45: Why A Whistleblower Walked Away From Over $8 Million

Managing editor of Bloomberg Markets? So Joe. On last week's episode, we were talking about money, and I rather globly said that money was the thing that everybody wanted. But what if I told you today that we are going to speak with someone who turned down eight point five million dollars, I wouldn't believe it. I wouldn't believe that such a such a person would exist, that a person would do such a thing. Well, we are going to talk to

someone who turned out point five million dollars. That person is Eric ben Artsy. You might remember him from some recent headlines. He used to work at Deutsche Bank as a risk manager and basically blew the whistle on the way the bank was accounting for a big position in derivatives. Since then, Deutsche bank got fined by these Securities and Exchange Commission in the US and part of that fine goes out to pay the whistleblowers. And Eric was just one of um well, I think in the end there

were two of them. So we're going to talk to him today about what it's like to be a whistleblower and crucially why he turned down all that money. This is so fascinating and surprising. I don't want to do any more intro. I think we should get right into it, all right, Eric, thank you so much for coming on the show today. Thank you for having me. So I guess to begin, maybe we should start with your career at Deutsche Bank, sort of ground zero for where this

all started. Tell us what you were doing at the bank. UM, My job as a risk officer was to oversee the risks, the market risks in the trading portfolio. We oversaw many of the businesses that the bank was in, both in New York and London. UM, in particular, I was looking at the credit derivatives portfolio and that's uh, that's where the that's where the problems came up. So tell us when did you join Deutsche Bank in what was your first indication that, in your view, something was wrong with

the way derivatives were being priced internally. UM. I joined the Beta Bank in the summer of two thousand and ten, and I had quite a bit of experience before that in credit derivatives, both through my work in City Bank and also UM at Golden Sacs uh So UM the assignment to the credit derivatives portfolio was was pretty natural, and I had experience with with the models, with the products involved. You know, Gradually, as I as I learned more and more about the portfolio at Deutsche Bank, I

had more and more concerns. And as I raised those concerns with my managers, with a countants, and eventually I went to the hotline uh the responses that I got were more and more alarming to me. So walk us through the problems that you discovered, because I know it can get a little bit complex, but there are some potentially big numbers involved here, and our and our listeners like complex details. You don't have to be afraid to get wonky okay great. So essentially, UM, the craving derivatives

in question were synthetic credit derivatives. These were tranches on on portfolios of CDs UM. Initially, I was doing some stress testing and and I was tasked with UH finding risk numbers to this portfolio. I wasn't quite aware of what the products underlying that we're actually in the portfolio, what they were. My assumption was that these were regular

tranches and UH. At some point when I started asking questions, all of a sudden I realized that I was looking at leverage tranches, leverage super seniors as they were called. These were more exotic, more risky trades that were worth less if you think of it as as an insurance contract than a leverage tranch. If you buy insurance in the leverage way, you have far less protection then if you have a regular tranche where you were protected for

the entire amount of your portfolio. So one one analogy that people seem to like is with U parking about full of full of cars. If you're a car dealer and you have a used car parking about full full of full of used kias, you know, you could argue about what kind of values those those used keyas you have. You can say there worth five thousand or ten thousand dollars, but you can't pretend that these are new ferraris and essentially I we realized that this is what the bank

was doing. It was misrepresenting the trade in its portfolio. And I also began to realize just how huge in this portfolio is. Essentially Deutsche Bank owned the majority of this market. So as as I was raising my concerns and getting um answers that made by sense, I also got answers that that may be more concerned about the the amounts that we're talking about, the the hidden losses

or if you will be in freded valuations. So back in the deep dark days of the financial crisis in two thousand ten, wasn't that far off from those understating those potential losses would have meant a big, big flattering of Deutsche Bank's bottom line, right, basically saving it on having to reserve lots and lots of extra capital. Absolutely, and so in two thousand ten, initially when I raised when I raised my concerns, I thought we were talking

