Sigrún Davíðsdóttir's Icelog

“It’s not unlikely that an international bank wants to avoid being accused of market manipulation,” said Prosecutor Björn Þorvaldsson in Reykjavík District Court on October 11, 2017. The “international bank” was Deutsche Bank and the court case was the so-called CLN case. Deutsche was not charged with anything – the criminal case was against Kaupthing managers, charged with fraudulent lending of €510m into a scheme concocted with Deutsche. However, both Kaupthing administrators and liquidators of two BVI companies saw a way of using alleged market manipulation in these transactions to recover from Deutsche the €510m, Kaupthing had paid to Deutsche. In December 2016, Deutsche eventually concluded that paying €425m was preferable to having to recount the ignominious saga in court. All parties to the agreement are unwilling to divulge further facts but a UK court document throws light on Deutsche’s part in the alleged market manipulation, affecting not only Kaupthing’s CDS spreads but also the bond market. – The question is if this really was the only scheme of alleged market manipulation that Deutsche instigated. Further, the case throws light on how tension between Deutsche’s staff working on the scheme and those responsible for legal and reputational risk was dealt with, potentially explaining the same in other Deutsche schemes.

In January 2009, Kaupthing’s ex-chairman Sigurður Einarsson felt compelled to send a letter to family and friends to counter claims in the Icelandic media regarding Kaupthing’s activities in the months before the bank failed in October 2008. One was that in 2008 the bank had traded on its own credit default swaps, CDS, linked to credit-linked notes, CLN, to bring down the bank’s CDS spreads and thus lower the bank’s cost of financing.

Einarsson wrote that Kaupthing had indeed funded such transactions, via what he called “trusted clients” in cooperation with Deutsche Bank; the underlying assumption was that a reputable international bank would not have done anything questionable – those were the days before international banks like Deutsche were being questioned and fined for criminal actions.

The Icelandic 2010 Special Investigations Committee, SIC, report told the CDS saga in greater detail, documenting Deutsche’s full knowledge from the beginning. A 2012 London court decision added to the story: in order to recover documents related to the transactions, Stephen Akers and Mark McDonald from Grant Thornton London – appointed liquidators of two BVI companies, Chesterfield and Partridge, used in the CDS transactions in the names of the “trusted clients” – had brought Deutsche Bank to court.

The CDS saga was summed up in 2014 charges in a criminal case in Iceland: Einarsson, Kaupthing’s CEO Hreiðar Már Sigurðsson and head of the bank’s Luxembourg operations Magnús Guðmundsson were charged with breach of fiduciary duty, causing a loss of €510m to Kaupthing, some of which Kaupthing paid to Deutsche literally as Kaupthing was failing. – All of this has earlier been reported in detail on Icelog(most notably here, December 2015 and here, November 2017).

The latest addition to the CDS saga is in another court document, consolidated particulars* from 2014, as the liquidators of the two BVI companies sought to recover funds from Deutsche in a civil case by suing Sigurðsson, Einarsson, Venkatesh (or Venky) Vishwanathan the Deutsche senior banker who liaised with Kaupthing on the CLN trades and, most importantly, the liquidators sued Deutsche Bank. The fifth defendant was Jaeger Investors Corp., BVI, a director nominee for Chesterfield and Partridge.

The 2014 document shows, in extensive quotes from emails etc., that contrary to Deutsche’s version in its Annual Reports etc., the bank was fully aware of the fact that Kaupthing set up these trades and funded them in order to influence its CDS spreads, i.e. allegedly the scheme was effectively a market manipulation. In addition, the Icelandic criminal case related to the CLN transactions documented that Deutsche was on the other side of the bet, thereby effectively creating a hedge for itself.

Thus the Icelandic SIC, the Icelandic Special Prosecutor, the Kaupthing administrators and of course the liquidators of the two BVI companies have all come to the same conclusion: Kaupthing and Deutsche colluded in market manipulation.

