1MDB Update: How 1MDB lit a bonfire that now engulfs Goldman Sachs

This article first appeared in The Edge Malaysia Weekly, on November 26, 2018 - December 02, 2018.

Blankfein was reportedly at two separate meetings with Jho Low and Leissner

Jho Low has been charged in absentia with money laundering and violation of bribery laws

Leissner has pleaded guilty to money laundering and bribery charges

Ng is currently awaiting extradition to the US and has yet to enter a plea

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FOR nearly five years now, the unfolding 1 Malaysian Development Bhd or 1MDB scandal has had little or no impact on Wall Street even though US investment banking giant Goldman Sachs was at the core of the shenanigans and a key enabler.

New York’s financial circles hardly noticed when 1MDB helped bring down the government of former Prime Minister Datuk Seri Najib Razak in May. Indeed, even the US Department of Justice (DoJ) indictments of Penang-born wheeler-dealer Low Taek Jho or Jho Low, Goldman Sachs ex-partner Tim Leissner and his deputy Roger Ng last month barely made a ripple in the financial markets.

Yet, last week, 1MDB was washing up on Wall Street like a tsunami. By the time the selling was done, Goldman Sachs stock was down a whopping 17%. The shares are now down over 30% from their late January peak, making Goldman by far the worst-performing large US financial stock this year.

When large stocks plummet, not just analysts, investors and financial media but also board members, top management and regulators are forced to sit up and take notice. The market is saying something is rotten at Goldman Sachs and swift action is needed. When the dust around the 1MDB scandal settles, Goldman and indeed the old ways of doing business in Wall Street could change.

Here’s why Goldman is in trouble: It raised US$6.5 billion for 1MDB. The US Department of Justice alleges that over US$3.5 billion was misappropriated from those funds by Jho Low, a close confidant of Najib. In pleading guilty to money laundering and bribery charges, Leissner blamed the 1MDB shenanigans on Goldman’s “culture” to work around internal legal and compliance controls as it was highly focused on consummating deals. Jho Low has been charged in absentia with money laundering and violation of bribery laws by the DoJ. He remains on the run reportedly in hiding in China.  Another former Goldman executive, Roger Ng, who was arrested by Malaysian authorities last month and is currently awaiting extradition to the US, has yet to enter a plea. Malaysia wants back the US$600 million 1MDB paid in fees to Goldma and restitution of a big chunk of the US$3.5 billion it lost.

On Nov 22, Abu Dhabi ’s state-owned International Petroleum Investment Company, and its subsidiary, Aabar, sued Goldman for its “central role” in the scandal.

To be sure, the rapidly unfolding 1MDB scandal is the most serious existential crisis that venerable Goldman (founded in 1869) has faced since the heady days of late 2008 when, at the height of the global financial crisis as the world’s largest investment bank, it reached out for help to the US Federal Reserve as well as billionaire investor Warren Buffett for additional liquidity and capital to keep itself afloat.

Until recently, the sceptical narrative around Goldman and 1MDB was that irrespective of its 1MDB problems, the Wall Street behemoth would cut a deal with the DoJ, pay a billion or so in fines and turn over a new leaf just as it has after every scandal in its history, including the global financial crisis.

Now, increasingly, there are concerns in Wall Street of far-reaching regulatory sanctions, above and beyond the fines, both in the US as well in Asia. There is also the long-term reputational damage to Goldman in Asia, the Middle East and emerging markets. Its franchise is already feeling strains in Southeast Asia since the 1MDB scandal first broke five years ago. And in Northeast Asia, Chinese banks as well as US rivals Morgan Stanley, JP Morgan and Citigroup have clawed back market share at its expense.

Let’s look at just how much might Goldman may have to pay in fines, refund of overcharged fees and restitution to Malaysia.

There is a wide range of outcomes on what the fines and penalties could be, notes Betsy Graseck, bank analyst for Morgan Stanley.

Although she has pencilled only US$1.8 billion in financial hit for Goldman at a minimum, Graseck notes that the Foreign Corrupt Practices Act’s anti-bribery provisions permit fines of up to twice the amount of fees obtained, in addition to returning the fees.

Christian Bolu, analyst for Sanford C Bernstein in New York, estimates that Goldman will have to disgorge its US$600 million fees from the 1MDB bonds, plus a minimum of US$600 million in fines under Anti-Money Laundering laws, US$100 million in Foreign Corrupt Practices Act (FCPA) fines and at least US$810 million in restitution to the Malaysian government for losses on 1MDB.

That’s US$2.11 billion in total.

Bolu says he based his estimates on recent enforcement actions around AML and FCPA. In 2012, HSBC paid US$1.26 billion in fines after it settled its anti-money laundering case with the DoJ. Earlier this year, US Bancorp paid US$613 million in settlement of its own anti-money laundering case.

Just two months ago, Brazil’s Petrobras settled its Foreign Corrupt Practices case by paying US$853 million in fines. Bernstein’s US bank analyst notes that in its latest regulatory 10-K filing with the Securities and Exchange Commission, Goldman increased “provisions” for “reasonable possible losses from US$1.5 billion in the June quarter to US$1.8 billion in the last quarter. Most of those provisions are for 1MDB-related fines.

