Deutsche Bank AG hired law firm Fried Frank Harris Shriver & Jacobson LLP in March 2010 to conduct an internal probe days after a trader alleged the bank had misrepresented the value of derivatives to mask paper losses during the financial crisis.
The law firm found no wrongdoing, Deutsche Bank Chief Financial Officer Stefan Krause told analysts and investors on a conference call today. While Fried Frank found limitations to the bank’s model, no adjustments to valuations were needed and the company switched to a new model in early 2010, Krause said.
Questions about how Frankfurt-based Deutsche Bank valued the assets resurfaced last week when a former quantitative risk analyst at the bank, Eric Ben-Artzi, said the lender hid losses, helping it avoid state aid at the height of the financial crisis. Deutsche Bank rejected the allegations, which related to a portfolio of collateralized insurance agreements that protected against the risk of corporate defaults.
“The bank’s response was immediate, appropriate and thorough,” Krause, 50, said on the call. “The bank has cooperated fully with the SEC and the Federal Reserve Bank of New York, which was appraised of the allegations.”
The lawyers from Fried Frank met with dozens of witnesses and spent several days with the trader for the credit correlation desk, as well as auditors, and reviewed millions of documents, Krause said. Deutsche Bank reported the allegations to the U.S. Securities and Exchange Commission in June of 2010, he said.
Deutsche Bank made several presentations to the SEC and Federal Reserve and submitted millions of pages of documents, the CFO said.
The investigation revealed that the former employees who alleged wrongdoing had no personal knowledge of or responsibility for “key facts and information,” according to the bank.
Deutsche Bank fell to a two-week low in Frankfurt trading today after it said fourth-quarter profit will be “significantly” reduced as it winds down riskier assets and faces higher reorganization costs.
The shares slid as much as 3.2 percent in Frankfurt trading to the lowest intraday price since Nov. 28. The stock was down 1.4 percent at 33.79 euros as of 4:22 p.m. local time.
Deutsche Bank firm reduced the notional value of its correlation book to 60 billion euros ($78.4 billion) at the end of September from 200 billion euros at the end of 2009, according to slides published today. The portfolio “substantially rolls off within three years,” the company said in the presentation.
“To date, no material losses have been recorded on any LSS trades,” Krause said, referring to the securities known as leveraged super senior credit derivatives.
The SEC and German financial-market regulator BaFin both declined to comment on the investigation when contacted by Bloomberg News last week.
The issues raised by the former employees were subject of “extensive discussion” among business and control groups within the bank prior to any allegations, according to Krause’s presentation. The internal review concluded that external auditors were aware of and comfortable with the bank’s treatment of the valuation issues, according to the presentation.
“Bank personnel evaluated all available information and tools and employed their best judgment for the fair value of this trading book during unprecedented market conditions,” the bank said in the slides.
When Ben-Artzi, the former risk analyst at the bank, first made his allegations in March 2011, the bank passed them to the SEC the same month, said two people familiar with the matter who asked to remain anonymous.
Krause didn’t refer specifically to Ben-Artzi. He said an employee in market risk who made similar allegations to those of the trader met with senior executives at the bank to explain his concerns and was provided contact details for the SEC lawyer handling the investigation. This analyst turned down an opportunity to present a different valuation methodology, the CFO said.
Fried Frank debriefed the employee in market risk and incorporated his allegations into its investigation, which has since concluded, said Krause.
Ben-Artzi, who joined the bank in 2010, is suing Deutsche Bank for wrongful dismissal after he lost his job in 2011, according to a statement last week from Labaton Sucharow LLP, his New York-based law firm. Steven Bodakowski, a spokesman for the law firm, didn’t immediately respond to a request for comment.
Ben-Artzi alleges that from 2007 to 2010 Deutsche Bank misrepresented the value of a portfolio with a notional value of as much as $130 billion, Labaton Sucharow said last week.
Deutsche Bank may have lost $12 billion from the insurance agreement credit derivatives had they been valued properly, the Financial Times reported Dec. 5. It cited estimates derived from comments by three former employees who testified to the SEC, including Ben-Artzi.
“This model has certain known limitations which were exacerbated as the market deteriorated during the economic crisis,” Krause said today. “While the bank developed and tested alternative models that would overcome the model’s limitation, the financial impact of these limitations was addressed through the taking of reserves.”