This goes a long way to explain why Deutsche, by the end of 2016, chose to settle with Kaupthing – Deutsche Bank was not going to be dragged into court to explain the discrepancy between its public statements and internal Deutsche documents, in addition to profiting from being a counterparty in the transactions. The liquidators alleged Deutsche took part in criminal activity. This has however not been tested in court; the SFO had as early as 2010 looked at these transactions but later apparently dropped its investigation as so many others.

One intriguing aspect of the CLN transactions is that Deutsche staff took measures to hide facts from staff working on legal and reputational risk. This has immense ramification for so many other questionable transactions in the bank, which have come to light over the last few years, inter alia Deutsche’s involvement in the largest known case of money laundering of all times: Danske Bank money laundering in Estonia 2007 to 2015, a saga still in the making.

The Deutsche version of the CDS saga (is very short)

Deutsche first mentioned the CLN claims in its 2015 Annual Report (p. 340). As an introduction to the bank’s 2016 Annual Report, Deutsche CEO John Cryan sent out a message to the bank’s employees on February 2 2017 where the settlement with Kaupthing was one of four legal issues the bank had resolved and chose to emphasise.

Deutsche has consistently presented the CDS transactions as if it had only learned of the realities well after the CLN transactions, as here in 2017 (the text is the same in Deutsche’s 2015 and 2016 (p. 369) Annual Reports):

Kaupthing CLN Claims

In June 2012, Kaupthing hf, an Icelandic stock corporation, acting through its winding-up committee, issued Icelandic law claw back claims for approximately € 509 million (plus costs, as well as interest calculated on a damages rate basis and a late payment rate basis) against Deutsche Bank in both Iceland and England. The claims were in relation to leveraged credit linked notes (“CLNs”), referencing Kaupthing, issued by Deutsche Bank to two British Virgin Island special purpose vehicles (“SPVs”) in 2008. The SPVs were ultimately owned by high net worth individuals. Kaupthing claimed to have funded the SPVs and alleged that Deutsche Bank was or should have been aware that Kaupthing itself was economically exposed in the transactions.Kaupthing claimed that the transactions were voidable by Kaupthing on a number of alternative grounds, including the ground that the transactions were improper because one of the alleged purposes of the transactions was to allow Kaupthing to influence the market in its own CDS (credit default swap) spreads and thereby its listed bonds. Additionally, in November 2012, an English law claim (with allegations similar to those featured in the Icelandic law claims) was commenced by Kaupthing against Deutsche Bank in London (together with the Icelandic proceedings, the “Kaupthing Proceedings”). Deutsche Bank filed a defense in the Icelandic proceedings in late February 2013. In February 2014, proceedings in England were stayed pending final determination of the Icelandic proceedings. Additionally, in December 2014, the SPVs and their joint liquidators served Deutsche Bank with substantively similar claims arising out of the CLN transactions against Deutsche Bank and other defendants in England (the “SPV Proceedings”). The SPVs claimed approximately € 509 million (plus costs, as well as interest), although the amount of that interest claim was less than in Iceland. Deutsche Bank has now reached a settlement of the Kaupthing and SPV Proceedings which has been paid in the first quarter of 2017. The settlement amount is already fully reflected in existing litigation reserves and no additional provisions have been taken for this settlement.

As can be seen from the text, the wording is carefully calculated. Inter alia, Deutsche has never in its public statements mentioned when and how it learned of the realities of the scheme, i.e. it was funded by Kaupthing in order to manipulate its CDS spreads.

Deutsche sent Venky Vishwanathan on leave in the spring of 2015 because of his involvement in the Kaupthing scheme. In 2016, Reuters reported that Vishwanathan was suing Deutsche for unfair dismissal. The status of his case is unclear; he has not responded to my queries on LinkedIn.

