March 9, 2017
By: Anna Sayre, Legal Content Writer, SanctionsAlert.com
On January 30, 2017, the New York State Department of Financial Services (DFS), NY’s financial watchdog, as well as the Financial Conduct Authority (FCA), financial services regulator in the UK,ordered Deutsche Bank to pay $425 million and £163 million, respectively, for violations of anti-money laundering regulations and continual, wide spread compliance failures. The so-called ‘mirror trading” scheme, involving the German lender’s Moscow, London and New York offices,resulted in $10 billion being transferred out of Russia.
The FCA and the DFS cooperated closely on the investigation into Deutsche Bank. For the FCA, the financial penalty represents the largest of its kind ever imposed by the UK regulator or its predecessor (the Financial Services Authority) for anti-money laundering failings.
This article will identify and review Deutsche Bank’s violations,which originated in the bank’s numerous missed opportunities to detect, investigate and stop the scheme due to five key compliance missteps.
The ‘Mirror Trading’ Scheme
Between 2011 and 2015, thousands of matching trade pairs (or ‘mirror trades’) were executed between Deutsche Bank Moscow, London, and New York, with at least 12 entities being involved in those suspicious trading activities, many of them closely related or linked by either a common beneficial owner, management, or agent.
According to the FCA’s ‘Final Notice’, mirror trades was carried out through a two-fold process:
“(1) a Russian customer of Deutsche Bank Moscow [would buy] highly liquid Russian securities from Deutsche Bank Moscow, paying in Rubles (the Moscow Side); and
(2) at the same time, a non-Russian customer of Deutsche Bank sold the same number of the same securities to Deutsche Bank in exchange for US Dollars (the London Side).”
This scheme of mirrored trades,coupled with widespread compliance deficiencies within numerous branches of the bank, allowed Deutsche Bank to move large sums of money out of Russia undetected. Those sums, originally consisting of Russian Rubles, were then converted to US dollars by Deutsche Bank operations in Moscow, London and New York to further their improper purpose.
Deutsche Bank Trust Company of the Americas (“DBTCA”), located in New York, was the entity through which US dollar payments flowed to the suspicious entities involved. The seller would be paid its shares in US dollars, which were cleared through DBTCA. In this way, the parties to the scheme were able to convert Rubles into U.S. dollars unnoticed. In the end, payments exceeding $10 billion were transmitted from London to New York.
Five Long-Running Compliance Deficiencies
The DFS and FCA identified numerous compliance deficiencies that “allowed the mirror-trading scheme to flourish”:
- Incomplete KYC/Due Diligence: compliance procedures, such as the on boarding of new clients, were “manual and functioned merely as a checklist,” according to the DFS. Furthermore, no steps were taken to periodically review and verify clients once brought in and no central repository for KYC information existed. The FCA further states that, “the customer risk rating methodology was flawed, the KYC policies & procedures were deficient, and the IT infrastructure was not fit for purpose.”
- Flawed Country Risk Rating Methods: “the Bank lacked a global policy bench marking its risk appetite, resulting in material inconsistencies and no methodology for updating the ratings,” said the DFS,“Nor was Deutsche Bank in line with peer banks, which rated Russia as high risk well before Deutsche Bank did in late 2014.”The FCA agrees that, “Deutsche Bank underestimated the level of AML risk associated with its customers, with less than 5% being categorized as high risk; significantly out of line with its peers.” Furthermore, “only 33 countries were categorized as high risk jurisdictions. Russia was not one of those countries.”
- Insufficient Compliance Procedures and Controls: the FCA found that Deutsche Bank’s “policies and procedures were deficient”, its “IT infrastructures was inadequate” and that the bank “lacked automated AML systems for detecting suspicious trades and lacked an effective system for monitoring money flows associated with transactions” and “failed to provide adequate oversight of trades booked.”
- Inadequate Compliance Staff and Resources: The DFS states that “the Bank’s intense focus on headcount reduction between 2010 and 2012 prevented the AFC and Compliance units in DB-Moscow and elsewhere from being staffed with the resources necessary to function effectively”. The FCA agrees that, “the AML functions of Deutsche Bank in the UK and of Deutsche Bank Moscow lacked sufficient resources.”
- Unclear Corporate Framework: the DFS blames the breakdown of Deutsche Bank’s compliance on its“decentralized” framework, which caused confusion in policies, roles, and responsibilities. “This decentralized model caused AML policies to be set at the regional, rather than global, level, resulting in the inconsistent formulation and application of policies and procedures. Little or no attention was paid to the implementation or adherence to controls designed to comply with international or other country requirements.” The FCA reiterates this by saying, “Deutsche Bank operated a matrix management structure along regional, divisional, and product lines. Within that structure, roles and responsibilities were not clearly defined or communicated… which resulted in significant confusion” and“unclear responsibilities.”
Further Questions, and Potential Sanctions Issues
Though the FCA and DFS enforcement action against Deutsche Bank does not mention inadequate compliance programs with regard to sanctions against Russia,the DFS states that the transactions, “lack obvious economic purpose and could be used to facilitate money laundering or other illicit conduct.” The FCA similarly identifies the transactions as “highly suggestive of financial crime.”
It is not the role of the DFS to criminally prosecute individuals or corporate entities.However, a further investigation of Deutsche Bank’s mirror trades may be undertaken by the U.S. Department of Justice, which could serve to reveal the financial crimes, such as sanctions violations, that were at play.
Last year, in a Bloomberg report, it was suggested that some of the money diverted through the mirror trades at Deutsche Bank belonged to Igor Putin, a cousin of the Russian President, and to Boris Rotenberg. The Rotenberg brothers own Russia’s largest construction company, S.G.M., and are associates of Vladimir Putin. They are on the U.S. Treasury’s OFAC “do not touch” list.
As part of the penalty, Deutsche Bank agreed to “engage an independent monitor, approved by DFS, to conduct a comprehensive review of the bank’s existing BSA/AML compliance programs, policies and procedures that pertain to or affect activities conducted by or through its [Deutsche Bank Trust Company Americas] subsidiary and the New York branch.” The independent monitor must be appointed within 60 days of the consent order, or by March 31, 2017, and will “recommend and implement important compliance reforms.”
Indications for the Future
This most recent fine from the DFS serves to further highlight the importance of its new risk-based anti-terrorism and anti-money laundering regulation, which became effective on January 1, 2017.
“In today’s interconnected financial network, global financial institutions must be ever vigilant,”reiterates NY SuperintendentVullo in a press release. “This Russian mirror-trading scheme occurred while the bank was on clear notice of serious and widespread compliance issues dating back a decade. The offsetting trades here lacked economic purpose and could have been used to facilitate money laundering or enable other illicit conduct, and today’s action sends a clear message that DFS will not tolerate such conduct.”
Mark Steward, Director of Enforcement and Market Oversight at the FCA, further states in a press release: “Financial crime is a risk to the UK financial system. Deutsche Bank was obliged to establish and maintain an effective AML control framework. By failing to do so, Deutsche Bank put itself at risk of being used to facilitate financial crime and exposed the UK to the risk of financial crime. The size of the fine reflects the seriousness of Deutsche Bank’s failings.”