‘Dirty Clients Running Rampant': An Analysis Of The Governance Failures At Deutsche Bank - Financial Services - Finance and Banking (2024)

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The recently released FinCEN FilesInvestigation is a collection of over 2100 SuspiciousActivity Reports (SAR). These reports are compiled by financialinstitutions for the U.S Treasury Department's Financial CrimesEnforcement Network (FinCEN), about potentially suspicioustransactions concerning USD 2 trillions worth of transactions between 1999and 2017. The reports offer an unforeseen look into the worldof global corruption, identifying the major banks that facilitatedmoney laundering and the predicate crimes from drug trafficking,terrorist financing and enabling political corruption – allwhile generating profits for themselves and shareholders. At theforefront of the revelations are Deutsche Bank, who account forover 60% of SARs in the report and processed USD 1.3 trillion dollars in potentially suspicioustransactions.

Deutsche Bank responded to the allegations by stating that nonew information was revealed in the report, that all allegationsoccurred before 2016, and that they are "a different bank now." Yet this isnot the first time this year that Deutsche Bank has received badpress. The revelations in the FinCEN files cast major doubt onDeutsche Bank's Chief Executive Officer, Christian Sewing, whohas been at the forefront of its effort to repair its reputationsince he became its Chief Executive in April 2018.

On July 7^th, 2020, the New York State Department ofFinancial Services fined Deutsche Bank USD 150 million for its"significant compliance failures" in itsrelationships with Jeffrey Epstein from 2013-2018, Danske BankEstonia from 2007-2015 and FBME Bank from 1999-2014; given thescandal-plagued history of Deutsche Bank these due diligence lapsesseem routine.

In this three-part series, CGLytics begins by discussing past governancelapses at Deutsche Bank and its effects on shareholders. In thesecond part, we will examine the Consent Order issued by the NewYork Department of Financial Services against Deutsche Bank touncover the extent of the gaps in diligence. Finally in the thirdwe conclude with an examination of the revelations about DeutscheBank (and other major banks mentioned in the FinCEN files) inconjunction with CGLytics data to show how a relative lack of risk,public affairs expertise and governance skills on the boards of bigbanks left them exposed to regulatory, reputational and financialrisks.

Complicated Background

Deutsche Bank started in 1870 as Germany's introduction tointernational banking and rapidly expanded to Asia and throughEurope within five years of opening. After losing assets duringWorld War I, it rebounded through several mergers and acquisitionsthat allowed it to stave off the Great Depression. DeutscheBank's original and most notorious governance lapse was duringWorld War II, when the bank loaned the German government money tobuild the Auschwitz concentration camp and took part in theconfiscation of over 300 Jewish-owned businesses between 1933 and 1938. After Germany was defeated thebank was broken up into multiple regional banks in 1948, however by1957 the regional banks had merged to form Deutsche Bank AG withits current Headquarters in Frankfurt.

Expansion & Introduction to Wall Street

Deutsche Bank entered retail banking in the 1960's throughsmall personal loans and continued with its international expansionthroughout Europe and Asia. It opened its first branch in New York in 1979. By the mid1990's, Deutsche Bank had become increasingly involved ininvestment banking in North America, culminating in the 1999acquisition of Bankers Trust for USD 10.1 billion which made it thefourth largest bank in the world. Following the re-opening of thestock market after 9/11, Deutsche Bank was officially listed on theNew York Stock Exchange (DB) allowing it to take advantage of the booming stock markets in the early-mid2000's.

Scandals Galore

In the wake of the 2008 financial crisis Deutsche Bank'sreputation began to falter. It had sold roughly USD 32 billion ofcollateralized debt between 2004 and 2008. Notably, Greg Lippman,(Deutsche Bank's former head of asset-backed securitiestrading) called bonds "crap" in internal emails tocolleagues, but promoted them as top investments to thepublic. It was forced to pay a USD 1.93 billion settlement in2014 to the US Federal Housing Agency for selling subprime mortgagebacked securities to Freddie Mac and Fannie Mae. It was also forcedto sign a USD 7.2 billion settlement with the US Department ofJustice in 2017 relating to the sale of mortgage backed securities.The US Attorney General at the time, Loretta Lynch, stated that"Deutsche Bank did not merely mislead investors, itcontributed to an international financial crisis".

In 2009, Deutsche Bank admitted it had hired a detective to spyon people who the Bank felt posed a threat, particularly ashareholder and a journalist. Deutsche Bank eventually fired itsglobal head of investor relations for his involvement in theespionage, although the Bank's top executives claimed ignorance of the situation.

