Commentary: Goldman Sachs’ 1MDB Compliance Failures Provide Lessons for Firms and Banks (Part 1)

Goldman Sachs and the government of Malaysia recently announced an agreement to resolve all criminal and regulatory proceedings involving the investment bank in the country over 1MDB through a $3.9 billion settlement.

It is hard to imagine how an investment bank such as Goldman Sachs, with a state-of-the-art compliance and oversight framework, could be “hoodwinked” by its own executives into participating in one of the largest financial crimes and compliance failures of this century.

Not only were serious criminal laws broken in Asia, the United States and Abu Dhabi, the compliance failures were detrimental to the Malaysian people. Goldman Sachs’ compliance and legal team failed to pick up the misappropriation of approximately $2.7 billion in distributed bribes and kickbacks to government officials in Malaysia and Abu Dhabi, as well as money laundering transfers that circled the world. It also did not question the appointment of a little-known Swiss bank that mechanically laundered money internationally for corrupt 1MDB officials with knowledge of some of Goldman Sachs’ executives at partner level.

Goldman Sachs’ explanation for the fraud is simple: a few “rotten apples” lied.

The compliance failures point to a culture that allowed business to be placed before compliance and risk, that sowed the seeds of the banks’ own internal vulnerabilities and ultimate fall from grace to face criminal charges in New York. Whatever conclusion is drawn as investigations of Goldman Sachs continue in the United States, there are several compliance lessons for all financial institutions and firms, their executives, legal teams and compliance staff.

Background

1 Malaysia Development Berhad (1MDB) is a state-owned and controlled investment fund created to pursue projects for the benefit of Malaysia and its people, which began in 2009. Between 2009 and 2014, 1MDB raised capital to fund projects and billions of dollars were diverted from 1MDB. A substantial portion of the diverted funds was some $6.5 billion in capital that 1MDB raised between May 2012 to March 2013 through three private bond offerings that it executed with Goldman Sachs.

In total, more than half of the money was stolen from the fund (and the Malaysian people), by convicted former Malaysian Prime Minister Najib Razak, recently sentenced to 12 years’ imprisonment, and other associates, including Jho Low. Razak is on bail pending an appeal and Jho Low fled Malaysia and is believed to be living in China and in possession of millions of dollars of stolen funds.

Many of the transactions were orchestrated by Tim Leissner, then a partner at Goldman Sachs and participating managing director and vice-chairman of the investment banking division for Asia, as well as chairman of South-East Asia. Leissner later pleaded guilty to bribery, conspiracy and money laundering and was required to forfeit more than $40 million in commission.

The U.S. Department of Justice’s (DoJ) indictment describes how Leissner “and others” in the shadows oversaw the bribing of government officials in Malaysia and Abu Dhabi to obtain lucrative business for Goldman Sachs.

Also charged with Leissner was the former managing director at Goldman Sachs’ Singapore office, Roger Ng, who is still awaiting trial in the United States. Ng acted as an agent for Goldman Sachs’ many transactions in Asia.

Interestingly, the DoJ indictment refers to the involvement of “others”, which may point to other Goldman Sachs employees or agents yet to be charged. Goldman Sachs is still under investigation by securities regulators in the United States and it is most likely it may have to plead guilty to various criminal charges in the United States and pay another multi-billion-dollar fine. The investment bank has never had to plead guilty in a federal investigation and is trying to avoid doing so in this case. Additionally, federal authorities are reviewing Goldman Sachs’ compliance procedures.

How did these compliance failures occur?

Goldman Sachs has indicated that it has a sophisticated compliance programme with monitoring, auditing, and forensic capabilities, and many established committees that review transactions. These functions were operating ineffectively, however, for the 1MDB bond deals.

The bank attributes the 1MDB compliance failure to a rogue employee who avoided compliance measures for personal gain and blindsided everyone.

Lloyd Blankfein, Goldman’s chief executive at the time, said: “These are guys who evaded our safeguards and lie, stuff like that’s going to happen”.

John C Williams, president and chief executive of the Federal Reserve Bank of New York, does not subscribe to the “bad apple” theory or the lone rogue argument.

“Illicit and unethical behaviour is rarely the result of an isolated ‘bad apple’. It’s more often the symptom of a rotten culture. And rotten cultures don’t appear overnight — nor for that matter do positive, inclusive ones, where people feel empowered and accountable to upholding the values of the organization,” he said earlier this year.

There were many warning signs and red flags for compliance and legal executives and Goldman Sachs’ overview committees that vetted the 1MDB bond deals. This compliance oversight makes it implausible that Leissner and Ng were the only main individuals inside the firm who were able to “dupe” some of the most sophisticated and intelligent compliance and legal teams in the world.

To understand how such a fraud and compliance failure of this magnitude could occur, it is important to consider some of the facts which have been made publicly available and consider issues around due diligence, accountability, circumvention of compliance controls and culture. The first issue to highlight is the failure of due diligence at the investment bank at the time.

Failure to undertake proper due diligence or turning a blind eye to the obvious?

The bond deals emerged from the background of money and politics. Goldman Sachs survived the financial crisis in 2009 partly due to the U.S. government’s bailouts. Shortly after, Blankfein began his relationship with then Malaysian Prime Minister, Najib Razak, who wanted to start 1MDB and continue his term in office and needed money – plenty of it. Razak appointed Jho Low (a junior person in his early thirties) as the fund manager to run 1MDB. Enter David Ryan, the then head of Goldman Sachs in Asia (under him Leissner and Ng), who had concerns about 1MDB and its inexperienced staff from the very start.

