Tug-o-War: Extradition And The Risks Faced By U.K. Executives Caught Up In The Fallout From The Subprime Crisis

Article by Michael O'Kane, Head of Fraud and

Regulatory Department, Peters & Peters

With the U.S. epicentre of the crisis and the involvement of

U.S. institutions, U.K. executives face the real possibility of

extradition to the U.S. to address allegations of fraud.

The Extradition Act of 2003 significantly altered the

evidential burden of the requesting state.

The number of high profile extraditions in recent memory have

set the tone for the legal arguments in these cases.

The fallout from the subprime crisis will be a double cause of

concern for U.K.-based company directors and executives especially

if they were employed by any of the major international financial

institutions currently under the spotlight. As well as their

concerns for their employment and financial prospects, there will

also be concerns about potential criminal and/or regulatory

enforcement action, primarily from the U.S.

In the U.K., the Financial Services Authority (FSA) has, in

particular, stated that it is looking critically at such

institutions.1 In the 2007/2008 Annual review, the FSA

stated that the reduction of financial crime was one of its

statutory objectives and "maintaining the integrity of

financial markets is essential to achieving efficient and fair

outcomes for, and sustaining the confidence of, market participants

and consumers, and ensuring the U.K. financial industry's good

reputation and international standing". Indeed, the FSA

has never been under more pressure to protect the reputation of the

City, with the Financial Times reporting in September 2008 that

this pressure was being exerted by bank chief executives and

traditional investors, as well as politicians and the popular

media.2 Although the FSA has prosecutorial powers, these

are very rarely exercised, so any such investigations are more

likely to give rise to regulatory action against the institutions

or the individuals considered responsible.

But what of the Serious Fraud Office (SFO) at this time of

national crisis? In respect of high-level fraud, potentially

undermining the confidence of the U.K. economy, one would expect

the SFO to play a lead investigative and prosecutorial role.

However, the new director of the SFO, Richard Alderman, has

expressed his determination that the SFO should focus on the

prevention of fraud and seems less interested in prosecutions that

are lengthy, high-cost and high-risk.3 Corporations and

individuals investigated in connection with the subprime crisis are

likely to be stabled in this category. Given that the crisis

appears to emanate from the U.S. and involve institutions on both

sides of the Atlantic, there must be a real risk that U.K. and/or

EU executives will be caught up. This is particularly so when one

considers that the FBI announced investigations into Lehman

Brothers, Fannie Mae, Freddie Mac and AIG, which are quite possibly

the tip of the iceberg with many statewide investigations also

being conducted.4

A key issue therefore for company directors and executives

caught up in the subprime crisis is possible extradition to the

U.S. for fraud-related conduct.

What might be alleged? Traditionally, banks financed mortgage

lending by deposits from their customers and mitigated the risk of

bad debt with thorough income checks and home valuations. Over

time, this model has evolved with the rise in the secondary

mortgage markets. They have managed to increase their ability to

finance mortgages by selling the mortgages on to the bond markets.

The positive aspect of this model was to allow banks to offer

mortgages to people who traditionally would not be granted a

mortgage (i.e. subprime) and therefore increasing home ownership.

The downside was two-fold: first, the subprime mortgages often had

high interest rates to make allowance for increased risk of bad

debt (which in turn led to bad debt) and second, the mortgage bond

market reduced the incentive for banks to properly check the

mortgages that they were offering.

The financial crisis was very much inspired by the high-risk

decisions made by banks, and the FBI investigations will be

focusing on whether major financial institutions put pressure on

ratings agencies to award top ratings to securities issued and, in

the extreme, whether they actively misled...