Ralph Orlowski/ReutersDeutsche Bank logo in front of the Deutsche Bank headquarters in Frankfurt.In the fall of 2009, Deutsche Bank quietly fired one of its top derivative traders in London after a colleague in New York complained about finding “substantial trading anomalies” in a multibillion dollar portfolio of high-risk credit default swaps managed by the German-based bank, Reuters has learned.
The bank dismissed Alex Bernand after a quick internal investigation prompted by the employee’s complaint led to the discovery of improper trading in one of Bernand’s personal brokerage accounts, according to documents seen by Reuters and interviews with people familiar with the situation.
The documents, part of a Sarbanes-Oxley whistleblower action filed against Deutsche in May 2010 by the employee in New York, also reveal that the Securities and Exchange Commission opened an inquiry last year into a related allegation that some of the assets in the derivatives portfolio overseen by Bernand may have been improperly valued in order to hide trading losses.
Deutsche bank spokeswoman Renee Calabro declined to comment on Bernand’s dismissal. But she said the allegation that some assets in the bank’s derivatives book had been improperly valued was investigated by the bank and is “wholly unfounded.”
The SEC investigation and Bernand’s October 2009 firing, neither of which has been previously reported, come as Deutsche is aggressively winding down the portion of its derivatives trading business that Bernand had overseen. Earlier this month, the bank reported in an investor presentation that its plan to unwind its “high-risk” credit correlation portfolio “is well ahead” of schedule. The bank first announced a plan to begin “de-risking” some of its derivatives trading desks in late 2008.
In January, Deutsche settled the whistleblower case by agreeing to pay $900,000 to trader Matthew Simpson and promoting him to managing director shortly before he voluntarily agreed to leave the bank in April. It was the largest Sarbanes-Oxley whistleblower settlement for a complaint filed in 2010. Simpson, who now works for Rochdale Securities in Stamford, Connecticut, did not return a phone call seeking comment.
UNFOUNDED ALLEGATION
“This complaint, which is over a year old, has been the subject of a thorough investigation, and we believe that any allegations about financial misreporting are wholly unfounded,” said Calabro, who declined to comment on the terms of the settlement with Simpson. “The bank is cooperating with the SEC on its review of the matter.”
An SEC spokesman declined to comment.
Bernand, who lives in France, also declined to comment. On his LinkedIn profile, Bernand describes himself as an “independent philanthropy professional.”
Simpson’s and Bernand’s names were redacted from the whistleblower documents seen by Reuters, but their identities were confirmed by two people familiar with the situation.
In its settlement agreement with Simpson, Deutsche also denied “any wrongdoing in connection with the matter.” In light of the settlement, the U.S. Department of Labor in February closed its investigation into Simpson’s claim that he had been retaliated against by some of his superiors for bringing the allegations of improper trading to the attention of the bank’s compliance department.
The firing of Bernand, a one-time rising star in the derivatives world, is something of an embarrassment for Deutsche. In 2006, the bank issued a press release to trumpet his hiring from Bank of America as its global head of credit correlation. At BofA, Bernand had pretty much built the Charlotte, North Carolina-based bank’s structured credit trading business from scratch.
Inside Deutsche, the portfolio that Bernand oversaw from London was called the “exotics book,” because many of the derivatives in the portfolio were tied to complex securities. At its peak, the portfolio was one of the largest on Wall Street with the assets underlying the trades valued in the tens of billions of dollars.
ILLUSORY PROFITS
The bank’s credit correlation desk specialized in using credit default swaps to make proprietary trades that were aimed at hedging some of the bank’s exposure to potentially risky corporate bonds, leveraged loans, currencies, indexes and commercial paper. Many of the trades put on by correlation traders involve synthetic collateralized debt obligations (CDOs), financial instruments that use credit default swaps to get exposure to various bonds and other assets.
Some have blamed credit default swaps — a type of derivative that is supposed to provide a level of insurance against an underlying asset going bad — with exacerbating the global financial crisis because they increase the level of risk on balance sheets of the world’s major banks. However, the synthetic CDOs traded by the correlation desk were not like the more popular variant of CDOs which were stuffed with subprime mortgage securities.
Janet Tavakoli, a Chicago-based derivatives consultant who has written several books on credit derivatives and structured products, said many bank managements did not fully appreciate the illusory nature of the trading profits being generated from derivatives correlation desks before the financial crisis. She said those profits often disappeared and turned into losses when the underlying assets turned south.
“The thing about correlation desks is that it will appear you are making a lot money from trades, but it is all money at risk,” said Tavakoli. “I call this kind of trading an invisible hedge fund.”
In an early 2010 regulatory filing, Deutsche attributed some of the rise in the bank’s value-at-risk, or VAR, at the end of 2009 to a “recalibration of parameters in the Group’s credit correlation business.”
On Wall Street, VAR is one metric used by a bank to estimate how much money it could conceivably lose in a day if all of its trading bets and hedges went awry. It’s an imperfect measurement, but one followed by most industry analysts.
A person familiar with Deutsche said the bank is winding down the credit correlation desk to both reduce its risk profile and better comply with the so-called Volcker Rule’s ban on proprietary trading in the United States.
The bank’s internal investigation into Simpson’s allegations was overseen by the big New York law firm Fried Frank.
The revelation that the SEC is investigating the valuations used for some of Deutsche’s derivatives portfolio comes at an awkward time. Over the past few months, the bank has taken some high-profile lumps for its role in contributing to the financial mess.
A Senate report released in April faulted Deutsche for continuing to churn out collateralized debt obligations and other securities backed by subprime mortgages even as the housing market in the United States was starting to crumble. The report from the Senate’s Permanent Subcommittee on Investigations said Deutsche aggressively marketed CDOs to its client, “despite the negative views of its most senior CDO trader” about the failing health of the housing market.
Just last month, federal prosecutors in New York filed a civil suit against Deutsche, claiming its MortgageIT subsidiary repeatedly lied about the quality of the mortgages it was issuing to obtain federal guarantees on those iffy home loans. The government seeks to recoup some $1 billion in losses it incurred from insuring the mortgages. Deutsche contends most of the problem loans were issued before the bank acquired MortgageIT in 2007.
Before filing his whistleblower complaint last May, Simpson had built a long track record at Deutsche. Over the dozen years he worked for the bank in New York, he held positions in finance, risk management and then trading. He joined the firm’s correlation trading group in 2008 and was responsible for trading derivatives tied to bonds and currencies.
In his whistleblower complaint, Simpson said when he reported his concerns about trading improprieties to Deutsche’s compliance department he “expressed concerns for future retaliations.”
Among the acts of retaliation that Simpson alleged were being passed over for a promotion in February 2010 and later “stripped” of all his trading and management responsibilities. Calabro said the bank denies Simpson’s claim of retaliation.
© Thomson Reuters 2011
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