For as long as anyone can remember, Bank of Nova Scotia took pride in running the country’s leanest bank. This week, that conscious decision to spend less than peers on its back office cost the bank a record US$127.5-million in fines for the violations it committed and a black eye in capital markets.
In the latest example of savvy and unscrupulous traders taking advantage of loopholes in their employer’s compliance and risk management systems – a theme that crops up consistently in financial services scandals – on Wednesday, Scotiabank settled criminal and civil charges over manipulative trading in precious metals markets that played out over eight years. More significantly, the bank agreed it misled Washington’s Commodity Futures Trading Commission (CFTC) and other U.S. federal agencies during their investigation.
The CFTC agreement makes it clear that as Scotiabank and regulators peeled back transactions done by four traders at offices in New York, London and Hong Kong between 2008 and 2016, they kept finding more evidence of illegal activity. The employees were “spoofing” investors by placing buy or sell orders on precious metals futures contracts that the traders never intended to execute, in order to move markets to their advantage. These fake or so-called spoof orders prompted investors to buy or sell genuine futures contracts to the traders, and that is how they made money for the bank.
Scotiabank’s earnings from precious metals trading amounted to pocket change at an institution that posted a $9.4-billion profit last year. The CFTC settlement – a record for such offences – requires Scotiabank to make a “disgorgement” of just US$11.8-million for what played out over eight years and US$6.6-million in “restitution” payments, with the rest of the US$127.5-million penalty reflecting the sanctions for “manipulative and deceptive conduct.”
It’s also clear that it took Scotiabank years to figure out what its people were actually up to, and that lack of supervision contributed to the record penalty and appointment of an independent monitor to keep an eye on Scotiabank’s operations for the next three years. In a news release, the CFTC said: “BNS’s compliance function failed to detect and deter the unlawful trading practices and that BNS’s compliance staff failed to act to stop the misconduct when they became aware of it.”
What’s striking about this situation – and must be hugely frustrating for Scotiabank executives – is that the bank tried to do the right thing by reporting this problem when it first became aware of the issue back in 2018. At the time, the bank paid a reduced penalty of US$800,000 and CFTC director of enforcement James McDonald said: “This case is another great example of the significant benefits of self-reporting and co-operation.”
However, two more years of regulatory digging unearthed multiple examples of the bank making statements to regulators that turned out to be false. The issue escalated – the investigation was no longer about what the traders did, it was about the bank’s failure to supervise its employees.
On Wednesday, CFTC official Joshua Sterling said: “BNS’s compliance and supervision violations highlight the need for all swap dealers to have the right tone at the top – plus appropriate programs and incentives in place – to instill a meaningful culture of compliance among their personnel.”
Since first reporting the spoofing issue in 2016, Scotiabank has doubled its annual compliance budget and hired more than 200 full-time compliance specialists. Chief executive Brian Porter, who had career-defining showdowns with traders over their hefty compensation when he ran the capital markets side of the bank, takes every opportunity to talk up investment in the bank’s systems and enhancements to its culture.
In a news release on Wednesday, the bank said: ”We understand that in order to maintain the trust of our stakeholders, we must adhere to trading-related regulatory requirements and compliance policies. We are committed to adhering to these standards.
That’s the universal lesson from Scotiabank’s tale of woe: In a successful financial services culture, the compliance and risk management teams are equal partners with the traders, fund managers and other revenue-generating staff, with everyone putting reputation before revenues.
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