Deutsche Bank Found `Systemic' Failure in Russia Cash Flight

  • Internal report outlines year of red flags over Moscow trades
  • Warnings from Cyprus, Moscow seen bogging down in London

Deutsche Bank Finds 'Systemic' Fail in Internal Controls

Red flags started popping up inside Deutsche Bank AG in early 2014 about billions of dollars in suspect trades from Moscow. A Cypriot bank sent a query to London. Russia’s central bank raised questions. Moscow back-office staffers compiled a list of dubious transactions.

Some of the warnings were ignored. Others were dismissed. It wasn’t until early 2015, when Russian authorities began interviewing bank employees in Moscow, that top executives in Frankfurt were alerted and the bank began a full-scale internal investigation.

What Deutsche Bank quickly found: a “systemic” failure in internal controls meant to prevent money laundering and financial crime. Those critical deficiencies, as it called them, allowed a “suspected money-laundering pattern” to pump as much as $10 billion out of Russia from 2012 through 2014.

That is the harsh conclusion of an internal bank report analyzing the German lender’s response to the so-called mirror trades, details of which were reviewed by Bloomberg News. Findings from the October 2015 report form the basis for this article, alongside details from a Russian central bank audit of the bank’s operations that resulted last year in a fine for reporting lapses.

Personal Oversight

Deutsche Bank’s internal audit found that the missed warnings went beyond the Moscow office to the bank’s compliance, financial-crimes and money-laundering watchdogs in London and New York. Deutsche Bank’s handling of the Russia trades is now being investigated by U.S. prosecutors and European regulators, adding to the string of legal challenges in the U.S. and elsewhere for the bank as it attempts to increase profitability. 

The Frankfurt-based bank’s shares are now trading for one-third of book value, as shareholders demand managers get a handle on losses and legal costs. Deutsche Bank has set aside about 5.5 billion euros ($6.2 billion) for potential liabilities including the Russian trades.

John Cryan, who took over as co-chief executive officer in July, has said he’ll personally oversee efforts to navigate out of the legal storms. He said he hopes to resolve investigations into the Russia trades and other major legal issues this year.

The co-CEO said at a conference in London last month that “it’s not our finest hour” and that the bank “clearly had a systems and control failure” related to Russian transactions. 

‘Weak Controls’

“This could be expensive for Deutsche Bank with the U.S. authorities investigating and just given the sheer volume of the transactions we’re talking about,” said Andreas Plaesier, an analyst at M.M. Warburg in Hamburg who has a hold recommendation on the shares. “The weak controls really don’t make Deutsche Bank look good, but any actual criminal energy is always going to be hard to stop.”

Deutsche Bank, in a statement, said it had submitted the internal report to its regulators in the fall. “Since that time, we have worked to address these deficiencies, taken disciplinary measures with regards to certain individuals and are fundamentally reviewing our client on-boarding and monitoring processes,” the bank said through Renee Calabro, a spokeswoman, who added that the work is important and ongoing.

Mirror Trades

In the mirror trades, a Deutsche Bank counterparty in Russia would buy local blue-chip shares for rubles, while the same stocks would be sold in London for dollars, the bank and the Russian central bank reviews determined.

Such trades are legal in some cases. What the U.S. Justice Department wants to know is whether Deutsche Bank broke anti-money-laundering protocols by not properly vetting them, people familiar with the matter have said.

Deutsche Bank’s internal report describes an interlocking web of offshore companies and Moscow brokers that attracted attention within the bank and from regulators for high volumes of trading, often in just one direction -- exclusively share sales, for example. All the companies were controlled from Russia, according to the report, and placed their orders through the bank’s Moscow equities desk.

Trades by one of those brokers raised suspicions inside the global bank and among at least one of its partner banks for months in early 2014. An audit of Deutsche Bank’s Moscow operations, performed in mid-2014 by an outside firm, found “severe weaknesses” in the unit’s processes for vetting customers. The Russian central bank alerted Deutsche Bank about several Moscow brokerages it was trading with, and the bank’s own staff also raised concerns.

Calls for Probe

Deutsche Bank stopped doing business with a few of the companies. But calls from Moscow back-office staff for a broader probe into such trades were ignored by superiors in London, Deutsche Bank found.

Several of the Russian brokers the bank identified later had their licenses revoked by the country’s central bank. But neither the central bank nor Deutsche Bank reports address a key issue: whose money was being handled.

