Are You Part of a (Trading) Cartel?

At least outwardly, the giants of investment banking — the big Wall Street titans and other financial institutions (FIs) — are rivals, competing over customers, returns, trading talent, and more. But over the years there have been multiple cases in which banks have been accused, and found guilty, of colluding or price rigging in conjunction with one another.

For example, in May 2021 seven FIs, including Bank of America, Natixis, Nomura, RBS, UBS, UniCredit and WestLB, were found guilty by the European Union of colluding in a way deemed to hurt EU Member states. Three of the FIs were fined a collective total of $453 million for their part in the wrongdoing. Employees at the FIs in question had participated in a bonds trading cartel, in which traders used chat rooms to share sensitive information with one another that they could use to inform how they bid at debt auctions. The incidents took place between 2007 and 2011.

This is far from an isolated incident. A decade ago, two separate lawsuits alleged that banks J.P. Morgan Chase & Co. and HSBC Holdings were manipulating silver futures by colluding and informing one another of upcoming big trades, flooding the market with a disproportionate quantity of orders.

One of the largest recent such incidents was the Forex scandal in which dozens (although potentially hundreds) of traders from at least 15 banks, including Barclays, HSBC, and Goldman Sachs, participated in online chatrooms — with names like The Cartel and The Mafia — in which they discussed the volume and kinds of trades they were planning to make. This manipulation of the Forex market may well have continued for years.

Cartels in action

This kind of sharing of illicit information — frequently using electronic communications for coordinating the behavior — is frequently referred to as being a cartel. While the name “cartel” might summon up images of drug-running outfits and gangland activity, it refers to any collection of independent businesses which collude with one another in a way that manipulates prices of a product or service.

Under normal circumstances, a FI will decide its strategy in order to maximize its profits, by choosing its investments, quantities, and more. However, it does this without considering the effect of its decision on other firms. In other words, it’s operating in isolation for the good of itself and its customers. Contrast that to a cartel, whereby FIs consider not just how particular strategies will affect themselves, but also other members of the cartel. They work together to ensure maximum profit for the entire group.

Collusion is expressly forbidden by law since it unfairly benefits the cartel (although not necessarily its customers), while hurting the broader market. Around the world, multiple laws have been put into place to stop cartels from forming and working together. In the United States, for example, both the Sherman Antitrust Act of 1890 and the Federal Trade Commission Act of 1914 cemented rules that would reduce competition through explicit agreements. In the U.S. cartels are banned under antitrust law, whereas in Europe they are barred by competition laws.

The right tools to defend against cartels

Cartels are bad news for customers, but they’re also bad news for firms. When discovered, they can result in heavy fines for the firms involved — even if they may have not been aware of the existence of the cartel. In some cases, it may only be a small number of bad actor traders acting in isolation but can nonetheless result in multimillion-dollar fines or other penalties. In 2019, the European Commission fined FIs including Barclays, Citigroup, the Royal Bank of Scotland, JPMorgan, and Japan’s MUFG Bank a massive 1.07 billion euros ($1.2 billion).

FIs today must make sure that they closely monitor all communication channels employed by traders, along with trading information, to ensure that there is no behavior that falls under the remit of collusion. Fortunately, this is becoming easier to do thanks to advanced tools, such as the ones we have developed at Shield, that combine boosted lexicon technologies and artificial intelligence algorithms to spot behavior suggestive that rule-breaking behavior is going on.

These tools can spot a wide range of potential market abuse scenarios, ranging from collusion and insider trading to front running. By monitoring for this behavior, and making it easy to generate (useful) alerts with minimal false positives, FIs can protect themselves from the damaging effects of cartel behavior.

And, in the process, better comply with increasingly tight regulations seeking to hammer wrongdoers.