In 2015, it was fined a record USD 2.5 billion by American &British authorities for its involvement in the Libor interest rate(Libor rate is an average of what banks charge for lending to eachother) scam between 2003 and 2007. During which its London branchpleaded guilty to wire fraud after accusations of manipulatinginterest rates which were in turn used to secure largeinternational contracts and loans, essentially fixing foreignexchange markets. Regulators required Deutsche Bank to firemultiple directors and other executives as a result of theirinvestigation.

Later that year Deutsche Bank was fined another USD 258 millionfor violating US Sanctions by conducting business with sanctionedcountries such as Syria, Myanmar, Libya and Sudan. Regulatorsdiscovered that between 2000 and 2006, 27 200 dollar clearingtransactions worth over USD 10.86 billion were disguised byDeutsche Bank. In addition to the fine, it was required to appointan independent monitor and dismiss employees involved in the scandal.

In 2017 Deutsche Bank was fined USD 630 million by American andBritish regulators for lapses in their Anti-Money Launderingsystems. Regulators say that Deutsche Bank failed to flag illegaltransactions, completely lacking knowledge of who was trading whatand where the money came from, known as 'Know YourCustomer' (KYC). This resulted in over USD 10 billionbeing laundered out of Russia through 'mirror trades'between 2011 and 2015 through its Moscow, London and New Yorkbranches. Clients purchased stocks in Moscow then sold them at thesame price through the London branch, with the end goal being thatit would eventually be cleared through the New York branch'soperations and be paid in US Dollars. Once again, as part of aconsent order reached between Deutsche Bank and the New York StateDepartment of Financial Services, Deutsche Bank was required toattain an independent monitor to review its internal compliance protocols.

Relationship with President Trump

Questions have also been raised about Deutsche Bank'srelationship with President Trump. New York prosecutors subpoenaedDeutsche Bank seeking financial records that President Trumpprovided to it over the years, as they investigate possible fraudallegations. Their relationship goes back to the 1990's whenDeutsche Bank was trying to establish itself as a mainstay ininternational investment banking. Deutsche Bank lent PresidentTrump over USD 2 billion over decades despite numerous defaults up until hiselection. Former employees of Deutsche Bank's Anti-MoneyLaundering department stated that in 2016 and 2017 they flaggedmultiple transactions involving entities controlled by PresidentTrump and prepared Suspicious Activity Reports, but top-levelexecutives at the bank never escalated the alerts. Tammy McFadden,a former anti-money laundering specialist who stated she was forcedout of Deutsche Bank after repeatedly raising concerns regardinginternal compliance protocols stated: "You present them with everything, andnothing happens.it's the Deutsche Bank way. They are prone todiscounting everything"

Corporate Governance Consequences

The various governance lapses Deutsche Bank had over the yearstook a toll on its share price, having declined over 80% since2010, from as high as USD 123.60 before the 2008 financial crisis.Glass Lewis called on investors to vote against ratifying DeutscheBank's Chairman, Paul Achleitner's actions at the Annual General Meeting due to "performanceconcerns". He announced, after three straight years ofsurviving shareholder votes to remove him, that he will step downonce his term ends in 2022.

Previous CGLytics research unveiled amisalignment between pay and performance during Deutsche Bank'sscandal plagued years. Deutsche Bank's Key PerformanceIndicators (KPI) were consistently negative between 2014 and 2018due in part to the series of scandals. Management suspendedvariable renumeration to assuage shareholder concerns, yet once thebank returned profit in 2018 management immediately restoredincentive payments which shareholders felt were alwaysexcessive.

Below are three graphs. The first shows Deutsche Bank's yearend share prices since 2010, the second showing the relativecompensation of its Chief Executive to his European counterpartsbetween 2016 and 2018, and the third showing Deutsche Bank'sCEO pay compared to performance, measured by Total ShareholderReturn, over three years.

Historically, it has been difficult to quantify reputationalrisk as essentially these are the opportunities an institutionfails to receive after bad press. The fines and consent orderslevied on Deutsche Bank are easily identifiable from a regulatoryperspective, and the subsequent share price decrease and finesagain show the financial risk. Deutsche Bank's governancelapses highlight the importance of maintaining an honest top-downcompliance culture, a good understanding of handling high riskclients, as well as the consequences if an institution failsthis.

In the second part, we will examine the consent order issued bythe New York Department of Financial Services regarding DeutscheBank's relationship with Jeffrey Epstein, FBME & DanskeBank Estonia.

In the interim, how can financial institutions improve theircorporate governance and gain oversight of their board effectiveness going forward? CGLyticsgovernance data and analytics tools provide the board compositionanalysis companies, investors and service provides need, now and inthe future, to reduce risk and ensure company success.

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.

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