SocGen Regulators - Be Not Proud!

Last week, the news media made much of the latest penalty imposed by US authorities on French banking giant Société Générale SA (SocGen) for processing sanctions-violating transactions.

On the back of the settlements, the US Attorney General for SDNY, Berman, has been full of celebratory praise for the "outstanding work" done by his team and his fellow investigative bodies. 

But we have examined the settlements, and they don't seem at all impressive.  Rather, they seem the result of defective investigative work.  Current SocGen shareholders, and ADR-holders, should be vexed.

Snapshot of Holders of SocGen's Sponsored ADR, including
Oregon Public Employees Retirement System
(incomplete list) via Bloomberg LP

Let's explain.

The $1.4 billion settlement will come out of SocGen's shareholders' pockets – not from the employees involved in the long-enduring misconduct nor the supervisors overseeing it.  

Thus, shareholders have long paid the wrongdoers' (no doubt handsome) salaries and now pay for their bad decision-making.  Or, said another way, current shareholders are paying for a concealed, misguided scheme which, as we will see, spanned an 8 or 9-year period ending 8 years ago.  

To be clear, this was no idle incident.  As admitted to by SocGen, this was broad, intentional misconduct, spanning many years, comprising thousands of illicit transactions, deliberately implemented (with procedures drawn up) and concealed.  The wrongdoers were aware, throughout, that they were breaking the law.

Excerpts from the Statement of Facts mutually agreed-to by the US Justice Department and SocGen, include:

• In total, SG engaged in more than 2,500 sanctions-violating transactions through financial institutions located in the County of New York, valued at close to $13 billion, during this period.

• For example, a senior member of SG’s Money Market department back office (“MMBO”) wrote to another MMBO employee in 2004 that “[t]he American authorities have now identified the procedure we were using (two MT 202s) to ‘circumvent’ the OFAC rules.”

• In total, SG processed over 9,000 outgoing transactions that failed to disclose an ultimate sanctioned party sender or beneficiary (“non-transparent transactions”), with a total value of more than $13 billion. The overwhelming majority of these transactions involved an Iranian nexus and would have been eligible for the U-Turn License. There were, however, at least 887 non-U-turn transactions with a total value of $292.3 million that were both nontransparent and violated U.S. sanctions. 381 of these transactions with a total value of $63.6 million were related to the Cuban credit facility conduct described below, while the remaining 506 transactions with a total value of $228.7 million involved other SG business with a sanctioned nexus.

• Between 2003 and 2010, in connection with the Cuban Credit Facilities, SG engaged in 3,100 unlawful U.S. dollar transactions that were processed through United States financial institutions located in the County of New York, worth approximately $15.1 billion

• Since at least 2002, SG engaged in the Concealment Practice in order to minimize the risk that sanctions-violating transactions would be detected and/or blocked in the United States. SG employees used cover payments for this purpose, in which SG would send one SWIFT payment message to the relevant U.S. bank, located in the County of New York, omitting the “beneficiary” field that would otherwise disclose the ultimate beneficiary of the payment, and listing only the bank to which the funds should be sent. SG would then send a second SWIFT message to the non-U.S. recipient bank, providing the name of the sanctioned party beneficiary to whom the funds should be remitted. Using this procedure (the “Cover Procedure”), SG would ensure that the sanctioned party beneficiary information was not disclosed to the United States bank that was involved in the transaction.

So, it was rather easy to get around the sanctions controls, and SocGen's employees did so many times .... which is hardly comforting.  But now that that's been uncovered we would, of course, have several SocGen employees awaiting criminal prosecution. Oh, no – there's none of that.  

Let's understand why.  

SocGen failed to self-report its misconduct – oops!

From the looks of it, SocGen didn't disclose the individual misconduct until after the statutory clock had run for bringing criminal claims.  

In other words, even after the so-called "Investigating Agencies" were onto them, they let SocGen self-report any individual violations (which they didn't do!), failed to follow up on a timely basis, and then simply fined the shareholders and declared that a success.  The Investigating Agencies seem to have outsourced their decision-making to the party being investigated, and that party obliged by sending the investigators down the wrong path.  

Now SocGen's stakeholders – which include US pension funds, and likely you and us! – are compensating US authorities for the misconduct of bank individuals 8 or more years back.  

Here are some choice (or inconvenient) extracts regarding the scope of the operation and the statute of limitations running, with our emphasis added.

