Speech by Tracey McDermott, director of the Enforcement and Financial Crime Division at the 10th Annual British Bankers’ Association (BBA) Financial Crime Conference
Good morning ladies and gentlemen. Thank you to the BBA for inviting me to speak at its tenth financial crime conference.
The timing of this event is appropriate. The last few months have once again seen a host of financial crime related issues from anti-money laundering (AML) controls, to insider dealing to boiler rooms to good old fashioned fraud hitting the headlines. These scandals damage yet further the reputation of the industry. More importantly, each of them causes damage to individual victims, the market and to the economy as a whole. They emphasise once again the critical importance of tackling financial crime in all its forms.
Today I will focus on the role the FSA – and subsequently the Financial Conduct Authority (FCA) – as regulator, plays in this. But this is not a job for the regulator alone. To be effective in this area, we must, as I mention below, work with other agencies. And, just as importantly, the industry must play its part in rooting out fraud and showing zero tolerance to those within the industry who tarnish its name by failing to meet basic standards of honesty, integrity or competence.
The issue of financial crime will certainly not be going away.
The Financial Conduct Authority
As you know, the regulatory reform process is well under way. This is the last speech I will give to you presenting the Financial Services Authority's views on financial crime. The Financial Conduct Authority, or FCA, is in the wings waiting to take over. And I believe this new organisation will be well placed to take a robust stance on financial crime.
The Bill currently going though Parliament gives a very clear mandate to the FCA in relation to financial crime. Its integrity objective explicitly tasks the FCA not to let the UK financial system be used for the purposes of financial crime. In contrast, the Prudential Regulation Authority, or PRA – the sister agency charged with overseeing the safety and soundness of financial institutions – has no such mandate. Countering financial crime is not part of its remit. This is deliberate: it gives a clear division of labour between the two authorities. Give a financial crime mandate to both authorities, and you might end up with muddling overlap or, worse still, buck-passing.
Of course, this does not mean that the PRA can forget about financial crime altogether. From its prudential point of view, fraud against financial institutions can be a significant source of operational and reputational risk – and so too is non-compliance with the legal and regulatory requirements of overseas jurisdictions. The PRA will need to know financial institutions are on top of these risks, and that their safety and soundness is not at risk.
The FCA’s focus will be different. Our focus will be on protecting consumers, and stopping firms facilitating crimes for which they can be a conduit, such as money laundering. Other things being equal, the FCA will not see its primary role as being to nanny or bully banks into protecting themselves against fraud. We presume that banks have natural incentives to do that for themselves. If they do it badly, their shareholders and bonus-pool participants should take some of the hit. The Payment Services Regulations also do an excellent job in this connection, by incentivising banks to protect their cardholders from fraud as well.
Of course, this does not mean we have no interest in how fraud more generally is tackled. As graphically documented by the National Fraud Authority in recent years, there are significant social costs of fraud. The fraudster who is blocked by one bank’s defences may move on to another, or directly con members of the public, or go in for a different line of crime altogether.
The country’s overall response to fraud requires not only robust systems and controls in financial institutions, but also a concerted public and private sector strategy. This is why we are an active and supportive participant in the Economic Crime Coordination Board (the ECCB – the precursor to the Economic Crime Command) and its prevention, intelligence and operations groups.
The challenges for the ECCB are considerable – to set out a coherent strategy and identify strategic priorities, to develop a tasking and coordination mechanism that appropriately mobilises autonomous agencies in furtherance of those priorities, and to devise a successful model for mutual engagement between public and private sectors. And all this at a time of diminishing public expenditure on criminal law enforcement, which makes efficient employment of available resources all the more important. We all have a stake in helping to see that these challenges are met. The FSA’s engagement with the ECCB, which will continue into the FCA, indicates how seriously we take that responsibility. And, of course, alongside that, we continue to work closely with other law enforcement agencies, here and overseas, in order to pursue our objectives.
Against that background, let me turn to one or two areas of current and future FSA/FCA activity.
Investment fraud
Criminals, both here and abroad, defraud investors in Britain of hundreds of millions of pounds a year through scams such as share-sale (or ‘boiler room’) frauds, landbanking scams, rogue carbon-trading firms or fraudulent collective investment schemes. Investment fraud remains one of our top financial crime risks.
Those who invest their money in such schemes are not protected by the Financial Services Compensation Scheme if they invest with businesses that are unregulated, and all too frequently lose all their money.
We recognise that tackling this activity requires us to attack it on several different fronts.
So we take a robust line against firms and individuals who break the law by conducting regulated activities without authorisation, making regular use of our criminal and civil powers in this regard.
By way of example, in the past few months we have executed search warrants and made an arrest of an individual who we believe was operating an unauthorised foreign exchange investment scheme.
We have frozen the assets of a landbanking company that we believe was selling relatively worthless land as an investment opportunity.
