The SEC and Libor

Securities and Exchange Commission (SEC)

Accounting Irregularities and Missing Internal Controls in the LIBOR Currency Manipulation Scandal

The London Interbank Offered Rate, or Libor for short, was the recent subject of collusion between some the world's largest banks to manipulate the exchange rates; no one seems to know for sure when these banks began to manipulate the exchange rate, but some reports show these activities beginning in 2003, or possibly much earlier (McBride, Alessi, & Sergie, 2015). The Libor rate represents a benchmark interest rate in which banks lend to each other in London interbank market. The exchange rate is calculated daily and determined by a submission of eleven and eighteen banks who submit their average borrowing rates for the day.

The Libor rate was considered to be a fairly reliable benchmark for determining an amount of interest that was used in determining short-term transactions and this rate had indirect implications for a wide range of international economic implications around the globe. For example, hundreds of trillions of dollars in securities and loans are based upon the Libor published rate which included everything from government and corporate debt to auto, student, and mortgages (McBride, Alessi, & Sergie, 2015). This analysis will look at the role of the bank's external auditors and their negligence in the oversight of internal controls in reference to the Libor rates that UBS offered.

Banks, Libor, and Auditors

The Libor rate was manipulated upwards or downwards for a variety of different reasons with collaboration from the banks who were responsible for providing their bank's average rate in which they borrowed money. For example, traders at Barclays would coordinate with other banks to alter the daily rate downward by telling Libor calculators that it could borrow money at relatively inexpensive rates to make the bank appear less risky and insulate itself (McBride, Alessi, & Sergie, 2015). However, there was not one bank alone that really had the opportunity to significantly sway the rates since the rates were based on averages from a number of different banks.

The fraud was perpetrated by individuals within the banking networks that worked together daily a close knit network that evolved, and in which a small group of people effectively had the opportunity to influence the Libor rate. For example, at the Swiss bank UBS at least 2,000 requests for "inappropriate submissions" to the key rates were documented and at least 45 individuals "including traders, managers and senior managers were involved in, or aware of, the practice of attempting to influence submissions," the FSA reported and feared every one of those submissions was potentially suspicious (Treanor, 2012). For example, on 18 September 2008, a trader explained to a broker (Treanor, 2012):

"if you keep 6s [i.e. the six-month Japanese yen Libor rate] unchanged today ... I will fucking do one humongous deal with you ... Like a 50,000 buck deal, whatever ... I need you to keep it as low as possible ... if you do that ... I'll pay you, you know, 50,000 dollars, 100,000 dollars ... whatever you want ... I'm a man of my word"

UBS, one of the largest issuers of structured notes in the world, agreed to settle the SEC's charges that it misled U.S. investors in structured notes tied to the V10 Currency Index with Volatility Cap by falsely stating that the investment relied on a "transparent" and "systematic" currency trading strategy using "market prices" to calculate the financial instruments underlying the index, when undisclosed hedging trades by UBS reduced the index price by about five percent (SEC, 2015):

"This first-of-its-kind case involving misstatements and omissions by a structured notes issuer shows that the SEC continues its commitment to pursue wrongdoing across the securities industry in order to better protect investors," said SEC Chair Mary Jo White. "It is critical that large global financial institutions have and implement policies and procedures designed to ensure that all facts relevant to investors are made known to individuals responsible for disclosures."

Among the various sections of the guilty plea settlement that USB entered into, the U.S. DoJ required that the bank strengthen their internal procedures, beyond the fines they were ordered to pay, which were as followed (Debevoise & Plimpton, 2015):

In connection with the FCA settlement, the Settling Firm must conduct an audit of the following areas to ensure its culture, governance arrangements, policies, procedures, systems, and controls are appropriate and adequate to effectively manage specific risks with respect to the FX business: (i) front office culture; (ii) the adequacy of the first line of defense (i.e. the risk and control environment relating to daily operations, including monitoring of traders' activity and conduct); (iii) the adequacy of the second and third lines of defense (e.g. compliance, audit, risk); (iv) the adequacy of the challenge of risk management by the second and third lines of defense; (v) the role and appropriateness of financial incentives and performance management; (vi) the adequacy of training for the specific relevant business area; (vii) the adequacy of communications monitoring and surveillance; (viii) the adequacy of the management of conflicts of interest; and (ix) benchmarks, whether trading, judgment, or submissions based, which fall within any of these business areas. If this audit identifies any areas requiring improvement, the Settling Firm must implement appropriate remedial action.