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When a regulator throws a bank up against the wall, frisks them and pulls 60,000 illegal transactions  worth $250 billion out of their pockets, you know someone will scream bloody murder.   Threaten to close down an illegal operation that generates $190 billion a day in transactions, and people will soil themselves.

Last week, most of the world's attention was focused on the Olympics in London.  But another drama was playing out in London's financial district.  While people were all excited about the feats of their favorite athletes, lawyers and government agencies on both sides of the Atlantic were having fits for entirely different reasons. The problem was a major London bank, Standard Chartered (STAN.L), got hit with criminal charges by banking regulators working out of an obscure agency's office in New York's financial district.  

How serious are these charges?  What right do these bureaucrats have to level them, in the first place? What regulatory agency would dare do this?  Why is this such a big deal? Why are The US Federal Reserve and the US Treasury Department screaming at the regulators?  

And who the hell is Benjamin Lawsky, anyway?

Let's  take the last question first. Benjamin Lawsky is the Superintendent of the newly created New York State Department of Financial Service (DFS).  Lawsky has been around for awhile, but now he is going to be getting a lot more attention.  A lot of that attention is going to be very unfriendly.  The reason he will draw serious fire is simple.  Last week he filed an ORDER PURSUANT TO BANKING LAW § 39  (caution PDF).  Many of the charges leveled against SCB mirror the charges against other banks recently in the news, notably HSBC.

The difference here is the NY DFS does more than merely seek a fine like the $700 million HSBC agreed to pay to clear up charges against them for similar wrong doing.  DFS went much farther.

Big fines are no joke.  Criminals hate to part with their money, but when push comes to shove, professionals will ditch the loot confident they will get it back after the smoke clears and they get return to business.  A fine of $700 million sounds like a lot.  It is.  It's historic, actually.  But it takes on a whole lot less significance when you consider there is $250 billion in potentially criminal transactions under consideration here.  Even if you treble the damages, you are still looking at less than 1% of the total.  Who wouldn't engage in lucrative criminal activities if the worst that happens is you get nicked for 1% of the gross?  Benjamin Lawsky knows this, so he went for the jugular:

Pursuant to the statutory powers vested in him by the People of the State of New York, Benjamin M. Lawsky, Superintendent of the New York State Department of Financial Services (the “Department” or “DFS”) caused an investigation to be made of Standard Chartered Bank (“SCB”), a wholly owned subsidiary of Standard Chartered plc (“SC”), for apparent grave violations of law and regulation.

For almost ten years, SCB schemed with the Government of Iran and hid from regulators roughly 60,000 secret transactions, involving at least $250 billion, and reaping SCB hundreds of millions of dollars in fees. SCB‟s actions left the U.S. financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes, and deprived law enforcement investigators of crucial information used to track all manner of criminal activity.

Having determined that good cause exists, the Superintendent has directed SCB to: (1) appear and explain apparent violations of law; (2) demonstrate why SCB‟s license to operate in the State of New York should not be revoked; (3) demonstrate why SCB‟s U.S. dollar clearing operations should not be suspended pending a formal license revocation hearing; and (4) submit to and pay for an independent, on-premises monitor of the Department‟s selection to ensure compliance with rules governing the international transfer of funds.  [emph. added]

This is the financial equivalent of putting a loaded gun to the head of Standard Chartered.  If the NY DFS suspended their dollar clearing operation,it would wipe out $195 billion of business every day they are down.  Revoking their license means they simply would not be able to operate. It would deny one of the largest banks in the planet access to one of the busiest market in the world.  

Who is the New York DFS?  

The New York State Department of Financial Services was created by transferring the functions of the New York State Banking Department and the New York State Insurance Department into a new department. This transfer of functions became official on October 3, 2011.
What do they regulate?

