain your business over the long haul," Dudley said in his speech across the pond.

"Incentives—compensation and promotion, in particular—are powerful tools for communicating the conduct and culture you desire for your firm. Of course, the cultures of firms can and should vary," Dudley continued. 

"But, the culture of every bank should share a common theme: stewardship—a word that implies professional care, exercised year after year for the benefit of the firm and its stakeholders," Dudley said. "A commitment to the long term must be at the core of banking. Incentives within a firm should support that goal, not undermine it"

Dudley's basic point, applied not only to Wells Fargo, but to the mortgage meltdown of 2008 and the economic collapse that resulted, is that bad incentive compensation schemes lead to bad behavior which leads to bad results.

"Compensation, once again, seems to be at the center of a scandal. Neighborhood bankers were paid based on the volume of new accounts opened, apparently with utter disregard for whether customers wanted them or even knew about them," Dudley continued.

"And, like mortgage brokers in the early 2000s, it appears that job security depended almost exclusively on meeting targets, regardless of how those targets were met," Dudley added. "There was a serious mismatch between the values Wells Fargo espoused and the incentives that Wells Fargo employed."

Dudley concluded by, again, addressing the broader issue of "corporate culture."

"Good culture is, in short, a necessary condition for the long-term success of individual firms," Dudley concludes. "Therefore, members of the industry must be good stewards and should seek to make progress on reforming culture in the near term."

I think Dudley is correct in asserting that poorly designed and/or managed incentive compensation schemes often (usually) lead to bad behavior by employees. I also agree that directors and management of financial institutions bear great responsibility for such bad behavior. Yet, in the case of both Wells Fargo in the most recent scandal, and the myriad cast of bad actors in the 2000s who caused the Great Recession, I also believe that the "incentivized" employees who engaged in bad behavior are equally as responsible. As Lane's article notes in passing, at least 5,000 Wells Fargo employees opened "as many as 2 million accounts without authorization." You don't have to have the moral insight of Thomas Aquinas to deduce that opening a loan account in the name of a customer that the customer does not authorize, or is even aware of, is wrong, legally and, more critically to me, morally, whether your moral code is based upon revelation, reflection, or created on the fly out of whole cloth based upon what you might have had for breakfast on any given day. If you do not realize that such activities are intrinsically "wrong," then, to paraphrase what John Locke once said about those who assert that something can be created by nothing, we have nothing left to discuss.

As was discussed when the Wells Fargo scandal broke, there were many employees of Wells Fargo who refused to do the wrong thing. Some of them were fired for failing to hit their sales goals and others quit their jobs at Wells Fargo and found work elsewhere. While the facts and circumstances of individual cases may lessen the culpability of some employees who engaged in bad behavior, a general proposition that requires individual responsibility for good behavior is as valid as a general rule that requires properly designed and managed incentive compensation schemes. Too many former Wells Fargo employees just said "no" to let those who just said "yes" entirely off the hook.

If you want to "reform culture," you need to remember that the process is not merely a matter of designing and managing incentive-based compensation schemes. Your cultural house needs to start with a strong foundation, and that's a sense of personal responsibility by every individual in the organization.

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I am in the process of relocating to another state and taking the first step into slowing down, after over forty-two years of being "all steam and whistles heading west." It's long past time to stop and smell the roses. On the other hand, I am only "semi-retiring." I'll remain connected to the firm with which I have been associated for the past seven years and will continue to blog here until I run out of gas or am shot by a reader. If I'm lucky, the shooting will be in the middle of the street by a jealous husband of twenty-five after I've reached the age of eighty. Over the next two weeks, I will be engaged in radio silence while I move (as I was over the past two weeks due to illness), but after early April, beware of further snark attacks.

Pax Vobiscum!

Credit Derivatives: Understanding The Esoteric

Eight years ago, I reviewed a book, Equity Derivatives, edited and partially authored by Mayer Brown London-based partner Edmund Parker. Recently, Mr. Parker wrote a follow-up tome, this one entitled Credit Derivatives: Understanding and Working with the 2014 ISDA Credit Derivatives Definitions. My colleague Kurt Leeper of Shapiro Bieging Barber Otteson LLP's Denver office was kind enough to review the book, and the following is his review. Yes, we're still wonks and nerds, but hey: someone's got to be.

