Ben-Artzi: “The problem is not that you have misbehavior on Wall Street. It’s that you have misbehavior by the people who are supposed to enforce the law, by the prosecutors, by the regulators.”
Deutsche Bank whistleblower Eric Ben-Artzi raised quite a few eyebrows this summer, when he publicly rejected a multimillion dollar award from the Securities and Exchange Commission via an op-ed in the Financial Times.
The award was Ben Artzi’s share of a $55 million settlement between the SEC and Deutsche Bank that concluded a five-year investigation into allegations that the bank had overvalued its derivatives portfolio at the height of the financial crisis, hiding potential trading losses. Ben-Artzi, a former risk officer at Deutsche Bank, was one of three whistleblowers who came forward in 2010-2011 and notified regulators of improper accounting at Deutsche Bank.
As a whistleblower, Ben-Artzi was entitled to 15 percent of the settlement under the Dodd-Frank Act. However, he publicly rejected his share of the award—which he estimates at $3.5 million after fees and payments to lawyers, experts, and his ex-wife.
In October, Ben-Artzi was interviewed by Guy Rolnik, a Clinical Associate Professor of Strategic Management at the University of Chicago Booth School of Business and co-director of the Stigler Center (also, one of the editors of this blog), via video conference. During the interview, he explained at length both his reasons for becoming a whistleblower, and what he has learned about the American judicial system, and the role of the revolving door within the SEC. You can watch a video of the event here:
The following is a transcript of the interview, slightly edited for clarity:
Guy Rolnik: You started in academia. You have a PhD in mathematics. How did you become a risk officer, and how did you get into Deutsche Bank?
Eric Ben-Artzi: I started before the financial crisis, in 2006, when credit derivatives were really growing exponentially. I worked for Citi and Goldman in structuring and modeling rules, primarily within credit derivatives. There was then a job at Deutsche Bank which was more quasi-academic, I would say. It was in the Quantitative Risk Research and Development Group, which is a small group within the Risk Management Department at Deutsche Bank.
We oversaw all of the trading book, so everything that had market risk in it. My role was to look into the more complex risks that the bank faced. That, in a nutshell, is what my role was. This was in 2010.
GR: How did you go from looking at risk, to assessing risks in a bank, to blowing the whistle on fraud?
EBA: My first project was to assess the risk in the credit correlation book, which consisted of credit derivatives, some of them more complex than others. Gradually, I started asking questions. Within a few months, I realized that things were not OK within this particular book. At first I thought it was just the stress tests that were incorrect, and those were, as far as I could tell, less important.
Gradually, I realized that it wasn’t just the stress test. It was the actual valuation. At its peak, the credit correlation portfolio consisted of about $130 billion of so-called leveraged super-senior tranches. That book was inflated, at the height of the crisis, by over $12 billion by my estimates. By the time I was looking at it in 2010, 2011, the number was several hundred million dollars. But you can see that this number was very significant for a bank such as Deutsche Bank, which was the largest bank, at the time, in the world.
Admitting those losses would have probably brought it to the point of needing a rescue. Today, unfortunately, it seems that it might be close to that point again.
GR: Just to be sure, we’re talking about inflated numbers, about a quarter of the equity of the bank during the financial crisis. In a way, are we talking about another Lehman Brothers?
EBA: Potentially, and people who are comparing it to Lehman Brothers are saying that it’s even worse. At the time, Simon Johnson, who’s a finance professor at MIT and previously the chief economist of the IMF, wrote pretty extensively that Deutsche Bank was the riskiest financial institution in the world, just because of the contagion effect, etc. It was probably more systematically important than Lehman, and probably still is.
The fraud that we’re looking at, and these inflated numbers, to me, it was clearly fraud, it wasn’t just these numbers. It was true across other asset classes as well. This was probably the largest derivatives book but it was true in other parts of the trading book, as well.
Just to give you an idea, Deutsche Bank controlled about 60-70 percent of the leveraged super-senior market in the world at the time. It was far larger than any other bank in that market.
GR: You suspected that the numbers were dramatically inflated. What happened next? What did you do?
EBA: Initially, I was only concerned with stress tests. I only asked people within my department. Once I started realizing that it’s a larger issue, I started asking people in other groups. Model validation, these are people who were actually responsible for the models that go into the valuation itself. I asked the risk managers that were dedicated to this particular type of trade.
Basically, I started asking people who were closer and closer to the trades themselves and to the valuation. Eventually, I made it all the way to the finance department, which is where the accountants who actually are responsible for the financial reporting sit.