about about potentially hundreds of millions of dollars. And once I asked more and more questions, I realized that this was you know, we're talking about billions. Uh so, so yes, these little, very large numbers I want to get to the part where you sort of blow the whistle and raise external issues. But I just want to get a little more specific on the specific problem that you saw

with the way that the derivatives were being priced. Because obviously pricing of derivatives and portfolio of derivatives is complex and people apply different models and techniques. But what was the fundamental difference in how you saw the products and how they should be valued versus how they were being valued by the bank. So I think that's that's a very good point that I wasn't arguing that a specific

model should view there. There are many many models that could potentially be used, and all of them had advantages and disadvantages. So you could argue about what the actual value was of these trades. That's there's no doubt there, But you couldn't pretend like they that You couldn't pretend that they were not leveraged. The standard valuation, the correct sort of financial engineering valuation of a leverage super senior

or leverage trunch is as a regular trunch minus an option. Essentially, you sold an option to the counterparty to walk away through the trade. That's that's really what the what the what the trade, UH the way to correctly value this trade. So what the value of this option is. You can argue over what that is. You can argue about you can take different models that would give you different numbers. What Deutsche Bank did was just said that these options

were worth zero. And other banks at the time we're using the gap option, right, they were valuing it like they could lose all the collateral because the counterparties walk away.

Absolutely so, so they were there were definitely models used being used in other banks and um when when the issue was raised that you know that the models that there's no model that that does a good job, that all the models are unstable, Well, the answer to that is if if you can't, if you can't value this option, you have to you have to apply the worst case, not the best case, especially when when you're looking at the underlying swap, you're you are quite happy to take

a maximal valuation. In other words, these level super seniors, their value is equal to the swap which is markto market left the option, which is also markto market, which took that was happy to take the positive markto market on the on the swap, which is also relevative in itself. But it but it just said, well, I don't know how to value that value. The option is is hard, so I'm just gonna market at zero. That was clearly dishonest.

I should say that that, you know, when I spoke with risk managers in other areas, this seems it seemed to be a consistent problem throughout the throughout the trading book. As I was raising concerns about this particular portfolio, which was probably the largest, I also began to realize that this there was something more widespread, more systematic here, that it seemed as though the bank was really operating on little or no reserves for for many trades that should

have been reserved for. And uh, it seemed as though I was trying to sort of inflate inflate its financials. That was my impression. So after you start looking at the book and talking to other people, walk us through exactly what happened when you brought this to the attention of your manager. As you mentioned making the call on the hotline, I imagine there was quite a process that you had to go through before you got to the

hotline part or the sec part. Yes, I talked with you know, with the line of command and within the risk management department. I went to the two I spoke with with managers and other adjacent areas, model validation, so other gatekeepers, if you will. I ended up going to the accountants the finance division, so that these are the

people ultimately responsible for the financials for the statements. And that's really where, you know, I was expecting throughout this this process that somewhere down the line, somebody is going to adjust for this leverage. Somebody's going to adjust for the fact that you know, Dutch banks sold a lot, you know, options on the huge portfolios that were being without good zero Somewhere there's going to be some some accounting for that, and the accounting was just it saved.

Eventually when I talked to the accountants, they said, no, it's just about the regular swap. And that's when I went to the hotline. So how did the conversations actually go, because I can imagine it must be pretty awkward if you go up to people and you say, hey, I think that um Deytsche Bank's potential losses on its LSS portfolio could be massively, massively bigger than we're accounting for. UM Yeah, So so absolutely, the answers were were evasive.