An overview of the Kaupthing CLN transactions

In February 2008, at the time of the first meeting regarding the CDS spreads with Deutsche bankers, the Kaupthing management was smarting from steadily increasing financing cost; Kaupthing managers insisted the bank was unfairly targeted by hedge funds and were trying to figure out how Kaupthing could erase the image of weakness implied by the CDS spreads. Already at the first meeting with Venky Vishwanathan it was abundantly clear that Kaupthing was seeking to use own funds to influence the CDS spreads; that was the plan from the beginning – the question was just how to structure it in order to influence the CDS spreads most effectively.

The CDS scheme was developed further in the coming months as the pressure on Kaupthing increased: in spring 2008, the CDS spreads stood alarmingly at 900bp. Deutsche advised against Kaupthing’s original idea of its own direct involvement in the transactions. The solution was to find trusted clients of Kaupthing – Kevin Stanford and his wife Karen Millen, Tony Yerolemou and Skúli Þorvaldsson, all large clients of Kaupthing – who would in name own Chesterfield, the BVI company, entirely funded by Kaupthing; the transactions would be done via Chesterfield.

The Chesterfield transactions were done in August 2008. According to the SIC Report (p.26-28; in Icelandic), the CDS spreads changed on 10 August 2008, following the transaction, from 1000bp to 700bp. Though the spread diminished only for some days, it was deemed success, which should be repeated. For the second round, in September, the CLN transactions were done via another BVI company, Partridge, owned by Ólafur Ólafsson, domiciled in Switzerland, still a wealthy businessman, then Kaupthing’s second largest shareholder and a major borrower in Kaupthing. Again, the Partridge transactions were wholly funded by Kaupthing, organised by Deutsche on behalf of Kaupthing.

In total, Kaupthing paid €510m to Deutsche for the Chesterfield and Partridge trades, the last millions transferred to Deutsche from Kaupthing just as the bank teetered; it formally failed 9 October 2008. Emergency funding from the Icelandic Central Bank to Kaupthing of €500m was partly used to pay Deutsche as part of the Partridge transactions although the funding had been issued to safeguard Kaupthing’s UK operations (See the longer version on Icelog.)

Kaupthing accordingly lost the €510m because the two BVI companies had no assets to speak of, which made it clear from the beginning that should the trades go awry, the loans would be non-recoverable; a fact the liquidators noted, as did the Special Prosecutor in Iceland.

Al-Thani and the CLN trades that never happened

A very intriguing part of this story surfaced in the SIC Report (p.26-28): there had been plans for a third round of Kaupthing-funded CLN transactions through Brooks Trading Ltd, owned by a Qatari investor, Sheikh Mohamed Khalifa al Thani. Kaupthing agreed to a loan of €130m to Mink Trading, an al Thani company, in addition to a loan of $50m to Brooks Trading Ltd, another al Thani company, as up-front profit from the trades.

Again, the purpose of the loan to Mink Trading was to invest in CLN linked to Kaupthing’s CDS, again via Deutsche Bank in transactions structured as the Chesterfield and Partridge transactions. But Kaupthing ran out of time; the loan to Brooks Trading was paid out according to the SIC Report, not the loan to Mink Trading; the al Thani CLN transactions never happened.

Sheikh al Thani is a well-known name in Iceland from his role in another Kaupthing criminal case, the so-called al Thani case; although the case is commonly named after the Sheikh he was not charged (the $50m loan to Brooks Trading might have been connected to the real al Thani case, not the CLN transactions, according the the SIC Report). In the al Thani case the three Kaupthing managers, charged in the CLN case, and Ólafur Ólafsson were sentenced to three to 5 ½ years in prison. As in the CLN case, the bankers were charged for fraudulent lending, breach of fiduciary duty and market manipulation; Ólafsson was sentenced for market manipulation.

According to the SIC Report Kaupthing also agreed to lend Ólafsson €50m against profits from the Partridge trade but SIC documents do not show that the loan was issued.

