Cleaning up finance: when corporate governance turns bad

If anyone questioned the European Commission’s current concern with corporate governance in financial institutions, last Friday’s bombshell that 17 international financial groups – including such household names as Goldman Sachs, Deutsche Bank and Royal Bank of Scotland – are to be sued by the US government for offences ranging from misrepresentation to fraud and aiding and abetting fraud was a telling reminder. The charges stem from the banks’ role in selling mortgage-backed financial products to the government sponsored home lending agencies, Fannie Mae and Freddy Mac, in the run-up to the financial crisis. Between them the agencies lost over $30bn when many of the underlying mortgages proved worthless. Senior bank officials knew about the poor quality of the assets, it is claimed, but failed to disclose this to the buyers, ignoring independent advice and riding roughshod over normal due diligence procedures.

The mortgage-backed securities business was a hugely lucrative one for banks at the time, and as the depositions state “defendants had enormous financial incentives to complete as many offerings as quickly as possible without regard to … the accuracy or completeness of…statements, or conducting …reasonable due diligence.” Unlike other recent fraud cases that targeted low-level bank employees, this lawsuit names senior managers such as the head of the Goldman Sachs mortgage department. The message from regulators is clear – the alleged fraud was not the result of the actions of a few rogue traders but the systematic failure of corporate controls to curb the pursuit of ever-increasing profit.

TI EU has emphasised to the European Commission on a number of occasions – see here for example – that robust corporate governance and controls are a bulwark against fraud and corruption more generally. Given the financial sector’s unique role in originating and amplifying economic crises – with profound consequences for the rest of us – there is a case for more stringent governance and disclosure requirements than for other companies. The New York Fed certainly thinks so . While the recent Commission proposals begin to address this issue, they ignore or fall short of our recommendations on risk management, enhanced reporting, whistleblower mechanisms and director liability. Further proposals on corporate governance in the EU may be in the pipeline, but the claims of US litigators point to a corporate culture in need of an urgent clean up.

Carl Dolan, Transparency International Liaison Office to the EU