People some people didn't want to talk about it. Therese gave answers that were just that we're just wrong. I think maybe just because they didn't know. Because these trades are pretty pretty complex. Anybody who wasn't who didn't really specialize in it, uh, could easily misunderstand. And you could tell them that you could you could run into a situation where they don't really understand what they're talking what

what how to value these trades. So some of the answers I got, I assumed we're just uninformed answers rather than attempt to hide. But when I talk to people who did understand, is that the answers were clearly evasive and and uh you know was like political were used? When when? When? When I asked about it? So all of these facts to me, and I want to get to the point where you begin to process is of

um calling the hotline and becoming whistleblower. First, I want to take a quick moment for a word from our sponsors, but knowledge to work and grow your business with c i T from transportation to healthcare to manufacturing. C i T offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn more at c I T dot com Put Knowledge to Work. And we're back with Eric ben Artzief, former risk analyst at Deutsche Bank

and a whistleblower. So walk us through the process. You talk about calling the hotline when you see that there's this major unresolved issue with the value of these derivatives. What how does that actually work? Walk us through what the process is like becoming a whistleblower essentially, So, UM,

the hotline, there's a number. You call the number and it's supposed to be operated by by third party ex turn off to the bank, I believe so to to the best of my memory, I talk to somebody outside of the bank and um and they just take down your concerns. That's what you don't You don't really you have to express, you know, a fairly complex issue to somebody who doesn't really understand what it is, but and then hope that that somebody will get back to you.

It telt a little bit like kind of screaming into the dark, but eventually, actually pretty quickly I was contacted by by the legal department, by the compliance department, so that that that part of it worked pretty well. And when did you go to the SEC, because I imagine once you made that hotline call, you were probably already at least a little bit worried about your job at Deutscha. Yeah, so my, my, my, my strategy there was to was

to go in parallel, essentially to be safe. And I wasn't sure whether I would be instantly fired after them to the hotline. There was always that that concern, so I made sure to go almost simultaneously to the SEC with information that I had add and to the Holland

at the same time. So effectively, it was as though these two you know, we're talking about March two thousand eleven, these two things were being were being raised and and I relater realized that there were ongoing investigations both inside the bank ended that you see, you know, a year prior, but at the time I thought it was starting investigations in both. There were other whistleblowers, and yes, as far as I understand it, I've never spoken to Matthew Simpson,

who is I believe he is the other whistleblower. And apparently there was another whistle blow before that, so we know of at least three three people who who are concerns there? But all were identifying the same thing. Apparently I didn't I've ever seen the concerns that that Matthew Simpson order the third person raised, and there I believe there might have been other whistle blowers as well. They

might have raised issues that are related or similar. Um, these businesses are very complex, you could use there are lots of different risks that you can look at. Um, the trades were, uh, you know, I'm going to be a little bit technical here. These will bespoke leverage super senior trades, which is an animal that I didn't really think existed before I joined Deutsche Bank. So they were very very There were different kinds of risks there, and

so I wouldn't be surprised this. Other whistle blowers raised concerns over other valuation issues, such as quanto. I've heard that that was an issue that which I did not raise. I talked specifically about the gap of the gap option, but there were other issues with this portfolio. Also, there are other portfolios that that we're kind of related and might might have been similar, maybe CDs portfolios or other CEO put photos that had similar issues in them. Possibly,

so this is all speculative. I don't really know of the other whistle blowers, really like what concerns they raised. But presumably since since Matthew Simpson, the other whistle low assuming is what Matthew Simpson is is uh was also given a whistle Goo award. They they also contributed to the to the investigation. So it's March of two thousand eleven, you've just gone to the SEC. I'm going to be slightly facetious. How quickly were you shown the door at

