Three German banks Commerzbank, HypoVereinsbank and the state-owned HSH-Bank have just settled with tax authorities in Nordrhein-Westfalen on illegal aid to tax evasion. The banks assisted clients in shifting their funds from Luxembourg to Panama to put the money out of reach of German tax authorities.
While the settlements partially provide for 8-digit fines, they do not include accountability for individuals. Just settlements should provide for effective, proportionate and dissuasive sanctions. Where evidence is sufficient, criminal prosecution of individuals should be the standard practice. In the absence of that, settlements might be perceived as a company buying its way out of punishment.
This should not be the end of the story. The question is why did the famous “three lines of defense” fail?
Why did the bank managers (first line) in Luxembourg not care about the bank’s codes of conducts that prohibit any assistance for illegal transactions? Were they too close to the customer? What other illegal transactions – like bribe payments or breaching of sanctions – would they be willing to handle?
Why was the paper on the “Panama connection business” – the elaborate web of shell companies with obscure ownership which helped conceal the funds – and the relevant complex legal documentation not reviewed by compliance and general counsel (second line)?
And finally why did no regular audit (third line of defense) in Luxembourg over the last 10 years ever raise concerns about this kind of illegal business? If audit reports addressed the issue why was the business not stopped?
Why did the bank managers in Luxembourg not care about the bank’s codes of conducts that prohibit any assistance for illegal transactions? Were they too close to the customer?
These questions demonstrate an urgent need for the German bank supervisory boards to look into the matter and for the banks’ regulators to initiate a special investigation (“Sonderprüfung”) on the effectiveness of the three lines of defense. Furthermore, the banks should consider dismissals of managers who breech the rules over such a long period of time. At a minimum there should be salary cuts and claw back of bonuses. The managers probably received huge bonuses for the lucrative “Panama connection business” while the banks have to pay the fines years later.
This points to the biggest problem: bankers are paid and incentivized for short-term profit as opposed to sound risk management. As long as compliance-based criteria such as respect for the code of conduct and participation in related trainings are not integrated into the performance management system with the same weight as quantitative criteria like how much revenue a person brings to the firm, there is a big chance that the first line of defense will continue to fail.
Any kind of remedial actions taken should be communicated to employees and other stakeholders, including citizens, customers, regulators and investors. Transparency can act as the most efficient deterrence. Furthermore, it will help restore trust and confidence in banks that are willing to change conduct and promote greater integrity in their corporate culture. The deterrent effect of fines negotiated in settlements is questionable, however, in particular if there is little accountability for the individuals who were involved in the crime and their managers.