Many Wall Street analysts see a parallel between Goldman’s involvement in the 1MDB scandal and the Salomon Brothers’ Treasury bid-rigging scandal in 1991 that cost its high-­flying CEO John Gutfreund his job and eventually led to the demise of the brokerage and bond trading giant.

Salomon was rescued by Warren Buffett nearly 27 years ago, not as a passive investor — the way he helped saved Goldman 17 years later — but as an active interim chairman of the board who helped guide the venerable investment house to safety before exiting at a nice profit. (Salomon was bought by insurer  Travelers Group which merged with Citigroup in the late 1990s. Citi, in turn, sold the brokerage and wealth management unit to Morgan Stanley in the aftermath of the 2009 financial crisis.)

Like Goldman’s dismissal of 1MDB, Salomon’s bid-rigging scandal, which was initially rejected by its top managers and the board as something just confined to a rogue bond trader, eventually spread all the way to the top, ultimately becoming a criminal investigation, encircling the powerful helmsman Gutfreund after it became clear that he had been repeatedly alerted about bond auctions scam but had refused to act until after the scandal became public. That’s exactly is what is happening at Goldman.

Essentially, the 1MDB scandal has moved from wrongdoings by upper mid-tier executives — Leissner, Vella and Ng— to what looks like potentially a criminal “cover-up” stage where the key is not just when Goldman’s top honchos first got a whiff of the foul 1MDB’s stench, or exactly what they knew, but whether they deliberately tried to hide material information about the 1MDB scandal and their own involvement in it from the board, investors and other stakeholders and, indeed, have been lying about the ongoing cover-up for months, if not years.

It is now clear from Leissner’s testimony that Goldman’s then CEO and current chairman Lloyd Blankfein was reportedly at two separate meetings with Jho Low and Leissner himself, the first one as far back in 2009, which was also attended by Najib, apart from one-on-one meeting with Jho Low and another meeting with Low and Aabar’s CEO Mohamed Ahmed Badawy Husseiny.

As recently as a few months ago, Blankfein was feigning ignorance. Initially, he didn’t recall meeting Low. Then he admitted meeting Jho Low but only because the chubby Penang-born fugitive had accompanied Najib and Leissner to their meetings. Now, it turns out that Jho Low accompanied Al-Husseiny and indeed even had a one-on-one meeting with the then Goldman boss. For months, Cohn and Salomon have also distanced themselves from Low and Najib as well as knowledge of any malfeasance and bribery. Now, it turns out that they knew a lot more than they have been letting on for some time.

It seems unlikely that Goldman cutting a deal with DoJ and agreeing to pay a few billions in fines will allow its top brass to walk away unscathed. Going by the Salomon Brothers and Gutfreund case, heads will have to roll. Six months ago, just after the Malaysian elections that ousted Najib’s government, and before Blankfein stepped down as CEO in September, Goldman probably still had an option of coming clean, admitting to malfeasance and negligence, paying hefty fines and returning US$600 million that it charged in fees to Malaysia, and moving on. That easy option may have lapsed. Now, there is the matter of six additional months of cover-up, which involves not only Blankfein but also the current CEO David Salomon who took over the reins on Oct 1 and has been as vociferous in his denials as his predecessor.

So, not only has the 1MDB cover-up been going on for a while now, it involved not just one or two but almost the entire top brass of Goldman at one point or another. And it was the prolonged cover-up of the bond scandal, by one of its “Big Swinging Dick” traders, which brought down Salomon Brothers and not the scandal itself.

Fines are not the only hit Goldman will take. Bernstein’s Bolu argues that reputational damage inflicted by the 1MDB debacle could drive Goldman’s new management team to tighten its new business approval process, especially in higher-risk emerging market regions. In 2010, when the US SEC fined Goldman US$550 million for pre-crisis mortgage CDO related issues to address the reputational fallout, the firm formed a Business Standard Committee that issued recommendations, including tighter transaction approval process in the trading businesses. He notes that constrained risk appetite is partly to blame for market share declines in its fixed income, currencies and commodities business over the last five years.

Morgan Stanley’s Graseck says her main concern is the potential fallout of the 1MDB investigation, how long it will take to resolve the issue, what the fines and penalties could be and what costs will Goldman incur to satisfy regulators. Goldman could also face a temporary ban in Asia. Earlier this year, Hong Kong regulators banned UBS from sponsoring initial public offerings for 18 months after an investigation into the Swiss bank’s role in certain listings on its stock exchange.

Whether Goldman takes over US$2 billion hit — about US$1.5 billion in fines and a US$600 million payout to Malaysian government — the base case being cited by Wall Street analysts — or needs to fork out US$3.5 billion — up to US$2 billion payout to Malaysia and another US$1.5 billion or so in fines plus sanctions, including temporary suspension of its investment banking licence in Asia ex-China and Japan — is a moot point.

What is clear, however, is that the iconic investment bank’s franchise is likely to take a huge hit aside from the huge fines and it will probably take years, even decades, to shake off its “vampire squid” reputation.

 

Assif Shameen is contributing editor at The Edge

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