DEUTSCHE BANK’S $10-BILLION SCANDAL

[From New Yorker]

Almost every weekday between the fall of 2011 and early 2015, a Russian broker named Igor Volkov called the equities desk of Deutsche Bank’s Moscow headquarters. Volkov would speak to a sales trader—often, a young woman named Dina Maksutova—and ask her to place two trades simultaneously. In one, he would use Russian rubles to buy a blue-chip Russian stock, such as Lukoil, for a Russian company that he represented. Usually, the order was for about ten million dollars’ worth of the stock. In the second trade, Volkov—acting on behalf of a different company, which typically was registered in an offshore territory, such as the British Virgin Islands—would sell the same Russian stock, in the same quantity, in London, in exchange for dollars, pounds, or euros. Both the Russian company and the offshore company had the same owner. Deutsche Bank was helping the client to buy and sell to himself.

Viewed with detachment, however, repeated mirror trades suggest a sustained plot to shift and hide money of possibly dubious origin. Deutsche Bank’s actions are now under investigation by the U.S. Department of Justice, the New York State Department of Financial Services, and financial regulators in the U.K. and in Germany. In an internal report, Deutsche Bank has admitted that, until April, 2015, when three members of its Russian equities desk were suspended for their role in the mirror trades, about ten billion dollars was spirited out of Russia through the scheme. The lingering question is whose money was moved, and why.

Mirror Trading

At first glance, the trades appeared banal, even pointless. Deutsche Bank earned a small commission for executing the buy and sell orders, but in financial terms the clients finished roughly where they began. To inspect the trades. These transactions had nothing to do with pursuing profit. They were a way to expatriate money. Because the Russian company and the offshore company both belonged to the same owner, these ordinary-seeming trades had an alchemical purpose: to turn rubles that were stuck in Russia into dollars stashed outside Russia. In the English-language media, the scheme has become known as “mirror trading.”

Mirror trades are not inherently illegal. The purpose of an equities desk at an investment bank is to help approved clients buy and sell stock, and there could be legitimate reasons for making a simultaneous trade.

Deutsche Bank

Deutsche Bank is an unwieldy institution with headquarters in Frankfurt and about a hundred thousand employees in seventy countries. When it was founded, in 1870, its stated purpose was to facilitate trade between Germany and other countries. It soon established footholds in Shanghai, London, and Buenos Aires. In 1881, the bank arrived in Russia, financing railways commissioned by Alexander III. It has operated there ever since.

During the Nazi era, Deutsche Bank sullied its reputation by financing Hitler’s regime and purchasing stolen Jewish gold. After the war, the bank concentrated on its domestic market, playing a significant role in Germany’s so-called economic miracle, in which the country regained its position as the most potent state in Europe. After the deregulation of the U.S. and U.K. financial markets, in the nineteen-eighties, Deutsche Bank refreshed its overseas ambitions, acquiring prominent investment banks: the London firm Morgan Grenfell, in 1989, and the American firm Bankers Trust, in 1998. By the new millennium, Deutsche Bank had become one of the world’s ten largest banks. In October, 2001, it débuted on the New York Stock Exchange.

In 2007, the bank’s share price hit an all-time peak: a hundred and fifty-nine dollars. But as it grew fast it also grew loose. Before the housing market collapsed in the United States, in 2008, sparking a global financial crisis, Deutsche Bank created about thirty-two billion dollars’ worth of collateralized debt obligations, which helped to inflate the housing bubble. In 2010, Deutsche Bank’s own staff accused it of having masked twelve billion dollars’ worth of losses.

$9bn in Fines – LIBOR Manipulation

Scandals have proliferated at Deutsche Bank. Since 2008, it has paid more than nine billion dollars in fines and settlements for such improprieties as conspiring to manipulate the price of gold and silver, defrauding mortgage companies, and violating U.S. sanctions by trading in Iran, Syria, Libya, Myanmar, and Sudan. Last year, Deutsche Bank was ordered to pay regulators in the U.S. and the U.K. two and a half billion dollars, and to dismiss seven employees, for its role in manipulating the London Interbank Offered Rate, or libor, which is the interest rate banks charge one another. The Financial Conduct Authority, in Britain, chastised Deutsche Bank not only for its manipulation of libor but also for its subsequent lack of candor.