The last conversation before I went and reported was with the person in the finance department who’s actually responsible for valuing these trades, when he told me that these leveraged super-seniors are valued as regular tranches. In other words, the massive short option position that is embedded in these trades was not valued.
At that point, I went to the hotline. I went to the SEC and reported. I did not report anonymously, by the way. Something like this would be very hard to report anonymously. This had to be followed with meetings with explanations etc., because it’s a fairly complex issue.
GR: Can you elaborate on the dynamics inside the bank after you decided to blow the whistle?
EBA: Within the bank, initially, I met with the head of compliance, and regulatory affairs called me, invited me for an introductory meeting.
As soon as he heard the details, just the first basic description of the securities and the concerns involved, he then said, “I think I know what you’re talking about. We already have an investigation into this. We’re going to meet with the outside counsel that is investigating this.”
If you fast-forward a few months, when the bank made public statements about these allegations, they said that these were matters that I wasn’t responsible for or that the people who were reporting it, this wasn’t their area of responsibility, and the allegations were wholly unfounded.
The phrasing and the framing of the bank’s counterarguments were very carefully tailored and clearly were based on this conversation that we had. It enabled them to frame their counterattack.
GR: When you decided to blow the whistle, were you aware of the consequences whistleblowers tend to face?
EBA: I had a vague notion that bad things could happen. First of all, I didn’t know any whistleblowers, so I didn’t really know the details. I wasn’t particularly interested in that area before, so I didn’t read up on it. So I guess the short answer is, “No.” I certainly wasn’t aware of the kind of power and influence of the people that I was dealing with. Even if I had known, I probably would have underestimated the type of trouble that I could get into.
GR: Did you take into account the possibility that you’ll be fired?
EBA: I took into account that it’s a possibility, especially after the first meeting. At the end of the first meeting, I asked the head of compliance, “What happens next? When are you going to tell me why it’s proper what we’re doing with the valuation of these trades?” He pretended not to hear me and said, “I don’t know what this is going to do to your career.”
At that point, it became pretty clear that things are not going too well for me within the bank. I still felt that this was my responsibility, and this is the right thing to do, so I continued pursuing the matter. After this initial meeting, he didn’t contact me again.
I did raise this issue with my superiors. I escalated up the chain of command. When I didn’t get any answers that were remotely clear or satisfying, I told them that I’m raising my concerns with the SEC. At that point, I sent an email to my boss saying, “I’m raising these concerns with the SEC.” Within an hour, I got a phone call from the same lawyer, from the head of compliance. He said he would arrange meetings in London. He would take me with him to London to meet the various executives who were responsible for the valuation. Eventually, he apparently decided not to take me to London, but instead brought them to New York.
I had a series of meetings with the directors and managing directors from the finance department, who were responsible for the valuation. Those meetings were far from satisfactory, in terms of explanations, but I did get yelled at quite a bit. I was told that this issue came from the tip of the bank. I was accused of trying to bring down the bank.
Certainly, at no point did I feel that the bank was trying to correct anything. It was more they were trying to either intimidate me or to see what I knew. Again, I was asked about my understanding of the modeling involved, what I understood about the trades. Eventually, I was just fired.
GR: At what point did you become aware of the new whistleblower program in the Dodd-Frank Act, that awards whistleblowers with monetary compensation?
EBA: I was actually more concerned with the whistleblower protection clause. Quite frankly, the Dodd-Frank award was completely new and untested. That seemed a little bit more far-fetched at that point, although it certainly existed in my mind.
What was more tested and I felt should have protected me was the anti-retaliation provisions. Those exist not only in Dodd-Frank, but also in Sarbanes-Oxley, so these are older provisions.
GR: The people at Deutsche Bank were not really excited about your initiative. How did the SEC react?
EBA: Initially, they certainly took it very seriously. I met with a number of investigators at the SEC. Their investigation also had been ongoing, because of the previous whistleblower. I wasn’t aware of the existence of that previous whistleblower until the first meeting with the head of compliance, when he said, “Yeah, I think I know what you’re complaining about. We already have an investigation.”
It became clear that there was a whistleblower already. The SEC investigation had been ongoing. They seemed to take my complaints quite seriously. I provided them with all the documents I had, with all the information I had. My hope was that this investigation would vindicate me.
Eventually, fast-forward a year or so, I received credible information, and by then I had hired a lawyer who was a long-time veteran of the SEC, knew people in the SEC. We got wind that the investigation was about to be shut down. By then, I realized the political connections that Deutsche Bank had within the SEC, so I was concerned about what was going on inside the agency.
