With a former HSH Nordbank AG executive nicknamed “Dr. No” and a collateralized-debt obligation transaction called Omega 55, the first German criminal trial over the financial crisis could be the backdrop for a James Bond thriller.
Dirk Jens Nonnenmacher, the 50-year-old ex-chief executive officer given the nickname by the media because of his Ph.D., is one of six former HSH Nordbank management board members who went on trial in Hamburg today. Another former CEO, Hans Berger, is also a defendant.
All six ex-board members were charged with breach of trust and two of them with false accounting over the Omega 55 transaction, the 2007 CDO package that prosecutors said led to 160 million euros ($211 million) in losses. At the height of the financial crisis in 2009, the Hamburg-based lender was bailed out with 30 billion euros in aid from German state and federal governments.
“The defendants didn’t live up to their duty to act as diligent businessmen when deciding whether to authorize the transaction,” prosecutor Karsten Wegerich told the court. “They took chances on incalculable risks of a highly speculative CDO.”
Prosecutors throughout Germany have investigated lenders that faltered during the financial crisis. While charges have also been brought against former managers at Bayerische Landesbank, SachsenLB and Landesbank Baden-Wuerttemberg, none of them has gone to trial yet.
Most of the troubled lenders are Landesbanken, which are owned by German states and savings banks. The Landesbanken received a combined 97.3 billion euros in state aid and guarantees during the global financial crisis, according to company and Bloomberg data.
Nonnenmacher, who was ousted as CEO in 2011 over his role in an unrelated spying scandal, and Berger deny the allegations.
Nonnenmacher didn’t commit any crimes, his attorney, Heinz Wagner, said in a phone interview this week. Berger, who resigned over the bank troubles, will fight the allegation, his attorney Otmar Kury said.
HSH Nordbank will follow the criminal case with “great attention,” spokesman Rune Hoffmann said in an interview.
After the charges were read out, Norbert Gatzweiler, a lawyer for defendant Peter Rieck, said the case was assigned to the wrong panel and an alternate judge was arbitrarily selected. Earlier this year, defense lawyers in the Cologne criminal trial of former managers at Sal. Oppenheim Jr. & Cie. halted the case for three months with a similar motion.
The former bank managers approved the deal with BNP Paribas SA at the end of 2007, during the first months of the financial crisis. Under the 2.4 billion-euro transaction, HSH Nordbank was able to transfer risky loans to a special purpose vehicle called Omega 55.
Presiding Judge Marc Tully said he and his colleagues allowed the case to go to trial because a preliminary assessment of the case indicated the defendants may have wrongfully approved the deal. The court found that the damage may be “way lower” than the 160 million euros claimed by prosecutors, because the transactions need to be judged based on the perspective of December 2007, not on today’s knowledge, he said.
“We cannot demand that the defendants should have known in 2007 how the financial crisis would evolve and how it would affect the value of the CDO,” Tully said. “It doesn’t matter whether a lucky twist turned it positive or an unlucky one negative in the end. What counts is how the risks needed to be gauged in 2007.”
Gatzweiler asked all judges to disclose whether they lost money with similar instruments during the crisis or whether they have relatives at BNP Paribas, law firms involved in the case or at the Bundesbank and German financial regulator Bafin, all actors in the financial crisis. The information is needed to determine whether judges should be removed for bias, he said.
Tully said that information would be disclosed in writing if deemed necessary. Judges won’t answer questions at a hearing, he said.
“Believe me, when I received the indictment, I checked every reason possible under the law to rule that I cannot hear that case,” Tully said. “Whenever I get such a huge case I’m asking myself: Why me and not one of the other 900 judges in Hamburg?”
The indictment has 606 pages and the files about 130,000 pages. In the German criminal system, judges hearing the case have to go through all the documents.
While the Omega 55 deal was designed to allow the lender to lower its capital needs and to stabilize its credit rating, steps deemed crucial for a planned public offering, the plan didn’t work out, according to prosecutor Wegerich. In turn, the bank assumed liability under credit derivatives that later led to the losses. A few months later, HSH Nordbank even had to retake the risks shifted to the Omega 55 vehicle.
The board members approved the deal after relying on a memo that didn’t fully inform them about the risks so that they couldn’t adequately balance the pros and cons, Wegerich said. The board should have seen that they didn’t have all the necessary facts to understand it instead of green-lighting the proposal. From no point of view was the deal reasonable and the executives shouldn’t have approved it, said the prosecutor.
If the prosecutors’ claims are correct, the Omega 55 transaction “may not have been in the epicenter of the kind of deals causing the financial crisis, but it was certainly driven by the crisis’s pressures,” said Christian Schroeder, a law professor at Halle University. “The use of special-purpose vehicles, the aim to make the balance sheet look a bit better, these are familiar features in the story of the crisis.”
The CDO package is one of several deals that led to the bank’s troubles, and HSH Nordbank has also sued lenders in U.S. courts over residential mortgage-backed securities.
The German states of Hamburg and Schleswig-Holstein, majority owners of HSH Nordbank, were forced to bail out the bank in 2009. They provided the lender, based in Hamburg and Kiel, with 3 billion euros in capital and 10 billion euros in guarantees to cover potential losses. HSH also tapped the federal government’s Soffin bank-rescue fund for 17 billion euros in guarantees.
While more trials over the financial crisis may follow, they won’t fix bugs in the system, law professor Schroeder said.
“You cannot regulate business action with the help of the criminal law,” he said. “What’s really needed to prevent problems like this is adequate regulation. Unfortunately, that’s exactly what’s missing. In 20 years of European Union market regulation, we’ve only seen one crisis following the other.”