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Amid Scandals, Deutsche Bank Tries a 'Do-Over'
Police cars staked out the building, a helicopter swooped noisily overhead, and hundreds of police and prosecutors stormed into Germany's venerable Deutsche Bank AG. The unprecedented assault on its corporate offices in Frankfurt, described in news accounts last December, was the ultimate in humiliation for the bank, which for the past several years has lurched from one scandal to the next. Quite simply, the raid meant that one of the largest financial institutions in the world was being treated like a common criminal.
Recent allegations against Deutsche are myriad; the raid stemmed from an alleged tax fraud aggravated by accusations of obstruction of justice. Other allegations include manipulating the interbank loan rates known as LIBOR, misleading investors in subprime mortgage deals, hiding losses from the public and regulators, and more.
Certainly Deutsche Bank is not alone. Many other prestigious banks face scrutiny in the LIBOR and subprime scandals. But combined with other legal crises, the investigations have cost Deutsche Bank dearly while big U.S. banks have for the most part escaped criminal probes.
It has already lost millions in legal fees and penalties. Indeed, in the fourth quarter of 2012the most recent financial report available at this writingthe bank announced a surprising $3 billion loss. Much of it was due to writing off losses. But more than $1 billion of it went to cover legal costs needed to ward off angry investor suits and government investigators at home and abroad.
And the suits keep coming. In March the U.S. mortgage finance company Freddie Mac filed suit against several banks, including Deutsche. The claim says the banks' collusion on the LIBOR rates cost Freddie and its sibling, Fannie Mae, an estimated $3 billion in damages.
Add to the expense of such suits the loss of executive time. Deutsche Bank's management, and its in-house legal department, have spent countless weeks and months dealing with prosecutors and the plaintiffs bar. Last, but not least, the bank has suffered a severe hit to its reputation and credibility. At least one German politician has suggested splitting up the institution, which claims it has more than 100,000 employees in 70-plus countries.
The cascade of problems spurred the German newsweekly Der Spiegel to write last December after the raid: "A Reputation in Ruin: Deutsche Bank Slides into a Swamp of Scandal." The article went on to say the bank "is facing myriad investigations, legal troubles, scandals, and accusations of malfeasance. Its current leadership has pledged a new beginning, but several executives are tainted as well." The story specifically named the bank's cochief executives and its chief financial officer. Though we made repeated attempts to contact the bank, no one from Deutsche Bank would comment for this story.
Another key executive inundated by the challenges is general counsel Richard Walker. A former director of enforcement at the Securities and Exchange Commission, Walker is trying to help the bank reinvent itself at the same time that he deals with a multitude of regulators, investigators, and litigators. The GC can't escape that many of these scandals happened on his watch.
No one has accused Walker of misconduct. In any corporate scandal, "ultimately the accountability flows to the CEO," says Arthur Middlemiss, a former prosecutor and now partner at Lewis Baach. Middlemiss, who headed the international white-collar crime unit in the New York district attorney's office, adds, "But the CEO will look directly to the general counsel. The general counsel can have an incredible role to play in creating and setting rules and enforcing compliance."
Despite the bank's legal problems, the bank promoted him in January to an enlarged 18-member management board, part of a broad effort to bring about change. The effort includes increasing capital reserves, levying cost controls, and imposing a foundation for what the bank ambiguously calls long-term, "deep cultural change."
But a change from what? Neither bank spokesman Duncan King, nor Walker, nor U.S. legal chief Joseph Polizzotto would discuss specific reforms. And Boston University law professor Cornelius Hurley, for one, doesn't buy into a reform effort that lacks transparency. Hurley, who directs the school's Center for Finance, Law & Policy, asks, "What's wrong with the culture now that you have to change it? Anytime you make a statement like 'We're going to change the culture,' without saying what's wrong with the old one, I am on guard."
So what's wrong with Deutsche Bank's culture? In many ways the bank's record of past behavior speaks for itself.
Controversy around Walker began even before his first day on the job at Deutsche Bank. The former partner at Cadwalader, Wickersham & Taft started working at the SEC in 1991 as director of its northeast regional office. Five years later, he became the SEC's general counsel for two years, and then director of enforcement until he resigned in July 2001.
