Not long after the 2008 global financial meltdown, Goldman Sachs’ then-chairman, Lloyd Blankfein, suggested everyone quit whining and let Goldman get back to “doing God’s work.” Fair enough. But reading the charges filed by the US Department of Justice and Malaysian authorities against Goldman Sachs bankers for their role in the 1MDB financial scandal, one wonders which god Mr. Blankfein had in mind?
In 2012 and 2013 Goldman Sachs helped Malaysia’s national economic development fund, 1MDB, issue bonds and raise US$6.5 billion. Malaysia’s then-Prime Minister, Najib Razak, was pulling the strings at 1MDB – and any competent corporate compliance unit would have known this.
Goldman pocketed $600 million for its efforts – several times the going rate. At least $2-3 billion was misappropriated (“stolen” in common parlance), and senior Goldman Sachs employees were involved; their offenses include paying bribes and laundering money.
Goldman Sachs has sort of apologized to the people of Malaysia, but claims it was duped by rogue employees and, anyway, couldn’t be expected to know what 1MDB would do with the money.
Perhaps. But as likely, Goldman Sachs did business with 1MDB because it wanted the $600 million. Sometimes it’s hard to spot criminals – real or potential – and sometimes it’s a judgment call, and excusable. But sizing up 1MDB was easy. Goldman only had to fly someone to Kuala Lumpur and get in any taxi and ask the driver about the wisdom of doing business with Prime Minister Najib.
Bear in mind that Najib was already widely rumored to have has hands in the public till. Not to mention he was earlier implicated in his girlfriend’s murder at the hands of his bodyguards when she threatened to reveal Najib’s role in corrupt arms deals.
Not exactly a sterling customer. And it doesn’t help Goldman’s case that Mr. Blankfein reportedly met both Najib and the 1MDB front men before the 1MDB deals went forward.
A fundamental tension
The 1MDB imbroglio highlights a fundamental tension at financial firms. In short, the more business you do the bigger your bonus. So the “front office” bankers want to do deals – any deal at all – while the “back office” – compliance or whichever unit vets customers and deals – tries to keep the front office from doing something unwise or illegal.
The firm’s top management is the final arbiter – but they also are paid based on “revenue.” Few Wall Street firms’ annual reports brag about “deals turned down.”
Given this bias toward deal making, compliance units are often considered pests that cost the firm money. And despite protests to the contrary, it sometimes seems they are kept around as “scarecrows” – keeping regulators at bay while allowing a firm to claim, should something go wrong, that it did “everything possible.”
To its credit, Goldman Sachs’s compliance group did apparently issue warnings about 1MDB and related parties. But one imagines the response: “Yeah, yeah, yeah. We get it. Now get out of here.”
A former compliance officer for another Wall Street firm tells of advising a business unit against a series of transactions with honest looking underworld front companies and being told: “OK, they’re organized crime. But we can make $5 million.”
Transpose “$600 million” for “$5 million’”and one understands 1MDB’s attraction.
How to recognize a company that is serious about running a clean operation
Ask three questions (and assume compliance is competent):
First, does the compliance review team have clout in the firm hierarchy equal to that of legal and finance and other “control” functions – to include being paid as much?
Second, do they report directly to the CEO – or via the head of legal, finance, or some other unit?
And, finally, can they have a deal killed – or at least make CEO’s quake and feel queasy about shaving to answer some day to regulators or reporters?
If the answers are not yes, firms will conjure up any number of excuses for doing business of the 1MDB sort:
They’re famous! Part of the elite! They’re connected with such and such powerful person.
Managing Director X knows them.
We met them. They’re great guys.
We did a Google search – they’re clean.
They’re not on the OFAC list.
Everyone else is doing business with them.
They’re listed, or they’re a regulated entity. (If local regulators haven’t arrested anybody, everything’s fine.)
They want to do business with us (and since we’re splendid people, they must be too).
