$200 Billion in Bank Scams

Level 3 - Virgin DeFi Analyst

Sep 20, 2022

Welcome Avatar! Recently we spoke with a friend who likes to follow the crypto space but has some harsh critiques. None of these critiques are new, of course.

“Most things are a scam” “Things get hacked” “Money laundering”

When people say these things, they tend to look at crypto in isolation and completely ignore what goes on in the rest of the world. You cannot look at crypto in isolation. There are bad people and bad businesses in every single industry. For the sake of brevity, we should compare these criticisms of crypto to its closest competitors - the banking and finance industries.

Both critics and lawmakers seem to have no problem turning a blind eye to the problems plaguing the traditional finance sector while overly penalizing crypto for the same things at a smaller scale.

We obviously do not support scams or money laundering. Instead, we think some of the primary critiques of crypto are largely unfair in the context of activity in comparable sectors.

In fact, there has been so much fraud and malpractice in the banking industry for the entire history of its existence that it was quite challenging to narrow the list down to our list of “favorites”.

Wells Fargo Fraud

You’ve likely heard of the Wells Fargo fraud from years ago, at least in passing. Wells Fargo is the fourth largest bank in the U.S.

In 2020, Wells Fargo agreed to pay $3 billion to resolve investigations into their business surrounding the creation of fraudulent customer accounts to boost sales.

This bank scam went on for 14 years, from 2002 to 2016. The Department of Justice states that executives pressured employees to achieve unrealistic sales targets over this period which drove them to sign their customers up for fake accounts and products at the bank.

Some of the unlawful conduct included:

Fraud
Identity Theft
Falsifying bank records
Selling product of no value to the customer

The employees of Wells Fargo under the direction of management would open checking accounts, savings accounts, debit cards, credit cards and more on behalf of unaware customers. This would involve forging customer signatures, moving money from customer accounts to other accounts, opening random credit cards and changing customer contact info.

This is the best part: “The top managers of the Community Bank were aware of the unlawful and unethical gaming practices as early as 2002”

The most senior people at the bank wanted the bank’s employees to commit fraud at scale and got away with it for well over a decade. As part of the settlement Wells Fargo admitted to wrongdoing. However, the bank paid the $3 billion bill and basically nothing bad happened to the executives beyond fines.

So Wells Fargo commits fraud for 14 years seemingly at the behest of its most senior staff, consumers get defrauded, the bank pays $2.5 billion to the DoJ and $500 million to the SEC to be distributed to investors.

A small handful of executives were fined. Namely, the former CEO John Stumpf was fined $17.5 million leaving him with the measly $60 million he earned at the bank and his $22 million pension. These were the other executives fined:

Source: https://www.occ.gov/static/enforcement-actions/eaN20-001.pdf

Interestingly, the Board of Directors seems to have been entirely cleared of any neglect and wrongdoing (although most resigned). We find it quite strange that this widespread scam could go on for 14 years and no one on the Board of such a large and important company knew. So strange that it’s practically unbelievable.

While digging into this story some more, we came across an entertaining video that highlights Wells Fargo’s history. The bank appears to have a long history of scamming their customers, dating all the way back to the original founders almost 200 years ago

Market Manipulation - “It’s a cartel now in London”

Crypto has its fair share of pump and dump scams. We all know this. If an influencer is shilling a token he must have been given an allocation / money to promote it or loaded up beforehand. Nothing new so far.

While small-time scammers might be able to manipulate some altcoin pairs on Uniswap with some tweets, this isn’t too different from the rampant ‘penny stock’ scams in the past (as memorialized in the Wall Street film “Boiler Room” over 20 years ago).

At least in the case of the manipulation of stocks and coins, investors have a choice not to believe slick snake oil salesmen promising big returns. You can “opt out” by not buying.

But when the prices of the largest, most essential markets in the world are systematically manipulated for profit by huge banks who believe their worst case is disgorgement of profits and sacrifice of some mid-level staff *if* they are caught, you can’t opt out.

This behavior harms honest investors and everyone who participates in the global financial system. We’ll cover a well known example which reads like a Michael Lewis book, except these events actually happened.

Interest Rate Manipulation (LIBOR)

This is the most serious as the price of money affects every entity which uses debt, including governments, businesses and most individuals.

The British Banker’s Association published a daily aggregate of the (self-reported) short term borrowing costs of major banks, known as the London Interbank Offered Rate. This rate affects the price of business and consumer loans, mortgages, and some student loans. Several hundred trillion dollars of derivatives are linked to LIBOR.

Between 2003 and 2012, a number of global banks including Deutsche, Barclays, UBS, Rabobank, and the Royal Bank of Scotland submitted false information about their borrowing costs.

Why would they do this? During the financial crisis, banks wanted to shore up their perception of creditworthiness and would have at times felt it beneficial to under-report their true borrowing costs to feign a stronger financial position.

