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Whistleblower Eric Ben-Artzi Refuses Multimillion Dollar Award

Whistleblower Eric Ben-Artzi, fired from Deutsche Bank for refusing to go along with the bank’s efforts to under-report the risks of a massive derivatives trading strategy, one that eventually blew up the Canadian commercial paper market, was the lead story at the Financial Times today.

Eric Ben-Artzi refused to take his share of a $16.5 million SEC whistleblower settlement, the third largest since this new program started. The reason? In a letter that Eric Ben-Artzi sent to the Financial Times (reproduced in full at the end of this post with his permission), he objected to the agency’s failure to punish anyone at the bank.  As he put it, “…after suffering at the hands of the Deutsche executives I will not join them simply because I cannot beat them.”

For background on the trade itself, see here for the details (note we wrote this post after Matt Levine at Bloomberg issued a typical “nothing to see here” dismissal. Even the normally-complacent SEC begged to differ). An overview from a 2013 post:

The underlying trade in question was a MEGO (My Eyes Glaze Over) type, a pre-crisis confection called a leveraged super senior trade. The extensive attachments to Ben-Artzi’s complaint made it clear (once you parsed them) that the valuation of this very large trade was basically a kludge. Ben-Artzi had been hired from Goldman to address that, and was pretty much prevented from doing his job, and then fired.

The reason this is a big deal is Deutsche’s losses on the trade would have been as much as $12 billion versus $45 billion of equity. And it had to go through what was called “the largest credit resturcturing in history” to dodge that bullet. Both the Bundesbank and the SEC are investigating the complaints about this trade.

As Ben-Artzi explained, and as we’ve discussed numerous times over the years, the revolving door between Deutsche Bank and the SEC is so extensive that it’s hard to see it as an accident. We’ve argued repeatedly that the failure of the SEC to pursue abuses in the CDO market in anything more than a cursory manner was due to the fact that the head of enforcement, Robert Khuzami, had been the General Counsel for the Americas for Deutsche Bank from 2004 to 2009. Deutsche Bank salesman Gregg Lippmann was patient zero of CDO abuses. CDOs constructed for the purpose of generating cheap subprime shorts were the mechanism that turned what would have been a savings and loan level domestic banking crisis into a global financial cataclysm. The failure of the press and regulators to pursue the central role of this strategy in the financial conflagration means that how and why we had a global financial crisis is still almost universally misunderstood. But any serious investigation of CDOs would have implicated Deutsche Bank and thus Khuzami.

And please don’t try arguing Khuzami could have recused himself. The head of an operation cannot effectively be taken out of the picture. No one is going to pursue a probe that will undermine his boss unless he thinks he can pull off a palace coup.

But as the Ben-Artzi case reveals, it’s even worse. As we wrote in June 2013 in Mary Jo White Institutionalizes Deutsche Bank Protection Racket at the SEC, the agency hired Robert Rice as its chief counsel. Rice had been head of governance, litigation and regulation for Deutsche Bank for the Americas. Ben-Artzi had filed an anti-discrimination suit against him and three others. Dick Walker, who had been the SEC’s head of enforcement from 1998 to 2001, left to join Deutsche Bank, later becoming its general counsel.

Critically, Ben-Artzi describes a two-tier standard of enforcement. He cites the SEC action against the pipsqueak Trinity Capital, and its Los Alamos National Bank operation, which engaged in misconduct that resembled that at Deutsche Bank. But there, the agency filed charges against five executives. The CEO paid a fine as part of his settlement and litigation against two other officers is still in process. The key section from Eric Ben-Artzi’s letter regarding the glaring conflicts of interest:

So why did the SEC not go after Deutsche’s executives? The most obvious concern is that Deutsche’s top lawyers “revolved” in and out of the SEC before, during and after the illegal activity at the bank. Robert Rice, the chief lawyer in charge of the internal investigation at Deutsche in 2011, became the SEC’s chief counsel in 2013. Robert Khuzami, Deutsche’s top lawyer in North America, became head of the SEC’s enforcement division after the financial crisis. Their boss, Richard Walker, the bank’s longtime general counsel (he left the bank this year) was once head of enforcement at the SEC.

