LIBOR Scandal: SEC, UBS, and Failed Auditor Oversight

Introduction to the LIBOR Scandal

The London Interbank Offered Rate (LIBOR) was the recent subject of collusion among some of the world's largest banks to manipulate benchmark exchange rates. No one knows for certain when these banks began manipulating the rate, but some reports indicate these activities began as early as 2003, or possibly much earlier (McBride, Alessi, & Sergie, 2015). The LIBOR rate represents a benchmark interest rate at which banks lend to one another in the London interbank market. The rate is calculated daily based on submissions from between eleven and eighteen banks, each of which submits its average borrowing rate for the day.

The LIBOR rate was considered a fairly reliable benchmark for determining interest amounts used in short-term transactions, and it carried indirect implications for a wide range of international economic activity around the globe. For example, hundreds of trillions of dollars in securities and loans are based on the published LIBOR rate, including everything from government and corporate debt to auto loans, student loans, and mortgages (McBride, Alessi, & Sergie, 2015). This analysis examines the role of banks' external auditors and their negligence in overseeing internal controls with reference to the LIBOR rates that UBS submitted.

Banks, LIBOR, and the Mechanics of Manipulation

The LIBOR rate was manipulated upward or downward for a variety of reasons, with collaboration from the banks responsible for submitting their average daily borrowing rates. For example, traders at Barclays would coordinate with other banks to push the daily rate downward by telling LIBOR calculators that they could borrow money at relatively inexpensive rates, making the bank appear less risky and insulating it from scrutiny (McBride, Alessi, & Sergie, 2015). However, no single bank had sufficient influence to significantly sway the rates on its own, since the rates were based on averages submitted by multiple institutions.

The fraud was perpetrated by individuals within banking networks who worked together daily through a close-knit structure that evolved over time. 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" — according to the Financial Conduct Authority (FCA), which feared every one of those submissions was potentially suspicious (Treanor, 2012). On 18 September 2008, a trader communicated the following 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 and the SEC Settlement

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

"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. 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."

Conclusion

Ernst & Young served as UBS's external auditor throughout the LIBOR scandal as well as other questionable practices, yet the firm has not been implicated in any wrongdoing. As the auditor who signed off on UBS's accounting practices for all five years of the criminal activity in question, the firm was unable to surface any of the rampant criminality that regulators later documented in detail. The LIBOR scandal ultimately illustrates how the failure of both internal controls and external audit oversight can enable systemic financial fraud on a global scale, with serious consequences for investors and markets worldwide.

References

Debevoise & Plimpton. (2015, May 20). United States of America v. UBS AG. Retrieved from SEC: https://www.sec.gov/divisions/corpfin/cf-noaction/2015/ubs-ag-052015-506d.pdf

McBride, J., Alessi, C., & Sergie, M. (2015, May 21). Understanding the LIBOR scandal. Retrieved from Council on Foreign Relations:

McKenna, F. (2012, July 6). Where was auditor PwC when its client Barclays gamed LIBOR? Retrieved from American Banker: http://www.americanbanker.com/bankthink/where-was-pwc-when-barclays-gamed-libor-1050689-1.html

SEC. (2015, October 13). UBS to pay $19.5 million settlement involving notes linked to currency index. Retrieved from SEC: https://www.sec.gov/news/pressrelease/2015-238.html

Treanor, J. (2012, December 19). Two former UBS employees charged in U.S. over LIBOR. Retrieved from The Guardian: http://www.theguardian.com/business/2012/dec/19/ubs-1bn-libor-payments-to-brokers