Malaysian prosecutors have filed criminal charges against Goldman Sachs and two former employees in connection with bonds issued by 1MDB, a state fund from which billions of dollars were allegedly misappropriated. The U.S. investment bank has called the allegations "misdirected."
But, whatever the legal outcome of this huge and complex case, the episode highlights the difficulty of banks operating in emerging markets, such as Asia.
Governance is not an Asian strongpoint. According to Transparency International, in 2017, Malaysia ranked 62 out of 180 nations in perceived levels of public sector corruption, equal with Cuba and behind Romania. The survey found most Asian countries to be moderately or highly corrupt, similar levels to South America and Africa. Given high levels of dishonesty, fraud and nepotism, foreign banks often hold their noses, accommodate local 'customs' and do their deals. Bankers justify their actions on the basis that it would otherwise be impossible to do business with many clients.
Central to business dealings in Asia is having connections or guanxi, the subtle Chinese term for highly-personal social and influence networks. For foreign banks, the need to create such relationships is the start of a slippery slope.
Courting clients necessitates entertainment such as expensive meals at smart establishments and diversions such as sporting events, or Broadway and West End shows. It can take more risque forms such as procuring escorts for clients.
Banks frequently train client staff, allocating them positions in prestigious internal training programs. Client's children or relatives are commonly given internships or prized positions. In 2016, JP Morgan was fined $264 million under the U.S. Foreign Corrupt Practices Act for improperly hiring unqualified children of China's leaders to win lucrative business. The practice was described as "a systemic bribery scheme" by the U.S. Securities and Exchange Commission.
Banks often second their own staff members to clients to provide expertise. This provides unique access to client information. Any advantage gained by the secondee's employer is considered natural, not corrupt. If all else fails, paying discreet commissions is often an option.
Once mandates from emerging market clients are secured, executing deals frequently entails short cuts. Thick rule books provide cover for tawdrier dealings. Expensive lawyers can navigate know-your-client, money laundering and disclosure rules or legal prohibitions. Outsourcing due diligence to third-party law and accounting firms, which don't look too hard but have good professional liability insurance, allows the pretense of rigor to be maintained. Plausible deniability and additional circuit breakers are created by using agents or joint ventures, or delegating actions to expendable local staff. Internal deception is not unknown.
Tim Leissner, one of the accused employees in the 1MDB case, told a court in August that it was "very much in line of its culture of Goldman Sachs to conceal facts from certain compliance and legal employees." The U.S. investment bank's new chief executive David Solomon later denied any systematic issues arguing that Leissner and Roger Ng, the second former Goldman executive under investigation, worked "blatantly around our policies and... broke the law."
Even when they want to, foreign banks face significant challenges in maintaining control. Senior expatriate staff frequently do not speak the local language or are only superficially familiar with business practices. Frequent rotations mean limited opportunities to build expertise. Head office staff posted abroad sometimes go native, provide poor oversight, and accept dubious local practices.
The drivers for banks are obvious. Emerging markets offer higher returns. Goldman's fees for the 1MDB bond issues (reportedly $600 million) for raising $6.5 billion through bond issues were generous (at least ten or more times normal levels). Dealing with 1MDB and the Malaysian government enhanced its credentials in the eyes of other Asian and emerging market clients. For some institutions, dubious decisions are justified on the basis that if the bank does not deal with a client, a rival will step in.
Asian clients understand the game and play it to perfection. They need the imprimatur of globally-branded banks for credibility and access to capital. They pay higher fees. Well-trained executives at client companies are adept at disguising uncomfortable realities in technical flimflam, reassuring more squeamish banks.
If problems arise, then a myriad defenses is available. All procedures were followed. There were no red flags. The 'no-one-could-have-known' defense is put forward; that is, the failures could only have been detected with perfect hindsight. Rogue employees misled the organization and acted in a manner inconsistent with the bank's general standards. If required, nonessential people can be sacrificed.
The problem may not, in fact, be problematic. A firm will be financially ahead if it made $100 million while fines, settlements and legal costs total $50 million. Where it coincides with a change of management, a new CEO may even find the scandal convenient. The decks can be cleared with a whole raft of matters being blamed on previous management.
Asian economies are already comparable to or aspire to be like advanced economies, in measures such as income per capita. However, business habits frequently are not at developed country levels. Clients and banks are trapped in corrupt links. The easy rewards on offer mean that the incentive for fraudulent behavior is high. In a world where emerging market governments and businesses have weak governance, banks are geared to generating fees and banker remuneration is performance related, the prospects for idealistic actions for the greater good are limited.
Reformers recommend better oversight, more compliance staff, greater training, additional legislation and ultimately better enforcement with more onerous penalties for miscreants. The U.S. Department of Justice's dogged prosecution of the 1MDB matter, where penalties are likely to greater than the benefits of the deals, is frequently cited favorably.
Unfortunately, similar measures implemented in the region after the 1997-1998 Asian financial crisis do not appear to have improved conduct. The reality is that you cannot legislate effectively for ethical behavior, in a region where corruption is widespread and accepted at the highest levels of government and business. As Upton Sinclair noted: "you cannot get a man to understand something when his salary depends on him not understanding it."
Asia needs concentrated and serious efforts to address corruption at all levels. Governments, regulators and companies must all alter incentives to reduce the problem, even if it might be difficult to eliminate it entirely.