Deutsche Bank? I took a few months, actually, so I I was fired in two thousand eleven, and in between that I was actually, you know, I became I was introduced to the to the head of compliance regulatory affairs at the bank in New York, Robert Rice, and he was one who was handling the investigation. There was also an outside law firm, Freed Frank that was so I guess they were formally in charge of the investigation and

cooperation was the compliance department. I'm not I'm not quite sure what what that means in terms of what the regulatory requirements are in terms of an outside law firm investigating this. But in the court during this during the next few months, I Robert rice Is the Compliance department introduced me to a number of other executives, mostly in the finance division, so most mostly accountants, h to explain or at least they claimed it was to explain to

me what what was being done inside the bank. Uh. In fact, those meetings were more I felt more away of trying to to to glean what I understood, what I knew, uh, and to help them get a leg up on the on the SEC investigation, and also to prevent me a vote, to discourage me nuplicitly discourage me from going to the SEC. That's that's how I interpret

those meetings. Uh. They certainly, I certainly was not satisfied with the answers that I was given, and I don't think that was I don't think an investigation that with the purpose of protecting shareholders would have been conducted differently, completely and hundred eighty degrees the Instead of instead of trying to download the information and try to essentially belong to my concerns, they should have They should have gone along and gotten to the bottom of it and corrected

the what what was wrong? And I'm pretty sure that you were trying not to do that. When you were fired, what did they say the reason was? They just said that it was my job was being moved to Berlin. In fact, Bank was opening a quantum center for a serious department in Berlin, and I had previously before I brew the whistle, I had been offered a job there and I expressed interest in moving to Berlin. So so this was this was clearly just an excuse. But nobody

ever said anything about conduct. I had. The reviews that I had were positives in the time that I expent to Burti Bank, So there was really no reason other than I can see no reason other than my whistle blowing. Did you regret going to the SEC at that point? Oh? No, I I thought I did the right thing, and I thought that the right thing would happen, that justice would

be would be uh served us. Well, let's skip ahead then, because you were just in the news at the end of last month because there was this huge um whistle blower award for you and your fellow whistleblowers, and you were offered several million dollars as a reward for shining a light on this and you didn't accept it. So explain to us how that a word came about and whether you're surprised by that, and how you made this decision that, as we said in the beginning, seems almost

unfathomable for a person to make. During the years since you know, I started, I blew the whistle and spring two thousand eleven really blew blew the whistle before that, because I started raising the concerns months before that. I gradually became not only attached to the case, but also attached to the to the idea of seeing justice carried out. And after I was fired, this case was also the case of my career. So so you could say that my life became completely I wouldn't say dependent, but but

it became very very much attached to this case. And uh. And so in the next few years, I pushed the sec along. At some points, um, you know, there was there was a point where we heard that where there were rumors that the the the case is about to be closed. Uh. This was in two thousand and twelve, and so we went and worked with the Financial Times to get the story out and that really kind of

gave gave gave new life to this case. So I wrote a lot to the to the Francial Times reporters in this case did a great job and and ultimately over these years, I became you know, I became I also became familiar with the the lawyers, the Deutsche Bank lawyers who went in and out of the SEC. I followed, you know, I was forced to follow their their their

career paths. You know, I read not to these piece in two thousand eleven about uh the SEC the internal whistle though Darcy Flynn, that's a story that I think hasn't gotten that the attention that it deserved. And you know which he drew the whistle to Robert Cruisealny the who was head of Enforcement and the ads he's seen previously was with Deutsche Bank's General Council al from North America.

At the same time I followed, you know, Robert Rice was appointed, you know, went from being the head of compliance to being the Chief Counsul at the SEC. So so I realized that a gold was working working against me and really was working against the rule of law in the United States. So the decision not to take the award was essentially a protest against this revolving door

concept between the SEC and Deutsche Bank. But that kind of throws up a question, do you think that there's a problem with whistle blowing in general or is it something specific because which I had so many people at the securities watchdogs, so I think I do think that that is the problem, the revolving dual problem. Uh. And maybe I shouldn't use the word revolving door. I think that the justice for sale problem is widespread. It goes beyond just bank. It was especially bad here, but I

think it happens quite unfortunately. It happens quite a bit today. So it's not a problem uh, necessarily with little blowing. It's a problem with with with the justice system. I think justice and money don't mix very well, and there are too many, too many loopholes to which it makes its way into the system. Not just insecurities law, but the insecurity laws especially bad. So so I think my case was especially bad. It was especially latent the fact

