As a CPA who has also earned a PhD in behavioral accounting, I have always been qualified to practice forensic accounting. After all, in order to catch a thief, one must be prepared to engage in critical thinking, to understand criminal motivation, and to apply theories of behavior to the fact patterns that have been uncovered.

I was assigned to my first forensic accounting engagement within a year of earning my undergraduate degree. I wandered the casino floors of one of the mega-resort casino hotels in Las Vegas, searching for chip-stealing conspiracies among the hotel’s employees. Career-wise, it was an early thrill.

That engagement, and others like it, prepared me to investigate what eventually became one of the most notorious financial scandals in history. For decades, the floating interest rates on most variable debt instruments were “based” on the “Libor” rate.

Libor refers to the London Inter-Bank Offered Rate, the average rate at which 16 global banks in the City of London declared that they would be willing to extend loans to each other. And based meant that virtually all variable market rates fluctuated in tandem with fluctuations in Libor.

The British Bankers’ Association collected rate quotes from the 16 banks. They tossed out the 4 smallest and 4 largest quotes; they then took a simple average of the remaining 8 quotes. That simple average represented the period’s Libor rate; it was published online with each of the individual bank quotes.

Assume, hypothetically for a moment, that a bank could profit from manipulating the market interest rate higher. It could thus furnish an unnaturally high quote to the British Bankers’ Association, thereby dragging the simple average higher. If it simultaneously arranged for other banks to furnish high quotes, it could drag the simple average much higher.

Periods of potential manipulation, however, can be flagged through the types of statistical methods that are employed to identify potential instances of collusion (e.g., with airline fares). Certain Libor patterns can thus be identified as questionable, thereby narrowing down potential areas of regulatory investigation.

As a CPA, I teamed with two economists and an Accounting PhD to analyze such patterns. We wrote a paper entitled “Libor Manipulation?” and posted it on the global Social Science Research Network (SSRN) in 2008 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1201389).

And then time passed. The next year, the global economy collapsed. For the following two years, all minds were focused on avoiding a second Great Depression. And throughout this period, the 16 banks continued to manipulate Libor.

Finally, in 2012, my coauthors and I published “Libor Manipulation?” in Elsevier’s Journal of Banking and Finance. CFO Magazine, CNBC, The Economist, Financial Times, L’Express (of France), Linkiesta (of Italy), MarketWatch, and the Wall Street Journal all cited our work.

Other publications not only cited our work; they were clearly excited by our findings. For example, on July 4, 2012, City AM (of London) published, “It Isn’t Just Diamond that Missed Libor’s Warning Signs.” It noted the following:

The world at large, it is now clear, didn’t pay [the Libor] story as much attention as it deserved. But it was enough to get the attention of a group of academics, variously specialists in derivatives accounting, conspiracies and manipulations, banking and credit risk.

The investigation of the team showed even deeper grounds for concern than the original article. The draft study … was posted by the Social Science Research Network in 2008 … Later versions were peer reviewed, discussed at a 2010 conference and published in January of this year [2012] by the Journal of Banking and Finance. The conclusions were not exactly hidden.

While the study did not find a smoking gun for effective manipulation of the Libor rate, it did identify “statistical evidence of patterns that appear to be inconsistent with those that are normally expected to occur under conditions of market competition.” What’s rather more embarrassing for all concerned is their observation that “many of these markers were readily available for review by market analysts” at the time. (https://bit.ly/3qL4Ya9)

 

Twelve days later, July 16, 2012, Bloomberg published “Libor Flaws Allowed Easy Rate Rigging, Traders Say.” It noted the following:

“At least 75 percent of the panel banks may unilaterally affect the average by moving the quote in their preferred direction.”

According to some estimates, the figure may be even higher. Between Jan. 2, 2007, and Aug. 8, 2007, 95 percent of submissions had an impact on where the rate was set, according to “Libor Manipulation?” a 2008 paper …

“You have 16 banks employing people who are eating at the same restaurants, drinking at the same pubs,” said Michael Kraten … a co-author of the “Libor Manipulation?” paper.

“They look at each other as competitors, but also as friends. It’s easy to believe that whether or not they’re explicitly talking to each other, they understand each other well and they’re implicitly colluding.” (https://bit.ly/42KRl7Y)

 

That did it! The image of 16 global bankers “eating at the same restaurants (and) drinking at the same pubs” went viral. It helped drive the public conversation about reining in Libor. And the result? Libor is no more. A final decision to phase it out of existence was made at the end of 2021. Steps have been taken to wind Libor down and transition away from its use, and it is expected to disappear completely later this year.

It’s amazing what CPAs can do, isn’t it? From the streets of Las Vegas to the City of London, I’m delighted to have played my part in investigating criminals and bringing them to justice.

Michael Kraten, PhD, CPA is director of accounting program initiatives at the University of Houston, Houston, Texas.

For Further Reading

“Conspiracy Theory: Lawyers Gear Up for High-Stakes Libor Case,” Risk Magazine, 2012,

“Costs of Forex Manipulation Could Be Worse than Libor,” Risk Magazine, 2014

“French Banks Have Been Overtaken by Liborgate,” L’Express, 2012

Hansard Debates, Government Transcript, House of Commons, Parliament of the United Kingdom, 2012

“How To Use Statistics to Seek Out Criminals,” Bloomberg View, 2013

“It Isn’t Just Diamond that Missed Libor’s Warning Signs,” City AM, 2012

“Libor Flaws Let Banks Rig Rates Without Conspiracy,”* Bloomberg Businessweek, 2012

* Article retitled and republished under content sharing arrangements with the following publications:

  • “Libor Flaws Allowed Easy Rate Rigging, Traders Say,” Financial Advisor Magazine,
  • “Libor Flaws Enabled Rigging,” Treasury & Risk,
  • “Collusion Illusion: No Conspiracy Necessary to Rig Libor,” Investment News, and
  • “Michael Kraten—Quotations,” Economic Times of India.

“Libor Manipulation?,” Social Science Research Network, 2008

“The Libor Probes: An Expensive Smoking Gun,” The Economist, 2012

“Libor Probe’s Hurdle—U.S. Regulators Face Challenges,” Wall Street Journal, 2011

“Libor Rate Fixing Scandal: A Useful Distraction for Myriad Failures,” International Business Times, 2012

“The Libor Scandal: The Rotten Heart of Finance,” The Economist, 2012; content shared with, and published by, CFO

“Libor Spotlight Falls on Critical Days in 2008,” Financial Times, 2012; content shared with, and published by, CNBC

“LIBOR Surge Jolts Borrowing Costs,” CFO, 2008

“Libor’s Slow Burn: The Rise and Fall of the World’s Most Important Number,” Equipment Finance Advisor, Reprinted by Securities Technology Monitor Magazine, 2012

“London Shaken by Watergate Finance,” Linkiesta, 2012

“New York Fed Knew of Libor Cheating in 2008,” Market Watch: Wall Street Journal, 2012

“U.S. Criminal Probe in Libor Scandal: Report,” Market Watch: Wall Street Journal, 2012

“U.S. Libor Probe Includes BofA, Citi, UBS,” Wall Street Journal, 2011

“What Impact Will Libor Have On Asset Managers?,” Bank Investment Consultant, 2012