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Blurred lines – regulatory sanction and civil claims in banking

Jonathan Kitchin, Michelmore's, Associate, London, 28 July 2015

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In the second part of his excursus on the information gleaned from compelled evidence, Jonathan Kitchin concentrates on why, during a regulatory investigation, every authorised person at the relevant private bank or fund firm should know to whom he is allowed to talk, about what and how.

It is the duty of every compliance officer to make his company understand that any evidence uncovered during a criminal trial can then be used to support a civil claim. During a criminal prosecution, every person the authorities interrogate has a right to remain silent and to protect himself against self-incrimination more generally. This is a concept that originated in the UK, although it has been eroded slightly as a result of the Financial Services and Markets Act 2000, which opens the door to disciplinary action against any person performing a 'controlled function' who refuses to talk to the FCA and which also makes it a criminal offence for him to lie to the FCA. It is also the case in recent years that if a suspect refuses to answer a question or explain something in more detail, the judge may well draw adverse inferences.

Privilege

In a further action for damages of £30 million that Property Alliance Group has taken against RBS in relation to swaps, RBS has been ordered to hand over documents that set out its negotiations with the FCA over a £390 million fine for London Inter-Bank Offered Rate (Libor) manipulation. The documents are kept confidential under seal as a condition of its DPA with US regulators. A judge will inspect the papers before ruling on whether they are admissible. This case re-affirms the general approach of the English Courts – that confidentiality does not trump a litigant's obligation of full and frank disclosure or the principle of open justice.

The disclosure of papers handed over in confidence (or in an inadvertent waiver of privilege, see below) is problematic when it forms part of negotiations with regulators. Firms must discharge their duties to statutory auditors and conflicts of interests can arise with directors or senior managers who are implicated. Furthermore, internal audit, risk and compliance functions can generate significant levels of detailed analysis and guidance.

The client-lawyer retainer

How can privilege be waived 'inadvertently'? Let us imagine that an organisation receives legal advice. If it circulates it widely throughout its offices, the action of doing so can strip the information of its legal privilege. In big institutions it is therefore important to set up small committees of people who act as 'the client' for the law firm that is distributing the advice. People in the organisation can waive privilege for a piece of information without knowing it. All they have to do is the following.

  • Take it into board meetings and disclose the contents without saying "we are waiving privilege."
  • Put it into board minutes at big organisations that will also be seen by sub-committees and other compliance people.
  • Put it into middle-management product reports (particularly in the compliance and audit departments) and circulating them.
  • Simply show documents to anyone outside the organisation. This can happen when people at the firm are liaising with firms of accountants and auditors. If an auditor in that situation asks a staff member some questions and the staff member sends off an email saying "see attached," that can be enough, as can a summarised explanation of the information.

The best defence against this is for the compliance officer to look at the contract between the law firm and the bank to see what is privileged and how to waive it safely. This is called the client-lawyer retainer. The bank must then evolve rules and training programmes to help everyone identify those people who are authorised to deal with counsel (typically anybody in audit and compliance, anyone on the board, and in-house lawyers) and what they ought to be doing during an investigation. This could take the form of a section in the staff handbook. Each authorised person should be given a precis so that he knows to whom he should talk, about what and how.

Technology

Another issue of which financiers must be aware is that of hardware and software. IT infrastructure and software which underpins data storage and security systems are a major target for investigators. A leading provider of data recovery, forensics and e-disclosure services recently carried out a survey which showed that 44% of UK respondents had been involved in an internal investigation and 33% in a regulatory investigation during the last 12 months. It is also important to consider where your servers or data managers are based, as it might be that they are backing up data in many jurisdictions where the rules on confidentiality, privilege and disclosure are different from one another.

For example, "wire fraud" is a US federal crime that can occurs when someone devises a way to obtain money on false pretences in communications he sends through e-mail servers. This has been particularly relevant to traders engaged in Forex manipulation who became infamous for the use of online chat-rooms to exchange confidential client information. From a legal point of view, the boundary between a legitimate exchange of publicly available information and market manipulation is the element of collusion and dishonesty, which is not always easy to prove but has been dredged from servers. Traders facing disciplinary action may attempt to pose as "whistleblowers" or state that a number of practices, such as "layering" or "front-running", were commonplace and an accepted part of the culture.

Interestingly, Tom Hayes, the UBS trader who is facing trial in London on eight Libor-rigging charges, is currently battling accusations that he revealed his intent through a wish-list on Facebook, according to transcripts of interviews between the former UBS and Citigroup Yen derivatives trader and the SFO, read out in court last week. Firms therefore ought to realise that personal as well as corporate email and social media accounts can be used in court.

No let-up and harsher sentences

There is no indication of any let-up. The Governor of the Bank of England, Mark Carney, has promised a crackdown on rogue traders, and recently declared that the "age of irresponsibility is over". The outcome of the Fair and Effective Markets Review, published on 10 June 2015, recommends more wide-ranging regulation of derivatives and Forex markets and longer jail sentences for financial crime in order to correct "ethical drift". Furthermore, financial employees who change jobs will require references from their previous employers, something that ought to help stop miscreants from avoiding detection. This is on top of tougher regulatory rules already on the way for senior managers on boards, operating committees, in-house lawyers and people with "significant influence functions". The Senior Managers' Regime will make it even easier for regulators to fine individuals and ban them from working in the industry.

These are very complex, inter-related issues for the private client sector to grapple with. Every firm should be very keen to manage cross-border privilege while undertaking an internal investigation, possibly with a view to telling the regulators about anything bad it might find. It might indeed be politic for the firm to tell all to the American regulators, who are held in particular dread, if it wants to arrive at a settlement that does not leave it with a criminal record from that quarter. Legal counsel can also be used to devise pre-emptive risk management strategies or, when necessary, to avoid misunderstandings about the basis on which employees or ex-employees co-operate with an internal investigation or a regulatory 'fact-find'. As with all legal proceedings, clarity is the key.

In relation to civil actions, regulators have paved the road, and litigants pursuing Libor-related misrepresentation claims in the High Court have sign-posted the way, for others to follow (even if the cases that those litigants have begun do not come to trial). Libor, Forex and Isdafix manipulation might, taken together, cast a very long shadow on the financial sector because claims based on fraud are not time barred. Individuals, moreover, ought to be aware that settlements based on fraud can be revisited and documents from regulatory 'fact-finds' or negotiations will be available for further use – as happened in the Barclays trial.

It remains to be seen whether the current trends in litigation that we have described here represent the beginning of the end or the end of the beginning. In the meantime, the line between regulatory investigations and civil claims has never been more blurred.

* Jonathan Kitchin is an associate at the City law firm of Michelmores. He can be reached on 01392 687635 or at jonathan.kitchin@michelmores.com

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