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Good Thing Wal-Mart Didn't Get a U.S. Bank Charter

Wal-Mart stands accused of a major bribery scheme that cuts to the core of the way this international giant does business in Mexico – and demonstrates how little U.S. regulators and investors know. 

The New York Times broke the news this weekend about a systematic plan involving more than $24 Million in illegal bribes allegedly paid to Mexican officials to expedite the expansion of Wal-Mart stores into Mexico. 

Wal-Mart de Mexico is now the largest private employer in Mexico and 20% of Wal-Mart’s stores worldwide are now located in Mexico. But there's a problem: In 2005, senior Wal-Mart officials learned of the bribery scheme and covered up Wal-Mart's subsequent internal investigations, hiding likely violations of Mexican law and the U.S. Foreign Corrupt Practices Act from U.S. and Mexican government agencies as well as Wal-Mart investors. 

The U.S. Justice Department and the SEC are now investigating Wal-Mart. A cover-up always makes things worse. Heads are rolling. If the allegations are proved, the Justice Department will likely assess large fines against the company and individuals will go to jail.

Beyond providing governance and ethics lessons about a shocking corporate scandal, this Wal-Mart story illustrates why combining commerce and banking is such a bad idea. It highlights once again how global corporations' wrongdoing in other countries can jeopardize their U.S. business profitability and reputations, because of interconnectedness on a grand scale.

There are special  functions we need banks to perform:  receiving insured deposits and making loans within a community, while serving as the highly regulated transmitter of monetary policy. The policy decisions that make Wal-Mart profitable are not congruent with the objectives of banking as we know it in the U.S. Once a corporate conglomerate includes an insured financial institution in the U.S., that enterprise gains access to the safety-net of federal deposit insurance and loans at the Federal Reserve window.  A U.S. bank charter opens the door to too-big-to-fail issues and potential taxpayer bailouts. Would we really want to protect Wal-Mart in that way? 

From 1999 to 2007 (the same period of time covered by the Mexican bribery scheme), Wal-Mart actively pursued the possibility of an FDIC-insured U.S. financial institution charter, first in Oklahoma, then in California, and finally in Utah.  As the U.S. bank regulators (FDIC, in particular) delayed and sent negative signals about the likelihood of obtaining a U.S. bank charter, Wal-Mart withdrew its application in 2007 and accelerated its banking expansion in Mexico.

But for the delay resulting from the change in FDIC Chairmanship in 2006, Wal-Mart might very well have obtained an FDIC-insured industrial loan company charter. Instead, Wal-Mart moved on to develop an extensive banking network in Mexico by placing bank branches in its retail stores. 

What if Wal-Mart’s phenomenal growth in the banking sector had occurred in the U.S.?  Even without a bank charter, Wal-Mart has not given up on a U.S. financial services presence; it offers pre-paid debit cards and check-cashing services through "Money Centers" in many of its U.S. stores. Wal-Mart recognizes the profit potential in providing banking services to a captive market of relatively unsophisticated, cash-strapped, low-to-moderate income shoppers.

At a minimum, the competitive advantage Wal-Mart can achieve through combining its banking and commercial locations, operations, and marketing could be a real threat to more traditional U.S. banks, especially community banks.  The banking industry has focused on this competitive threat. 

The most significant threat is the difficulty of effective examination and regulation of global financial entities that combine banking and commerce. Let us pose some hypothetical questions to illustrate some ways in which the U.S. dodged a bullet in not granting Wal-Mart a bank charter:

  • If Wal-Mart now had a major banking presence in both the U.S. and Mexico, what would be the impact of this Mexican bribery scandal on the U.S. side of this conglomerate's banking operations? 
  • Could corporate problems in Mexico bleed off bank capital, leaving U.S. taxpayers at risk? 
  • Could the Mexican operation also have money-laundering issues that would spill over the border? 
  • If U.S. banking officials had acceded to Wal-Mart's push for a U.S. bank charter, would U.S. bank regulators have been able to detect this fraud and financial risk occurring in Mexico?
  • If Wal-Mart executives failed to disclose that they knew or should have known about the Mexican bribes at the same time Wal-Mart was applying for a U.S. bank charter, what else was concealed from U.S. regulators by this large, complex, international conglomerate?

