Financial crimes around the world

Financial crimes around the world


1)        Introduction

When you think about the word “crime”, what does it usually remind you of? Murder, theft or assaults? But today, we focus on the topic of financial crimes. This article will be depicting the importance of knowing the types of financial crimes being done around the world, followed by the solutions.


So what is a financial crime? There isn’t a definite or distinguishable definition set by the studies but generally speaking, we define financial crime as “crimes that used financial companies or board of directors of the companies as intermediaries that brought great disorder in the financial market sectors” and such financial crimes talked about here should be fraudulent accounting or manipulating stock quotations.


Indeed all the financial supervisory services around the world are putting a lot of effort on prevention of financial crimes but among them, United Kingdom seems to be putting extra effort than the others. United Kingdom has set one of the 4 main goals of FSA (Financial Services Authority) as downsizing the rate of financial crimes in U.K. In U.K’s capital markets act, the law strictly elucidates that if a financial crime is related to the following three deeds, than the action is considered as a financial crime.

The followings are

  1. Financial fraud or dishonesty
  2. Making an improper use of information related to the financial sectors
  3. Handling of the proceed derived from the financial crimes


2)        Cases (Foreign and Korea)

  1. International Cases

On the day of February 2005, one of the world’s most renowned investment banks, Barings went bankrupt. It was all because of Nick Leeson. Nick Leeson felt strong interest in the derivative securities which eventually led him to join Barings. In the year of 1993, Leeson alone earned 20% of Baring’s revenue which earned him considerable credit from the board of directors (BOD). With more power in his hand, in the year of 1995, he gambled on Japan’s Nikkei Stock Average Index. However, his sole decision left 1.3 billion dollars loss behind because of an earthquake in Kobe, Japan and the change of American bank-rate policy. Leeson was sentenced 6 years of imprisonment under the charge of fabrication of financial documents and frauds. Finally, the 232 years of Barings Bank was sold at a dollar to ING Corporation.

The financial experts indicate several problems from the Barings’ case.

1)      Failure of internal control

2)      Conflict of segregating the function duties

3)      Failure in regulating an excessive position

4)      Lack of cognition of the board of directors


  1. Domestic Cases (Korea)

On November 11, 2010, directors from Deutsche Bank’s Hong Kong and Korea branches have plotted conspiracy to earn unfair profits. This incident is called the “Option Shock” or “11.11 Option Shock”. So how did they earn excessive profits? A director from Korean branch and three directors from the Hong Kong branch, under mutual consent, have agreed to sell the securities holdings right before the closing session of the trading. As a result, 2.79% of price index of stocks dropped temporarily. This is not the end; the Hong Kong branch purchased put-options and exerted these put-options to earn 448 million won.


The situation of Busan Savings Bank

In February 2011, 15 Korean savings banks including the Busan Savings Bank underwent suspension of business. Since this report is focusing on financial crimes, let us take a look at the financial crimes done by the savings bank, especially the case of Busan Savings Bank.

  1. Evading the bounds of credit grants and investor’s loan regulation by establishing SPCs (special purpose companies)

–          The bank has established a number of SPCs, by borrowing the names of their acquaintances and employees. These SPC with its subsidiaries, have granted loan of 4.6 trillion won.

  1. Establishment and expenditure of watered stock.

–          The bank has spent 130~150 million won annually under the pretext of operating expenses and wages of BODs affiliated with the SPC.

  1. They have concentrated on 120 development and constructional industry-based businesses rather than focusing on their inherent banking business.

–          Have invested 4300 million won building a new airport in Cambodia

–          Have invested 3000 million won in a resort and shipbuilding industry.

–          Illegally loaned 1200 million won to a charnel house without a proper business license.


3)        Conclusion / Evaluation

There are numerous other cases related to financial crimes such as the account book fabrication of Enron. But even from the cases mentioned before, you probably have already felt the importance of internal control and supervisory regulation of the banks. In order to prevent these crimes, we need to have a better understanding and recognition to detect loopholes and weaknesses of the derivative securitized products and the market. The financial supervisory agencies around the world should become more vigilant.


Moody’s Credibility Degradation of World’s Renowned IBs.


Moody’s is one of the world’s most credible and renowned credit-rating agencies. Their reports indeed, are not conclusive or definite but are quite trustworthy and also have spread effect in the world of finance. Before getting into the point, let us take a look at brief information about Moody’s and their elaborate rating system grids. Not a lot of people would have known, the Moody’s corporation we usually talk about has its genuine name which is Moody’s Investor’s Service (MIS). Moody’s Investor’s Service is the actual division that does the bond credit rating and so on. They also provide international financial research on bonds and credits issued both in commercial entities and governments. Moody’s is considered one of the world’s big three credit rating agency with Standard & Poor and the Fitch Group.