that the victims were clearly the shareholders. There was no third party, you know, there was no way to I can't see any way to argue that the shareholders benefited from this, uh, from the inflation of this portfolio. I think this is like end there's the shareholders are clearly to me the primary victims. I was just gonna say, there is a devil's advocate type argument where you could say, well, all right, so Deutsche Bank didn't value the gap risk in the way that it should have, but it ended

up not suffering catastrophic losses anyway. Right, So it made it through and its assumptions about the gap risk turned out to be correct, and in effect it's saved as shareholders a lot of pain. Again, that's just a devil's advocate argument for you, but it does get to the heart of the point that Joe made earlier, which is these are really complex things and you're making a lot of assumptions about them, and right and wrong aren't always

that clear cut. Yeah, So I think this devil's advocate argument is very important and I've heard it in a number of times, and I think the answer to it is you can look at you can see the answer in the stock place. So the stock price was in two thousand and ten after the financial crisis, was north of seventy dollars and now it's you know, it reached something like twelve with their team. I'm not sure where it is today, but you know, the rumors about them

may possibly requiring a bailout. So it's hard to argue that Deutsche Bank didn't take some of those losses and just spread it out over subsequent years. And in those years that that it tindles losses, the executives took large

bonuses at the extense of the shareholders. So you're arguing that the ill fortunes we've seen of Deutsche Bank in recent years, and the stock price is down about from its pre crisis peak, is not just some secondary result of poor conditions for European banking, but also to some extent a direct function of what you see you saw as the behavior of the people internally. Two, as you say,

misstate the value of the assets on the books. Absolutely, I think that's it's not the only Obviously, you know, this gaps was just one of many things. And yet the weakness in your in the European economy I'm sure did not help, don't your bank, But if you look at some of the other banks, so that the US banks, for example, they didn't suffer the same kind of losses over the subsequent quarters. Gutamic has a big has a big presence in North America, the global bank, So you

wouldn't expect that you just be exposed only to Europe. Also, I want to address one point that Tracy brought up, which is well that you know those laws that deutchmk was correct and assess things that the gap risk glosses are going to go away. Well, that's another way of thing of of looking at this is to say that

the value of the swaps was not was inflated. In other words, if you say that the gap option it was worthless, was was worth zero and it was just a temporary fluke around two thousand nine and ten or eight nine ten, that its value was very high, you have to say the same thing about the swap itself. So the swap in the options go hand in hand. So you can't make an argument about one without making

the same argument about the other. What I see is having happened to Deutsche Bank in those years is that they invented quite a bit of capital on the on the balance sheet, and that in that capital that they invented, they dissipated it over the subsequent quarters. How much was the Deutsche Bank scandal that you identified to do with the complexity of these leverage super senior positions, and how much of it had to do with a cultural problem

at the bank. I guess what I'm asking is, could we get a scandal on the same sort of level for something like a certificate of deposit or like a much simpler type of product, or is this something that you think could only happen in the deep dark realms of the derivatives world. I think certainly it's easier to too high losses when you have something that nobody really understands.

So certainly when you have these these I think they're called level three assets with with very complex UH models that understanding what the what the contract itself is, you know, a very complicated It's easier to to to inflate the valuation. It's a lot harder to to say that, you know, some stock of company X, Y and Z which is treading at twenty. It's harder to market at forty dollars. So what are you doing now? So you've renounced this

U reward? Do you feel that you've made a statement that you tried to make by not accepting this money, that the punishment of Deutsche Bank shouldn't fall on the shareholders. Do you feel like you've made that statement? And where to next? For you. Uh So I think it's it's not so much a statement as much as it just

refusal can be part of that. So I just don't want to, you know, if you saw, you know, if you saw the analogy that I like to give it, if you if you saw somebody getting mugged in the street in New York and then you call the cops, and then the cops shows up, and the cop is actually the guy who just who just mugged the victim, and he mugged the victim again, and then wild you a couple of dollars out of the water so that you shut up. You probably woudn't do that, And so