According to published testimony:

DFS regulates and supervises the activities of nearly 1,700
insurance companies with assets exceeding $4 trillion, nearly 300
state chartered banks with assets of $2.1 trillion, and more than
1,600 licensed financial entities, including mortgage loan
In other words, if you conduct financial business in New York, DFS is the regulatory agency you answer to.  All fine and well, but what gives them the right to impose actual sanctions?   Note, they regulate and supervise.  The consolidation led to the formation of new divisions.  One division of particular interest:

1) The Financial Frauds and Consumer Protection Division is responsible for protecting and educating consumers and fighting financial fraud, by pursuing civil and criminal investigations. This unit has the ability to look at almost all financial services and products sold in New York.

So what is the financial fraud alleged here?  Basically, it is money laundering for Iranian banks to help European companies skirt the sanctions put in place against Iran.  If true, the allegations are breathtaking in their scope.

In its evident zeal to make hundreds of millions of dollars at almost any cost, SCB undertook a course of conduct that included: falsifying business records;
* offering false instruments for filing;
* failing to maintain accurate books and records of all transactions effected and all actions taken on behalf of SCB;
* obstructing governmental administration;
* failing to report misconduct to the Department in a timely manner;
* evading Federal sanctions; and
* numerous other violations of law that, as with the above, have an impact upon the safety and soundness of SCB‟s New York branch and the Department‟s confidence in SCB‟s character, credibility and fitness as a financial institution licensed to conduct business under the laws of this State.
False instruments for filing?  Cooking the books?  
Specifically, SCB ensured the anonymity of Iranian U.S. dollar clearing activities through SCB‟s New York branch by falsifying SWIFT wire payment directions. When SCB employees determined that it was necessary to “repair” unadulterated payment directives, they did so by stripping the message of unwanted data, replacing it with false entries or by returning the payment message to the Iranian Client for wire stripping and resubmission. Thus, SCB developed various ploys that were all designed to generate a new payment message for the New York branch that was devoid of any reference to Iranian Clients.
Ever heard the term "follow the money" when it comes to tracking down illegal activity?  One way they do that is by checking the data on the wire payments through the system known as SWIFT.  That is the system you use when you use Paypal to buy something on Amazon using a credit card issued through your bank.  That is the system that keeps things in check so everyone knows where the money is coming from and where it is supposed to go.  That way you buy the  stuff you want with your money and not someone else's.   Evading the system is difficult and why money launderers get paid handsomely for their work.  In this case, DFS has about 60,000 transactions where the bank handling the transaction cut the headers out so no one could track the money.  

Standard Chartered is claiming this is a clerical problem.  Which might make sense except that this was done manually.  Even more damning, what they did was designed to specifically subvert the automatic safeguards in the SWIFT system.  If you simply send a wire transfer hrough the system with no identifier, it gets flagged and certain fields automatically populated identifying the relevant banks. Have you ever sent a payment, provided the routing number and noticed the name of your bank was automatically provided?  In this case, that would have meant someone would look at it.  SCB came up with a work around:

SCB understood that simply omitting Iranian Client information on SWIFT MT 202 payment messages going to New York was insufficient because the electronic payment system would automatically fill in blank data fields, identifying the Iranian Client. Consequently, in order to disguise the transactions effectively and thereby avoid regulatory scrutiny, SCB made false and misleading entries in SWIFT “field 52,” a data field that would identify the Iranian party.
Most people use form MT 103, but banks can transfer to each other using the MT 202 form which has less identifying information on it.  But even that wasn't enough for them, they had to completely obliterate the trail to the Iranians, so they put in false and misleading entries into the relevant data field.  That certainly doesn't sound like a clerical error.  But it get's even more audacious.  They wrote a manual directing people on how to do this!
Senior SCB management memorialized many of these procedures in formal operating manuals. One such manual entitled, “Quality Operating Procedure Iranian Bank Processing,” directed SCB London employees to “repair payment[s] by making appropriate changes” to transacting party codes. It provided step-by-step wire stripping instructions for any payment messages containing information that would identify Iranian Clients. An example directive read: “[e]nsure that if the field 52 of the payment is blank or displayes [sic] any SWIFT code that it is overtyped at the repair stage to a „.‟ This will change the outgoing field 52 on the MT103 to a field 52D of „.‟ Or, in the case of a „normal‟ MT202 instruction change the field 52 on the outgoing MT202 to [SCB‟s New York branch] to a „.‟ (Note: if this is not done then the Iranian Bank SWIFT code may appear – depending on routing – on the payment message being sent to [the New York branch]).