Ann Graham is a professor of law and director of Business Law Institute at Hamline University School of Law, St. Paul, Minn.


(3) Comments



Comments (3)
Professor Graham,

You are wrong about Woodlands Commercial Bank. It did not "suffer severe financial losses as a result of the mismanagement and collapse of the holding company." It stopped lending when Lehman collapsed because it got all of its loan business through the parent. Its biggest challenge was creating phone, computer and payroll systems from scratch on Monday morning. It then self liquidated. It had one construction loan go bad but that had nothing to do with Lehman's collapse. It had some mark to market write downs because its loans were all held for sale and remarkably the parent bankruptcy estate contributed some new capital to cover those paper write downs but all of that was recovered as the loans either paid off or were sold.

In the end, the bank paid all of its creditors then paid a $1 billion plus liquidating dividend to the parent. Not bad for a bank that had $7 billion in assets when Lehman failed.

I don't dispute that problems at a parent company of a bank can be significant to the bank and should be detected and prevented when possible and dealt with appropriately when they happen. I do dispute that they are of paramount significance and must be avoided at all costs. As a former regulator I understand that a regulator's most important job is controlling who controls the bank. But as long as there are holding companies the risk will be there that someone will behave badly.

So what is the point of your essay? WalMart violated the law. No dispute. That didn't start a run on its Mexican bank. Why do you think it would start a run or otherwise damage a US bank if WalMart owned one? Without banning holding companies altogether, how could regulators ensure that no one at a holding company would ever engage in unlawful behavior in the future? We have had a number of banks in Utah survive largely unscathed when the parent company filed for bankruptcy. Some continued operating normally but under regulatory orders that prohibit transactions with the parent while it is in Chapter 11 and freeze the bank in place until the problem has passed. Others, like Woodlands Commercial, stop lending and self liquidate. The record of these banks is far better than failed banks owned by shell holding companies that did nothing wrong but also had no ability to support the bank when it was in trouble.
Posted by gsutton | Tuesday, May 01 2012 at 5:52PM ET
As a former senior bank regulator and a financial institutions attorney for 37 years, in addition to being a financial institutions law professor for 8 years, I respectfully submit:

1. Illegal activities at the holding company level, such as the Wal-Mart bribery scandal which involves violations of the U.S. Foreign Corrupt Practices Act, directly impact bank subsidiaries, both through reputation risk (which can, among other adverse consequences, translate into higher borrowing costs and loss of customers) and the legal risk that this is a corporate culture that tolerates massive legal violations and inadequate internal controls. Such a corporate culture should concern bank and bank holding company regulators.

2. When a bank holding company gets into legal and financial trouble, it often becomes difficult or impossible for the bank subsidiary to continue as a viable entity. The two banking subsidiaries of Lehman, Aurora Bank, FSB, and Woodlands Commercial Bank, suffered severe financial losses as a result of the mismanagement and collapse of the holding company.

Washington Mutual, Inc., is another example of a holding company in trouble, with problems that did bleed over into the federal thrift. On September 15, 2008, the holding company received a credit rating downgrade, triggering a run on the subsidiary bank and leading within a matter of days to the bank's demise.
Wachovia is yet another example of interrelated financial problems pervading both the bank and the bank holding company.
Yes, a bank and its bank holding company may be separate legal entities, but their financial viability is strongly linked.
Recognizing that Wal-Mart's overall financial situation is apparently healthy, I note that it is so large and has such an extensive presence that allowing it to have a bank branch in each U.S. retail store could have created another systemically important institution (SIFI), with serious "too big to fail" ramifications. Such a business model would also have yielded an instant, very powerful competitor for local community banks across the country.

