The latest news from Washington is that Obama's Department of Justice prosecutors are close to getting a guilty plea from Credit Suisse Group AG (NYSE:CS). If this happens, the megabank may be forced to pay more than $1 billion as a settlement.
The Department of Justice (DOJ) believes that the bank has helped affluent Americans evade US tax laws. US officials are becoming increasingly more confident that they will be able to enforce their case; in fact, they are looking to wrest a guilty plea from the bank within days. Meanwhile, Credit Suisse's spokesman has not commented on the current state of negotiations.
Implications of A Guilty Plea
It is not clear what a guilty plea would mean for the bank. The DOJ's main concern is that if the bank goes out of business, it may impact the country's economy. Yet, by the same token, Attorney General Attorney General Eric Holder, US prosecutors, and bank regulators are no longer willing to be intimidated by the "too big to fail, too big to jail" loophole that the largest banks have been using to avoid heavy penalties for flaunting legal and regulatory rules.
Currently, US officials are talking to the Federal Reserve to get assurance that a guilty plea will not close down the bank. They are also holding similar talks with the New York's Department of Financial Services. Due to the delicacy of the issue and the size of the white-collar crime of enabling substantial tax evasion, a deal is not certain.
A Deferred-Prosecution Plan
US prosecutors are all-too familiar with the broad repercussions of extracting a guilty plea for a large fraud from a prominent financial institution. In 1989, after Drexel Burnham Lambert Inc., the junk-bond giant, admitted to 6 counts of fraudulent activities, it went out of business. Similarly, a criminal indictment closed down Arthur Andersen. Still, a guilty plea does necessarily equate with a business death sentence. In 2013, SAC Capital Advisors LP, a hedge-fund powerhouse, admitted guilt for fraud without closing its doors.
Banking analysts believe that US authorities may propose a deferred-prosecution plan to get an admission from Credit Suisse without threatening its banking charter to operate in the US. There is precedence for this strategy. In 2012, HSBC Holdings PLC agreed to pay almost $1.3 billion for money laundering, as well as a $650 million civil fine. However, using a deferred-prosecution plan, the company was able to stay in business.
Essentially, a deferred-prosecution plan relies on three components:
- First, it allows fines to be negotiated.
- Second, it puts the offender on probation.
- Third, it gives the rogue institution a second chance to mend its ways and pursue an ethical line of conduct.
This is not the first time that US prosecutors have worked with a large financial institution that flaunted its tax laws. In 2009, UBS AG (NYSE:UBS) admitted to assisting tax evaders. However, it only had to pay $780 million in restitution, interest, penalties and fines. With Credit Suisse, there is a whole new level of magnitude to consider, because the settlement could exceed $1 billion.
Still, if Obama's U.S. prosecutors are successful in wresting a guilty plea and structuring a settlement, while still preventing a revocation of the bank's license in the US, it will create a powerful precedence for holding billion-dollar financial behemoths accountable for large-scale fraud.
Final Points for CS Investors
While such a scandal should be enough in itself to sway investors away from Credit Suisse stock, additional negative aspects include:
- Credit Suisse missing earnings-per-share estimates consistently for the past seven quarters, while certain megabank rivals, such as Morgan Stanley (NYSE:MS), have consistently beat estimates in this category.
- CS stock performance flattening over the past year, particularly YTD. (Chart below: Nasdaq.com)Click to enlarge
- Troubles in pulling back "unwanted business" in its investment bank.
- Decreasing dividends since 2009.
Given these factors, we recommend investors take profits in Credit Suisse and consider Morgan Stanley as an alternative.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.