Some of the money spirited out of Russia belonged to close associates of Russian President Vladimir Putin, people familiar with the matter have previously told Bloomberg News. These associates include a relative of the president and two of his longtime friends, Arkady and Boris Rotenberg, the people said.

There’s no indication that the Rotenbergs or other individuals are under investigation. A representative for the Rotenbergs said the brothers weren’t involved in any such transactions. The Kremlin has called the allegations unsubstantiated.

First Clue

The first clue about the mirror-trade activity arrived in January 2014, the bank’s inquiry found. Cyprus-based Hellenic Bank filed a request for assistance to Deutsche Bank’s London office, asking about “suspicious high-volume transactions” through the account of a U.K.-registered company called Ergoinvest LLP. 

Hellenic sent at least two reminders to London before a response arrived, in March, from Deutsche Bank Moscow. The equities office there -- rather than its compliance or anti-money-laundering departments -- vouched for the clients and the trades, the bank found.

While one part of Deutsche bank was defending Ergoinvest, yet another was posing questions about it: An anti-financial-crime unit in New York flagged questionable activity by the company, directing its inquiries to Hellenic Bank. The Cyprus bank, receiving conflicting signals about Ergoinvest, began asking the New York unit for clarification. It didn’t respond, the bank found.

Crisscrossing Questions

Hellenic Bank declined to comment. Representatives for Ergoinvest -- which is owned by companies registered in the Commonwealth of Dominica, according to U.K. corporate registration data -- couldn’t be located to comment.

In spite of the months of crisscrossing questions, Deutsche Bank continued doing business with Ergoinvest -- including mirror trades, according to the Russian central bank report -- until Russian authorities began asking about it and other brokers in 2015.

For all the suspicions raised about Ergoinvest, the transactions that were flagged didn’t represent a complete mirror trade. 

Soon, however, back office staffers in Moscow pieced together an example not involving Ergoinvest, the Deutsche Bank review found. It showed both sides of a mechanism that was effectively moving cash out of Russia -- a small Russian broker buying shares in Moscow, and a British Virgin Islands holding company selling the same stocks for cash in London.

Cutting Ties

In late August, senior Moscow executives decided to stop doing business with both companies, according to the Russian central bank report. The same day, the Moscow back office offered to help colleagues in London look for similar trades by other clients with Russian ties, the bank found. But there was no response to the request, the bank found.

Deutsche Bank told Russian regulators that it didn’t follow up on the trades because at the time it believed they were an isolated episode, according to the central bank report.

Even as warnings accumulated, Deutsche Bank conducted an internal audit of the Moscow equities operation that gave it “satisfactory” grades and made no mention of the flagged trades. Almost a year later, the bank’s review of the handling of the transactions characterized that 2014 audit as marked by “severe shortcomings.”

After Russian authorities began interviewing people in the Moscow office about Ergoinvest and a local broker regarding possible tax evasion, Moscow staffers again alerted the bank’s financial-crime team in London, sending a spreadsheet of the suspected mirror trades, the bank found.

Project Square

More than a week passed. Still awaiting response from London, on Feb. 25, 2015, Moscow compliance staff raised the issue to an incident-management group in Frankfurt.

The bank opened a full-scale inquiry, calling it Project Square. In less than two months, the bank turned up more than 2,000 transactions that bypassed internal money-laundering controls.

The U.S. Department of Justice, the U.K.’s FCA, through a spokespeople, declined to comment, as did Bafin, Germany’s banking supervisor.

Russia’s central bank examined a year of trading and determined Deutsche Bank had been the victim of a criminal scheme -- issuing a fine of about $5,000 for lapses such as missed deadlines and failure of staffers to indicate their middle names on some documents, people familiar with the situation have said. The central bank has declined to comment on its probe and didn’t immediately respond to a request for comment for this article.

Since its internal audit, the bank has cut much of its operations in Russia, without linking the move to the mirror-trade probe. It dismissed three people in Moscow, all of whom have denied wrongdoing and are contesting the bank’s action. 

The bank has also reorganized its regulation, compliance and anti-financial crime operations into a new structure with a global overseer. With Cryan balancing the needs to reduce risk and increase profitability, the bank said in November that it would suspend accepting new clients in what it called high-risk markets.

“The company has so many different technology systems that the gaps between them are open to manipulation,” said Plaesier. “Cryan can pull off the plan to improve the bank’s controls, but shifting the systems of such a big company is never going to happen overnight.”

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