 An instruction on that manual‟s cover stressed that “this procedure is a mandatory requirement” and that “[a]mendment is not permitted without prior approval of the Head of Cash Management Services UK Quality System.”
So, not only did they document how to commit fraud.  They made it clear anyone who wasn't committing fraud needed to get prior approval from one of the highest ranking executives in the bank.  This is not a rogue trading operation.  The whole damn bank is going rogue.  But it doesn't even stop there.  The bank became so good at this, they couldn't keep up with the volume of illegal activity!
These masking procedures evolved to meet SCB‟s growing volume demands. When SCB anticipated that its business with Iranian Clients would grow too large for SCB employees to “repair” manually the instructions for New York bound wire transfers, SCB automated the process by building an electronic repair system with “specific repair queues,” for each Iranian Client.
So let's pause for a second and consider where we are:  The bank is intentionally engaging in illegal activity.  It is training its personnel on how to engage in that illegal activity as a matter of routine operations.  The top management is aware of this.  They are so successful, they automate the process.   Surely, someone must have noticed this and said something.  

Of course, people noticed.  How are you going to hide hundreds of billions of dollars in illegal activity from your internal auditors?  One memorandum entitled "Business with Iran – USA Perspective" written by SCB‟s CEO, Americas  and sent to SCB‟s Group Executive Director for Risk, its Group Head of Compliance and its Group Head of Public Affairs warned they were going to run afoul of American banking laws.  The memo was explicit.

“Firstly, 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. [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.”
This generated a blistering response from SCB‟s Group Executive Director:
“You fuckng Americans. Who are you to tell us, the rest of the world, that we‟re not going to deal with Iranians.”
That was in 2006, years after other banks like Lloyds of London had dropped this kind of business for these very reasons.   What exactly was the problem from the US side? Financial transactions with Iran have been subject to U.S. economic sanctions since 1979. These measures were strengthened by Executive Orders in 1995, which set strict requirements for U.S. banks to follow in clearing U.S. dollar transactions with Iran.  

The US Office of Financial Assets Control (OFAC) is responsible for making sure all US financial institutions track their transactions so any money moving from, to, or through a sanctioned entity is caught and investigated.  If need be, the money is frozen until the investigation is completed.  This was clearly being subverted by SCB.

By 2008 it was clear that this system of wire transfer checks had been abused, and that U.S. foreign policy and national security could be compromised by permitting [the transactions] to continue. In November 2008, the U.S. Treasury Department revoked authorization for "U-Turn" transactions because it suspected Iran of using its banks to finance its nuclear weapons and missile programs. The U.S. also suspected that Iran was using its banks to finance terrorist groups, including Hezbollah, Hamas and the Palestinian Islamic Jihad, and engaging in deceptive conduct to hide its involvement in various other prohibited transactions, such as assisting OFAC-sanctioned weapons dealers.
So the volume of traffic was such that even with their internal efforts, SCB was not able to hide all the money.  No surprise.  A billion here, a billion there, eventually you are talking real money.  Not surprisingly, this wasn't the only dishonest thing they were doing.  In 2003, they were caught red-handed engaging in other activities.  This brought the Feds in:
By 2003, New York regulators had discovered other significant violations at SCB‟s New York branch, including deficiencies in its suspicious activity monitoring and customer due diligence policies and procedures. In October 2004, SCB consented to a formal enforcement action and executed a written agreement with the Department and the Federal Reserve Board of New York, which required SCB to adopt sound practices with respect to foreign bank correspondent accounts (the “Written Agreement”). The Written Agreement also required SCB to hire an independent consultant to conduct a retrospective transaction review for the period of July 2002 through October 2004. The review was intended to identify suspicious activity involving accounts or transactions at, by, or through SCB‟s New York branch.