The Credit Rating Grid of Moody’s Investor’s Service    

 According to Moody’s, the purpose of the rating grid system is to provide investors with a simple system of gradation by which future relative creditworthiness of securities may be gauged. The numerical modifiers show the creditworthiness of each securities. Lower the number, the higher-end the rating. The Credibility Degradation On the day of 23, June, 2012the global financial world was drained in chaos. Moody’s Investor Service has announced 15 investment banks’ credibility to be dropped. The renowned banks such as Goldman Sachs, Citigroup, Deutsche Bank, Credit Suisse Bank, Royal Bank of Canada and Bank of America is also included among the list. Credit Suisse’s credibility has dropped 3 phases from Aa1 to A1 and Goldman Sachs and other 10 banks have dropped 2 phases, and lastly Bank of America showed radical depreciation of 4 phases. So what would be the core reason of these massive and firm-looking banks’ credibility degradation? Moody’s official stance of radical degradation seems to be quite reasonable but at the same time, hard to believe. Their official reason is that as the 15 banks mentioned, have been investing in a random way in the capital markets, which have lead them to excessive riskiness. In addition, due to the European financial crisis that rooted from Greece, their long-term profitability and growth are depreciated. But the biggest problem coming up-head is that Moody’s emphasized that the degradation process is not yet finished. This means that there can be more degradation done, depending on the sudden changes and situations the banks and financial markets will undergo.

Jack Ablin from Harris Private Bank has left a message for the investors around the world. In his massage, he strongly recommends to avoid investing in banks, until you will be able to see stability in economic sectors. But by evaluating the current situation, it will take quite a long time for both the banks and the financial markets (especially the EU crisis) to be recovered. Evaluation / Conclusion Ever since Merrill Lynch and few other worlds’ renowned banks went bankrupt, there had been numerous warnings on banks that they should be very precise and rationale on their investments. The IBs are following short term interests rather than looking for investment stability in a long-run. In case of Korea, as the revised proposal of the Capital Markets Act by FSC gets legislated, Korean commercial banks will be able to turn into an investment bank as they suffice certain level of capital ratio. FSC (Financial Services Commission), in cooperation with Financial Supervisory Service (FSS) is providing numerous capital regulations and policies to make prudential financial companies.

Revised Proposal of Capital Markets Act

Reasonably, the biggest issue rising as a hot potato in the Korean financial circles is legislating the revised plan of the Financial Investment Services and Capital Markets Act (also known as the Capital Markets Act). The Financial Services Commission had finally announced on the day of May 11, 2012 that it will re-legislate Capital Markets Act as soon as the 19th National Assembly will be held. FSC has made clear that the revised plan they are currently pursuing is not a fixed version from the one that they have submitted to the 18th National Assembly, as it will take time to revise the plan once again. This hurry signifies that legislating the revised version of Capital Markets Act is quite urgent. Once the proposal gets through the National Assembly, the act will be in operation within 3 months.

The revised plan is generally being composed of 4 distinctive areas. The main goal of this plan is to use currently operating financial regulations appropriately meaning to ban the needless and propel or add effective ones.

  1. Invigoration of Financial Investment Industry.

First part is on the invigoration of financial investment industry. After the global financial crisis Korea indeed, has been a bit careless on the domestic investments. But the revised plan, to make a vital financial investment environment, is focusing on domestic banks and financial companies by allowing them to launch new businesses and aligning the personal net worth. Also, the proposal is pursuing world-class asset management regulating system by reforming regulatory systems of public offering funds, trust businesses and rationalizing of hedge funds and private equity funds. In the case of PEF (Private Equity Funds), CBs (Convertible Bond) and BW (Bond with Warrant) will be allowed as a method of investments because of this revision, small and medium sized companies will be able to supply their funds without collaterals.

The key point of the first proposal is to promote and nurture Korean-styled investment banks. Market of asset management seems to be growing day by day. Korean banks are claiming to act as an IB, but their equity capital is 1/30 of prominent IBs like JP Morgan and Goldman Sachs for that, they failed in risk-taking and provided investors with financial instruments with no differentiation. So basically all they focus on currently is commission from investors by enticing them. Standing member of Securities of Futures Commission, Hong Yong Man has said that as the revised plan gets legislated, by June, 2013 we will be able to see approximately 5 investment banks.

A security company with equity capital of 3 trillion won will be qualified to act as an IB. The Diagram on the left shows current equity capital of top 10 security companies of Korea. It seems that as the revised plan of capital market act gets legislated, some of them will be able to act as an investment bank soon enough. The public sentiment’s attention is being amplified as it expects to see the “Korean Goldman Sachs”. An investment bank can practice M&A (Merger and Acquisitions) or make an enterprise loan directly and even trade stocks. FSC has announced that it will apply same loan rate of commercial banks (according on Basel standards) and also reduce NCR. NCR is commonly known as BIS ratio of security companies. The ratio is calculated by dividing liquid equitable capital with total risk values.