This goes beyond the typical revolving door story. In this case, top SEC lawyers had held senior posts at the bank, moving in and out of top positions at the regulator even as the investigations into malfeasance at Deutsche were ongoing.

This took place on the watch of Mary Jo White, the current chair of the SEC, whose relationship with Mr Khuzami and Mr Rice dates back 20 years. She bears ultimate responsibility for the Deutsche fine.

And to reiterate the point we made earlier: Khuzami and Rice recusing themselves from the Deutsche Bank investigation was a joke. The individuals who would be left running the project would all be their subordinates. Mary Jo White, per her endorsement of this revolving door and the SEC’s continued refusal to sanction executives at major firms, despite continuing pressure from the media and reform-minded legislators like Elizabeth Warren and Sherrod Brown, is clearly no supporter of enforcement that might shake up big banks or worse, highlight how badly she erred in accepting senior staff members from banks with more than a little air of sulphur about them. Any SEC employee with an operating brain cell would see that following a line of investigation that might implicate Khuzami or Rice would be a career-limiting move.

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This case highlights an even bigger issue: the degree to which attorneys and other professionals are now in the business of providing cover for crooked behavior. In the stone ages of my youth, lawyers used to tell clients what the rules were, how close to the line they could go, and what would happen if they stepped over it. Now they seem mainly to be acting as professional liability shields. One way is via having outside firms rationalize questionable actions. The execs can say, “We relied on expert advice!” and they are off the hook. Benjamin Lawsky, the former Superintendent of Financial Services for the State of New York, started to tackle that issue by sanctioning outside consultants and law firms for providing liability cover in dodgy circumstances.

The Deutsche Bank (and also Goldman) heavy-duty use of the revolving door is another protection racket. The idea that Khuzami and Rice could effectively recuse themselves is an insult to the intelligence of anyone who has ever worked in an organization of meaningful size. Inside players then going into key regulatory positions that shield all actions taken on their watch in their past life has to stop.

And keep this in mind: having lawyers from big firms that have poor compliance cultures (and even by the bad standards of Wall Street, Deutsche Bank was a standout) has another destructive effect: those attorneys will be deeply invested in defending the tainted institutional standards of their former home. That means that they will depict this dubious conduct as normal to SEC staffers, further undermining vigorous enforcement.

The Financial Times story on Ben-Artzi’s rebuff describes the cost to him:

The award determination, which was made in July but has not been previously disclosed, allocated $8.25m each to Mr Ben-Artzi and Matt Simpson, a former Deutsche trader, who both applied for it…

Mr Ben-Artzi said that although he would refuse to take any money himself, he was not able to reject parts of his award — accounting for the majority of the $8.25m — that were claimed by his ex-wife, lawyer or outside experts who worked on his submissions to the SEC.

Help make sure this sacrifice was not in vain. More and more members of the Senate have come to recognize that Mary Jo White, who was once enormously effectively prosecutor, is engaging in compliance theater in her current role. Nine Senators wrote White last month to demand why the SEC had not taken the basic step of issuing investor bulletins, which summarize recent abuses and enforcement actions on private equity, as it has with hedge funds. While this may seem like a minor bureaucratic failure, it actually gets at the heart of the SEC’s too-obvious lack of enthusiasm for pursuing private equity abuses in anything more than a pro-forma manner.

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Please e-mail or call the Senators who signed the July letter. Urge them to demand an explanation from Mary Jo White of the failure to fine Deutsche Bank executives over the leveraged super senior trade abuse, and more generally, to probe White’s failure to question how the depth of revolving door relationships between Deutsche Bank and the SEC have made it impossible for the agency to conduct anything more than a superficial investigation, particularly on the central issue of who was ultimately responsible and therefore needs to be held to account? Please press them to conduct hearings on how the revolving door amounts to a protection racket for senior bank executives, and above all, the lawyers themselves that turned a blind eye to or actively enabled misconduct.

These Senators are:

Tammy Baldwin
Sherrod Brown
Richard Durbin
Al Franken
Patrick Leahy
Jeff Merkeley
Jack Reed
Bernie Sanders
Elizabeth Warren

You can find their contact information here. If any of them is your Senator, be sure to mention that, and in those cases, it would be desirable to call their office in their home state.