SCB vowed to the regulators that it would comply with the Written Agreement.

The fact this continued for at least another seven years is clear evidence they had no intention of complying with anything "you fucking Americans" were going to insist on.   Not only does this show a pattern of wanton disregard and contempt for US laws, it also explains why Lawsky didn't inform the Federal Reserve and Treasury of this latest action.  Last time they had gotten a written agreement from SCB, it wasn't enforced.

There is more to the story and those interested can read the full ORDER PURSUANT TO BANKING LAW § 39  (caution PDF).  However, this brings us more or less up to date.  Now is the time to circle August 15th on your calendar.   That is the day Lawsky opens the next act of this drama.

IT IS NOW HEREBY ORDERED that, pursuant to Banking Law § 39, SCB shall appear before the Superintendent or his designee on Wednesday, August 15, 2012, at 10:00 a.m., at the Department's offices located at One State Street Plaza, New York, NY 10004, to explain these apparent violations of law and to demonstrate why SCB‟s license to operate in the State of New York should not be revoked; and

IT IS HEREBY FURTHER ORDERED that, on August 15, 2012, SCB shall also demonstrate why, pursuant to Banking Law § 40, SCB‟s U.S. dollar clearing operations should not be suspended pending a formal license revocation hearing; and

that, pursuant to Banking Law §§ 36 and 39, and Financial Services Law § 206(c), SCB shall immediately submit to and pay for an independent, on-premises monitor of the Department‟s selection, which will ensure that SCB‟s New York operations fully comply with all BSA/AML requirements. The monitor will also review the accuracy of SCB‟s books and records pertaining to the processing of wire payments from New York to U.S. sanctioned foreign jurisdictions that are either direct or ultimate beneficiaries of the transaction; and

that, any assessment of monetary penalties shall await a formal hearing to be scheduled upon further notice by the Superintendent.

If Lawsky makes good on his threat, one of the largest banks in the world is going to find itself locked out of the largest market in the world.  The entire British banking system will be shaken at its very foundation.   When such titanic forces come together, no one can predict how things will turn out.  But one thing is certain, this is going to be much more important than any silly "gotcha" distraction the corporate media decides to chase for the next few days.  

=== UPDATE =====

4:33 PM PT: If you got this far, you can appreciate that a story of this magnitude is long and complicated.  It took several days to distill it down to its essence for a general audience, so the magnitude of this behavior can be appreciated even without a banking background.   In the comments I wrote,"if this ends in a fine, the fix is in."

Well, this just came across the wires:

Benjamin M. Lawsky, New York Superintendent of Financial Services, issued the following statement today.

"The New York State Department of Financial Services ("DFS") and Standard Chartered Bank ("Bank") have reached an agreement to settle the matters raised in the DFS Order dated August 6, 2012. The parties have agreed that the conduct at issue involved transactions of at least $250 billion.

"The settlement also includes the following terms:

The Bank shall pay a civil penalty of $340 million to the New York State Department of Financial Services.

The Bank shall install a monitor for a term of at least two years who will report directly to DFS and who will evaluate the money-laundering risk controls in the New York branch and implementation of appropriate corrective measures. In addition, DFS examiners shall be placed on site at the Bank.

The Bank shall permanently install personnel within its New York branch to oversee and audit any offshore money-laundering due diligence and monitoring undertaken by the Bank.

“The hearing scheduled for August 15, 2012 is adjourned.

"We will continue to work with our federal and state partners on this matter."

THE BOTTOM LINE: The fix is in. The banksters are getting away with a fine that is about one tenth of one percent of the volume of illegal business that was indisputably transacted.   Even though I am thoroughly disgusted by this, I am going to keep this diary up as an indictment against our broken and corrupt system.  
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