And, in completed cases, we worked with the Crown Prosecution Service and the City of London Police to secure the conviction and four-and-a-half year sentence of Michael McInerney who helped launder money for Tomas Wilmot, a share fraudster who himself was convicted last year and sentenced to nine years imprisonment along with his two sons who each received a five-year sentence.
Equally importantly we also seek to remove victims from the picture by alerting the public to the dangers of investing in such schemes including by, for instance, proactively writing to those we identify through intelligence, as being on the target list of fraudsters. This year we wrote to 76,000 people who we found were at risk of being targeted by investment scams. And we have provided consumer guidance to many millions through our media work and by providing educational videos on the main types of investment scams.
We also use the courts to help victims of investment scams to get some compensation. This has involved us freezing £33m in the last 18 months, which we hope to return to victims once cases are concluded. And in the case I referred to earlier, confiscation proceedings are ongoing relating to the assets of the Wilmot family and their associate Michael McInerney. Depriving criminals of their ill-gotten gains is a key aim for us, and this is a tool we will not be shy of using in future.
That is what we are doing to combat investment fraud. But it is not all about us. The industry also has a role to play. Most money which passes to a fraudster in these schemes goes either from or to (or sometimes both) a UK account. Our recent thematic review of banks' defences against investment frauds looked at the steps firms take a) to protect their customers, and b) to detect when they are providing banking services to people perpetrating these scams.
Our review found many examples of good practice, and individual staff members with a strong commitment to protecting customers, but we saw little systematic focus on the specific issue of investment fraud. While some bank staff made real efforts to warn customers who were about to fall victim to investment fraudsters, other banks are doing very little.
We found no banks could show they allocated resources to this issue on the basis of purposive risk assessment or senior management decisions: efforts to protect customers from this type of fraud were worryingly haphazard.
We also had real doubts about some banks' ability to detect where they are offering banking services to the fraudsters themselves, which is essential if banks are to comply with their AML obligations. This is really basic stuff and we expect the industry to do it right.
We published draft guidance to the industry in June, and the BBA submitted a detailed and helpful response, which includes a request for greater intelligence sharing with the regulator, both on individual cases and on fraudulent techniques. There will always be limits to what can be shared, but we are keen to explore more fully with BBA what scope there is for improvement. Meanwhile, we plan to publish our final guidance, which will contain amendments to clarify many of the points raised by respondents, in November.
High-risk customers
And on the topic of guidance.
It is now over a year since we published our findings on how banks handle customers and situations that present a higher risk of money laundering –serving politically exposed customers, for example, which means overseas public officials who may be able to abuse their position for personal gain. Other types of high-risk activity include providing wire transfers or correspondent banking services.
You will recall we were very concerned by our findings.
You will also have noted that several enforcement actions have followed.
On 2 August this year, we fined Turkish Bank (UK) Ltd £294,000 for failing to meet the Money Laundering Regulations' requirements related to the provision of correspondent banking services.
In May, Habib Bank AG Zurich was fined £525,000 for failing to take reasonable care to establish and maintain adequate anti-money laundering systems and controls. We also fined Habib's money laundering reporting officer personally £17,500 for his failures in ensuring the bank had adequate anti-money laundering controls.
And in March we fined Coutts and Co £8,750,000 for its failings in relation to high-risk customers.
At the time of our thematic review we made it clear our focus on AML controls would continue. Twelve months on, you might like to reflect whether your institution has a convincing story to tell. What practically has changed from before? Have you looked again at your risk appetite, and whether it is properly reflected in the customers you have on your books? Has the way you treat the highest risk customers on your books altered? What evidence is there your institution – and your senior management – are on top of this issue?
London is a world-leading financial services centre. Businesses here should grow and flourish by offering excellent service, nurturing client relationships, and showing peerless expertise. Firms should not seek to grow by taking grubby money from shady people or by turning a blind eye to the risk of doing so.
I might pause for a moment here to reiterate what the FSA is looking for from AML controls. That is a proper assessment of the risks a particular customer or type of business poses and a proportionate and effective way of managing that risk. We do not require all customers to have the same type of due diligence. We do not specify how many forms of ID should be produced.
We do not, apart from PEPs, specify what constitutes a high-risk customer. These are judgements you are both best placed, and obliged, to make.
Trade finance
Looking at the future, a new thematic review, which we are just beginning, will look at how banks that finance international trade control the financial crime risks in these businesses. Trade finance seeks to ensure exporters (who are worried they might not be paid) and importers (concerned they might not receive their goods) walk away from the transaction happy, with banks standing in the middle to vouch for their customers and make the transaction work. You could argue the whole setup is intended to prevent financial crime – whether that is a fraud committed by the seller or by the buyer.
But there are many ways international trade can be abused. For example, practices such as under- and over-invoicing can allow criminals to transfer value between countries – say, claiming a shipping container is full of mobile telephones with a certain value when in fact it is empty – while an underlying fund transfer shifts the money with an apparently legitimate paper trail. Likewise, some customers may seek to conceal that a shipment in fact breaches trade embargoes. To what extent can banks, which only see the documents and never handle the physical goods, detect this type of abuse?