While Walker was still head of enforcement in the late nineties, the SEC opened an investigation into Deutsche Bank. The bank had allegedly made a materially misleading statement while pursuing plans to acquire another company, Bankers Trust Company. But shortly after the SEC staff issued a Wells Notice, indicating that charges were being considered, Walker suddenly recused himself from the probe and announced that he would leave the agency in July 2001.
Two weeks later, the SEC terminated the investigation. And two months later, the bank announced that it had hired Walker as its general counsel. Not until 10 years later did anyone raise serious questions. An SEC whistle-blower told Congress that Deutsche investigative files had been shredded. And the whistle-blower questioned Walker's role in the probe before he left the SEC.
The media pounced. Forbes and Rolling Stone wondered why charges were never filed against the bank, and raised questions about the timing of Walker's hiring. But nothing substantive ever came from the questions.
(The bank has had other friends at the SEC. In 2002 Walker hired Robert Khuzami, a former colleague at Cadwalader, Wickersham & Taft, as global head of litigation and regulatory investigations in the bank's New York office. He promoted Khuzami two years later to GC for the Americas. And in 2009, Walker recommended Khuzami to be chief of the SEC's enforcement divisiona job Khuzami held until last January. During his reign, Khuzami recused himself from any SEC matters involving the bank.)
One Wall Street critic believes that such inbred relationships are why so few big banks have been prosecuted for the financial crisis. Steven Berk, founder of Berk Law in Washington, D.C., and author of a legal blog called The Corporate Observer, says it's not unusual for big banks to hire counsel with connections to regulatory agencies and the U.S. Department of Justice. "That's not to say people are acting in bad faith, but it's a very incestuous relationship there," says Berk, who also worked at the SEC before becoming an assistant U.S. attorney in Washington, D.C.
Meanwhile Deutsche Bank, under Walker's legal supervision, has skidded from one legal crisis to another. And the coCEOs, Jurgen Fitschen and Anshu Jain, have been tarnished by the scandals. The public prosecutor in Frankfurt is still investigating Fitschen and the bank's chief financial officer because they signed a company tax statement for 2009 that claimed a $403 million refund that was linked to an alleged fraud. This issue, and a perceived lack of cooperation with authorities, led to December's raid in which five other bank executives were arrested. Deutsche Bank has since corrected the tax declaration, but the investigation continues. The bank has denied any wrongdoing.
Jain, the other coCEO, carries his own legal baggage. As head of global markets and investment banking since 2004, he and his unit were tied to toxic securities deals that a U.S. Senate report said played a key role in the financial crisis of 2008. The report by the Senate permanent subcommittee on investigations singled out Deutsche Bank for assembling deals, filling them "with low-quality assets that its top CDO trader referred to as 'crap' and 'pigs' " and then selling them to unsuspecting customers.
And that wasn't all. The report went on to say that Deutsche Bank and The Goldman Sachs Group Inc. were the worst CDO offenders contributing to the financial crisis. The subcommittee chairman, Senator Carl Levin, a Michigan Democrat, said of the banks at the time: "Our investigation found a financial snake pit rife with greed, conflicts of interest, and wrongdoing."
Several of the Deutsche Bank deals have resulted in lawsuits seeking billions of dollars in damages. In March, for example, a suit by the Allstate Insurance Company moved forward when a New York judge refused to dismiss Allstate's claim. The giant insurance company alleges that a Deutsche Bank subsidiary duped it into paying for $185 million worth of mortgage-backed securities that lost their value.
And the bank had other mortgage-related problems. The Justice Department in 2011 alleged that Deutsche Bank knew that thousands of its U.S. mortgages were not eligible for government insurance, but that its underwriters lied about that. When the mortgages failed, taxpayers were stuck with the losses. U.S. Attorney Preet Bharara in Manhattan said at the time of filing suit, "MortgageIT [a subsidiary] and Deutsche Bank ignored every type of red flag and breached every duty of due diligence before underwriting thousands of federally insured mortgages." The bank "accepted responsibility" and settled the case in May 2012 for $202 million.