Below is  Eric Ben Artzi’s letter. I hope you’ll circulate it widely.

By Eric Ben-Artzi , a mathematician and former risk analyst at Goldman and Deutsche Bank; now a vice president of risk analytics at BondIT

We must protect shareholders from executive wrongdoing

just got word from the Securities and Exchange Commission that I am to receive half of a $16.5m whistleblower award. But I refuse to take my share. My award, which comes from a fund allocated by Congress, amounts to 15 per cent of the $55m fine the SEC imposed on Deutsche Bank in May 2015 after I informed regulators that my colleagues at the bank had been inflating the value of its massive portfolio of credit derivatives.

I was a risk officer at the bank, and one of the three whistleblowers who in 2010-11 reported the improper accounting internally and to regulators around the globe.

The SEC attorney who oversaw the investigation told the New York Times: “It’s the only enforcement action where we allege that a major financial institution failed to properly value a significant portion of its portfolio of complex securities.”

But Deutsche did not commit this wrongdoing. Deutsche was the victim. To be precise, the bank’s shareholders and its rank-and-file employees who are now losing their jobs in droves are the primary victims.

Meanwhile, top executives retired with multimillion-dollar bonuses based on the misrepresentation of the bank’s balance sheet. It is therefore especially disappointing that in 2015, after a lengthy investigation helped by multiple whistleblowers, the SEC imposed a fine on Deutsche’s shareholders instead of the managers responsible.

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Compare this outcome with a contemporaneous SEC enforcement action against the less connected executives of a smaller firm, Trinity Capital, and its subsidiary Los Alamos National Bank. The violations at Trinity seem similar to Deutsche, but orders of magnitude smaller. Five executives at Trinity were charged, the chief executive settled and paid a fine, and litigation continued against two senior officers.

“We will hold senior executives liable when they misstate the company’s performance and fail to come clean with shareholders,” explained Andrew Ceresney, director of the SEC’s Division of Enforcement.

So why did the SEC not go after Deutsche’s executives? The most obvious concern is that Deutsche’s top lawyers “revolved” in and out of the SEC before, during and after the illegal activity at the bank. Robert Rice, the chief lawyer in charge of the internal investigation at Deutsche in 2011, became the SEC’s chief counsel in 2013. Robert Khuzami, Deutsche’s top lawyer in North America, became head of the SEC’s enforcement division after the financial crisis. Their boss, Richard Walker, the bank’s longtime general counsel (he left the bank this year) was once head of enforcement at the SEC.

This goes beyond the typical revolving door story. In this case, top SEC lawyers had held senior posts at the bank, moving in and out of top positions at the regulator even as the investigations into malfeasance at Deutsche were ongoing.

This took place on the watch of Mary Jo White, the current chair of the SEC, whose relationship with Mr Khuzami and Mr Rice dates back 20 years. She bears ultimate responsibility for the Deutsche fine.

In 2010 I joined Deutsche from Goldman Sachs as a vice-president in the market-risk department. I am a mathematician and had worked in risk-modelling at other banks. When I joined Deutsche I was not made aware that an internal “investigation” was already under way into the inflated valuation of the bank’s $120bn portfolio of exotic credit derivatives.

Within a few months, though, I realised something was very wrong, and I called the internal hotline. That is when I met Mr Rice. He was then Deutsche’s top lawyer for compliance and regulatory affairs, and asserted that our conversations were subject to “attorney-client” privilege and could not be disclosed. I did not agree and was fired. My Wall Street career was ruined.

When I first helped the SEC investigation, the whistleblower award was a powerful incentive. My lawyers and ex-wife have a claim on a portion of my award, which I am not at liberty to reject.

Although I need the money now more than ever, I will not join the looting of the very people I was hired to protect. I never intended to turn a job in risk management into a crusade, but after suffering at the hands of the Deutsche executives I will not join them simply because I cannot beat them.

I request that my share of the award be given to Deutsche and its stakeholders, and the award money clawed back from the bonuses paid to the Deutsche executives, especially the former top SEC attorneys.

I would then be happy to collect any award for which I am eligible.

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