In April, 2015, the mirror-trades scheme unravelled. After a two-month internal investigation, the three Deutsche Bank employees were suspended. One was Tim Wiswell, a thirty-seven-year-old American who was then the head of Russian equities at the bank. The others were Russian sales traders on the equities desk: Dina Maksutova and Georgiy Buznik. Afterward, Bloomberg News suggested that some of the money diverted through mirror trades belonged to Igor Putin, a cousin of the Russian President, and to Arkady and Boris Rotenberg. The Rotenberg brothers own Russia’s largest construction company, S.G.M., and are old friends of Vladimir Putin.

In June, 2015, with pressure from shareholders intensifying over the mirror trades and other scandals, the co-C.E.O.s of Deutsche Bank, Anshu Jain and Jürgen Fitschen, announced that they would resign. They were replaced by John Cryan, whose remit was to clean up the bank. That September, he announced the impending close of all investment-banking activity in Russia.

Many businesses in the Russian Federation avoid taxes by using offshore jurisdictions, such as Cyprus, for their headquarters. Rich Russians, meanwhile, often funnel their private fortunes offshore, in an effort to hide their assets from the capricious and predatory Russian state. Frequently, this fugitive money is invested in assets such as property: on Park Lane in London, or Park Avenue in New York. (Boris Rotenberg’s wife, Karina, told the Russian edition of Tatlerthat the family has three main houses: one in Moscow, one in Monaco, and a “dacha” in Provence, where she keeps her horses.)

The impact of this capital flight is felt at both ends of its journey. Research published last year by Deutsche Bank’s own analysts suggested that unrecorded capital inflows from Russia into the U.K. correlated strongly with increases in U.K. house prices and, to a lesser extent, with a strengthening of the pound sterling. Capital flight also has weakened Russia’s tax base and its currency. In 2012, Putin began a “de-offshorization” program, urging businesses and oligarchs to keep their headquarters and their fortunes at home. Two years later, after Russia’s incursion into Crimea led to sanctions from the European Union and the U.S., Putin declared that offshorization was illegal. But as the ruble and the economy foundered many Russians felt even more eager to remove their money. Mirror trading was an ideal escape tunnel.

5% Fee for Money Laundering

The counterparties were not owned by Russian oligarchs. They were brokerages run by Russian middlemen who took commissions for initiating mirror trades on behalf of rich people and businesses eager to send their money offshore. A businessman who wanted to expatriate money in this way would invest in a Russian fund like Westminster, which would then use mirror trades to move that money into an offshore fund like Cherryfield. The offshore fund then wired the money, in dollars, into the businessman’s private offshore account. A middleman who formed one of the Russian counterparty funds told me that the cost of his services depended upon the Russian authorities’ desire to stop the export of capital. In 2011, when controls were lax, the fee was 0.2 per cent. In 2015, when sanctions were strong, and Putin was determined to retain as much wealth as he could in Russia, the fee rose to more than five per cent.

Whose fortunes were being hidden? In April, I met a broker in Moscow who had worked with clients of the Deutsche Bank mirror trades. He told me that mirror trading was not a new scheme. It was invented, in the late aughts, by other banks in Russia, to help importers avoid heavy taxes on their products. The scam was ingeniously simple. A Russian importer would claim on his invoices that he had bought, say, ten rubber ducks rather than the true figure of ten thousand rubber ducks, in order to pay tax on only ten rubber ducks. Of course, the importer still needed to pay his supplier overseas for the remaining rubber ducks. He did this by expatriating money using mirror trades. Instead of paying a large tax to the Russian treasury, the importer paid a much smaller fee to money launderers.

The broker found it hard to believe that the wealthiest Russians, such as the Rotenberg brothers, would have used mirror trades. After all, there were so many ways for Putin’s friends to send their money offshore, including through Russian government-owned banks, like Gazprombank, which have branches overseas. Other people I spoke with disputed the broker’s assessment: U.S. and E.U. sanctions have made it increasingly difficult for Russian billionaires to expatriate money, and mirror trades had the advantage of being a quiet method, because of the relatively small amounts involved in each transaction.