And if nothing else works, there’s the old standby: “They’ve got a ton of money”
Of course, it’s not just Goldman Sachs
In recent times, powerhouse banks Hong Kong and Shanghai Bank (HSBC), Standard Chartered, Deutsche Bank, and more than a few others have been sanctioned for money laundering and other financial misdealings.
HSBC was fined $1.9 billion dollars in 2012 for laundering Mexican drug money, while Standard Chartered was hit the other day for $1.1 billion for sanctions busting – after paying upwards of $1 billion in 2012 and 2014 for Iran sanctions violations and other money laundering offenses. Painful no doubt, but mostly in the sense top executives laughed so hard it hurt, or were pinching themselves at their good fortune. A billion dollars just isn’t much money for banks this size.
Moreover, nobody is ever really to blame other than a lower level employee – or maybe once in a while a Managing Director or two – banished from the herd and declared “rogue.” An HSBC board member at the time of the 2013 sanctions – later promoted to chairman – even complained that he shouldn’t be responsible since the bank’s operations were so complex.
As for reputational harm, once a bank is “too big to fail” and is making its major clients money, reputation doesn’t seem to matter – as long as it can blame a few bad apples once again and swear they have put the latest troubles behind them.
A former USG financial crime expert noted that typically, once trouble hits, the banks “hire a lot of unqualified or marginally qualified people with fancy-sounding titles, v.p. for financial crime, etc., leave them with no authority and no idea of how to do the job and then claim victory. As long as they appear to be dealing with the issue they’ve accomplished their mission.”
“Even if the banks get caught,” the expert continued, “the corporation – really their shareholders and customers – pay the fine, and the responsible executives are protected. Just business as usual.”
It remains to be seen how the Malaysian Government’s suit against Goldman will play out, but the US Department of Justice appears content with a fine levied against the bank and punishment of two Goldman Sachs managing directors most directly involved in the 1MDB business.
All in all not much retribution – and it might leave the “business = bonus” crowd thinking: “Just don’t get caught.”
To change this behavior, several things need to happen:
First, authorities might someday suspend a major financial institution’s banking license. They never do – claiming the economic disruption and political fall-out will be too much.
Next, and as important, the punishment needs to be personal – and directed at the top management.
If a firm’s most senior executives are forced to pay fines – say, $600 million in the 1MDB case – out of their personal wealth and not out of company funds – that will concentrate minds more than anything.
And if they spend some time in government lodgings (aka prison) the effect will be most bracing.
Until then, however, nothing much will change.
One problem, as Rolling Stone’s Matt Taibbi wrote, is that the regulators and the regulated often have a cozy relationship – with the former wanting to work on Wall Street post-retirement and make some real money. Thus, even more reason not to be too hard on anybody.
One can hear the response to these ideas: “Get a grip. This is how the world works.” “Finance is a competitive, sharp-elbowed business, and to succeed you’ve got to cut corners and deal with unsavory characters.”
Maybe. But being a widely held belief does not make it so.
A few institutions do recognize that a strict approach to vetting clients and deals is, in fact, a competitive advantage. Of course there’s avoiding trouble of the sort Goldman Sachs finds itself in.
But there is also the benefit of being seen by regulators (and shareholders) as a clean company. And when criminals and shady characters recognize this they will instead go after easier targets.
The then-president of a prominent investment firm’s foreign branch in Asia was once asked if he minded giving up business in such cases: “No. People see what kind of firm we are and we get more business as a result.”
And that firm’s bankers routinely gave up business (and bonuses) – even in slow years – rather than deal with criminals or disreputable customers. One local organized crime boss even noted it was the only foreign financial firm his people couldn’t deal with. Najib and his 1MDB friends wouldn’t have gotten in the front door.
Admittedly, this is not industry practice, and maybe never will be – human nature being what it is.
However, 1MDB is a reminder that it ought to be – and there’s no reason it couldn’t be – with a little help from the US Government.