By Brian Monroe
February 2, 2017
Regulators in New York and the United Kingdom this week issued a landmark penalty totaling more than $600 million against Germany’s largest bank, a glimpse into the future of regulatory oversight where international cooperation extends to egregious financial crime compliance failings.
In the action, the New York Department of Financial Services (NYDFS) and the U.K.’s Financial Conduct Authority (FCA) issued penalties of $425 million and $204 million respectively for widespread and longstanding anti-money laundering (AML) failings at Deutsche Bank, chiefly tied to the laundering of some $10 billion out of Russia through a simple yet brutally effective securities scheme called “mirror trades” between 2011 and 2015.
The mirror trades typically involved a three-part system. In the first step, a trader in Russia put in a trade through Deutsche Bank’s Russian branch to buy Russian Blue Chip stocks. At roughly the same time, the same person or a co-conspirator used another company secretly owned by the group to place an order to sell the same amount of Russian stock through London.
The last step was the Deutsche Bank trading arm located in the U.S. in New York issuing U.S. dollars to the parties involved in both sides of the trade.
“The suspicious security trading schemes identified – termed ‘mirror trades’ -permitted this corrupt consortium to move very large sums of money out of Russia under the radar and without the scrutiny of Deutsche Bank’s compliance function,” according to the New York action.
“This Russian mirror-trading scheme occurred while the bank was on clear notice of serious and widespread compliance issues dating back a decade,” NYDFS Superintendent Maria Vullo said.
“The offsetting trades here lacked economic purpose and could have been used to facilitate money laundering or enable other illicit conduct, and today’s action sends a clear message that DFS will not tolerate such conduct.”
But inextricably linked to the mirror trades – which basically acted as an off-the-radar way to evade AML compliance scrutiny and allow companies with anonymous ownership structures to trade Russian rubles for dollars – are broader compliance failures, evincing a Deutsche bank program beset by an array of deficiencies at the most basic levels.
The FCA penalized Deutsche Bank for roughly the same failings in AML program staffing, transaction monitoring and risk scoring. Both countries have similar AML frameworks, with the main difference being the U.K. collects and will be publishing corporate beneficial ownership data.
FCA shows teeth in historic penalty
The penalty is the largest ever imposed by the FCA, or any predecessor agency. If not for a 30 percent discount for being forthright with the regulator and attempting an aggressive remediation plan, Deutsche Bank would have faced a fine of just under $287 million.
“Financial crime is a risk to the UK financial system,” said Mark Steward, Director of Enforcement and Market Oversight at the FCA, in a statement.
“Deutsche Bank was obliged to establish and maintain an effective AML control framework,” he said. “By failing to do so, Deutsche Bank put itself at risk of being used to facilitate financial crime and exposed the UK to the risk of financial crime.”
The magnitude of the penalty should also be a warning shot to other banks.
“The size of the fine reflects the seriousness of Deutsche Bank’s failings,” Steward said. “We have repeatedly told firms how to comply with our AML requirements and the failings of Deutsche Bank are simply unacceptable. Other firms should take notice of today’s fine and look again at their own AML procedures to ensure they do not face similar action.”
The action is also a porthole view into the creativity of criminals working through the securities sector.
In that world, the seemingly simple act of a stock trade can include an at times confusing jumble of parties, entities and transactions, including full service brokers, introducing brokers, clearing brokers, and scenarios where an adviser at one firm is selling products in the name of another company, just to name a few examples.
Both New York and FCA examiners noted that Deutsche bank operations in Russia, the U.K. and U.S. had significant failures in monitoring, risk-ranking clients and customers and the accuracy and depth of know-your customer (KYC) data.
Part of that is due to profit-driven traders, not just nefarious insiders.
Some traders openly admitted they didn’t look deeper at trading counterparties because they didn’t want to lose out on hefty commissions that propped up the division during an overall securities sector slowdown.
Compliance, business line clashes continue
The NYDFS specifically mentioned that even when, in a few rare cases, someone internally raised questions or concerns around the mirror trading scheme, they were rebuffed, from being given dismissive responses to open hostility to questioning trades, a microcosm of the global battle being waged behind the scenes between business line executives and compliance cops.
Moreover, the frustration by New York authorities is clearly evident in the action, beyond even the massive size of the penalty – the figure is among the largest ever handed down for purely AML failings, particularly with a securities slant. The order notes that Deutsche Bank’s program was “afflicted” with problems and the result of “machinations” by top executives.
Both regulators touched on other Deutsche Bank compliance problems that have become a common refrain in many U.S. actions in recent years.
The order detailed a lack of staffing that had a snowball effect, leaving compliance personnel feeling overwhelmed, wearing multiple hats, and having no real authority to challenge suspicious behaviors or clients even when they did find some.
The NY action quoted one compliance officer as saying he had to “beg, borrow and steal,” resources for the compliance department.
More worrisome, according to examiners, is that Deutsche Bank’s compliance program, lacked the basics needed for a massive, international trading desk, such as automated screening procedures for suspicious transactions.
All the while, this occurred as the bank sat on more than $2 trillion in assets.
At the same time, arguably the most critical part of a bank’s AML program, the independent audit prong, was dulled due to this lack of staff, expertise and authority.
