Monday, May 11, 2009

Zero Hedge Exclusive: One Whistleblower's Fight Against Goliath Over The Definition Of Risk

When Zero Hedge recently posted a letter from Deepak Moorjani, it was means to be shared as more of an opinion piece with some policy implications - it is, after all, rare to get the insight of whistleblowers who decry allegedly illicit practices. The fact that Moorjani's previously published piece had been removed from certain main stream media outlets, however, raised some red flags and I decided to probe further.

What I have discovered is an ever-developing, very intricate story, with potentially substantial ramifications not only for one specific company's internal corporate policy and potential abuses thereof, but additionally having significant political implications, as well as explaining a lot in terms of recent oddities in terms of Mark-To-Market, mainstream media interactions with sensitive Wall Street clients, and lastly, shedding some much needed light on that most thorniest of recent subjects - the commercial real estate bubble.

First some background. Mr. Moorjani, contrary to what Zero Hedge represented, is still technically an employee of Deutsche Bank Japan, specifically their Commercial Real Estate department, despite being already involved in several years of litigation with the company. We provide his relevant biography compliments of The Huffington Post:
Deepak Moorjani is an employee and shareholder of Deutsche Bank AG. The views expressed herein are his own and do not necessarily represent the views of Deutsche Bank AG. As disclosure, he is presently involved in litigation as a plaintiff and as a defendant with Deutsche Securities Inc, a subsidiary of Deutsche Bank AG.
The reason Mr. Moorjani is still employed at DB Japan is that in Japan the concept of at will employment does not exist. His status as an employee would end when either (i) he resigns or (ii) the courts officially recognize a valid termination by the company. So far, neither has happened. Indeed, DLA Piper chimes in on the topic: "Japanese labor laws tend to be very labor friendly, especially when compared to the labor laws from other Asian jurisdictions and countries such as the United States. There is no concept of "at-will" employment in Japan and the employer's right to terminate, transfer and discipline employees is limited by statute, case law and custom."

As some more background, in April 2007 Mr. Moorjani sent a due diligence report to DB's head of global banking, Michael Cohrs, in which he detailed numerous observations from a whistleblower's perspective. The company's retort was the pursue litigation against Mr. Moorjani, which has since escalated over the past two years. I will not focus as much on the details of the lawsuits, however I do provide links to documents which are public domain and have been filed in Japanese court for whoever desires to conduct additional an drill-down on this topic. A full overview of the background of the Moorjani-case can be gleaned from the following set of documents, posted by Mr. Moorjani on his Scribd account.

Among some of the other relevant allegations, is an interesting piece that could be quite interesting to Zero Hedge readers as it deals with an issue I have touched upon in the past, namely potential Mark T0 Market shenanigans in the world of CMBS. A Nikkei press release from April 29 summarizes a few of the most pertinent issues best:
Deutsche Securities May Take Lumps For Sloppy Asset Value Calculations
Tokyo (Nikkei)
April 30, 2008

Deutsche Securities Inc. is suspected of using sloppy, inconsistent methods in computing the fair value of asset-backed securities sold to institutional investors, The Nikkei learning Tuesday.

With the potentially far-reaching impact on the market, authorities are considering recommending administrative action against the brokerage under the Financial Instruments and Exchange Law.

The irregularities were detected through Securities and Exchange Surveillance Commission inspections that began last November. According to the SESC's findings, the brokerage is suspected of presenting different market prices for the same securitized product depending on the client, in addition to showing multiple market prices for a single securitized product and having the investor choose from among them.

Deutsche Securities is also believed to have used the wrong dates in calculating market prices and to have erred when computing changes in such prices, among other missteps.

The SESC is taking the situation seriously because the market prices that brokerages give for securitized products are used as reference prices, as recognized under accounting rules, for businesses to assess the value of their securities holdings and to book valuation gains and losses. Should there be a problem in how these reference prices were calculated, this would impact not only the earnings of companies that bought these securitized products, but also ordinary investors that invested in these businesses.