I don't think what I did is so extraordinary. I think if people, if you see the see it the way I do, which is which is as you know, the victim being robbed again and the award money being sort of hush money, then then it's what I did is really not not not extraordinary at all in terms

of the impact or the outcome. You know, I think it's you know, the the fight to get the justice system cleaned up, if you will to to to have you know, to have the same the same kind of justice of the power phone that connected as everybody else. I think that's that's a really long term struggle. So I don't think I'm going to make buy myself. I'm

not gonna make a difference. But I do think that I have that they make a small difference and hopefully there will be more people like me and then hopefully we will make a difference together. What's next for me? Uh? You know, I've we built my career and UH in the fintech company are very proud of of the work

we're doing. The name of the company's bond i t um We we had a product aims to improve the world of invest in bond investing specifically, so we work with with some of the major financial institutions in the world to help construct smart portfolios, small bond portfolios for their retail and private banking customers. Would you ever return to Wall Street? Could you ever return to Wall Street? You know, I think I think that as yes I would,

and I also think yes I could. I just think that you know, it's it's it's a matter of it's a matter of a change in in in culture and perception. I think I think the fact that what I didn't seems extraordinary. It's conceivable that it could happen that that the culture and the management in in some of these major financial institutions would be um more aligned with that, more aligned with the shareholders, more aligned with with the

rule of law. Then I think, then I think I couldn't very well find myself working again on Wall Street. It may sound like, you know, like uh, like a dream when I'm saying it now, but I think, you know, stranger things have happened. All right, let's leave it there, Eric, thank you so much for joining us today. Thank you.

I appreciate are you having done so? Joe. I thought that was a really fascinating story, And I think the thing that emerges the most from it is probably the courage of a guy who kind of knew he was probably going to lose his job by blowing the whistle on this, and then the idea that he gave up millions of dollars on principle. I like to think I would do the same thing, But let's be a real realistic.

How many of us actually would? Yeah, um, you know, he said he didn't think that that was a really extraordinary thing, and I did like his framing that Essentially, if you consider what he blew the whistle on to be deleterious to shareholders, and his whistleblow reward would also come from shareholders that he was, as he put it, participating in the theft. I still think that is a

way of framing it. That is quite extraordinary that very few people would get to that way of thinking about it when given the opportunity to collect so much money. The other thing that struck me is, uh, you know, it warms my heart to talk about all these financial crisis relics like leverage, super seniors and quanto risk and correlation books and things like that, but it throws up

this question. You know, many years after the financial crisis, it feels like we've gone some way towards tackling some of the complexity in banking, but I'm not sure we've done that much to actually fix some of the cultural problems that people like Eric have identified. I totally agree with that. One of the things I thought was interesting was this kind of reminds me a little bit of the discussion that we had several weeks ago with the professor who say, uh, Lehman could have been saved. And

when we go back to these stories. Common thread, of course is that during periods of extreme volatility and with these complicated financial products, there's often some debate about how

they're valued at any given moment. So I like the way he clarified that his take, which was that this was not really, in his view, a debate about which model to use, and of course you could have agreed, um, disagreement about that, but sort of fundamentally the building blocks of the model, just acknowledging what you and it's sort of like agreeing on a common side facts to go into the model and so being a little bit, in his view, more clear than mirror sort of disagreement about

or deconstructing your conclusion, right right, right, all right? Um, well on that happy note, shall we deconstruct this conversation? Sounds good? All right? Uh, this is another episode of Odd Thoughts. I'm Tracy Alloway. You can find me on Twitter at Tracy Alloway and I'm Joe wi Isn't All. You can follow me at the stall Warts. Thanks for listening. Put knowledge to work and grow your business with c

i T. From transportation to healthcare to manufacturing. C i T offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn more at c I T dot com put knowledge to work