NYS Order on Standard Chartered’s Iran Transfers Opens Up US, UK Regulatory Pig Fight

I hope Benjamin Lawsky, the New York Superintendent of Financial Services, has balls of steel. He will need them.

In case you missed it, a major news story yesterday is the bombshell that Lawsky dropped on the British bank, Standard Chartered, in the form of an order (a regulatory determination) that set out in considerable detail how the bank, with deep involvement of senior in house counsel and compliance staff, had doctored (“repaired”) wire transfers so as to disguise the fact that the customers were major Iranian banks, including its central bank. Both SCB’s outside US counsel (in 2003) and the head of the US operations (in 2006) raised big red flags that the way the banks was operating was out of line with the regs. The US chief was begging to exit the Iran business. From the order:

Firstly,” he wrote, “we believe [the Iranian business] needs urgent reviewing at the Group level to evaluate if its returns and strategic benefits are . . . still commensurate with the potential to cause very serious or even catastrophic reputational damage to the Group.” His plea to the home office continued: “[s]econdly, there is equally importantly potential of risk of subjecting management in US and London (e.g. you and I) and elsewhere to personal reputational damages and/or serious criminal liability.

Yet these concerns were ignored. The order states that over $250 billion was transferred impermissibly from 2001 to 2010 on behalf of Iranian clients, and it is also looking into similar transfers with Libya, Sudan, and Myanmar.

The order says that the state regulator will put a monitor of its own choosing in place at the bank’s expense, and it has summoned it to appear on August 15 and explain why it should not lose its New York license and its access to US dollar clearing services. As we pointed out yesterday, it is very unusual for a state regulator to act on its own in such an aggressive manner (not that I disapprove). And I can’t think of a single case where a bank has been threatened in public with the loss of a major license. I presume that is what happened privately to Salomon in the wake of its Treasury bond bidding scandal, when CEO John Gutfreund and three other executives suddenly stepped down. Bankers Trust pleaded guilty in a suit by New York and other states for escheatment fraud. Guilt of a felony meant municipalities and many private companies were forbidden to conduct business with it, which lead to a brokered marriage to Deutsche Bank.

Across the pond, banks, MPs, and the media are up in arms. Part of this is a failure to understand the laws and the DFS’s role; this is seen as a Washington conspiracy to kick the City when it is already down thanks to the Libor scandal (and if I were at the Bank of England or the FSA, I’d be furious at the way Geithner managed to fob off all responsibility on them, so I suspect there is a lot of pent up hostility looking for an outlet). Per the Financial Times:

“This is an attack,” said one senior City figure. “If we don’t stand up to it, it could be catastrophic for London’s financial standing. There has to be some stage where Number 10 or the Treasury says something in defence of the banks.” A second said: “Political intervention may be needed over this.”

And in a separate article:

In London, John Mann, an opposition Labour party member of parliament’s influential Treasury select committee, said he was concerned about an “increasing anti-British bias by US regulators and politicians”, which he said could have been influenced by a desire to shift financial business from London to New York.

“This is a real power grab [by US authorities] and the stakes are very high,” he said.

And of course, Standard Chartered is trying to claim that these were “small paperwork errors” (where have we heard that line before?). If you read the order, there is too much evidence in there alone to regard that as credible.

But the Treasury and Fed are also in an uproar, although they have no one to blame but themselves for their discomfort. The Treasury (supposedly the lead actor in investigating “terrorist financing” and violations of economic sanctions; the Office of Foreign Assets Control is a Treasury operation), Fed, DoJ, District Attorney of New York and the DFS were all investigating Iran transfers at various banks, including SCB, since 2010. The others has settled; SCB was still under investigation and seemed to believe it would get a clean bill of health.

The UK media is depicting Lawsky as a “rogue regulator,” a lone wolf who has way overstepped his authority and is out of line in trying to enforce Federal laws relating to Iran. The facts are somewhat different.

Lawsky came into his post in 2011. A reliable and connected source says that the Fed has gone out on the broad tape claiming that Lawsky did not inform them. In fact, he met with them about three months ago, laid out his case, and the folks at the Fed said, in effect, “Go for it.” Lawsky took them at their word and now everyone is gunning for him. The behavior pattern is awfully reminiscent of what another prosecutor, Neil Barofsky, found when he worked busting drug lords in Columbia: like DEA and DOJ, the Fed evidently cares far more about not being made to look like incompetent enablers rather than shutting down a massive infusion of money to Iran. Geithner has also mounted a major campaign against Lawsky.

