Cross-border 1MDB probes shine light on AML compliance

The multibillion dollar corruption scandal related to 1Malaysia Development Berhard, or 1MDB, the state investment fund set up in 2009 to finance infrastructure projects in Malaysia, has had significant repercussions for cross-border private banking. 

The scandal, which has shaken financial elites on three continents, has led to an extensive series of asset seizures, fines and settlements, jail sentences and bank closures.

Over the past decade and across Asia, US and Europe, funds allegedly flowed from the $8bn sovereign wealth fund into priceless artwork, jewellery, sports cars, yachts, luxury real estate and even the production of movies including, ironically, the Hollywood hit film “The Wolf of Wall Street”, which focused on an earlier era of financial crimes. 

Many of these fraudulent transactions went through private banks. Institutions including Coutts, DBS, Standard Chartered, UBS, UOB and Credit Suisse were fined for breaching anti-money laundering (AML) rules in transactions related to the state investment fund. In 2016, BSI and Falcon Bank were forced to cease operations in Singapore, following the city state’s 1MDB probe and were also left facing drastic measures in Switzerland. 

Just recently, Switzerland’s top criminal court handed down a fine of SFr50,000 ($55,000) to a former compliance officer at Coutts, who the court heard had repeatedly ignored internal warning signs around the origins of $700m, transferred in 2009 from an offshore company controlled by Malaysian businessman Jho Low, now reportedly living in China.

Regulators fight back

Such risks are not new to private banks, as fraudsters have always used financial systems to their advantage, leveraging rogue employees, says Shelby du Pasquier, partner and head of banking and finance at Swiss law firm Lenz & Staehelin. 

What is new in recent years is the “more assertive approach of regulators”. They have also become much more demanding with regards to the conduct of private bankers, effectively turning them into their ‘long arm’. 

This is illustrated by the increased scrutiny over politically exposed persons, the gradual lowering of thresholds triggering suspicious activity report filings, the requirement to systematically document bank transactions and the personal accountability of compliance officers at a criminal level. 

As a result, over the past 10 years, banks have gradually strengthened the role of relationship managers in the due diligence process and monitoring of their clients, and reinforced internal compliance and risk functions. Approval from the compliance department is a precondition to any new business relationship.

But the larger the clients, the more difficult it can be for the banker to obtain documentary evidence supporting the activity of the account. In the 1MDB case, the client was a state-controlled institution, working with several reputable international banking groups and law firms, whose transactions involved hundreds of millions of dollars, argues Mr Du Pasquier. 

This, combined with the complexity of the structure and multiplicity of jurisdictions, put the government fund above any suspicions of impropriety, making it “very difficult” for bankers in charge to request corroborating documentation to support requested transactions.

The fraud was more about the poor governance and corruption of the Malaysian institution than poor governance of the banks involved, ventures Mr du Pasquier. Given the difficulties of catching and convicting the prime suspects of the scam, prosecutors, courts and regulators across the world focused on pursuing financial institutions, which were still holding some of the swindled assets, and have deep pockets. 

Most practitioners do not blame regulations. In fact AML rules are getting tougher in most jurisdictions, making it harder to both open bank accounts and run them without adequate proof of source of funds, says James Quarmby, partner at London-headquartered law firm Stephenson Harwood. Banks will often query transactions in accounts that have been open for years.

“Most banks do take AML seriously and are more than happy to both turn away clients and offload existing clients, where there are concerns about money-laundering or source of wealth generally,” says Mr Quarmby. “We are now at AMLD5 and each new version of this directive gets tougher, so I would imagine it will be harder for outliers to continue to survive.”

Other factors, such as corporate culture, can play a particularly significant role when it comes to the bank’s risk management.

The risk profile of a bank differs depending on whether it is a partnership, such as Lombard Odier, Pictet or LGT, or a listed company, the likes of Credit Suisse or UBS. 

“A partnership can take a very long-term view and wouldn’t take unnecessary risk, it tends to be more conservative,” argues Kian Leong Quek, a partner at PwC in Singapore. Partners would usually have the final say over critical issues, “as it is not just their money on the table, it is their name on the signboard”. 

The compensation structure tends to be more balanced and more discretionary, unlike for listed companies, where revenue is a “significant driver”.

 “The bar on AML/CFT (combating the financing of terrorism) has risen over the past two to three years and what was tolerable in the past may no longer be so. In today’s world, it’s better for private banks to err on the side of caution, as regulators have little patience in this space,” says Mr Quek. 

The 1MDB scandal involved the deaths of several people, including a prosecutor who was brutally murdered investigating the crimes. At the end of July, Malaysia’s former prime minister, Najib Razak, was sentenced to 12 years in jail and fined RM210m ($49m) as he was found guilty on charges including money laundering, criminal breach of trust and abuse of power related to 1MDB. 

Goldman settlement

A $3.9bn settlement reached between Goldman Sachs and the Malaysian government, to resolve criminal charges around the US bank’s role in the affair, has led to much international scrutiny. Roughly $4.5bn was misappropriated from the 1MDB fund, according to US and Malaysian investigators.

The deal struck by Goldman Sachs – which underwrote and arranged bond sales for the wealth fund totalling $6.5bn – involves a cash payment of $2.5bn to the Malaysian government and a guarantee to recover $1.4bn in assets bought with the fraudulently diverted money. In exchange, the Malaysian government will drop its criminal and regulatory investigations into the bank. According to Malaysian authorities, Goldman secured the work with the help of bribes arranged by two former bank employees and others. 

Goldman Sachs, which has denied allegations, has repeatedly apologised for its part in the 1MDB scandal, saying it had learned “important lessons”.

But the settlement does not resolve ongoing US Department of Justice (DOJ) and regulatory investigations into the case. The settlement Goldman is negotiating with the DOJ should be “unmistakably severe” and include a guilty plea to criminal charges by the bank holding company, says Dennis Kelleher, president of US-based non-profit organisation Better Markets, aimed at promoting public interest in financial markets.

This is warranted, says Mr Kelleher, given Goldman Sachs’ “recidivist history” and its “shocking” conduct in this case, including the involvement of more than 30 Goldman executives, including the CEO. “If the DOJ does less, it will once again show that Wall Street’s biggest, wealthiest, most politically connected banks are still too-big-to-jail, no matter how many crimes they commit, how many laws they break, how many victims there are, or how much damage they inflict.”