Jumbo Goldman 1MDB fine upends 2020 trend to lower losses

Financial fraud and fat fingers loom large, but annual top 10 op risk losses still show fewer fails. Data by ORX News

Fraud fine

Ask any op risk manager to imagine the perfect storm for fomenting loss and they might well describe the scene for 2020. Many feared the pandemic, which forced employees to up sticks overnight and work from home indefinitely, would stir up a squall of problems, such as money laundering, fraud and cyber attacks for their op risk profiles.

Yet, as the numbers clearly show, 2020’s reported incidents and op risk losses confounded these expectations and, along with capital levels, trended lower for most banks (see figure 1). Total losses fell to $26.7 billion for the year, a modest dip from $29.2 billion in 2019 – and a major drop from the number in 2016, the industry’s Armageddon, at $60.2 billion, as tracked by ORX News.

 

Inevitably, there were notable exceptions, but the prevailing direction was downward – loss incidents dropped to 407 – less than half of the rolling average for the previous four years. Regulatory fines in particular fell sharply in almost every jurisdiction as the US and most of Europe entered lockdown – a trend some viewed as a form of regulatory relief granted to beleaguered banks.

Of course, op risk losses have a notoriously long tail. Just ask any of the banks appearing in this list of 2020’s largest losses – all but one feature some form of fraud, and they arguably all have roots in incidents and control environment failures that date back years (jump to table A).

Almost half the losses in the 2020 top 10 are multi-billion-dollar fraud schemes – most of them relatively unsophisticated – and all of them undetected for a period of several years or more.

A prime example is 2020’s largest loss, in which Goldman Sachs shelled out a combined $5 billion in fines and settlements to various parties for its involvement in extensive fraud at Malaysian sovereign wealth fund 1Malaysia Development Berhad. Goldman agreed to pay $2.5 billion to the Malaysian government to settle criminal proceedings over the $4.5 billion fraud perpetrated by its executives that, between 2009 and 2015, lost 1MDB up to $5.7 billion.

According to the US Securities and Exchange Commission, former Goldman executive Tim Leissner and other senior executives worked throughout 2012 and 2013 to obtain and retain business from 1MDB through promises and payments of bribes and kickbacks to government officials in Malaysia and Abu Dhabi – financed in part by embezzled proceeds from $6.5 billion in bond offerings that Leissner helped the fund to raise. The SEC estimates that Leissner and others misappropriated more than $2.7 billion to this end.

The Malaysian government sought as much as $7.5 billion and agreed to return at least $1.4 billion in proceeds from assets linked to 1MDB. Goldman agreed to pay a criminal penalty of $2.32 billion to the US Department of Justice and a disgorgement of $606 million to settle an investigation into the bank’s role in the fraud. The Hong Kong Securities and Futures Commission announced a further fine of $350 million against the firm’s Malaysia operation over its deficient controls.

The fine leaves Goldman with a steep rise in op risk capital: the bank’s op-risk-weighted assets surged 12% to a record $132.5 billion over the three months to the end of June 2020 – its steepest level by that measure on record.

 

In second place for the race to the bottom, the Blue Cross Blue Shield Association agreed to pay $2.67 billion to settle a class action lawsuit over anti-competitive practices. The multi-district litigation against the BCBSA, a federation of 36 separate US health insurance companies that insure more than106 million people, was first filed in January 2013. The complaint alleged that it had violated the Sherman Antitrust Act by entering into an unlawful agreement to restrain competition among the BCBSA member plans in the market for health insurance.

The BCBSA reportedly allocated geographic territories, limited member plans in competing against each other, restricted rights of member plans to be sold to a non-member of BCBSA and agreed to other ancillary restraints on competition. In agreeing to the $2.67 billion settlement, the group agreed to significant, unprecedented and far-reaching changes to its rules and regulations.

The potential penalty for 2020’s third-largest loss puts these hefty financial fines into perspective. Cai Guohua, former chairman of China’s Hengfeng Bank, was found guilty of causing the bank 10.3 billion yuan ($1.6 billion) in damages through various illegal schemes. Between 2014 and 2016, he allegedly issued illegal rewards and incentives to employees and used his position to transfer 4.8 billion yuan of the bank’s funds in the form of trust loans to a company under his control. In 2018, Cai is alleged to have issued 3.5 billion yuan in loans to a borrower who did not meet loan conditions, and assisted eight other firms and individuals in obtaining loans and other assistance in exchange for bribes.