Once there was concern that it was going to be closed down, the next step was to go to the media. We vetted, we carefully chose the best media outlet that we could find. The considerations were that this was a fairly technical issue, fairly involved. The journalist would have to learn about credit derivatives, about valuation, options, a pretty steep learning curve for a journalist who probably doesn’t have a master’s in financial engineering. On top of that, they would have to take my word.
There were internal documents as well, but I wanted the journalist to do more than just provide a “He said, she said” account. I wanted them to actually go out with an article that basically vindicates me, which is what I wanted from the SEC in the first place.
That vindication would require an outlet that has journalists who are both technically savvy, but also willing to invest the time and also have the integrity and be impartial enough, so that they could take on a major Wall Street bank. That’s a non-trivial statement.
GR: And you had to cross the Atlantic to find this kind of journalist?
EBA: Actually, not. I was fortunate enough to find them in the Financial Times. The Financial Times is London based, but the journalists that I worked with, two of them were in New York and Washington, DC, and one of them was in London. It was Tom Braithwaite and Kara Scannell in the U.S., and Michael Mackenzie in London.
They proved to be excellent journalists. They took a huge personal risk. I think the newspaper took a risk as well, because it took them several months of work, without knowing that this work would eventually pay off with an actual article. They ended up finding not just the other whistleblower, but a third whistleblower, so there were three of us altogether. Each one did not know of the others.
They were able to confirm most of the major points. Certainly every major point that I raised, they were able to confirm. The article they ended up publishing a few months later was pretty much everything I could hope for.
I should say that, initially, I intended to remain anonymous. Not anonymous, but not have my name published, both because I was concerned about the repercussions for me, and also because I didn’t want it to distract from the story. I didn’t want the story to be about me. I wanted it to be about the fraud. But I was advised that without my name and without me being public, the story just won’t have the same impact. So eventually, I also became public with this.
GR: What happened the day after the FT ran this story on its front page?
EBA: Obviously, there was a media frenzy in terms of the response, because the FT basically said Deutsche was like Lehman, except they cooked the books. Not in so many words, obviously, I’m making it a little bit stronger, but they implied that.
There were some bloggers, some people who were on Deutsche Bank’s side, and I won’t speculate as to why, who tried to throw mud at it. Others confirmed the story. But I think, from the investigation point of view, this revived the investigation, and it also allowed me to reach out to other people, which was very important.
I was able to use the story to find experts that would help me bring more evidence from outside of Deutsche Bank, evidence as to the valuation of these trades, the valuations that Deutsche Bank sent to its counterparties, expert opinions about the ongoings in the market in those days. Really, this was crucial in the success of the investigation, ultimately.
GR: What did the SEC find after it resumed the investigation?
EBA: In the end, fast-forward a few years later, the SEC did accuse them, made the same allegations that I did, but they settled for much less, so effectively Deutsche Bank didn’t have to admit anything, and no executive had to pay any sort of price. No executive was mentioned or had to take any hit, even though this was a case where Deutsche Bank’s most senior officers paid themselves large bonuses based on false financials. They issued shares in the aftermath of the financial crisis that were overvalued.
Maybe this is a good place to just remind people of what happened to the share price in those years. The share price, even before the Brexit, when the complaints were raised, and this is after the financial crisis, the share price was $60-70. It was $13 even before the now famous Department of Justice fine, before the Brexit.
Part of this is due to the weakness in the European economy, but much of it is also due to these inflated valuations being gradually spread out, or the losses being spread out over subsequent quarters. In those quarters, Deutsche Bank’s executives were able to take very large bonuses, which they never had to pay back.
GR: You spent a lot of time researching what happened in Deutsche Bank, and the dynamics within the SEC. Do you think that Deutsche Bank is a unique, outstanding case, or is it representative of the industry at large?
EBA: I think there was quite a bit of criminality on Wall Street, not just in Deutsche Bank. I think some banks were worse than others in terms of their culture of compliance. I’d worked for Goldman before that and I did not see any violations when I was there. Obviously, I was in a different role, but my distinct impression was that there was a much stronger culture of compliance. Risk management was taken more seriously. I don’t think all the banks are the same.
What I’ve learned about that revolving door phenomenon within Deutsche Bank, between Deutsche Bank and the SEC, is far worse than anything that I’ve seen with the other banks. I think other institutions may have had influence over enforcement, but nothing like this.
