The Standard Chartered Bank plc saga, part I

I will not be alone in saying that the Standard Chartered Bank’s compliance problems with the New York State banking regulator (Department of Financial Services - DFS) caught me by surprise. 

I have been following this bank for several years, as it seemed to provide straight forward banking services internationally and made a good return in so doing.  Management seemed quite competent.  Finally, the fact that it had acquired what remained of American Express Bank Ltd. where I spent the first 16 years of my professional career added to my interest.  Actually, I was looking for a good entry point to invest in its stock.

However, the misdeeds that it allegedly committed and apparently did not contest as well as what has transpired so far about its senior management’s conduct have led me to suspend any investment attempt.

Essentially, the bank was accused of willingly defying US regulations forbidding banks to channel money of sanctioned countries such as Iran through the US.  The DFS accused it of laundering more than $250 billion over several years through its US banking operations, of falsifying internal records to prevent regulators from tracing the identity of its Iranian clients and of filing untrue reports.  That a major bank decide, in a very big way, to defy the laws of its host country is simply baffling.

The reaction of senior and top management in this whole affair further raised alarm bells in my mind.  There was of course the now infamous email exchange between the Head of US operations and his superior in which the former clearly outlined the dangers of the bank’s course of action and the latter replied “who these f*** Americans think they are to tell us what to do”.  There was also the truculent initial response to the DFS action stating that only $14 million of transfers had been mishandled and that the bank was contemplating countersuing for damage to its reputation!  This from a bank that had been under Federal oversight from 2004 to 2007 for money laundering.  Then, in short order, the bank agreed to settle with the DFS, paying $340 million and accepting renewed oversight.  As Butch Cassidy asked the Sundance Kid in the eponymous movie, “Who are these guys”? 

What is worrying in this case is that this is not an instance where a low level trader decides to go rogue.  It is likely that the decision to continue doing business with Iran was vetted by the very top management; the Board of Directors was probably at least aware of the decision/policy, and if it was not, then more serious questions must be asked.  What management decides to choose Iran over the US?  What kind of senior manager blurts out the f*** word when referring to the Congress of a host country?  So far, I find no reassuring answers.  Either we are dealing with a culture or a strategic problem. 

The cultural hypothesis is that the top echelons of the bank include throwbacks to the Indian days of the British Empire, except that New York is not a remote outpost in the bush.  When a senior manager not only refuses to listen to his country manager’s cogent alert and advice but also responds with unrestrained fury, when the corporation lets it be known of its intent to counter sue its regulator for damage to its reputation, under the circumstances, I, for one, wonder about the culture of the place.

The strategic hypothesis is that the bank’s main focus is emerging markets, many of which, by definition, are less closely regulated than developed ones, often condone business practices which would be frown upon elsewhere, and in some cases are governed by regimes which are not models of good behavior.  New York is important to the bank for providing access to the US dollar system, but the Americas-Europe-UK segment accounted for only 10% of Standard’s operating income in 2011.  In that sense, and in my view, the bank probably has a higher risk profile than generally acknowledged.

Bottom line, the US regulatory and judicial process is not over by a long shot as the Federal Reserve, Treasury and the Justice Department are still to conclude their own enforcement actions.  I am among those who applaud the DFS decision to go public and break the apparently stalled multi-party negotiations.  I found the allegations against the bank shocking (called me an old-fashioned banker). 

Finally, having myself spent most of my banking and investing careers in emerging markets, I have come to the conclusion that the Standard Chartered business model is riskier than previously thought, and more importantly, that such higher risk profile is unlikely to be easily reduced. 

At some point under the right circumstances and at the right price, the bank may become an interesting investment or trading idea.