The doggedly diligent liquidators

The liquidators of the two BVI companies, Stephen Akers and Mark McDonald, quickly seem to have sensed a potentially intriguing story behind the CDS transactions and had some impertinent questions for Deutsche Bank. When Deutsche was remarkably unwilling to answer their questions the liquidators took legal action against the bank in order to obtain documents, as seen in this UK court decision in February 2012.

In his affidavit in the 2012 Decision, Akers said: “It is very difficult to see how the transactions made commercial sense for the Companies.” ­– As the liquidators were to uncover the short answer here is that the transactions did not make sense for the companies, which were only a tool for Kaupthing managers, as Deutsche full well knew.

This can be gauged in detail from the 2014 consolidated particulars. Well documented, it recounts the whole saga behind the CLN transactions, inter alia the following:

Already at the initial meeting in February 2008 it was clear that Kaupthing’s only reason for setting up the schemes was to bring down its CDS spreads and Kaupthing would fund the transactions; Kaupthing was willing to pay Deutsche for reaching this goal and Deutsche agreed to assisting Kaupthing in reaching it, i.e. bringing down its CDS spreads; from Kaupthing, its most senior managers were involved; at Deutsche, senior staff in London worked on the plan (para 56). A larger group were kept informed by emails, amongst them Jan Olsson managing director of Deutsche and CEO of Deutsche in the Nordics.

After a slow start, the urgency increased in summer 2008: on 18 June 2008, Vishwanathan sent an email to the Kaupthing managers proposing a concrete strategy: “Kaupthing should fund the purchase of a CLN referenced to itself. DB, as the vendor of the CLN, would then hedge its exposure under the CLN, by selling Kaupthing CDS in the market, and this would have the desired effect of lowering Kaupthing’s CDS spread.” (para 62.)

A flurry of emails followed, also because Deutsche’s legal department was hard to please (para 68-69). The bank’s Global Reputational Risk Committee was involved. Kaupthing managers understood that Deutsche staff was “bit stressed about this from a ‘reputation’ point of view.” In July, Deutsche invited Hreiðar Már Sigurðsson and his family on a trip to Barcelona, i.e. paid for flights and hotel, where Sigurðsson attended DB’s Global Markets Conference and discussed the CDS scheme (para 75).

The conclusion was that Kaupthing could not be seen to go directly into the market in transactions linked to its own CDS. The solution was to set up a Luxembourg company for the CDS trades, as Sigurðsson explained in an email to Vishwanathan during the conference: Kaupthing’s lawyer would be “setting up the lux company for our trade” (sic), also offering to discuss further “the right structure that you (i.e. Deutsche) would be comfortable with.” (para 79). That same day, Vishwanathan sent an email to a colleague informing him he was working on “putting together a bespoke ETF for some of (Kaupthing’s) close high net worth clients to take a view on (Kaupthing) CDS…” (para 80).

Late July, Kaupthing’s lawyer in Luxembourg presented an overview in an email to Deutsche’s Shaheen Yusuf, including the ownership structure with the names of the four Kaupthing clients who owned Chesterfield. The presentation clearly stated that the funding, €125m, would come from Kaupthing and that the CLN used was part of a wider scheme where Deutsche would offer CDS for sale with a total nominal value of €250m (para 89). – This document included everything regarding the planned transactions, also the funding.

As all of this is documented in email exchanges between Kaupthing managers and Deutsche staff it is clear that when Deutsche claims, inter alia in its 2015 and 2016 Annual Reports it did not know a) that the funding came from Kaupthing – and – b) that the aim of the transactions was to lower Kaupthing’s CDS spread, it goes against documents, which Deutsche had on its system at the time and should still have.

Avoiding a paper trail

Given that Deutsche’s legal department and its Global Reputational Risk Committee had been worried, the overview and its detailed information on funding etc. was unavoidably a strong dosis for Deutsche to stomach. Yusuf called Kaupthing – it’s not clear if she spoke to Hreiðar Már Sigurðsson or Magnús Guðmundsson – but her mission was to ask Kaupthing to withdraw the presentation and replace it with a new one where the fact that Kaupthing was funding the transactions would be omitted. The Kaupthing Luxembourg lawyer quickly followed her instructions, sending another presentation, with the requested changes: Kaupthing was no longer referenced as the lender.