Then came the whistle-blowers. In December three whistle-blowers went public with accusations that the bank hid billions of dollars in paper losses during the financial crisis. Their suit is pending. A bank spokesperson at the time denied the charges in a statement sent to Corpcounsel.com, saying, "The allegations of financial misstatements, which are more than two-and-one-half-years old and were publicly reported in June 2011, have been the subject of a careful and thorough investigation, and they are wholly unfounded."
Now the bank faces potential penalties over the LIBOR scandal. Traders at Deutsche Bank allegedly colluded with other global banks to manipulate the interbank loan rates. Both U.S. and British regulators are investigating Deutsche Bank's role, and its financial liability is unknown at this writing.
No doubt the scandals have taken their toll on the bankfinancially, emotionally, and reputation-wise. But now the once proud institution has pledged a new beginning. It seeks to restore investor confidence, financial stability, and its good name with a far-reaching strategic plan.
Its reformation began in mid-2012. It named its chief risk officer to the bank's management board, along with the GC. Two insiders, Fitschen and Jain, replaced the then-CEO. Jain, 49, a Briton of Indian origin, is an investment banker from London who speaks little German. He leads the international charge, while Fitschen, 63, tries to bolster the confidence of major domestic clients at home.
In a June 2012 letter to employees, board chairman Paul Achleitner vowed that management would create a strategic plan by fall. "We have opened a new chapter in the development of our bank," Achleitner wrote. And he promised to "reestablish the bank's reputation as the cornerstone of a modern society." The following month the bank announced an update to that goal. To help bring about cultural change, it pledged to review its codes of personal conduct. And it said it would review its compensation practices to address "the relative balance between rewards for shareholders and those for employees."
A formal plan called "Strategy 2015+" was announced in September. It spelled out structural reforms to help the bank address a changed business environment, and it set a course to be more "client-centric." The strategy included a commitment "to a fundamental change in the bank's culture."
Then the United States gave the bank a hefty vote of confidence. Despite the Senate subcommittee report, the fraud charges, the Freddie Mac suit, and the ongoing LIBOR probe, last fall American officials chose the bank to lead the landmark sale of government shares in bailed-out American International Group Inc. Jain called the move "a remarkable honor for a non-American bank" and "an important milestone on the road to postcrisis stabilization" for Deutsche Bank. It was a $21 billion deal"the biggest-ever transaction of its kind," Jain noted.
The bank found more help to spruce up its image in Great Britain. It hired Sir Richard Lambert, the longtime editor of the London-based Financial Times, as a "senior independent adviser" last December. Lambert "will help Deutsche Bank adapt to a new regulatory environment," according to a bank statement.
Then, in January, it named a new head of public affairs in Berlin to help deal with the German government. To further drive home the message of change, its two CEOs presented a detailed speech explaining how the bank would right itself. In the speech, Jain assailed "the sheer volume of regulatory change. . . . No industry in recent history has had to face such wide-ranging regulatory changes, simultaneously and across all major jurisdictions, as the banking industry faces today."
Then Fitschen took up the topic of cultural change. He said the bank had tightened its control environment, reducing the scope for unacceptable behavior. It increased mandatory compliance training and in 2013 would roll out business conduct and ethics training for all employees. "Our framework of internal controls is very different from what it was precrisis," he said. "Our goal is to transform our risk cultureensuring that the bank's reputation is at the heart of our decision making."
There was more. Fitschen said the bank strengthened its red flag monitoring system, which reports on breaches of compliance. And it integrated the monitoring results into its governance and reporting structures, tying those results into its promotion and year-end bonus processes. Jain warned, "There are consequences for any staff member who does not respect our control environment."
Berk, the corporate blogger, remains skeptical. A company can have the best compliance program in the world, he says, "but at the end of the day it is just window dressing." To create real change in financial institutions, Berk says, prosecutors need to charge individuals when there is wrongdoing. "That would have a real chilling effect on criminal conduct, greed, and malfeasance," he insists.
And Berk, like Hurley, says the other key to any cultural change is transparency. "As [U.S. Supreme Court Justice Louis] Brandeis said, 'Sunshine is the best disinfectant.' "