1. Knowledge about Jho Low

At some point in 2009, Leissner tried to have Jho Low accepted as a client of Goldman Sachs, but Goldman Sachs’ compliance department and committees refused him as a customer of the bank on the basis that they could not determine his wealth. This is often a red flag that the unsourced wealth may be derived from criminal activity and/or money laundering. Irrespective, Jho Low appears to have had at least two meetings with Blankfein in Malaysia and New York. It is unclear if the compliance department was aware of these meetings.

What emerges from the DoJ indictment is that Leissner “and others” worked with Jho Low on the three 1MDB bond deals and on the Abu Dhabi transactions that delivered lucrative business to Goldman Sachs.

Senior executives at Goldman Sachs must have known about Jho Low’s questionable background and that he was playing a central role in the 1MDB deals by acting as an intermediary between Goldman Sachs, 1MDB, and Malaysian and Abu Dhabi government officials.

“Leissner and other senior executives of Goldman Sachs also knew that Low promised to pay bribes and kickbacks to these officials to secure 1MDB business for Goldman Sachs,” the DoJ indictment said.

The DoJ indictment makes it clear that many more of the banks’ executives had knowledge of the criminal activity beyond Leissner and Ng.

The DoJ indictment also sets out that there were numerous meetings with Goldman Sachs’ executives and Jho Low in London, New York, and Abu Dhabi in relation to creating more business for Goldman Sachs. It is hard to fathom that senior executives at the internal committee level within Goldman Sachs did not know that Leissner and Ng were dealing with Jho Low in relation to the bond deals. It is also hard to imagine that Goldman Sachs executives at the highest level did not know how business was being won in these jurisdictions as these transactions would have to go through compliance or legal for approval.

2. Auditors resigned from 1MDB

Another major red flag was that Ernst & Young, the initial auditors of 1MDB, resigned, as did the second and auditors, KPMG and Deloitte. Goldman’s committees must have been aware that the auditors had resigned and should have been on notice to further investigate what was going on. The resignation of an auditor in relation to a fund, or replacement of auditors (i.e. a partner refusing to sign off), has become a major red flag since Enron Corporation collapsed in 2001 as a result of corporate fraud and corruption.

3. Senior partner sidelined for advising against the bond deals

In 2009, according to the recent Harvard Law School “Forum on Corporate Governance”, David Ryan, president of Goldman Sachs in Asia (and Leissner’s superior), urged caution in dealing with the 1MDB offerings and was not convinced the bank should do the deals. According to the Forum, Ryan had visited 1MDB staff in Malaysia and voiced concerns about Malaysia’s plan to take on so much debt. He also noted the youth and inexperience of the 1MDB fund management staff. After expressing these views, Ryan was sidelined and left Goldman Sachs in 2014 “partly was because he was frustrated that his concerns about the 1MDB deals were not heeded”. There is no doubt Ryan would have voiced his concerns to the internal committees or executives serving on them. This means senior people at Goldman did not heed the advice of their most senior banker in Asia, who was troubled by the deals.

4. Goldman Sachs Middle East office declined to get involved

It notable that different areas within Goldman Sachs declined to be involved in the 1MDB deals and Goldman Sachs’ Middle East headquarters in Dubai urged caution and refused to be involved in the 1MDB transactions involving Abu Dhabi State Energy Investment Fund and International Petroleum Investment Company. Goldman requested investment bank Lazard to value the Middle East assets for the underlying transactions, but it also refused to be involved in any valuations. Goldman Sachs (Asia and New York) then assumed the additional role as an advisor to 1MDB and reportedly valued the assets at a level justifying the purchase price. This was a conflict of interest and undisclosed until much later. It is likely the committees and compliance department were aware of these facts.

Click here to read the second part of the commentary and key takeaways for firms and banks.

Niall Coburn is the Regulatory Intelligence Expert at Thomson Reuters in the Asia-Pacific region and a Barrister at the Queensland Bar.

As an expert on regulatory issues at Thomson Reuters, Niall writes articles, white papers, gives presentations in the region and liaises with the banking industry internationally concerning regulatory developments in the Asia-Pacific region.

Prior to joining Thomson Reuters, he was the regional Managing Director at FTI consulting, responsible for leading its Regulatory and Forensic Investigation Practice in Australia. FTI is a global consulting firm listed on the New York Stock Exchange with 500 offices worldwide.

Niall was also a Senior Lawyer and Specialist Adviser at the Australian Securities and Investments Commission. In this role he led high-profile investigations into complex corporate crime cases. He has also worked internationally, being part of a team that created the regulatory structure for the Dubai International Financial Centre (DIFC).

Niall was appointed Director of Enforcement at the DIFC in 2003 and worked with international law enforcement agencies to combat financial crime.

Niall has also worked in the Asia-Pacific region in his own consultancy, Coburn Intelligence in China and Hong Kong, investigating major frauds and misleading conduct in the investment industry.

Niall was awarded an Australia Day Honour from the Commonwealth Government for his work leading major criminal investigations at ASIC. He is a Barrister of the High Court of Australia and a member of the Queensland Bar Association and the International Bar Association.

 

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