The BVI liquidators point out that there was a phone call and not an email, concluding this was done in order to avoid a paper trail at Deutsche (para 92-93).

When the Chesterfield trades were executed in August 2008, the effect was immediate, just as Deutsche bankers had promised (para 114). In an email to Vishwanathan Hreiðar Már Sigurðsson said it seemed “our Barcelona trip paid of” (sic) – the trip where the plans were finalised (para 115-116).

Indeed, so pleased were the Kaupthing managers that they decided to do another trade of the same kind (in spite of a very short-lasting effect) (para 117). This time, it would be through a company owned by Ólafur Ólafsson, very much a part of the Kaupthing’s inner circle and a close friend of the Kaupthing managers.

“Are u not paid to work for us?”

Due to force majeur, the second CDS transactions hardly registered: Lehman Brothers collapsed on the 15 September 2008, shaking the world’s financial system to its core. Two days later, Kaupthing’s CDS spread had deteriorated further and stood at record 1150bp. As if nothing had happened in the world of finance, Magnús Guðmundsson, clearly less than pleased, wrote in an email to Vishwanathan: “How can the CDS spread be were they are compare to our trade(.) Are u not paid to work for us? (sic)” (para 128).

This exchange clearly shows how Kaupthing saw Deutsche’s role – Deutsche was acting on behalf of Kaupthing, not for the owners of the two BVI companies. Both Kevin Stanford and Tony Yerolemou have stated they had no idea how the BVI companies in their name were used – they had no idea of the funds that flowed through their companies as Kaupthing strove to meet margin calls. – Interestingly, these are not the only examples of Kaupthing using clients’ companies without the owners’ knowledge.

The liquidators conclude that the nature of the transactions of Chesterfield and Partridge were unlawful as “they were intended to, and did, secretly manipulate Kaupthing’s CDS spreads and thereby the market for CDS referenced to Kaupthing, and the market for Kaupthing bonds.” (para 142-148, further 149-176.)

According to the liquidators, Deutsche Bank broke laws on market manipulation and market abuse not only in the UK but also in other countries where financial products, influenced by Deutsche’s unlawful activities, were traded. (para 143-145).  This abuse and manipulation did not only affect Kaupthing’s CDS but also Kaupthing’s bonds as the manipulated CDS affected the pricing of Kaupthing bonds.

Further questions regarding the CDS transactions

In addition to market manipulation and being counterpart to trades Deutsche itself set up, the Kaupthing CLN transactions have other interesting aspects to ponder on.

Emails between Deutsche staff show how employees involved in the Kaupthing transactions were allegedly prepared to withhold information on the owners of the BVI companies from Deutsche’s own know-your-customer team. Also, the staff was aware of the reputational risk from being involved in transaction where a bank tried to influence its own CDS spreads.

There is nothing to indicate that this was done because the Deutsche bankers engaging with Kaupthing were less ethical than other colleagues or more prepared to stray away from the straight and narrow road of regulation – rather, that this was a way of working at the bank. It can only be assumed that in a case like this there was no guidance from the echelons of power at Deutsche, relevant to keep in mind given the enormous sums Deutsche has paid out over the years in fines, also in cases with criminal ramifications.

The CLN saga shows the inner workings of Deutsche, relevant to understand how the bank’s internal safeguarding against illegal activities were side-lined when up against the possibility of profit. Relevant for so many other cases of questionable conduct that have surfaced in the last few years. Intriguing to keep in mind regarding the latest Deutsche scandal: it’s role in Danske Bank’s money laundering in Estonia where $230bn were laundered in 2007 to 2015, where Deutsche seems to have handled around $180bn.

