Libor for Detection and Deterrence of Cartel Wrongdoing

Our paper, The Lessons from Libor for Detection and Deterrence of Cartel Wrongdoing (forthcoming Harvard Business Law Review), examines the antitrust implications of Libor. We are cautious to draw overly broad conclusions until more facts come out in the public domain. What we note at this time, based on public information, is that the alleged Libor conspiracy and manipulation seems not to be the work of a rogue trader. Rather it seems to have been organized across firms and apparently required the active knowledge of a number of individuals at relatively high levels of seniority among certain Libor setting banks.

The involvement of more than one bank in such a cartel is a significant corporate governance failure due to the coordination that such a cartel would have required among the various cartel members. That the Libor cartel seems to have occurred in such a highly regulated industry after a wave of corporate governance reforms post-Enron and a push to greater internal compliance in the early 2000s is perhaps even more surprising. Yet, the very nature of what may have occurred regarding Libor manipulation, in hindsight, seems rather obvious. The rate did not move for over a year until the day before the financial crisis of 2007 hit. Also, quotes by the member banks that were submitted under seal moved simultaneously to the same number from one day to the next starting in the summer of 2006. After the beginning of the crisis, banks submissions seem to have been “too low” when compared to estimated borrowing costs based on credit risk. Had any member bank that set Libor or indeed any antitrust authority undertaken an econometric screen, they would have detected these anomalies, undertaken a more in-depth investigation and discovered the wrongdoing.

The art of flagging unlawful behavior through economic and statistical analyses is commonly known as screening. A screen is a statistical test based on an econometric model and a theory of the alleged illegal behavior, designed to identify whether manipulation, collusion, fraud or any other type of cheating for that matter, may exist in a particular market, who may be involved, and for how long it may have lasted. Screens use commonly available data such as prices, bids, quotes, spreads, market shares, volumes, and other data to identify patterns that are anomalous or highly improbable.

As established through the identification of the alleged Libor conspiracy and manipulation, and other previous successes, screens can be very powerful tools when properly developed and implemented. However, they do require expertise. There are two golden rules of screens: (i) one size does not fit all; and (ii) if you put garbage in, you get garbage out. Without expertise in developing a screen, the attempt at screening will likely fail. Such failure should not necessarily be attributed to the screening methodology itself generally, but to the errors in development and application in a particular case.

In general, we can point to six requirements to appropriately developing and implementing an effective antitrust screen for collusive behavior: (i) an understanding of the market at hand, including its key drivers, the nature of competition, and the potential incentives to cheat—both internally and externally—to the firm; (ii) a theory on the nature of the cheating; (iii) a theory on how such cheating will affect market outcomes; (iv) the design of a statistic capable of capturing the key factors of the theory of collusion, fraud, or the relevant type of cheating; (v) empirical or theoretical support for the screen; and (vi) the identification of an appropriate non-tainted benchmark against which the evidence of collusion or relevant cheating can be compared.

Given the importance of screens to detect wrongdoing, we note with some puzzlement why the Department of Justice Antitrust Division does not use screens to detect cartels even though other antitrust authorities use them. Strangely, the rigorous applied industrial organization analysis of antitrust on the civil side is distinct from antitrust analysis on the criminal side. In certain critical ways antitrust cartel enforcement in the United States looks more like other non-antitrust conspiracy white-collar crime enforcement than the heavily economics driven antitrust monopolization or merger enforcement. Yet, U.S. criminal antitrust is different not merely from other areas of antitrust but from some other areas of white-collar crime in which econometrics play a more significant role.

Other regulatory agencies worldwide routinely use screens to help detect illegal behavior in other areas and markets, not only conspiracies and manipulations, but also insider trading, actions violating the Foreign Corrupt Practices, tax evasion, revenues management and other types of accounting manipulations. These include the U.S. Securities and Exchange Commission, the U.S. Commodities Futures Trading Commission, the U.S. Department of Transportation and the U. S. Internal Revenue Service.

We use this essay to explore the use of screens and their implications for detection of collusion within antitrust.

The full paper is available for download here.