Deutsche's Dilemma

As earnings and shares surge, the bank's top execs are headed for court

In every financial category, the news for Deutsche Bank (DB ) could not be better. Long known for high costs, low earnings, and tradition-bound management, the German giant now boasts surging profits, a rising share price, and a sudden flood of new business from corporate clients. Cost-cutting and restructuring programs initiated by former CEO Rolf-E. Breuer and intensified by his successor, Josef Ackermann, are paving the way for a strong 2004. Deutsche's return on equity -- a paltry 1.1% in 2002 -- is expected to top 9% this year and 11% next -- some feat for a bank based in Europe's slowest-growing and most over-banked economy.

Yet for all its recent achievements, Deutsche remains under a cloud. That's due less to any concerns about its balance sheet than to uncertainty about what's going on in the boardroom. Both Ackermann, 55, who became CEO in May, 2002, and Breuer, 66, now chairman of the supervisory board, are embroiled in separate legal cases that could cost the bank billions of dollars and lead to the two veteran bankers' resignations.

CRITICAL TIME. Ackermann is on trial for allegedly not acting in the best interests of shareholders at Mannesmann, the Düsseldorf telecom and engineering group where he served as a supervisory board member because Deutsche was a big shareholder. A criminal conviction would cost Ackermann his banking license. Breuer has already lost a civil suit for breaching bank client Leo Kirch's confidentiality. If Deutsche Bank must pay huge damages to its former customer, the board could seek to recoup the money from Breuer himself. Legal experts say both cases will probably drag on into 2005. "That could put a heavy strain on [Breuer and Ackermann] both physically and emotionally," says Peter O. Mülbert, a banking law specialist at Mainz University.

The court cases could slow the bank's momentum at a critical time, just as the German financial sector is poised to embark on restructuring and consolidation, and while Deutsche management switches its attention from cutting costs to growing revenues. Company spokesmen insist that life goes on as normal inside the twin-towered Frankfurt headquarters of the bank, which boasts $1.07 trillion in assets. So far, at least, the leadership's legal entanglements don't seem to have hurt earnings. Analysts predict that pre-tax profits could surge by up to 40%, to $4.65, billion for 2003.

DAMAGING DEPARTURES? But there's no doubt that court proceedings are taking a toll on morale. Both Breuer and Ackermann have become much more muted when talking to investors and the press. With no clear successors ready to step in, analysts say Deutsche Bank is ill-prepared for a potential future without either man. In the worst case, analysts say a change at the top could leave Deutsche more vulnerable to takeover by a foreign bank. That's something few in Germany's conservative business world would welcome.

If Ackermann, in particular, had to quit, it would be a huge setback not only for the bank but for German industry as a whole. That's because he has won widespread respect from his peers by reshaping Deutsche along American and British lines by putting profit ahead of patronage. Ackermann did that by slashing costs and selling off some of the bank's vast industrial holdings, including, in the last year, big stakes in specialty chemicals and engineering firm MG technologies and publishing group Axel Springer. The Swiss-born Ackermann is considered one of Europe's finest managers. "His departure would be a disaster," says Guido Hoymann, an analyst at Frankfurt's Metzler Bank.

Ackermann's legal problems stem from February, 2000, when Mannesmann agreed to be acquired by Britain's Vodafone Group (VOD ) after a long and bitter battle -- but not before the supervisory board approved multimillion-dollar "appreciation awards" for then-CEO Klaus Esser and other top managers. Big bonuses for good performance aren't illegal in Germany, but they often generate controversy. Local prosecutors investigated. In February, 2002, they charged Ackermann and four other Mannesmann directors with breach of trust -- essentially, cheating investors by agreeing to unneccessary payouts -- an offense punishable by up to 10 years in prison.

Independent experts such as Bochum University company-law specialist Uwe Hüffer say the payouts were justified because Mannesmann's stock price rose to record levels during the takeover battle. That gave shareholders a windfall. Critics of the prosecution fear it will deter foreign companies from investing and drive talented managers abroad. They note that Ackermann himself gained nothing in approving the Mannesmann bonuses. "The indictment is a blow to Germany's reputation as a place to do business," said Angela Merkel, leader of the opposition Christian Democrats, in September.

Those concerns didn't prevent a Düsseldorf court ruling on Sept. 19 that Ackermann and the other defendants would have to stand trial. Proceedings begin on Jan. 21. Meanwhile, Breuer already has lost the first round in his case. The bank, Breuer, and Ackermann aren't commenting on the result.

Breuer's troubles started in February, 2002, when he told Bloomberg TV in New York that banks were reluctant to extend fresh loans to Kirch's troubled media empire. When banks pulled the plug and Kirch's company collapsed two months later, he sued Breuer for disclosing confidential information. In February, 2003, a Munich court found in Kirch's favor. On Dec. 10, an appeals court confirmed the ruling and ordered Deutsche Bank to pay damages.

Kirch says he may seek more than $7 billion -- a penalty so steep it would probably force Breuer out of the bank. However, given that the German press was full of Kirch's financial problems well before Breuer gave his fateful interview, legal experts say damages probably won't exceed $620 million.

Regardless of the outcome, Ackermann and Breuer are spending time with lawyers or in court that could be better spent running the bank. And the cases could drag on for an additional 18 months, keeping both employees and shareholders unsettled. No matter how well Deutsche Bank is performing now, it will be quite a while before it shakes off the ghosts of Christmases past.

By David Fairlamb in Frankfurt

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