But the main motivation pre-crisis was to profit from derivatives positions. The scam was to trade a huge quantity of interest rates derivatives and then nudge the underlying market in a direction which improved the profitability of those positions by reporting false borrowing costs.

swaps traders often asked the Barclays employees who submitted the rates to provide figures that would benefit the traders, instead of submitting the rates the bank would actually pay to borrow money

Barclays admitted to misconduct and paid $425 million to settle regulatory proceedings in 2012. Ex-UBS and Citibank trader Thomas Hayes was convicted and sentenced to 12 years in prison for rigging LIBOR rates while colluding with traders at Royal Bank of Scotland who were doing the same. RBS paid GBP 390 million to settle connected regulatory proceedings.

"I acted with complete transparency to my employers. My managers knew, my manager's manager knew. In some cases the CEO was aware of it," Mr Hayes told the court.

Another bank trader described the collusion between bank rates traders as ‘a cartel’.

We haven’t heard about any managers or C-level execs being jailed for LIBOR rigging.

How Does DeFi Solve This?

An oracle could inspect a DeFi lending market to report the true average borrowing cost in a way which is proven to resist tampering. Derivatives contracts based on this oracle could therefore not be manipulated in the way that the LIBOR based contracts were. Transparency and verifiability removes manipulation risk.

Money Laundering

You’ll often read from critics that crypto is a haven for money launderers, criminals, terrorists. Most recently the White House claimed that DeFi has been used to finance the “proliferation of weapons of mass destruction”.

Implied in the critiques of DeFi’s attempts to build financial privacy is the assumption that regulated financial services providers are able to effectively counter criminals. This simply is not true.

Here are some well known examples where banks failed to follow the anti-money laundering laws, with the implication that criminals were able to evade detection.

Capital One’s check cashing group failed to report suspicious activity despite knowing that some of its customers, including an organized crime syndicate, were facing criminal charges. Despite warnings from the regulator, Capital One failed to prevent money laundering and was fined $390 million.

Last year global bank HSBC was fined $85 million by the London regulator for continuing failures in its transaction monitoring systems. In 2012, the bank paid $1.9 billion to US authorities to settle allegations including failure to detect $881 million in drug trafficking proceeds being laundered through the bank.

Australia’s second biggest bank Westpac paid $920 million for breaches of money laundering rules, including failing to spot transfers suspected to be linked to child trafficking in Asia, and international terrorism. The bank failed to report 19.4 million international payments to regulators during a 5 year period.

We’re also told that crypto enables tax cheats.

Source: CNBC article “Cryptocurrency poses a significant risk of tax evasion”

Israel’s Bank Hapoalim paid $904m in penalties to settle a probe into its facilitation of US tax evasion and a money laundering scheme linked to grandees of an international soccer association.

There is a long history of banks and their wealth management arms implicated in facilitating customer tax evasion through offshore accounts e.g. the 2008 Liechtenstein tax affair.

Although it is useful to law enforcement to be able to access financial records of suspects, this does not prevent or deter the vast majority of serious and organized crime. It simply imposes costs on less sophisticated criminals and has resulted in a cottage industry: “money laundering as a service”.

How Does DeFi Solve This?

We would argue that on-chain records offer a superior ability for law enforcement to track criminal activity, as identities can often be associated with wallet addresses. And. Monitoring the on and off ramps to crypto remains effective.

Others agree.

Gartner predicts that criminal use of cryptocurrencies will drop 30% by 2024.

Law enforcement departments including the FBI, Secret Service, and the IRS are reported to have large budgets to invest in blockchain surveillance. A proxy for law enforcement activity is legal requests to exchanges. Coinbase reported 5,562 law enforcement requests in Q1-Q3 2021, up from 1,197 requests in H1 2020.

Law enforcement requests to Coinbase, by country

Conclusion

The main takeaway is that money is inextricably linked to criminal activities.

Better Markets examined 430 legal actions against the top 6 US banks over the last 20 years and discovered ~$200 billion paid in fines. The alleged conduct describes almost every type of financial crime: fraud, money laundering, bribery, Ponzi schemes, market manipulation, even violations of election law!

Follow the link under the graphic to read the full report.

Source Wall Street Rap Sheet report by Better Markets

Large, centralized institutions are opaque and amass the political power to operate at scale, with impunity, for years, and affecting all users of the financial system. Rather than being mere passive conduits for illicit activity, banks have been repeatedly willing to break laws to boost profit. A proven failed model.

Blockchain based financial networks are inherently transparent and technology can help prevent abuse. Financial crime isn’t a good reason to avoid using or investing in DeFi. Oracles and public ledgers can prevent some forms of market manipulation.

There has never been a credible argument that DeFi-facilitated financial crime is worse in scale or degree compared with the traditional financial system. And. There are signs that crypto is becoming harder for criminals to use, something which can’t be credibly stated about banks based on the information above!

What’re your favorite bank scam stories? Let us know in the comments.

If you’re tired of bank scams like we are, join DeFi Education below for more insights on the world of crypto.

Sources: To All News Articles

New York Times - Libor Scandal

BBC News - Libor Tom Hayes

Bloomberg - RBS Libor

WSJ - HSBC Money Laundering

News.com.au - Austrac Scandal

Times of Israel - FIFA Bribe Scandal

Gartner - Predicts Crypto Crime to Decrease

Coinbase Transparency Report

Better Markets - ix biggest banks $1B in fines

Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds.