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America’s financial system

Law and disorder

Financial institutions are vulnerable toinvestigation, prosecution and litigation from

every directionOct 13th 2012 | NEW YORK | from the print edition

A STAFFER at a federal agency says he is often asked how many entities investigate and

prosecute financial firms in America. The only short answer he can give is: “a lot”. Here’s a

longer one.

Some entities are obvious: the Securities and Exchange Commission (SEC); the Commodity

Futures Trading Commission (CFTC); the Office of the Comptroller of the Currency; the

Federal Deposit Insurance Corporation; and the Department of Justice (DoJ). Others are

less well known: the Office of Foreign Assets Control and the Financial Crimes Enforcement

Network are both part of the Treasury, for example. The Federal Reserve has gained newpowers and responsibilities under the Dodd-Frank act; it is also obliged to pour money into

the newly created Consumer Financial Protection Bureau. The Federal Housing Finance

Agency has filed lawsuits against banks for allegedly selling risky home loans to Fannie Mae

and Freddie Mac without proper disclosure.



Other departments with nominally different patches participate in prosecutions, too. TheDepartment of Housing and Urban Development, for example, had a hand in a $25 billion

mortgage settlement struck with big banks earlier this year. The Federal Trade Commissionis explicitly blocked from regulating banking, but it too has been involved with litigationconcerning the servicing of loans. Pensions are regulated by the Department of Labour.

Many of these entities have sub-departments that act independently of each other. One

bank in the recent past found itself under investigation by three separate offices of the SEC

(there are a dozen). The DoJ often works through its 93 regional offices. Historically,

financial wrongdoing was prosecuted out of the Southern District of New York, which this

week sued (San Francisco-based) Wells Fargo for allegedly “reckless” lending practices,

among other things. But other attorneys have elbowed into this patch, as has headquarters,

which has created a unit for financial crimes in Washington, DC. Any of these units can start

its own inquiries, as can Congress itself —witness its recent probe of HSBC’s involvement in

processing illicit Iranian and Mexican payments.

Beyond all these are parallel departments in state governments, each of which has an

attorney-general (cynically referred to as “Almost Governors”). Their statewide jurisdictionoverlaps with district attorneys, who are elected locally and are in no short supply—62 in

New York state, 58 in California, and on and on—as well as with various departments in

each state devoted to the regulation of banking, securities and insurance. Standard

Chartered’s recent $340m settlement over allegations of evading Iranian sanctions, for

example, was with the New York Department of Financial Services (DFS).

And behind them, of course, are private armies of lawyers, ready to march wherever there

is money. During fiscal year 2011 the SEC collected $414m in fines from large financial

institutions in America, according to NERA, an economic consultancy; settlements in class-

action lawsuits reached $1.5 billion during the 2011 calendar year.

The upshot is a deluge of paperwork. If banks once did banking, now they practise law.

Wells Fargo has lower legal costs than many of its rivals (see chart) but still receives around



300 state, federal and grand-jury subpoenas a week on average. Some are against the bank

itself, though many are legal orders pertaining to the suspected crimes of others. The bank

gets so many legal orders—5,000 a week in total—that it has two centres that work full-

time on processing them, one on the west coast, one on the east. A specific group works on

prioritising the bank’s response to subpoenas; a weekly call involving 25-30 of the more

senior people in the compliance division is designed to iron out problems that arise from all

these requests.

Given what went on during the crisis, it is no surprise that there is lots of litigation. But

financial institutions can be hit from multiple directions at once. Investigations into

allegations of LIBOR rate-fixing, for instance, already involve the CFTC, the DoJ, state

attorney-generals from Connecticut, New York, Massachusetts, Florida, North Carolina and

Maryland, and at least 30 serious civil litigants. A reported investigation by Eric

Schneiderman, New York state’s attorney-general, into tax strategies on the part of private-

equity funds could easily also fall into the purview of the Internal Revenue Service and the

SEC.

A cast list this varied requires co-ordination. There is a history of different government

entities working together to prosecute crimes. Some of this co-operation is practical; it also

reflects the legal principle of “comity”, a type of reciprocity that results in one legal

jurisdiction voluntarily deferring to another. Since the SEC is limited to civil charges, it often

refers cases to the DoJ. Investigations into terrorist finance, sanction evasion and money-

laundering have traditionally been in the remit of the Manhattan district attorney.

But as the Standard Chartered case showed, when the DFS brought its charges unilaterally

and secured a rapid settlement with the bank, co-ordination between agencies is not

guaranteed. Indeed, the DFS’s success in collecting $340m may sharpen the incentives to “prosecute by press release”, if only because the rewards for being the first to file can be so

great.

A settlement with one regulator, moreover, does not mean settlement with them all. In

theory, American law discourages double jeopardy—being prosecuted twice for the same

crime. But in practice this does not apply to civil cases, or to cases prosecuted in different

systems (ie, federal or state)—a distinction often misunderstood, says David Aufhauser, an

attorney with Williams and Connolly and a former Treasury official. Standard Chartered is

still being investigated by state and federal agencies over its Iranian payments. Many banks

involved in the mortgage settlement in February with an array of federal departments and

state attorney-generals are still enmeshed in litigation; California’s new “Homeowner Bill of

Rights” has created the opportunity for more.

Unsettled

When Eliot Spitzer was New York’s attorney-general, he justified this prosecutorial

marketplace by arguing that it lit a fire underneath dozy regulators. But it is hard to argue

that the current set-up serves justice. Since an indictment against a financial institution can



lead to a suspension of its licence, and open the door to private litigation, firms often

choose to settle when an investigation is launched. According to NERA, in the course of

fiscal year 2011 and the first half of fiscal year 2012, the SEC reached 13 settlements of

$5m or more with big financial firms. All were announced on the same day the SEC filed its

complaint.

A settlement often suits the authorities as well as the banks. Fines are frequently used to

fund government budgets; and many a political career has been launched on the back of a

high-profile deal, without the need to prove allegations in court.

This cosy alignment of incentives worries some. If an institution has committed an offence,

a settlement mitigates the risks of harsher penalties. If it has not done anything wrong,

shareholders are paying up to get prosecutors off their backs. Oklahoma’s attorney -general,

Scott Pruitt, was the only one of his colleagues not to participate in the national mortgage

settlement earlier this year. Mr Pruitt said it had nothing to do with genuine fairness or

justice, rewarded bad behaviour and reflected an illicit expansion of regulatory power.

The courts themselves have also voiced concern—particularly about how cases are settled

through back-room negotiations. “An application of judicial power that does not rest on facts

is worse than mindless, it is inherently dangerous,” wrote Judge Jed Rakof f, in response to a

settlement by Citigroup with the SEC.

To cope with the deluge of litigation, banks are falling over themselves to hire ex-

regulators, feeding the idea that the law is too chaotic to be understood by anyone outside

the system. Financial firms should of course be held to account when they do wrong. But

there must be a better way

Exports and the economy

Made in BritainExports are growing, but too slowly to rescuethe economyJan 21st 2012 | from the print edition

JUST over a mile from Liverpool John Lennon Airport, named for one of Britain's most

successful exports, sits the Halewood operations of Jaguar Land Rover. Its foreign saleswould make a Beatle envious. Over the December holidays the Tata-owned car factory ran

extra shifts to keep up with demand. An expansion to the facility, which could create 1,500

jobs, is reportedly under consideration. JLR is already building a new engine plant in

Wolverhampton. Other car firms are enjoying similar success. In 2010 Nissan invested over

£400m in its state-of-the-art Sunderland factory, which produces for export to more than

90 countries.



As Britain's economy stumbles toward a likely recession, hopes are pinned on exports,

particularly to faster-growing parts of the world. George Osborne, the chancellor, flew to

China this week and marvelled at that country's hunger for goods and services. Since 2007

the pound has dropped nearly a quarter on a trade-weighted basis. A devaluation in the

early 1990s helped Britain export its way out of recession. Can it repeat the trick now?

There are some encouraging signs. Britain's trade deficit shrank from 4% of GDP in 2007 to

around 1% of GDP by early 2011. But the economy might have been expected to do better

after such a big depreciation. The obstacles have been many. Falling global demand blunted

the impact of a cheap pound in 2008 and 2009. Once global trade recovered, so did Britain's

appetite for imports—despite a rise in relative import prices of roughly 20% since 2007. A

decade of strong sterling has chipped away at the capacity of manufacturing industry—and

factories cannot be rebuilt quickly. The financial-services industry, which accounted for a

third of British exports in 2008, has been slow to recover.

A deeper concern is that Britain has become too dependent on moribund rich-world

markets. The share of exports going to Europe has fallen in the past decade, but the

continent still accounts for half of British exports (see chart). That market is shrinking; the

Economist Intelligence Unit, our sister company, forecasts that the euro-zone economy will

contract by 1.2% in 2012. One Conservative MP, Douglas Carswell, has complained that it is

like being “shackled to a corpse”. America absorbs more British exports than any other

single country and its economy still looks relatively robust. British exports to that country

fell 4% in the year to September, but showed signs of recovery, along with America's

economy, in October and November.

The emerging economies of Asia and Latin America seem a better long-term bet than

Britain's established markets. But the combined share of British exports going to the three

emerging-market giants—China, India and Brazil—is less than 5%. Britain can boast neither

the large natural-resource endowments nor the focus on production of capital goods, like



machine tools, that appeal to rapidly industrialising economies. And firms have been

lamentably slow to build trade links with these fast-growing economies. That may be a

legacy of Britain's past imbalances: when the domestic economy was strong, there was little

incentive for its firms to go to the trouble of finding customers in unfamiliar markets.

The recent success of Britain's car industry suggests all is not lost. Domestic car sales fell by4.2% in the year to November, but exports to China rose 23%, and sales to India were up

by 67%. Foreign carmakers who built export-oriented operations in Britain in previous

decades have taken advantage of the fall in sterling to expand market share, particularly in

emerging markets. Luxury outfits like JLR, Rolls-Royce and Bentley hawk Britishness to the

new rich. The car industry may, then, offer a blueprint for a rebalancing with “exports at its

heart”, in David Cameron's phrase. For that to occur, however, producers in other industries

long battered by dear sterling must find a way to learn from and duplicate the success now

on display in Liverpool. Let it be

http://www.economist.com/node/21559358

Oilfield services

The unsung masters of the oil

industryOil firms you have never heard of are boomingJul 21st 2012 | ABERDEEN | from the print edition

A TECHNIQUE called “directional drilling” has transformed the energy business. Fifteen

years ago the best drillers could force a well-shaft into a gentle arc. These days shafts can

be drilled vertically to a depth of several kilometres—then made to turn sharply and

continue horizontally for up to 12km (or 7 miles). Will Grace of Schlumberger, an oilfield

services company, likens it to dropping a plumb-line from the top of the Empire State

Building and then guiding it through the rear and front windscreens of every car parked in

the nearby streets.

Such technology vastly increases the area one rig can cover (see diagram). For an

illustration, Mr Grace points to squiggles and shadings on a computer screen in one of the

34 offices Schlumberger operates in Aberdeen, a Scottish oil city. The lines show the

progress of a well completed for a Canadian oil firm a few hours earlier. It is 13,000 feet

(4,000 metres) deep and has been brought to a halt 6,500 feet horizontally away from the

rig, within three feet of its target.






Instruments in the “drill-string”—as formerly inflexible steel drill-shafts are now called—are

meanwhile transmitting dozens of additional measurements: of the radioactivity of the

surrounding rock, its resistivity to electromagnetic waves, and so on. In this case, the rock

gives a low radioactivity reading, which suggests that it is sand; its resistivity is high, which

suggests it is oil-bearing. This is wizardry that few firms can match. And probably none is a

regular oil company.

Oilfield services (OFS) firms such as Schlumberger are the unsung workhorses of the oil

industry. They do most of the heavy lifting involved in finding and extracting oil and gas.

They are far less well-known than the oil firms that hire them, but immensely lucrative.

Schlumberger, with headquarters in Paris and Houston, earned profits of $5 billion on

revenues of $40 billion last year. Its market capitalisation has risen fourfold in the past

decade, to $91 billion. That is bigger than several international oil companies, including ENI

($82 billion), Statoil ($75 billion) and Conoco-Philips ($71 billion).

Schlumberger’s success highlights a shift in the balance of power between oil companies

and their flunkeys. Until the 1990s OFS companies were far smaller and earned low margins

on straightforward tasks, such as drilling vertical wells. That has changed dramatically.

With the price of oil so high, firms are scrambling to pump it out of ever more remote and

costly crevices. Over the past decade the oil industry’s annual spending on exploration and

production has increased fourfold in nominal terms, while oil production is up by only 12%.

The big services companies, which invest heavily in technology (see chart), have been

growing by around 10% a year. According to McKinsey, a consultancy, OFS companies

grossed around $750 billion last year.

OFS firms come in three flavours. Some make and sell expensive kit for use on drilling rigs

or the seabed. These include FMC, Cameron and National Oilwell Varco, all $10-billion-plus

companies. Some own and lease out drill-rigs. These companies include Transocean,



Seadrill, Noble and Rowan. The third group carries out most of the tasks involved in finding

and extracting oil. It is dominated by four giants: Schlumberger, Halliburton, Baker Hughes,

and Weatherford International.

Most of these firms were relatively small until the 1980s, when several oil companies

decided that humdrum drilling chores were no longer worth doing in-house. Oil was easythen. Drilling yielded low margins that did not justify its claim on capital, so the oil majors

outsourced it. This gave OFS firms space to grow.

They grew even faster in the early 1990s, when a tightening oil market drove demand for

new technology. This led to breakthroughs in 3D seismology and directional drilling. These

breakthroughs allow oil to be sucked economically from far beneath the ocean floor, and out

of depleted and formerly abandoned wells.

But such inventions do not come cheap. Schlumberger invests roughly $1 billion a year in

research and development, a level it maintained even during the slump after the 2008

financial crisis. That is as much as the mighty ExxonMobil spends; as a share of sales, fivetimes more. The big OFS companies now probably file more patent applications than the oil

majors, whose technological skills are largely interpretive. (For example, an oil major may

decide where and how to drill based on geophysical data provided by an OFS firm.)

The oil business is likely to grow even more dependent on brainy OFS firms. Global

production from mature oilfields is falling by between 2% and 6% a year. In the North Sea

it has declined by 6% a year on average since 1999. With global demand for oil growing by

1-2% a year, there are persistent fears of a supply shock. Hence the current high oil prices:

even after a 20% fall in recent months, Brent Crude is now around $100 a barrel. Oil firms

are searching harder in more remote places, such as the Arctic and the deep seas off Brazil.

Operating in such places will require yet more snazzy technology.

With hindsight, the oil companies’ decision to outsource the grubby bits of the job looks like

an opportunity squandered. It has also left the oil firms hostage to the availability of

increasingly expensive and sought-after services, from advanced drilling to deepwater rigs,

which a dwindling number of OFS firms can provide.

There is, at present, still a fair amount of competition in most parts of the services industry.

Each big OFS firm has different strengths, and plenty of smaller ones occupy specialised

niches. Yet in some areas, especially the geographically remote ones, the demand for

complex services often outstrips the supply.

Even worse for the likes of Exxon and BP, this has come at a time when state-owned oil

firms have been muscling onto the stage. In the past couple of decades these national oil

companies have claimed the best acreage in most old oilfields. The OFS firms have helped

them to do so. Where once the state-owned giants hired oil majors to do the work, now

they can manage projects themselves and hire technical help directly from the services



firms. This can sometimes involve a limited sharing of risk between national and OFS firms,

just as in a regular joint venture between oil companies.

Schlumberger, for example, will agree to a measure of payment-for-performance in big

contracts. If it can drill more oil from a well than the contract says it must, it charges a

higher fee. Other services firms have gone further, taking small equity stakes in explorationprojects.

Some analysts wonder how all this might hurt the oil majors. A few decades ago national oil

companies had to turn to oil majors for the technology required to get the stuff out of the

ground. Today, oilfield service companies offer all the necessary technology and are

increasingly willing to take on some of the same risks as an oil company, notes Marcel

Brinkman of McKinsey.

Still, it would be wildly premature to bid Exxon adieu. Schlumberger’s performance-based

contracts are a long way short of owning reserves—something the company says it will

never do. It lacks the mammoth balance-sheet that oil firms maintain to manage the hugerisks in oil exploration. It also lacks Exxon’s expertise in managing huge projects. And it is

reluctant to annoy its customers by competing with them. Moreover, choosing where and

how to explore (another strength of the oil majors) is trickier than you might think.

Instead, Schlumberger is planning more of what it is best at: pushing the technological

boundaries of extracting the black stuff. It has recently been busy making acquisitions—

including of Smith International, an American drill-bit company, for $11.3 billion—which

have given it know-how in most segments of exploration and production. It now hopes to

re-engineer the entire process.

The prize of increased efficiencies—delivered in barrels of money, not oil—could be vast. A

big deepwater drilling rig costs half a million dollars a day to rent, and can take three

months to drill a complicated well. Any OFS company that can shave a few days off that

time will be in the money. Drilling is thrilling, and getting more so.



directional drilling oil well sonda de petrol foraj cu circulatie directa

drillers foraj

well-shaft

gentle arc arc subtire

oilfield service company companie de servicii petroliere

plumb line perspective perpendicular; linie vertical; fir cu plumb

rear



front widescreen

rig

squiggles mazgalitura

shadings

halt oprire, a pune capat

dril-string cablu d eforaj

steel drill-shaft

oil bearing

wizardy

unsung

market capitalization

fourfold

drifting vertical wells

crevice

drill rig instalatie de foraj

humdrum drilling oarecare obisnuit

depleted

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