Will Bad Bankers Ever Be Punished?

Malaysia’s justice authorities have filed serious charges against Goldman Sachs that may launch a new era in international efforts to punish major global banks for alleged fraud and corruption.

Never before have the authorities of an emerging market country filed criminal charges against one of the world’s leading banks and threatened fines that could run into several billion dollars.

For too long, the world’s major monetary authorities have been complacent about the fraud and corruption at banks, despite the mounting threats that the continuation of such behavior pose to global financial stability.

Soft Europe

Until now, European authorities have negotiated generally modest fines with banks caught in all manner of malfeasance, while the U.S. authorities have leveled far greater fines. Now, Malaysia appears to be following the U.S. example.

Attorney General Tommy Thomas said criminal charges under the country’s securities laws are being brought against Goldman Sachs in connection with $6.5 billion raised for Malaysia’s 1MDB development fund.

Mr. Thomas said that Malaysia will seek a fine in excess of $2.7 billion, plus the $600 million commission that the bank charged for raising the cash for Malaysia.

Goldman Sachs is already under a U.S. Justice Department investigation for its role in the 1MDB scandal. News of the Malaysian charges pushed the bank’s stock down to its low level of 2018 at $166.53, which compares to the year’s high of $275.33.

The stock has been under pressure for many reasons this year, including the U.S. investigations.

Meanwhile, in Europe, Deutsche Bank’s stock price has fallen sharply as its troubles multiply. This includes a potential new money-laundering scandal after 170 police officers and tax investigators recently raided its Frankfurt headquarters.

Three inconvenient facts

Fact: On both sides of the Atlantic, we find major banks riddled with malfeasance.

Fact: The same mega-banks are repeatedly caught in the middle of scandals.

Fact: Banks just pay fines, while their most senior executives are never personally prosecuted, let alone jailed.

Mega-scale of scandals

The largest banks have paid over $340 billion in fines in the decade since the world’s financial crisis and the total keeps rising. Even so, the core culture of banks –providing the greatest bonuses to bankers who secure the largest short-term profits –shows little indication of changing.

It was precisely such incentives which played a role, for example, in the vast money-laundering schemes used by Russians through the tiny Estonian branch of Danske Bank. The schemes involved over $225 billion of cash going through the bank over several years and its top executives claimed that they never even noticed any of that activity.

It is also conceivable that the ongoing investigations by Special Counsel Robert Mueller of Russian involvement in the 2016 U.S. presidential campaign, as well as New York State investigations into the activities of the Trump organization, will yield connections to laundered Russian cash through numerous major banks.

Meanwhile, Goldman Sachs’s recently retired chairman Lloyd Blankfein was aware of the vast commissions of about 10% that the bank was receiving for raising $6 billion in funds for the government of Malaysia.

Almost certainly, Goldman’s former COO, Gary Cohn, who subsequently became President Trump’s chief White House economic policy advisor for a while, was also aware of the huge commission. Both may well be witnesses in the unfolding cases against the firm.

Two of Goldman Sachs’s former top Asian executives, Tim Leissner and Roger Ng, have already pleaded guilty in the United States to having paid bribes connected to the 1MDB scandal. They have also been charged now by Malaysia.

Goldman Sachs says it is cooperating with the U.S. Justice Department to resolve any inappropriate behavior and appears to be trying to brush aside the Malaysian charges.

Solutions

There are only two ways to change the sense of impunity and the proliferation of banking malfeasance.

First, prosecute some of the top bankers and, if found guilty, then lock them up. The prospects of this happening continue to seem remote. Bankers have too much political influence.

Second, the alternative approach is to change the banking culture. This is more gradual and subtle. Pressures could mount from central banks that see meaningful risks to the health of the financial system resulting from the continuing stream of large-scale banking scandals.

In this regard, monetary authorities should take close note of a new report, “Banking Conduct and Culture: A Permanent Mindset Change,” produced by The Group of 30 (G30).

Comprised of former finance ministers, central bankers and a few leaders of private finance, this body of seasoned professionals appears to be losing patience with the board of directors at many banks.

The G30 established a working group to develop this report which has been headed by William R. Rhodes, who not only worked for Citigroup for more than 50 years and was its top international officer, but — for full disclosure’s sake — who is also a good friend of mine.

Rhodes has long been deeply concerned that many bankers continue to fail to pay sufficient attention to securing the good reputations of their firms and placing the interests of their customers first. The result, he asserts, is that public confidence in banks and the financial system erodes.

The report’s first recommendation for improvement concerns actions that boards of directors should take. Too many board of directors are too friendly with the top managers that they should be monitoring. Too many board of directors enjoy their large fees and yet get to toil in relative obscurity, thus escaping from public attention.

The problem is that banking regulators are not sufficiently equipped to monitor institutions’ internal culture, which ultimately extends to every aspect of conduct in banks. They thus have to rely upon the banks to implement effective systems to do this.

To tighten the reins at least somewhat, the G30 report recommends that those systems need to be overseen by special governance committees of boards of directors in the interests of all the stakeholders – not just shareholders, but employees and customers and the public at large. And it demands that the directors need to be held to account.

The new report underscores that there has to be a core mindset change at banks. Indeed, a rotten culture needs to be replaced.

Maybe the Malaysians, followed by others, will force the boards of banks to understand that paying fines can no longer be just accepted as a cost of doing business.