3. The fact that Wal-Mart and its senior management will be subject to heavy fines and prison time if the allegations are proved, clearly did not prevent these legal violations of the Foreign Corrupt Practices Act from occurring.

4. U.S. financial regulators have the power to investigate foreign subsidiaries, but all regulators concede that this is extremely difficult. U.S. regulators had the power to deal with the newly-revealed Wal-Mart violations of the Foreign Corrupt Practices Act, but that did not prevent illegal bribes from being concealed for almost a decade.

5. The fact is that Wal-Mart did not disclose these violations at the time it filed an application for federal deposit insurance, despite submitting that application under oath and penalty of perjury.

6. The capable bank examiners I worked with would never shrug off their responsibility to search out potential violations on a theory that, when and if they came to light, they could be addressed through closing the bank. Their approach was: If there's smoke, there could be fire. That is also the policy underlying Suspicious Activity Reports. Suspected wrongdoing merits a closer examination.
Posted by | Monday, April 30 2012 at 2:57PM ET
As a former regulator and a bank regulatory attorney for 30 years, I will try to answer Professor Graham's questions.

1. A bribery scandal in Mexico would likely have no material impact on bank operations in the U.S. The two would be completely disconnected except having a common owner. It is noteworthy that despite all of Professor Graham's fulminating on the subject there is no indication that the bribery scandal (and it is a scandal) has impacted WalMart's Mexico banking operations in any way.

2. Nothing happening at a corporate level in any company would affect a U.S. bank's capital in any way. Existing federal laws firmly isolate a federally insured bank from any improper transactions with any affiliate. The classic example is Lehman, which had an industrial bank subsidiary in Utah. When Lehman became bankrupt the bank stopped lending and commenced a controlled liquidation operating under orders issued by the FDIC and State of Utah prohibiting the parent from exercising any control over the bank. The bank recently permanently closed after repaying all depositors and creditors in full and then paying a liquidating dividend exceeding $1 billion to the the Lehman bankruptcy trustee for distribution to the parent's creditors.

3. I have no idea about money laundering in Mexico but I do know that it is illegal in the U.S. and anyone in any U.S. bank involved in money laundering could be charged criminally. In addition, U.S. regulators could remove any bank officer involved in laundering, ban him or her from banking permanently and assess civil money penalties of up to $1,000,000 per day if the violation was intentional.

4. Theoretically U.S. regulators could investigate whether a parent was engaged in unlawful bribery activities anywhere. Under existing law both the FDIC and a state regulator can examine anything they want in an affiliate and have a full range of supervisory authorities to deal with any problems they find that may impact the bank. In reality, I doubt a US bank regulator would be examining holding company operations in another country unless it was looking for something specific but other U.S. authorities do look for those things and impose punishments when they find problems, as in this case.

5. This is a purely rhetorical question that reminds me of a friend who was a park ranger in Mesa Verde and was often asked how many undiscovered ruins there were in the park. The fact is that all bank applications are submitted to regulators under oath and penalty of perjury and verified by bank regulators to the maximum extent possible. If a falsified application had been submitted regulators could pursue criminal changes for perjury, banish those responsible from the banking industry, assess civil money penalties and, if it appeared the corporation itself was culpable and demonstrated that it did not have the requisite integrity and honesty to own a bank, the regulators could take possession of the bank and either sell it to another bank or liquidate it.

All of this said, I have never represented WalMart and I am not advocating that WalMart get a bank charter in the US without strong assurances that it would not impact community banks and potentially diminish the availability of banking services in any area. However, any debate over any company getting a bank charter should proceed on the basis of accurate and reliable information, not the rhetorical and ad hominem arguments presented by Professor Graham above.
Posted by gsutton | Wednesday, April 25 2012 at 5:49PM ET
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