GR: When did you decide you’re not taking the money? You and your partners were awarded $8.5 million from the SEC, from the government, and you decided you’re not going to take your share.
EBA: If you’d asked me five years ago, obviously I would have taken it without blinking, immediately. The decision not to take it brewed over the years.
The fine was announced a year ago, in 2015, and initially I was upset that no executive was punished. I was told, “Just wait. Maybe something is going to happen.” I waited, and a month goes by, another month goes by, nothing happens, and this case just died. It felt as though the victims were the shareholders here and when we’re talking about accounting fraud, it’s like Enron. The executives are the culprits, and the shareholders are the primary victims.
I felt like someone who saw a robbery and calls the cops. Then the cops show up, and it’s the guys who just robbed the victim, and they’re robbing the victim again, and now they were throwing me a few bucks out of their wallet, basically hush money. If I had taken that money, I would be party to this injustice on the one hand. I wouldn’t be able to speak here in front of you, because, “You took the money, what are you complaining about now?” I was just furious.
I think the short answer to the question of “How could you possibly not take the money?” is after you’ve gone through years of watching this injustice go on, you don’t want to be part of it.
I should clarify that much of that money would go to the other shareholders, if you will, in that award. The actual money that I gave up is not eight million dollars, it’s less, significantly less.
GR: You chose to decline the money and on the same day, the same weekend actually, you published an op-ed in the Financial Times explaining why you didn’t take the money. Specifically, you decided to point a finger at the SEC and the revolving door. Why?
EBA: First of all, the SEC is a big organization with lots of people. Most of the people there are fine. I am focusing specifically on three top lawyers at the SEC who revolved in and out of the SEC and into Deutsche Bank.
I felt that those lawyers were responsible. At Deutsche Bank, they betrayed the shareholders that they were supposed to protect. I think they fostered a culture that allowed criminality to take place. You might argue that the risk taking before the financial crisis, they didn’t understand it. That’s fine.
But what happened after 2008, some banks came clean. What happened at Deutsche Bank in those years when I was there, 2010, 2011, was that the legal department there made sure that anybody who raised issues was removed and that the malfeasance went on. We know that some of these things, including these particular accounting violations, went on for years afterwards.
I think the important question is whether the cops are going to be honest or not. I think that’s really what distinguishes the outcome of this crisis. The problem to me is not that you have misbehavior on Wall Street, it’s that you have misbehavior by the people who are supposed to enforce the law, by the prosecutors, by the regulators.
These are lawyers, so they should be held to a higher standard. People will ask, “Why have criminal charges not been filed?” Let’s assume that the bar for a criminal case has not been cleared in this case. We certainly know that the bar for a civil case has been cleared because a civil case has been filed, both in my case and in many other cases.
The question is, “Why is the civil case filed against the shareholders, and not against the executives? Why aren’t they hit with a fine?” Even if you can’t hit them with a fine, just litigating against them could really cost them quite a bit. Just the threat of litigation, or just the action of suing them and naming them, that would be in and of itself a significant punishment.
The upsetting thing is that the top brass at the SEC decided not to do that. I think they decided not to do that because they would do that against themselves. The purpose of my talk here, what I want you to walk away from this lecture with, is the understanding that the crime on Wall Street, the misdeeds on Wall Street, are a symptom. They’re not the disease.
The disease is that in the judicial system in the U.S., there are far too many conflicts of interest that go not only unpunished, but unaddressed. It’s completely prevalent. This example is particularly bad.
GR: Before I turn to audience questions, tell us what happened to your career. We know that you didn’t take the money, but what happened to your career after you decided to blow the whistle?
EBA: The Wall Street career was over. I couldn’t get a job in another bank. I applied for a number of jobs in various banks. Some of them, I probably would not have considered before that. The good news is that I did find a position in a FinTech company. Many whistleblowers never recover from the loss of their career and from being blackballed in their previous industry.
I think I was fortunate, partly because my background is more technical, so I was able to make that career change to the technology area. Obviously, it doesn’t hurt that FinTech is such a booming field now.
Female Audience Member: I’m wondering if you have a prescription for how to improve the situation: if you think there should be some rule about whether you can take an SEC position if you’re coming directly from the industry you’re regulating.
EBA: Class action lawyers, I’m not sure. That’s not particularly my area, but I think those also tend to hit the shareholders. I’m not sure if that’s the solution. I do think that regulations that would prevent the revolving door would be helpful. I think part of the problem is that the legal system that is tasked with enforcing these rules is itself conflicted.