Bank ‘missed key opportunities’ to uncover scheme
NYDFS found that Deutsche Bank and “several of its senior managers missed key opportunities to detect, intercept and investigate” the long-running mirror-trading scheme facilitated by its Moscow branch and involving New York and London branches.
The scheme had several international components.
At the outset, operating through the equities desk at Deutsche Bank’s Moscow branch, certain companies issued orders to purchase Russian blue chip stocks, always paying in rubles.
Then, quickly, “sometimes on the same day, a related counterparty would sell the identical Russian blue chip stock in the same quantity and at the same price through Deutsche Bank’s London branch,” according to the order.
The counterparties involved “were always closely related, often linked by common beneficial owners, management or agents,” though the bank in most instances did not make those connections or report the activity as suspicious in the early years of the scheme.
The critical U.S. component came as the trades were routinely cleared through the bank’s Deutsche Bank Trust Company of the Americas (DBTCA) unit.
The trades included classic red flags and historically high-risk entities and jurisdictions.
The selling counterparty “was typically registered in an offshore territory and would be paid for its shares in U.S. dollars. At least 12 entities were involved, and none of the trades demonstrated any legitimate economic rationale,” according to the actions.
But allowing these trading tactics to continue for years were lax AML practices across the board.
“Afflicted with inadequate AML control policies, procedures, and structures, Deutsche Bank missed several key opportunities to identify and interdict this scheme,” according to New York.
Moreover, the suspicious mirror-trading “machinations” occurred at a time Deutsche Bank “was on clear notice of numerous deficiencies in its BSA/ AML systems and management, and yet the steps it took to remediate the situation proved seriously inadequate.”
The group also did the mirror trades involving banks other than Deutsche Bank in other countries, where Deutsche could only see one piece of the buy or sell, a tactic referred to in the documents as “one legged trades.”
Even so, those trades still used the same trader at Deutsche Bank, activity that should have been calculated into the risk assessment.
Tipped off, but compliance was not topped off
One reason regulators issued such a harsh penalty is that the bank was tipped off about a similar scheme happening in Russia, with an article sent to several top bank executives and compliance personnel in Moscow and London, but the crux of the warning was not heeded, according to the order.
When bank staffers found out that an unnamed counterparty to the trades was suspended by a Russian business authority, they didn’t look into why or what kind of trading the operation did at the bank, or pushing for the issue to be escalated and an investigation or lookback be undertaken.
Instead, the group squabbled about a desire to recoup more than a million dollars from the suspended party because it had not settled certain trades.
As well, the bank missed a chance to uncover the massive trading scheme when an unnamed European bank asked for more details about a counterparty, asking if the trades could be suspicious and if the party had been vetted by Deutsche Bank.
A compliance manager, who U.S. authorities believe was corrupt and took bribe payments disclosed as nebulous “consulting fees,” finally responded to the European bank after repeated requests for assistance that the party was not risky, the trades were fine and the entity has passed through a rigorous KYC vetting process.
The person allegedly even broke AML and anti-corruption laws by reaching out to the company thought suspicious by the EU bank.
No support, backbone in AML audit backstop
But while Deutsche bank’s AML audit division didn’t technically break any laws, it was clear from both orders the group’s spirit was broken.
Although Deutsche Bank’s Group Audit specifically identified deficiencies in the Bank’s risk rating methodology in a Global Anti-Money Laundering Report prepared in 2012, the Moscow division “resisted adopting modified risk-rating procedures because most of their clients would be re-classified as high risk, and the office lacked the operational resources required to handle the increased compliance workload.”
The bank also had “inadequate compliance and internal audit resources,” according to the order.
These deficiencies were “exacerbated by Deutsche Bank’s ineffective and understaffed” anti-financial crime (AFC), AML, and compliance units.
“At a time that it was increasing risk in various business segments, the Bank’s intense focus on headcount reduction between 2010 and 2012 prevented the AFC and Compliance units in DB-Moscow and elsewhere from being staffed with the resources necessary to function effectively,” according to New York.
A senior compliance staffer repeatedly stated that he had to “beg, borrow, and steal” to receive the appropriate resources, leaving existing personnel “scrambling to perform multiple roles,” according to regulators.
In a sad snapshot, at one point in time, “a single attorney who lacked any compliance background served as DB-Moscow’s Head of Compliance, Head of Legal, and as its AML Officer – all at the same time. And a number of employees with leadership positions in the AFC, AML, and Compliance groups lacked necessary experience or training.”
The New York regulator took a recidivist tone with Deutsche Bank due to its “substantial history of regulatory violations” overly the last decade, which “placed it squarely on notice of the need to address potential compliance issues that permitted the mirror trading scheme to fester.”
The penalties cited by New York include a $600 million penalty last year for its participation in the global LIBOR scandal, where individuals at multiple institutions illicitly collaborated to influence interbank rates for their own gain, a $258 million penalty for sanctions violations also last year and a 2005 written agreement on AML issues through correspondent banking portals.
“In short, Deutsche Bank’s AML control failures were longstanding and enterprise-wide, enabling the mirror trade scheme to flourish and persist,” the regulator concluded.