Another aspect is how keenly the Kaupthing managers honoured the agreement with Deutsche. Money was tight in August 2008 when the Chesterfield transaction was done. In September, money was quite literally running out and no doubt the three managers had a lot on their mind. Yet, they never lost focus on these transactions with Deutsche, diligently though with great effort meeting margin calls, even making use of the emergency lending from the Icelandic Central Bank. The managers have explained that Kaupthing’s relationship mattered greatly. Yet, given what was going on at the bank, the question still lingering in my mind why these transactions were apparently so profoundly important to the Kaupthing managers.

Deutsche Bank – the bank that paid €14.5bn(!) in fines March 2012-July 2018

Over the last few years, Deutsche Bank has been fighting regulators on all continents. In total, Deutsche paid fines of €14.5bn from March 2012 to July 2018 for criminal activity ranging from Libor fixing to money laundering, according to ZDF. And there might well be more to come as Deutsche is now involved in the largest money laundering saga of all times, Danske Bank’s laundering of $230bn from 2007 to 2015 where Deutsche allegedly handled close to $180bn of the $230bn.

Intriguingly, in June 2010 the SFO was looking at Deutsche’s role in the CDS trades, according to the Guardian. But as with so much of suspicious activities in UK banks around 2008 (and forever!) nothing more was heard of SFO’s investigation.

Deutsche has refuted having known about the realities of the CDS transactions – that Kaupthing was indeed funding the trades and doing it in order to lower its CDS spreads. However, the paper trail within the bank tells a very clear story, according to the liquidators: Deutsche full well knew the realities and thus took part in market manipulation that in the end affected not only the CDS spreads but, much more seriously, the price of Kaupthing’s bonds. The same was clear already from the SIC Reportand from the CLN criminal case in Iceland.

As mentioned earlier on Icelog, the CLN charges (in Icelandic) support and expand the evidence of Deutsche’s role in the CDS trades. The charges show that Deutsche made for example no attempt to be in contact with the Kaupthing clients who at least on paper were the owners of the two companies; Deutsche was solely in touch with Kaupthing. Inter alia, the owners were not averted regarding margin calls; Deutsche sent all claims directly to Kaupthing, apparently knowing full well where the funding was coming from and who was making the necessary decisions.

Another interesting question is who was on the other side of the CDS bets, i.e. who gained in the end when the Kaupthing-funded companies lost so miserably?

According to the Icelandic Prosecutor, the three Kaupthing bankers “claim they took it for granted that the CDS would be sold in the CDS market to independent investors and this is what they thought Deutsche Bank employees had promised. They were however not given any such guarantee. Indeed, Deutsche Bank itself bought a considerable part of the CDS and thus hedged its Kaupthing-related risk. Those charged also emphasised that Deutsche Bank should go into the market when the CDS spread was at its widest. That meant more profit for the CLN buyer Chesterfield (and also Partridge) but those charged did not in any way secure that this profit would benefit Kaupthing hf, which in the end financed the transactions in their entirety.”

Deutsche’s fees for the two CLN transactions amounted to €30m for the total CDS transactions of €510m. In addition, Deutsche will have profited from going into the market buying “a considerable part of the CDS” thus hedging its risk related to Kaupthing.

Effectively, Deutsche was not interested in having the realities of the case tested in court – it did not want to spell out in court its part in the Kaupthing market manipulation and it did not want to spell out it had itself been a counterpart in the trades. After years of legal wrangling, it chose to settle with Kaupthing and agreed to pay back €425m of the €510m Kaupthing paid to Deutsche for these transactions. – Another case of alleged banking fraud buried in the UK.

*Published by Kjarninn Iceland as an attachment to an open letter (in English but the attachments are linked to the Icelandic version) to Hreiðar Már Sigurðsson and Magnús Guðmundsson from the well-known UK retailer, Kevin Stanford. He and his ex-wife Karen Millen were clients of Icelandic banks, also of Kaupthing. – All emphasis above is mine.

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