Getting Off Lightly: Bankers Stonewall Investigators in Crisis Probes

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Not surprisingly, IKB's owners demanded a special audit. A court appointed Harald Ring, an auditor from the western city of Krefeld, to determine the extent to which former board members under then CEO Stefan Ortseifen were responsible for IKB's plight. Ring was also asked to investigate the role played by the supervisory board.

A short time later, KfW sold its IKB shares to the Texas-based private equity firm Lone Star Funds. The new owners swiftly put an end to the investigation KfW had requested, a move that opposition politicians believe was undertaken in consultation with the German government. The auditing committee included, in addition to Jörg Asmussen, state secretary in the finance ministry, prominent members of the German business community like Ulrich Hartmann, the chairman of the supervisory board of energy giant E.on.

As a result, the calls for examination of the IKB case quickly subsided. Neither the executive board nor the supervisory board were interested in dissecting each other's mistakes.

Only now, more than two years after the IKB crisis erupted, is there a glimmer of hope that some light will be shed on what actually happened at the bank. A few weeks ago, the Düsseldorf district court, responding to an application filed by small shareholders, decided to appoint a new special investigator. But it remains to be seen whether the auditor will be able to quickly ascertain the reasons for IKB's near-crash.

As Jörg Ziercke, president of the German Federal Criminal Police Office (BKA), noted some time ago, anyone who hopes to penetrate the complex transactions related to packaged and repackaged debt securities and credit default swaps has his work cut out.

Authorities Overstretched

Ziercke's agency has sought to shed light on the complexities of banking transactions in a series of workshops, and devoted its last autumn conference in November 2008 to the subject. Ziercke's remarks highlighted that the BKA isn't really up to the task, which should come as no surprise. If even bankers, supervisory board members, rating agencies and the German banking regulator BaFin are having trouble keeping up, how can the BKA's criminal investigators be able to keep their head above water in the sea of evidence? Even with the "current cases associated with the capital market crisis, we are encountering data volumes in the two to three-digit terabyte range," Ziercke complained.

But this only marks the beginning of the challenges the investigators face. Eventually, they will "face the problem of having to properly evaluate extremely complex economic information." For example, investigators who hope to substantiate the charge of "embezzlement" must first prove that bankers intentionally acted in a way that was contrary to their duty. The law has an almost lyrical way of describing such an offender as someone who "in the manner of a gambler, deliberately and contrary to the rules of prudence in business, assumes an extremely high risk of loss merely to obtain an extremely doubtful prospect of achieving a profit."

Depending on how it is interpreted, this characterization could apply to many bankers who were involved in the global trade in toxic mortgage securities.

Lack of Risk Management at HSH Nordbank

It clearly applies in the case of the troubled Hamburg-based bank HSH Nordbank, at least according to Gerhard Strate, a Hamburg attorney. He is convinced that the risks associated with the bank's investments in subprime mortgage securities were foreseeable. But, says Strate, a company-wide risk management system "never existed" at HSH Nordbank.

An entire team of investigators is now working on the HSH case. Pursuant to a criminal complaint Strate has now filed, HSH CEO Jens Nonnenmacher and his fellow members of the executive board are now being investigated directly.

The investigators are mainly interested in a $45-million payment to US bank Goldman Sachs, which had obtained credit insurance from HSH against the Lehman bankruptcy. Strate is convinced that "HSH should not have had to pay up. Goldman clearly missed the deadline. This is a breach of trust on the part of the HSH executives."

Indeed, even HSH's own lawyers had long advised management to remain unbending because of the missed application deadline. In the end, the bank argues, it was in HSH's interest to pay up and not risk a lawsuit.

Hard to Prove Intent

Cases like the HSH disasters force journalists to address fundamental questions. Is it even possible to bring bankers to account with a term like breach of trust? Is Germany's criminal code even applicable to wrong decisions and mismanagement? It is rarely possible to prove intent, which explains why many executives, even those responsible for billions in losses, are either acquitted or let off with minor fines.

The investigators are often successful when, in the course of their research, they encounter criminal acts that have little to do with the financial crisis. This was the case during an investigation of Herbert Süß, the former chief executive of the ailing state-owned bank Sachsen LB.

When they searched his apartment in Dresden (Süß was spending several weeks at his farm in South Africa), the authorities found unsecured hunting weapons and ammunition -- a clear violation of Germany's gun control law. It's a bit reminiscent of the US case against mobster Al Capone, who was never convicted for any of his numerous criminal activities but for ordinary tax evasion.

The case against BayernLB could proceed in a similar direction. Like its fellow state-owned bank in Saxony, the bank is in trouble as a result of the financial crisis. But the most recent investigations against former CEO Schmidt have little to do with the crisis, but primarily with the acquisition of Austrian bank HGAA.

HGAA, which was still majority-owned by the Austrian state of Carinthia in late 2006, had run into difficulties a short time earlier as a result of risky foreign exchange transactions. According to a representative of the relevant state holding company, the bank was at risk of losing its banking license at the time.

To the relief of the state's then governor, Austrian Freedom Party politician Jörg Haider, who later died in a car accident, help came from an unexpected source. Within a few days at the end of 2006, German-Austrian financial manager Tilo Berlin assembled a group of investors that would later gradually acquire a quarter of the troubled bank's shares.

"Project Knox"

The new shareholders planned to hold the share packages for a few years and then sell them on the market for up to €4.7 billion. The code name for their ambitious plan was "Project Knox" -- a reference to the US government's legendary Fort Knox, where it stores its gold reserves.

But then, according to manager Berlin, BayernLB CEO Schmidt entered the scene. Schmidt urged Berlin on behalf of senior members of Bavaria's conservative Christian Social Union party to sell him the shares, says Berlin. Schmidt wanted a majority stake in HGAA, and he wanted Berlin was to take over the management of the Austrian bank.

In the end, the Bavarians paid more than €1.6 billion for a bank that had been considered doomed only a short time earlier. Within a few months, Berlin turned a profit of €145 million for himself and his investors.

The risks to which Schmidt had exposed his employer became clear shortly after the deal was registered in October 2007. Only a month later, BayernLB had to inject an additional €440 million into the Austrian bank, and a year later the new acquisition required a further capital injection of €700 million.

The public prosecutor's office now wants to know, among other things, why BayernLB banker Schmidt did not renegotiate the deal retroactively. It would undoubtedly have been difficult, because the contracts expressly ruled out subsequent changes to the purchase price.

Opposition politicians in Bavaria speculate that Schmidt himself may have been an investor in Berlin's fund -- and, therefore, benefited personally from the considerable profits. Financial manager Berlin rejects this as an "absurd assumption." "Mr. Schmidt was never part of the investor group," he insists, "nor was there any connection between him and my firm, Berlin & Co."

In the end, no one is likely to be left with the blame, and the bill will be passed on to taxpayers.

Reporting by Beat Balzli, Matthias Bartsch, Dinah Deckstein, Conny Neumann, Wolfgang Reuter, Marcel Rosenbach, Michael Sauga, Steffen Winter

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• Part 1: Bankers Stonewall Investigators in Crisis Probes
• Part 2: Botched Investigation into IKB