• Despite the awareness of both Group Compliance and senior SG management that SG had engaged in both the Concealment Practice and the unlawful U.S. dollar payments under the Cuban Credit Facilities, SG did not disclose its conduct to OFAC or any other U.S. regulator or law enforcement agency prior to the commencement of the present investigation.

• SG did not disclose the Concealment Practice or the Cuban Credit Facilities during these discussions, and its proposals for the scope of that lookback did not include the time period, business lines, or geographic regions that would have revealed that unlawful conduct. It was only after SG performed a detailed forensic analysis based on the broader scope of investigation required by the Investigating Agencies that it disclosed, in October 2014, the Concealment Practice and the Cuban Credit Facilities to the Investigating Agencies.

• As a result of this untimely disclosure, the statute of limitations for [Trading with the Enemy Act] or [International Economic Emergency Powers Act] violations relating to the Concealment Practice, and to much of the individual conduct involving the Cuban Credit Facilities, had already run by the time the Investigating Agencies learned of them.

Given enforcement agencies knew in 2014 that there were governance issues and large-scale unsustainable business practices ongoing at SocGen concealed from shareholders, why has it taken until 2018 to share that crucial information?  Regulators often have a specific mission that would encourage the dissemination of precisely this type of information, to ensure efficient and orderly public markets, and maintain the public's trust and all.  (The SEC's mission, for example, reads: "The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC strives to promote a market environment that is worthy of the public's trust.")

It's worth reading the entire document, as there seems also to be evidence that US regulators could earlier have shut down the misconduct at SocGen, had they earnestly tried. 

High 5s all around - but little achievement

Manhattan US Attorney Berman warns: 

"Other banks should take heed: Enforcement of U.S. sanctions laws is, and will continue to be, a top priority of this Office and our partner agencies." (emphasis added)

But was it a "top priority?"

It took years to identify pretty basic noncompliance. Much of the misconduct was reported to them, or else it was missed.  There doesn't seem to be much enforcement here, aside from the fining of shareholders.

Top priority enforcement would mean identifying anomalous transactions early and shutting down promptly any misconduct before it escalates – not fining an institution's shareholders 8 years after the last of a series of illicit transaction has taken place, which themselves in many cases endured for 8 or 9 years.  The Investigating Agencies let SocGen define the scope of the investigation, and then followed the bait.

It seems very much like the fox was running the hen-house.  And it results simply in more pain for the punter.

Can Technology Freshen Up Stale CMBS Ratings?

Sears' recent bankruptcy filing underscored the challenges confronting shopping malls in the late 2010s. Because mortgages on these facilities often account for the lion’s share of CMBS asset pools, shopping mall performance needs to be top of mind for those analyzing (or rating) CMBS tranches.

New technology – originally targeted at investors analyzing retail sector stocks – might also be applicable to CMBS analysts.

Foot Traffic

Consider, for example, Advan Research. The company processes billions of daily foot traffic measurements from cellphone applications, and computes foot traffic data pertaining to 1,800 companies including both retailers and Real Estate Investment Trusts. Since many REITs own shopping malls, the company collects foot traffic data for these retail centers.

I asked Advan for data on a mall discussed in a previous post. A mortgage on The Mall at Stonecrest in Lithonia, Georgia accounts for almost all of the remaining collateral supporting Banc of America Commercial Mortgage Series 2005-1. Fitch rates the most senior remaining tranche, Class B, at Single-B. S&P assigns the same tranche a low investment grade rating of BBB-. 

Who’s right? The data from Advan suggests a downward trend in foot traffic at Stonecrest, as shown in the accompanying chart. Average estimated visitors for the five Saturdays in July 2017 were 19,816; for the five Saturdays falling 52 weeks later, the average fell to just 12,659. On the other hand, a similar comparison between October 2017 and October 2018 shows only a slight drop, suggesting that perhaps the decline in visits has been arrested. 

To the extent that Advan’s data can be relied upon, it seems to give us a more recently refreshed gauge on the shopping mall’s health than other data sources. Certainly, the trustee report is not giving us up-to-date guidance. The November report includes the following special servicer comments: 

Modification closed and funded 8/5/2017. The loan is currently paying as agreed. The loan matures in 8/2018 and the Borrower advises that the proposed adjacent 100 acre sports project has been put on hold due to lack of funding. Although the collateral is 97% occupied, the dark Kohl's and Sears may trigger some co-tenancy issues. The Borrower advises it is in the market seeking refinancing, but due to the current situation with the sports project and 2 dark anchors, refinancing may not be sufficient to pay off the loan in full at maturity. The Borrower has engaged CREMAC to aid it in its workout negotiations with the Lender/Special Servicer. A new appraisal has been ordered and received. Valuation is under review. Maturity Date extend to 8/1/18; principal reduction in the amount of $1,233,073.95 for a balance of $92,066,680.26; no change in rate of 5.603%. 