The China Banking Regulatory Commission investigation into Hengfeng found Cai guilty of abuse of power, corruption, embezzlement, bribery and illegal loan issuance – and sentenced him to death with a two-year reprieve, which will allow his sentenced to be commuted to life imprisonment.

 

The year’s fourth-largest loss dates back to 2017, when executives in Russia’s Promsvyazbank were alleged to have embezzled 87.2 billion rubles ($1.18 billion). The Investigative Committee of the Russian Federation found that several of the bank’s executives conspired to transfer billions of rubles to foreign companies, ostensibly as payment in a bogus securities purchase. The funds were transferred to Cyprus, where the owners of the bank laundered the funds and disposed of them through further illegal transactions. Several of the bank’s former executives are wanted in connection with the embezzlement.

JP Morgan Chase paid a whopping $920.2 million in the year’s fifth-largest op risk loss – the largest penalty order ever issued by the US derivatives watchdog. Three separate regulators found the firm’s traders had engaged in spoofing and market manipulation of precious metals futures and US Treasury markets from 2008 to 2016.

The Commodity Futures Trading Commission (CFTC), the DoJ and the SEC all found that Morgan’s traders had engaged in misconduct during the eight-year period. The CFTC ordered Morgan to pay restitution to the amount of $311 million for the damage done to other market participants and a disgorgement of $172 million, representing its profits from the scheme, and a civil monetary penalty of $436 million. DoJ and SEC penalties were offset by the CFTC’s order.

In April 2020, it was reported that HSBC had been potentially defrauded of up to $600 million in financing, extended to Singapore oil trader Hin Leong, in 2020’s sixth-largest loss. In the first half of April, it was reported that some lenders had stopped issuing new letters of credit to Hin Leong and on April 17, it filed for bankruptcy. The firm’s founder and director said in an affidavit that he had instructed its finance department not to disclose $800 million of losses incurred in futures markets over several years. Hin Leong owes around $3.85 billion to more than 20 banks.

 

 

Seventh and eighth places in the largest losses list were stunning examples of sheer brass neck – or rather, copper. Two Chinese banks – Minsheng Trust and Hengfeng Bank – lost 4.07 billion yuan and 3.89 billion yuan ($575 million and $549 million) respectively, when one of China’s largest gold jewellers, Kingold, used an estimated 83 tons of fake gold bars as collateral for 20 billion yuan in loans from them and other lenders. The scheme was discovered by Hengfeng in 2019, when incoming management sued Kingold for unpaid loans and moved to dispose of the collateral. A test of the bars found they were “all copper” – and when another investor tried to liquidate its collateral to cover defaulted loans, it discovered its own gold bars were a gilded copper alloy. The total outstanding amount owed by Kingold to its investors was 18.4 billion yuan.

In ninth place, Russia’s VTB Bank lost $535 million in a fraud involving loans to state-owned companies in Mozambique. Between 2013 and 2016, three Mozambique companies borrowed over $2 billion to finance maritime projects. The loan comprised $535 million from VTB, $622 million from Credit Suisse and an $850 million Eurobond, arranged by VTB and CS. The loans were guaranteed by Mozambique’s government.

Mozambique Asset Management, which took the $535 million loan from VTB, defaulted in May 2016, after generating virtually no income. In January 2019, three former CS employees pleaded guilty to conspiracy to commit money laundering and wire fraud and were charged in the US. VTB filed a lawsuit against Mozambique Asset Management and the Mozambique state on January 6, 2020, to recover its $535 million.

And, rounding out the list, the year’s 10th-largest loss event occurred at Citi, which accidentally wired $900 million to a group of Revlon lenders. Bank and lenders were already disputing a soured loan to the private-equity-backed cosmetics giant.

The bank was able to stop some of the payments, but, as of August 21, it had not recovered a total of $520.4 million, for which it is suing the lenders involved. They argue that Revlon had defaulted on its loans and that they were therefore using the funds to pay back the loan. The day after Citi’s payment, the lenders sued Revlon.

Editing by Louise Marshall

All information included in this report and held in ORX News comes from public sources only. It does not include any information from other services run by ORX, and we have not confirmed any of the information shown with any member of ORX.

While ORX endeavours to provide accurate, complete and up-to-date information, ORX makes no representation as to the accuracy, reliability or completeness of this information.

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