...The SESC itself lacks the authority to take punitive action. It can only make a recommendation to the FSA, and the two organizations are now discussing the matter.

Securitized products are backed by such assets as loan claims and real estate. In some cases, those products are divided up and rebundled as separate products. Many financial institutions have sustained large losses on these complex products, including collateralized debt obligations. The products in question apparently include such complex securitized vehicles.

These are very critical allegations, especially since it is arguable whether this type of CMBS marking frivolity was isolated to the Japanese market and was not a more pervasive phenomenon (and not just at DB for that matter).

And it has been none other than Deepak Moorjani who has been fighting to get both internal and external attention not only on this issue, but many others, which go to the core of Moorjani's argument of rampant alleged Moral Hazard violations at the German bank. A full reprint of one of Mr. Moorjani's letters to his supervisors is presented below, with the key points recaptured:
In approximately six months, we have announced more than $7 billion of write-down related to our credit exposure. Our losses were made in two announcements: (i) a €2.2 billion write-down announced in October 2007 and (ii) a €2.5 billion write-down announced in April 2008. For perspective, these write-downs are slightly more than 75% of total net income for 2006 and slightly more than 130% of net income for 2005. It may no longer be appropriate to say, "Strategically our path is clear: we stay the course!"

With two write-downs, some may begin to attribute these write-downs to failings on our part, rather than to an external "crisis." We should consider whether we contributed to these losses by our actions or by our omissions to act. Some may allege that we mispriced risk, or perhaps more accurately, we underpriced the risk. Some may contend that lax controls allowed a culture of risk to flourish with negative consequences for our stakeholders. Warren Buffett recently commented on the "crisis" by saying: "It's sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end." [TD: even more poetic that Mr. Buffett himself apparently had come to the punch bowl party armed with plastic cups himself.]


As you know, I come from an investment management background with more than ten years of private equity experience in the U.S. In this role, one of my responsibilities has been to provide oversight of management teams and to be an agent of change, when necessary. I was recruited to join Deutsche Bank to build an investment business in 2006, and over time, I began to conclude that we had inadequate corporate governance structures and law internal controls. While some of this commentary may have offended powerful interests, we should address these issues proactively. As Edward R. Murrow offered, "We must not confused dissent with disloyalty."

In addition to legal and regulatory concerns, we have a moral hazard problem. Specifically, there may be a principal-agent problem which led us to take excessive risks. I did a summary economic analysis of our Commercial Real Estate ("CRE") lending activities in Japan in January 2007. This email was distributed to several of my colleagues, and my conclusions was simple: our real estate lending activities in Japan did not make economic sense, or as I stated, "We would generate more profits in the carry trade."...
The letter goes on to give many more details on the alleged subsequent retaliation by DB against Mr. Moorjani and his proposed recommendations for fixing the problems he has addressed.

And the whisteblower fight goes on. In a missive sent out on April 28, 2009, which among others CC:'s not just Deutsche Bank executives Josef Ackermann, Hugo Banziger and Michael Cohrs, but German chancellor Angela Merkel herself, Moorjani presents yet more critical arguments (full referenced letter from Scribd provided below), especially with regard to the sensitive topic of AIG-funneled taxpayer bailouts:
At Deutsche Bank, I consider our poor results to be a "management debacle," a natural outcome of unfettered risk-taking, poor incentive structures and the lack of a system of checks-and-balances. In my opinion, we took too much risk, failed to manage this risk, and broke too many laws and regulations.