The financial world in 2017 is a very different one from that which existed in 2007, the year in which Edmund Parker’s Credit Derivatives: Documenting and Understanding Credit Derivative Products was first published. It is in this altered world of 2017 when Mr. Parker’s helpful successor to that book, Credit Derivatives: Understanding and Working with the 2014 ISDA Credit Derivatives Definitions, is finding its way to bookshelves. As Mr. Parker helpfully notes in his book, in late 2007 there was a notional $62 trillion of credit default swaps outstanding, while in late 2015 that amount had shrunk to $12.3 trillion (albeit with a significant portion of that decline being due to trade compression). The tradeoff has been a better organized market, and while the storm has passed, so to speak, the stated mission of Mr. Parker’s book is to continue that of its predecessor: to create a better understanding  of credit derivatives products, and in particular the new 2014 ISDA Credit Derivatives Definitions. In short, the book succeeds admirably in accomplishing that mission.

Over the course of Credit Derivatives’ 500-plus pages, Mr. Parker ably achieves this goal through a combination of lucid prose, well-organized charts and helpful examples. The book is divided into four main sections, providing an overview of credit derivatives and the market, an overview of the 2014 ISDA Credit Derivatives Definitions and changes from their predecessor versions, an in-depth discussion of the 2014 ISDA Credit Derivatives Definitions and finally a catch-all section providing an overview of a number of related topics.

Like most books of its nature Credit Derivatives will appeal to two distinct audiences. First, there is the reader with no or minimal experience with credit derivatives but who seeks a reasonable understanding of such instruments; to speak the language, so to speak. This reader will find significant value in Mr. Parker’s book and would indeed be well-served simply by reading the first of the above-described four sections of the book, which covers over 100 of the book’s densely packed pages. Throughout, Mr. Parker helpfully sets out the parties who use certain derivatives and why while also providing illustrative hypothetical and real-world case studies.

Second, there is the practitioner who, whether on an infrequent or regular basis, deals with credit derivative-related issues in his or her practice (or, just as likely, lacks the free time or inclination to read through an entire book on the subject).  This reader, too, will find plenty of use in keeping a copy of Credit Derivatives handy on a nearby bookshelf. It is this reader at whom the majority of the book is focused, as in-depth discussion relating to the 2014 ISDA Credit Derivatives Definitions spans the majority of its pages. Mr. Parker helpfully breaks down the discussion on an article-by-article basis, making for quick, easy reference when necessary.

While in the last 10 years the world may have changed and the world of credit derivatives with it, the value of understanding these seemingly arcane instruments is as great as ever. To this end, whether a weekend reader or a seasoned practitioner, a reader of Credit Derivatives: Documenting and Understanding Credit Derivative Products will find all that is required to ensure that he or she is knowledgeable about the book’s subject matter for many years to come.

Trump Sends Mixed Smoke Signals On Mary Jane

Bankers in states where marijuana businesses are legal (under state, but not federal, law) have been confused for the past several years about the relative risks of banking what is undeniably a cash-rich sector of the economy. When Trump appointed Jeff Sessions as his Attorney General, we thought that was not a good sign for banks that are engaged, or are planning to engage, is providing services to such businesses. A few weeks ago, the White House Press Secretary threw another wet blanket of the marijuana campfire and Dorsey & Whitney's Joe Lynyak thinks that The Spice Boy's half-a$$ed-hearted warning to state-legal marijuana business owners (and, by implication, their "co-conspirators") bodes ill for bankers.

In a client alert Joe issued last week, he explicated.

As noted above, even though there have been some informal indications that the current non-enforcement approach adopted by the Obama Administration would continue, on Thursday, February 23rd, the White House Press Secretary stated that enforcement of federal drug laws aimed at limiting the proliferation of marijuana sales may occur.

Although the Press Secretary softened this warning by stating that medical marijuana businesses would not be targeted, the fact remains that the Trump Administration appears to be reconsidering the above-referenced guidance that has been relied upon by banks when electing to offer deposit and lending services to marijuana businesses.