Our project will visit a range of banks to understand current practice, focusing in particular on the risks of letters of credit and bank collections. We will publish our report next summer.
Systemic Anti-Money Laundering programme
Thematic work will continue to be a key part of the FCA’s approach but it will not be all of it. A new feature of our AML supervisory strategy is for us to mount systematic, recurrent, in-depth reviews of the biggest banks’ defences against money launderers and sanctions breaches. This ‘Systematic Anti-Money Laundering Programme’, piloted over the past year, is a new venture for us; it will be applied to the largest banks operating in the UK (and not just high street retail banks – several investment banks too), with reviews of one institution or another taking place on a permanent basis.
The ‘Systematic Anti-Money Laundering Programme’ will mean the FCA will take a view on an ongoing basis of how robust the anti-money laundering and sanctions defences are in the banks that act as gatekeepers to the vast majority of the financial transactions in this country.
What will it look at?
We will consider each bank's anti-money laundering defences as an end-to-end process – with new customers entering at one end, and suspicious activity reports coming out the other, and all the intermediate stages probed to see how well are they tied together. How well do various parts of the institution communicate with each other? Are some risks falling between the gaps? Are the bank’s highest risk customers being given the right level of due diligence and monitoring?
All in all, the systematic programme will help us achieve the FCA's aim to intervene earlier to minimise detriment to consumers and society as a whole.
A crisis of confidence
Most of you will have heard FSA speakers on many occasions talking about banks’ defences against financial crime, and about our regulatory interest in robust systems and controls that make it hard for financial criminals to take advantage of the vital products and services that banks supply. And you’ve just heard me talk along similar lines today. But now it is time to face up to the fact that there is an elephant in the room.
All summer long, LIBOR-rigging, money-laundering and sanctions-busting have filled the pages of Britain’s newspapers. An industry suffering a crisis of public confidence as a result of the financial crisis itself, as well as of mis-selling to retail and small business customers, has sunk further in the public eye. ‘People are angry with banks and bankers.’ The LIBOR scandal reveals ‘a dealing room culture of cynical greed’. There has been ‘a collapse of trust in bankers’. These remarks are not drawn from the pages of Private Eye, or even a Treasury Select Committee report. They come from my boss, the chair of the FSA, Lord Turner. There is a real problem here that needs to be fixed.
So what is to be done about it?
Clearly, there has to be intense and well-focused supervision. The FSA has got better at that in recent years, in relation to firms’ defences against financial crime as well as in other areas. And the FCA will build on that.
Next, there has to be robust enforcement action. Take it from me: there will be.
Ultimately, however, we would much prefer to see more prevention to avoid the need for the cure. To highlight two things which are vital for that:
First, there needs to be strong management commitment to better culture and better values. The managers of banks need to understand that they are guardians of the public interest, and not just of profitability. Nowhere is this more true than in relation to money laundering and other crimes that hurt society. If there is a single sentence that sums up what we saw when we looked at high money- laundering risk scenarios last year, it is this – that again and again we saw the desire to win and keep the business trump the obligation to honour the AML rules fully and in good faith. That must change. To quote Lord Turner:
‘Unless management and boards themselves shift the tone from the top … and in addition make effective controls against dishonest behaviour the highest priority throughout the organisation, then we are not going to change the external perception of bankers”
The other vital thing is to sort out the incentive structures by which individuals are motivated and rewarded. Culture does not exist in a vacuum; nor can it be changed by exhortation alone.
The incentive structures which can drive individual behaviour have to be aligned with the high values proclaimed by the firm. The FSA made an important start here nearly three years ago with its remuneration code for the highest earners. We are currently consulting on proposed guidance on incentive schemes for other staff in financial institutions, because of the real risks that they pose in relation to mis-selling.
This is not the right place for a technical analysis of the bearing of the remuneration code on financial crime risks. Indeed, to be quite frank, technical analysis might distract us from the key point, which is this…
…Just as banks must make sure their remuneration structures do not foster prudential risk and consumer detriment, so you must make sure that your remuneration structures do not aggravate financial crime risk, and indeed that they militate against financial crime risks. People should be rewarded for doing the right thing – which might include turning away business – not just for the short-term income they generate. This will be an area of ongoing interest to the FCA.
And I say ‘short term’ advisedly. That income, whether from mis-selling or financial crime, comes with a poisoned tail.
The events of this summer have made that clear – if it wasn’t already. Banks are still picking up the tab for behaviour that took place five or ten years ago. All the more reason, surely, if you have the long-term interests of your own institution at heart to be fully getting to grips with questions of culture and incentives now.
It is in all of our interests, as members of the public, to see financial crime tackled, to prevent dirty money being laundered, to ensure those who are prepared to break the law for their own benefit are punished. The FSA, and the FCA, are committed to playing our part in that. We expect you to do so too and look forward to working with you to achieve that.
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