As widely reported, we have been one of the biggest beneficiaries of the AIG bailout. We recently received nearly $12 billion from AIG, a firm which has effectively been nationalized with $180 billion in taxpayer funds. (Note: This $12 billion payment was more than 50% of our market capitalization at the time of its disclosure.) Since taxpayers have been forced to pay for the losses from our bad trades, we have an increased obligation to encourage transparency and accountability within our firm.
Moorjani presents a very curious case study, demonstrating the excesses of the Commercial Real Estate bubble.
Project Lindberg

Perhaps we should consider an example. The attached documents detail “Project Lindbergh,” our lending proposal to Morgan Stanley’s real estate investment group in late 2006. Internally, this lending transaction was supported by Frank Forelle and Steve Adang of the Deutsche Bank Commercial Real Estate (“CRE”) lending business.

As reported, Morgan Stanley was in the process of purchasing “13 hotels and two property management units from Japanese airline All Nippon Airways Co. Ltd. for $2.4 billion in the biggest hotel transaction in Asia, the U.S. investment bank said on Friday, making it the largest hotel owner in Japan . . . Under the deal, ANA will sell its stakes in ANA Property Management Co. Ltd., ANA Hotel Management Co. Ltd. and subsidiary companies of 13 hotels as of June 1 for 281.3 billion yen . . . Analysts said the deal underlines a shift in investors' strategy to seek riskier assets including shares of companies that hold properties.”

For Morgan Stanley, this investment was sponsored internally by Sonny Kalsi. As reported in February 2009, Mr. Kalsi was placed on administrative leave after Morgan Stanley disclosed in a filing to the Securities and Exchange Commission that one of the members of his group in China "appear to have violated the foreign corrupt practices act, a US law that prohibits corporate bribery.”

The Deutsche Bank CRE business delivered a highly-aggressive proposal for these risky assets. While we “lost” this deal to Citigroup, this lending proposal illustrates that bankers sought to commit billions of dollars of shareholder and depositor capital in a highly-leveraged transaction. The reason is simple: our incentive structure encourages this excessive risk-taking. Had we won this lending assignment, bankers would have been paid millions of dollars of bonuses for their “success.”

How risky was our proposal? While the properties were appraised at only JPY 236 billion (US $1.97 billion), Morgan Stanley purchased these properties for JPY 281.3 billion (US $2.34 billion), a 2.74% cap rate. Our lending proposal offered JPY 220.1 billion (US $1.83 billion), approximately 93.27% of the value of the properties. In any market, this 93.27% loan-to-value purchase would be considered risky. In hindsight, this lending proposal is seen as ridiculous given (i) the assumption that the underlying cash flows would increase more than 65% by 2010 and (ii) the realization that much of this loan could not be securitized due to its riskiness; much of this loan would have been forced to remain on the Deutsche Bank balance sheet.
The full text of this mesmerizing story is presented below:

Has Ms. Merkel taken these allegations seriously? The German bank, that by some estimates, has a leverage ratio that far surpasses even the wildest dreams of its U.S. counterparts, has been considered the epitome of European systemic risk, and the prudent course of action for not just her, but all DB executives (not to mention the gentlemen at the Federal Reserve) would be to take all the warnings presented by Mr. Moorjani and act upon them, instead of continuing to pursue allegedly retaliatory litigation.

In the meantime, Mr. Moorjani's story waits to be told. As I pointed out the removal of his opinion letter from Dealbook without a reason leaves many unansewered question. The questions only become louder if one considers the lack of response by other main stream media sources to capture this story and present it is in entirety: as Mr. Moorjani points out, a dissemination of this case could simply "offend powerful interests" and as such various media outlets would be loathe to shut out powerful and wealthy clients from the ranks of sponsors and revenue generators. Zero Hedge does not have that problem.

Of course, the questions of moral hazard, of mismarking and outright adjusting CMBS price levels, of obvious "overbidding" practices (with other people's money) remain, and will continue to do so until there is a clear resolution of Mr. Moorjani's case. In the meantime, Zero Hedge will continue to present every ongoing development in this saga as it is the right (and duty) of shareholders (and recently taxpayers), both foreign and domestic, to see just how their capital is (mis)spent in the ongoing pursuit of ever increasing Wall Street bonuses and levered revenues at global banking concerns. Sphere: Related Content
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