Another Russian banker, who helped to set up the mirror-trade scheme, told me that much of the money belonged to Chechens with connections to the Kremlin. Chechnya, the semi-autonomous region in the North Caucasus, is ruled by the exuberantly barbarous Ramzan Kadyrov, who is close with Putin. Chechnya receives huge subsidies from Russia, and much of the money has ended up in the pockets of figures close to Kadyrov.

In August, 2015, shortly after Wiswell was suspended from Deutsche Bank, he was fired. He initiated a wrongful-dismissal suit. The court hearings, in Moscow, were open to the press. On February 1, 2016, a lawyer for Deutsche Bank called Wiswell “the mastermind of the scheme for the withdrawal of billions of dollars from the country.” The lawyer also said that Wiswell’s wife had received a quarter-million-dollar payment, for “financial services,” into the bank account of a corporation that is registered under her name. Wiswell lost the suit.

London Centre for Money Laundering

On March 9, 2015, less than a month before the mirror-trades scandal became public, Oliver Harvey and Robin Winkler, two strategists in the research department of Deutsche Bank in London, published a report, “Dark Matter,” which described the vast unrecorded transfer of money among nations. Most economic papers are politely ignored by the world at large, but “Dark Matter” attracted wide interest. Several newspapers ran articles about it, and Harvey appeared on both CNN and the BBC to discuss his research.

The report’s conclusions confirmed long-held suspicions. In any national economy, the authors explained, there are capital flows that do not appear on what is called “the balance of payments.” Errors and accidental omissions should be random, and therefore reveal no pattern. The authors found that in the United Kingdom the pattern was anything but random. Britain had “large positive net errors” that suggested significant “unrecorded capital inflows.” Analyzing data from other countries, Harvey and Winkler deduced where the vast majority of unrecorded capital flowing into the U.K. was coming from. Since 2010, they wrote, about a billion and a half dollars had arrived, unrecorded, in London every month; “a good chunk” of it was from Russia. “At its most extreme,” the authors explained, the unrecorded capital flight from Moscow included “criminal activity such as tax evasion and money laundering.”

In a connected and digitized financial system, how could such capital flight happen? Bank transfers leave a footprint. Imports and exports are accounted for. How could money disappear in one place and show up in another? The two strategists did not have to wait long, or look far, to learn the shameful answer: of the eighteen billion dollars that the researchers had estimated was flowing into the U.K. each year, about twenty per cent had arrived there as the result of trades made at their own bank. Half the trades were settled at Deutsche Bank’s City of London headquarters, which is a short walk from the office, in Pinners Hall, where Harvey and Winkler worked.

Deutsche Bank Trashes $12.58

John Cryan, the Deutsche Bank C.E.O., has little time to think about such embarrassments. Whatever the outcome of the various investigations into mirror trades, the bank is in trouble. It lost seven and a half billion dollars last year. Cryan has called the 2015 result “sobering.” Britain’s recent decision to leave the E.U. has imperilled Deutsche Bank even further. So far in 2016, the bank has lost half its market valuation, and in early August its stock price dipped to an all-time low, of $12.58. The only investors who now like the bank are short-sellers. The financier George Soros took a short position in Deutsche Bank before the Brexit referendum, effectively betting against the share price, and is estimated to have made more than a hundred million dollars as the stock nose-dived. Meanwhile, unlike many other Wall Street lenders, Deutsche Bank continues to loan millions of dollars to businesses associated with Donald Trump. When theTimes questioned Trump recently about his credentials on Wall Street, he said that a private wealth manager at Deutsche Bank, Rosemary Vrablic, could vouch for him.

Since 2011, the Federal Reserve has performed a yearly “stress test” of U.S. lenders, assessing whether banks would have enough capital to withstand the shock of an economic downturn. Deutsche Bank failed the test in 2015, and failed again this June, when “broad and substantial weaknesses” were uncovered. Soon after the Federal Reserve’s latest report was released, the International Monetary Fund issued a dire warning. Deutsche Bank, it said, was not only “one of the most important net contributors to systemic risks in the global banking system”; it was also a contagious agent, because of heavy financial “spillover” between Deutsche Bank and other lenders and insurers. Any kind of failure at Deutsche Bank, the I.M.F. suggested, would be extremely bad news for everybody.

Ed Caesar is the author of “Two Hours: The Quest to Run the Impossible Marathon” (Simon & Schuster).