Joe has some potentially disturbing observations for those banks that have been following FinCEN's guidance on banking marijuana business, advice based on the so-called "Cole Memo," by filing MJ-specific suspicious activity reports (SARs), a type of SAR that Joe and others (including the hose-heads who blog at this venue) affectionately refer to as "Cheech and Chong SARs."

[B]y having filed with FinCEN one of the three new SARs (which in virtually every case would be the Marijuana Limited SAR), a bank has made an admission of probable criminal conduct on its own part if the federal government elects to initiate criminal action against the filing bank and its management. Because prosecuting criminal drug laws against individuals and small businesses is time consuming and a drain of resources, using a bank’s own statement of liability in a statement made to the federal government under penalty of perjury might be a preferred strategy. Although a list of potential penalties might be available (e.g., asset forfeiture, civil and criminal penalties and RICO actions), it is certainly possible that the federal government might pressure banks to withdraw from providing banking services to marijuana businesses. A bank should also consider the possibility that fines and penalties, including criminal penalties, might be pursued not only against the bank, but also against officers, directors and employees of the bank. (Among other things, the availability of insurance coverage to pay for legal defense costs should be verified.)

Bankers who service marijuana businesses probably want to break out the paper towels to wipe up the spewed coffee after their quite understandable "Danny Thomas Spit Takes."

That's right: by following the "guidance" of the DOJ and FinCEN, and dutifully filing Cheech and Chong SARS, banks may have teed up themselves, their officers, directors, and employees for easy-to-prove criminal charges that they violated a plethora of federal criminal laws. In response to claims that such action on the part of federal prosecutors would "unfair," I offer the immortal words of former Dancing With The Stars stoner, Tommy Chong: "Unfortunately, the American justice system is just riddled with lies and inconsistencies." I also deem insightful the lyrics of NaS: "Life's a bitch and then you die/That's why we get high."

After making the day of MJ bankers everywhere, Joe has a few other observations, which I'll quote at length, because (A) they're pithy and pertinent and (B) I'm lazy.

Second, banks wishing to continue providing banking services to marijuana businesses should revisit the current interpretative guidance and determine whether the bank’s on-going due diligence required by the guidance is commensurate with the degree of due diligence that the guidance mandates. Further, since the Administration may elect to distinguish between medical marijuana and recreational establishments, the degree of due diligence required for the two categories of marijuana businesses may be significantly disparate in nature.

Third, a bank may elect to review the banking services it provides to vendors of marijuana businesses, such as suppliers of fertilizer, irrigation, energy and similar products and services. A related issue arises in regard to banking a company that has an affiliated entity directly involved in marijuana, but the bank’s relationship is limited to non-marijuana affiliated operations. Similarly, if the vendor provides support services to both medical and recreational marijuana businesses, separating those functions may be difficult or impossible.²

Fourth, in light of what appears to be a changed enforcement posture on the part of the Trump Administration, the senior management of the bank and its board of directors should be fully briefed regarding the increased legal risk that may soon be presented.

Finally, a bank electing to continue banking marijuana businesses should consider retaining counsel with white-collar criminal experience, including AML expertise, in advance to assist should a DOJ inquiry occur. Among other things, the bank’s compliance with the current guidance should be organized, and counsel should be well-versed in the enforcement perspective and strategy employed by the DOJ when it considers bringing a criminal prosecution or investigation.

I've seen a number of service providers who tout their "solutions" to the MJ banking conundrum. Many of them claim that they've got the whole Gordian knot untied with their better-than-sex software, systems, or fairy dust. Good luck with all of that. Just make sure the color and design of your underwear go well with pinstripes and don't drop the soap in the shower of the federal prison camp you may have the privilege of gracing. Especially if the MJ-hostile Sessions follows Flynn into the wilderness for drinking too many White Russians during the campaign, and the Orange Lord appoints a really vicious MJ-hater to succeed him, like a Bridge-Too-Far Chris Christy. No matter how you try to camouflage the money trail, the fact remains that aiding and abetting the manufacture, sale, or distribution of marijuana remains an offense under federal criminal laws that can ruin your whole day. If you bank marijuana businesses (and even businesses that serve marijuana businesses), you are relying on the consistent tolerance and forbearance of the federal executive branch, and whatever other words you wish to use to describe the current crowd in charge of that branch, "tolerance" and "forbearance" are not two that immediately pop into my mind.