My feeling is that the conflicts of interest within the legal system need to be taken on head on, including, by the way, the judiciary. Judges also have conflicts of interest within the U.S. system. Unfortunately, those have not gotten any better in recent years.
For those of you who’ve been following the aftermath of the crisis, there is a judge by the name of Jed Rakoff who tried to reject these types of settlements. He took a very brave stand against the SEC settlements with the banks, but he was overruled.
I think to resolve this matter, to improve the situation, you need to address the conflicts of interest both for judges, and we’re talking about judges elections, judges appointments, etc., but also for lawyers. For example, taking the disciplinary function out of the bar association, which is I think a little bit too lenient with lawyers’ conflicts of interest. This is obviously a pretty tall task.
Female Audience Member: I’m a law student. In class we’ve been reading about First Amendment retaliation cases. It sounds like, from the small description you’ve given us, that you exercised your right to free speech, blew the whistle on criminal activity, and then fired. Can you share some more details about your situation that made it legal for you to be fired? That’s what I’m really confused about. How is it legal for you to be fired?
EBA: The answer is it’s illegal, and it’s a crime. In terms of the impact on me, it was severe. But unfortunately the legal system generally, in most cases, whistleblowers do get fired and the people who do the firing get away with it. If you ask, “How is that possible?” let’s go back to the discussion of the conflicts of interest.
Unfortunately the SEC is not the only regulatory body in the U.S. that has been co-opted by the people that it’s supposed to regulate. That’s my short answer.
Female Audience Member: As far as I know, the SEC Whistleblower Program is the first to provide some kind of financial reward to whistleblowers. Do you think providing financial rewards to whistleblowers is effective in actually preventing and uncovering fraud?
EBA: Yes. I absolutely believe that it’s very important. Without the financial incentive, I would not have been able to hire all the people that I did, lawyers, experts, etc. I hired all of them based on a percentage of the eventual award. I do think that this is crucial, but I also feel that in the end, it’s insufficient.
The current Dodd-Frank is very nice, but as long as you don’t have a regulator that is intent on enforcing it honestly, the outcome is going to be that you’re going to have settlements that reward whistleblowers and their lawyers but don’t properly address the financial crimes.
I think that’s what we’re seeing in recent years. We’re seeing quite a few fines in the U.S. against the banks but not against the executives. I don’t think that this is deterring. We’re just waiting for the next crime wave to hit us if it’s not already there, because I don’t see how this is deterring anybody from committing these violations.
Male Audience Member: First, I wanted to thank you for your courage and integrity. I’m an SEC whistleblower. I completely blew up my career last year, and it’s still going on. The SEC investigations have been the hardest months of my life. I’m sure it was really difficult [for you too]. I’m sure you’ve lost a lot of…A lot of sleepless nights. When did you decide, when was the moment for you when you said, “No. This isn’t right. I’m not going to let this happen. I’m going to do everything in my power to make sure this comes to light”?
EBA: First of all thank you for your courage. I can tell that it hasn’t been easy for you. There are a number of points where you’re really, really frightened. You have to make a big decision. I would say there was the point before going to the hotline, internally at Deutsche Bank, and going to the SEC.
I still remember sitting in front of my computer and filling out the SEC form, and being really scared about pressing that “send” button in the end, and before the first meeting with the SEC investigators, before going to the press. It was really frightening.
Before the story broke out at the Financial Times, I did not know what the outcome would be. For months when I was at Deutsche Bank, I increased the security on my computer. I lived in New York at that time. Every time I crossed the street, I would look both ways. I didn’t know what would happen to me.
I had to make sure that all the information that I had within Deutsche Bank was backed up, both with my lawyers, I kept some of it with a friend. There was always that concern. There was the concern when I was still at Deutsche Bank, I never knew, is my pass going to work this time when I try to get into the building?
I think that in the U.S in particular, but throughout the developed world today, corruption is probably the number one problem. The biggest fight that we have is against the influence of money in our government, but especially I would say in the legal system, because to me at least that’s the most painful part.
You assume that politicians are going to be…They’re elected officials, you don’t expect much from them, but you expect a lot from a judge or from a prosecutor. My experience over the last few years, seeing that that component of our system is for sale, especially in the U.S., was shocking. It was a huge disappointment.
I think you and I, and hopefully other people, we’re going to change that together. I don’t feel that I’ve been successful ultimately on a personal level. I don’t know if you will be. Hopefully you will be one day. All I can say is that because of us, because of Darcy Flynn, because of whistleblowers before him and hopefully whistleblowers that will come after us, eventually we’re going to win.