02 May 2019
KYC360 readers will be aware of the world’s largest money laundering scandal involving the Estonian branch of Danske Bank (“Danske”), which faces allegations that up to €200 billion in criminal proceeds, primarily from Russia, passed through its accounts.
Understandably, the bank’s lawyers have their hands full engaging with criminal prosecutors in Denmark, Estonia, France and the United States over alleged breaches of financial crime laws. What is less discussed are the bank’s other legal problems related to the money laundering network: the class action lawsuits cited in its Q1 results earlier this week.
The plaintiffs in those civil cases claim that the bank’s directors hid the scale and nature of its money laundering problems from the market for many years.
Following the publication of its quarterly results on Tuesday, Danske lost nearly €900 million in market value in a single day. The bank, which has seen a steady decline in share prices since the summer of 2017, saw its market value fall by half in September 2018 after its legal advisors issued a report outlining the activities of its Estonian branch. The drop cost its investors up to €10 billion.
American Depositary Receipts
The most prominent related lawsuit facing the bank began in January when the Plumbers & Steamfitter Local 773 Pension Fund filed a class-action lawsuit in the Southern District of New York on behalf of investors who purchased American Depository Receipts (ADRs) between 9 January 2014 and 23 October 2018.
An ADR gives US investors the same economic rights as owning the underlying shares, including the ability to trade the ADR in the market. In this case, Danske Bank sold its shares to an American broker, who in turn deposited the shares with a US depository bank. The institution then issued the broker depository receipts that were subsequently listed on a US exchange, allowing investors to buy and sell them as well as receive dividends from the underlying shares.
In such a situation, the value of an ADR is directly linked to the value of the underlying share. The usual factors that affect the value of a share—for example, the state of the economy, interest rates, new laws or regulations, new products, new technology and staff shortage—will also directly affect the value of an ADR, just as news of any regulatory or criminal investigation into the company will.
Super profits vs serious allegations
The class action lawsuit alleges that Danske and some of its senior managers were aware in 2014 of the scale and the nature of the problems in Estonia and as well as the fact that its compliance had contributed to its so-called “super profit,” which the bank cited in financial disclosures without mentioning the related suspicious account activity.
Rather than disclose the institution’s potential liabilities, Danske executives attributed the bank’s returns to its purported “ongoing operational and strategic prowess”. Therefore, the plaintiffs claim, Danske’s shares and ADR prices were artificially inflated while investors were kept in the dark about its Estonian problems. The financial statements separately led to the bank credit ratings that allowed it to raise funds through the issuance of corporate debt, the litigants said.
The class action further states that Danske failed to disclose that a whistleblower had first reported money laundering in Estonia in December 2013 and that the bank had attempted to silence him, that a regulatory investigation by Danish supervisors launched in 2014 was not revealed to the market, that the bank had overstated its profits by including the proceeds of illegal transactions in Estonia, that it had exposed itself to further penalties by concealing the results of its own internal investigation from Danish regulators and that it failed to implement adequate systems and controls.
For these reasons, the bank’s statements to the market and its annual financial statements were materially false and misleading, and lacked a reasonable basis during the class period, the lawsuit claims.
Danske responds to rumours
The plaintiffs separately allege that Danske executives sought to minimise rumours of the Estonian troubles beginning in February 2017. In a statement issued at the time that lauded its new anti-money laundering compliance procedures, the bank said “several media today report a case of possible international money laundering and Danske Bank is mentioned as one of the banks being used. For Danske Bank, the transactions involved are almost exclusively carried out at our Estonian branch in the 2011 and 2014 period.”
After subsequent news reports, Danske amended its characterization by announcing it had “expanded its ongoing investigation into the situation at its Estonian branch” and, following further analysis, had concluded that “several major deficiencies led to the branch being not sufficiently effective in preventing it from potentially being used for money laundering in the period between 2007 and 2015.”
The media continued its investigations. The scale of the problems in Estonia were revealed in September 2018 when Danske published a report by its legal advisors that it had commissioned in September 2017. The review found that up to €200 billion in criminal proceeds had been laundered through the Estonian branch involving as many as 15,000 foreign customers with no apparent links to Estonia.
The class action notes that the ADR value in February 2018 was $20.90. By the following October, the value of an ADR was $9.50, which represented a 54 percent drop in value. In total, Danske investors suffered a loss of $2.79 billion in the value of their investments.
One important factor to remember when comparing civil cases in the United States to similar cases before the English courts is that legal actions in the US are heard in front of, and are decided by, a jury of ordinary people. In contrast, English cases are adjudicated by a sole specialist judge. Although US jurists are guided by a judge, juries decide both on the merits of the case and the amount of damages to be awarded. Because of this, large organisations such as Danske, can be at a disadvantage with a jury whenever the alleged victims are ordinary people.
Were other investors misled?
A couple of months after the US class action was launched, Danske was hit with another legal suit in the Copenhagen City Court. A group of over 160 international institutional investors, including public authority pension funds, government bodies and asset managers from Asia, Europe, Australia and North America, launched the class action case. As with the US case, the plaintiffs allege that they suffered substantial losses from Danske permitting unchecked money laundering of criminal funds through the Estonian branch. The lawsuit seeks $475 million in damages on behalf of all investors who purchased Danske securities since 31 December 2012.
The group’s lawyer stated that “Danske Bank’s management engaged in a concerted cover up of its enormous money laundering exposure, while continuing to present a rosy picture to investors. For years, leadership made no disclosure about the problem and then misrepresented its participation in the scheme, while touting the bank’s money laundering policies and procedures.”
At an annual meeting held five days after the lawsuit was filed, Danske’s new chairman Karsten Dybvad appeared unconcerned about the possibility of the bank having to pay billions of US dollars in damages to investors.
“It is our fundamental position that the bank has lived up to its information obligations. As such, we don’t find any basis for the lawsuits or for a settlement,” Dybvad said.
Time alone will tell if his confidence is justified.
A fiduciary reminder
The civil legal cases that Danske faces serve as a reminder for financial institutions that use the public capital markets to raise funds that they have a strict legal obligation to advise their investors through market announcements of any matter that may materially affect, positively or negatively, the value of institutions’ securities. Failure to make the relevant disclosures may attract legal or regulatory sanctions.
The financial statements of many listed international banks often contain extensive information on ongoing legal suits and regulatory investigations. For example, in the recent Q1 2019 results announcement of the Royal Bank of Scotland, the bank notified investors that they were seeking to verify media reports that two of their subsidiaries were involved in a money laundering scheme involving Russian and Lithuanian entities. What’s more, the statement acknowledged, the bank was fielding regular inquiries from regulators.
No doubt, in the Danske cases, the question of whether its market announcements about its Estonian problems were timely, accurate and complete will be thoroughly explored during court hearings.
Denis O’Connor is both a Fellow of the Institute of Chartered Accountants in England & Wales and the Chartered Institute of Securities and Investment. He was a member of the British Bankers’ Association Money Laundering Committee from 2003 -10; and a member of the JMLSG’s Board and Editorial Panel between 2010 and 2016.
He has been a frequent speaker at industry conferences on financial crime issues, both in the UK and abroad.
This article is expressing personal opinions and is meant for information purposes only. The article does not intend to replace professional or legal advice. It is recommended that readers seek independent professional or legal advice, or speak to authorised persons/organisations.
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