These comments do not appear to have been revised since the most recent term extension for the Stonecrest mortgage which was through August 1, 2018.

Social Media and Other Sources

In addition to reviewing foot traffic, analysts can monitor the web and social media for news about relevant shopping malls. For example, a local newspaper, the Springfield News-Sun, reported that nearly 100 cars in the mall’s parking lot were broken into on October 5, 2018. A nail salon employee at Stonecrest argued that the mall does not provide video surveillance of the parking lot, making it harder to identify and apprehend any wrongdoers. A search for #stonecrestmall on Twitter reveals that a shooting occurred at the center – but it took place three years ago.

While it is possible to use free tools like Google Alerts to monitor individual shopping centers, that approach might not scale well to a large portfolio. Specialized search services like Bitvore (for which I used to consult) enable analysts to track news on large numbers of positions, even allowing news searches by CUSIP number.

Cell phone activity, web content and social media posts offer new ways for rating agencies and other analysts to track CMBS mall collateral real time. Finding or compiling the nuggets of useful data from these information streams is a challenge that new technology firms can help solve.


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This piece was written by Marc Joffe, who consults for PF2.  Marc Joffe is a Senior Policy Analyst at the Reason Foundation and a researcher in the credit assessment field. 

KPMG's Big Announcement

If you're ever in the UK or Australia, you'll notice that local newspapers run what seem to be daily articles portraying popular dissatisfaction with the quality of audits being performed.

The Financial Times, back in August, ran a terrific series of articles entitled "The Big Flaw: Auditing in Crisis."  The FT's series, and much of the debate generally, has centered on two broad themes:

1. the potential for consulting arms of the Big Four to jeopardize the independence of their audit function (to the degree they consult for clients they audit too)
2. the lack of competition in the audit sector

These issues are serious and thorny.  They are not, however, new.  

Back in 2002, in the near aftermath of Enron's failure (then big-5 firm Arthur Andersen was the auditor) at a congressional hearing concerning WorldCom's failure, Congressman Bernie Sanders castigated an Arthur Andersen representative:

Mr. Dick, it appears very clearly that Arthur Andersen failed in their audit of WorldCom. You failed in the audit of Enron. You failed in the audit of Sunbeam. You failed in the audit of Waste Management. You failed in the audit of McKesson. You failed in the audit of Baptist Foundation of Arizona. What was Arthur Andersen doing? I mean, how do you—it is incomprehensible to me that a major accounting firm can have such a dismal record in trying to determine what the financial health of a company is. It’s almost beyond comprehension.

Recent, topical examples include perceived deficiencies in the audits of Taylor, Bean & Whitaker (Deloitte); Steinhoff (Deloitte); Wells Fargo (KPMG); GE (KPMG); Carillion (KPMG); Abraaj

(KPMG); Colonial Bank (PWC); Vocation (PWC); and Sino Forest (Ernst & Young).

In the news again this week is the 1MDB saga, said to be among the largest of a new generation of frauds. 1Malaysia Development Berhad (or 1MDB) went through three of the Big Four between 2010 and 2016. Each of E&Y, KPMG and Deloitte was either fired or resigned from the role.  KMPG and Deloitte signed off on 5 annual reports between them, with 1MDB reportedly announcing that its 2013 and 2014 audited financials should not be relied on.  Oh well.

Today, KPMG made a significant announcement. 

Having been criticized by UK accounting regulator, the Financial Reporting Council, for their audits having deteriorated to an "unacceptable level," KPMG decided to limit or stop all consulting work for those large UK clients for which it also acts as an auditor. 

(Interestingly, our understanding is that it was never shown to be the case that this specific conflict undermined the quality of the audit provided; but the possibility remains that it can undermine auditor independence ... and perception can be as important as reality.)

This raises a number of questions:

• If the conflict is real, why only implement this procedure for large clients?  
• Why only in the UK?  
• If this makes sense for accounting firms, would it also make sense for other providers of financial services, like price providers or credit rating agencies: should rating agencies that rate corporates limit their ability to consult for them too (e.g., in the sale of analytics).