Despite the enormous row that this action has kicked up, Lawsky may be able to ride it out. The key is whether Cuomo continues to back him. At least as of the publication of stories last night (I’m putting this up to go live a bit after I turn in), Treasury has made no formal statement, although there was a bit of a bleat issued, per Bloomberg:

The New York intermediary through which the transaction went through did not have to be notified by the British bank that it was carrying out this transaction on behalf of an Iranian entity in order to meet the requirements of this regulation, said John Sullivan, the Treasury Department spokesman responsible for terrorism and financial intelligence.

Sullivan declined to discuss any further details about the probe of Standard Chartered.

The Administration may well be hamstrung in its ability to rein in Lawsky. Given that this is an election year, and the race is close, Obama can’t afford to alienate older, well heeled Jews, who are ovewhelmingly pro-Israel (the younger generation is another story). So Geithner and Obama can’t afford to engage in open war. Indeed, if the Romney camp is smart, it will depict the Administration’s failure to join Lawsky as proof that it is soft on Iran and terrorism generally.

Similarly Lawsky will gain considerable stature if he prevails, so it isn’t likely that the Administration can offer a big enough inducement to get him to back off (and the way Schneiderman was seduced and then treated shabbily would be enough to make anyone with a operating brain cell wary of trusting them to deliver on their promises).

Separately, I’m astonished by the amount of abjectly ignorant commentary on this matter thus far. The UK press is not comporting itself well (failing to understand that dollar clearing services are ultimately backstopped by the Fed, hence something the US is within its rights to regulate, or complaining about a “Washington” regulatory grab by a New York regulator). But there are some lapses in the US coverage as well, particularly (and I suspect to see more of this) the uncritical acceptance of the argument that SCB (and now the embarrassed and upset Federal regulators) is trying to make, that Lawsky’s case rests on his supposedly aggressive reading of the reporting requirements for transfers with Iranian banks. An example in the New York Times:

The agencies involved, including the Treasury Department, are debating just how expansive the suspected wrongdoing was at Standard Chartered. Benjamin M. Lawsky, a former prosecutor who now leads the state banking regulator, claimed the bank had processed $250 billion in tainted money while cloaking the identities of its Iranian clients by stripping their names from paperwork. Some federal authorities, though, believe that the amount is much smaller, perhaps in the millions. Standard Chartered, for its part, said that only $14 million did not comply with regulations.

The wide disparity stems from different interpretations of how many Standard Chartered transactions violated a federal rule that governs the way money from abroad moves through the American financial system.

It’s hard to see the DFS position as some sort of regulatory overreach when the bank’s own US outside counsel objected strenuously to the bank’s view thåt wire stripping was OK in 2003, and the top executive in the US was later deeply concerned too. More important, if you read the order, only one of the seven violations of the law cited relies on the Federal statue involving clearing of dollar transactions with Iran, and that is formulated narrowly:

SCB engaged in transactions within the United States without complying with the requirements of 31 C.F.R. 560.516 in that SCB prevented its New York branch from determining whether the underlying transactions were permissible under by 31 C.F.R. 560.516 before effecting them.

Two of the other violations, Offering False Instrument for Filing P.L. § 175.35, and Falsifying Business Records P.L. § 175.10, depending on the severity of the violation (and these look severe) are Class E felonies. Note from the Bankers Trust example above: being found to be a felon is a death warrant for a bank.

Some readers are unhappy that this action centers on Iran, but as I keep stressing, this initiative is all about past violations, and does not escalate the conflict with Iran. And the Brits and the US media are treating this contremps as a banking story, not a Middle East story. I find the stung reaction of the British bankers a positive sign. Maybe Lawsky’s charge will finally demonstrate that a race to the regulatory bottom erodes the stature and credibility of a financial center. As remarkable as it no doubt seems to Americans, we aren’t at the bottom in some areas of banking, and that might come to be seen, as it was until the 1980s, as a competitive strength.

This post originally appeared at naked capitalism and is posted with permission.