  1. Direct Investing and Internal Stability of General Meetings of Shareholders.

Second proposal is mainly compromised of two distinctive parts which are vitalizing direct investments of the enterprises and building up the internal stability of general meetings. Firstly, let us take a look at the direct investment part. To attract investments, diversification of financing is needed. The reason why FSC has admitted conditional capital and independent warrants is because there had been endless demands from the enterprises that they limited access on procuring capitals. The typical example of conditional capital is reverse convertible debenture. RCD is a bond that is being automatically transferred to a security when one had set specific grounds at the issuing time. For example, when a bank’s equity capital rate goes below against specific Basel regulating standards, the bond automatically is converted to a security. With conditional capitals, the company will be able to expanse capital and get ready for the critical situations. Next, the independent warrants. An independent warrant is a claim that can ask the quoted (public) company to issue new stocks with a price set beforehand. According to the Korean commercial law, currently only six types of corporate bonds are allowed but with these 2 bonds, corporations will be able to deliver funds a little bit easier and in a compact way. Also, Financial Commissions Service is considering implying crowd funding to the Capital Markets Act under their jurisdiction in the future. Crowd Funding, to simply put is a technique of gathering funds from the public (crowd). [1]It is also called social funding as it actively makes use of social networking services such as Facebook and Twitter. Usually crowd funding is used by artists or social activists by posting on their composition or social welfare projects but FSC is considering this technique to be used on initially starting companies to gather up funds in small sizes with investment contracts. Crowd Funding is a technique benchmarked from U.S’s JOBS law which is to support fledgling companies with funds.


The Second part is on the internal stability of shareholders’ general meetings. The thing we need to notice here is the shadow voting. Shadow voting is a policy that had been introduced in the year 1991 in Korea in order not to disband the general meetings as it might face lack of a quorum. It allows the stockholders to exercise their rights without actually attending at the general meetings but as there had been numerous drawbacks pointed out that this policy has been used as a quorum of small number of board of directors and majority shareholders to reinforce their management rights without encouraging minority shareholders to participate. So with the revised plan of the capital market act, from the year 2015, shadow voting will be legally banned. With this act, minority shareholders’ authorities will be strengthened and electronic voting system will be settled down.


  1. Reformation on Infrastructure of the Capital Market

The third part is mainly focusing on reforming the infrastructure of the capital markets. This proposal is to adopt ATS (Alternative Trading System) and Stock Exchange Market (Ex. KRX). To tell the truth, most of the (marketable) securities, derivatives and stocks are traded through HTS (Home Trading System). So why is the FSC trying to vitalize ATS AND SEM? First reason would be that current monopoly system of KRX’s international competitiveness looks infirm compared to the internationally renowned ones.

The biggest merit of the Stock Exchange Market is that is has the power to surveillance of the market. Insider trading and stock-in-trade manipulation would be the most widely known unfair trade practices. Unlike the Stock Exchange Market, the ATS is a small exchange market without the capacities of market surveillance and stocks’ listing. In other words, ATS is focused on sales only. Since it only focuses on the trading (sales), it can reduce the costs (commissions), improvements in services and has the merit of high speed. This revised plan of the act is proposing that the ones that have minimum value of five hundred million won of personal net worth and each stockholder should hold at least 15% of the shares (with the permission of FSC, 30% possible), will be permitted to establish ATS. Also, if the scale of ATS grows up, and certain billing is set, then changing over to a Stock Exchange Market is possible. But because the scale of Korean financial market is too small compared to the foreign ones, dividing the market into ATS and SEM will be dangerous as dispersion will happen. FSC’s stance is that they will carefully observe the situation. Lastly, the adoption of CCP catches the sight. CCP (Central Counter Party) is a service for the products being traded in the face-to-face market in order to settle based up on an open account but with the revised plan of the act, CCP will be provided also to the derivative products being traded in over-the-counter markets. So in short, the transactions made in OTC will be handed over to CCP to be provided with settling service. At the Pittsburg G20 Summit in 2009, it has been agreed that all standardized over the counter derivatives should be traded through stock exchange market or electronic trading platform and lastly, liquidated through CCPs, until the year of 2012. This is another reason why adopting these policies mentioned above has been a bit accelerated.

  1. Alleviation of Regulatory Effectiveness on the Protection of Investors

Last part is on the alleviation of the regulatory effectiveness on the investors’ protection. In short, it focuses on advancing the system of regulating the unfair trades. According to this proposal; manipulation of market price using the over-the-counter market derivatives and disturbing the market orders will be strictly prohibited. Also, penalties and monetary restrictions will be introduced. Lastly, to protect innocent investors, there will be reasonable improvements on policies of buyout and public announcements. In scope, FSC is pushing ahead policies like normalizing the IPO (Initial Public Offering) market as scale of IPO or revising the policy of petty public offerings.

The Capital Markets Act indeed also has pros and cons but by looking at the current situation of Korean financial industries. By borrowing sayings from the actual participants in the industries and looking at the problems currently being occurred, it seems that Capital Markets Act is a must needed law for the financial market. As seen from above, the revised version contains many fixations and newly pursued policies that could cover up currently ongoing problems. Yes, possibly, other unsuspected conflicts can be occurred, but FSC, together with FSS is constructing a system that gives real-time alerts which will eventually lead to prompt measures. The revised proposal will be appraised as soon as the 19th National Assembly to be in session. I sincerely hope that the revised plan could offset the issues raised by the current Capital Markets Act, and also see the Korean financial companies to advance as world’s renowned ones. As soon as the revised proposal of Capital Markets Act gets legislated and take effect in 3 months, the related institutions, government and we too will have to monitor with close approach to see future prospects.