Deutsche Bank’s Legal Woes Deepen As Overhaul Hits Profit

Deutsche Bank AG (DBK)’s announcement yesterday that earnings will suffer this quarter added to a cacophony of negative news over the past two weeks that’s increasing pressure on the bank’s new leadership.

Two days ago, police raided Deutsche Bank’s Frankfurt headquarters, arresting five employees, in a tax probe involving the sale of carbon-emission certificates in 2009 and 2010 that includes co-Chief Executive Officer Juergen Fitschen and Chief Financial Officer Stefan Krause, who signed tax returns.

Fitschen and Anshu Jain, his co-CEO, are grappling with escalating regulatory probes and litigation stretching from the alleged rigging of interbank lending rates to claims the bank misrepresented products tied to U.S. mortgages. Resulting fines could cut into the company’s capital levels, the lowest of Europe’s four biggest investment banks.

“Deutsche Bank’s employees, right down to the doormen, must feel like a storm has descended on the company like a typhoon,” said Klaus Fleischer, a professor of banking and finance at the University of Applied Sciences in Munich. “It will be tough to repair the damage, even though Deutsche Bank has done a lot to bring about cultural change in the industry.”

Deutsche Bank said yesterday it expects earnings will be “significantly” reduced in the fourth quarter by bigger losses from offloading riskier assets and higher restructuring costs. It fell 3 percent in Frankfurt, heading for the biggest decline in a month and trimming the stock’s advance this year on the 28- member Euro Stoxx Banks Index (SX7E) to 9.8 percent.

Hindering Work

“I feel unfairly treated,” Fitschen said of the CO2 tax investigation in an interview with German newspaper Handelsblatt published today. “In my opinion, the prosecutor’s approach was excessive. I also feel that the allegations against me will hinder me from implementing what I plan to do.”

Fitschen and Jain took over as co-CEOs six months ago.

Last week, Eric Ben-Artzi, a former risk analyst, accused the bank’s managers of hiding billions of dollars in paper losses on a portfolio of collateralized insurance agreements between 2007 and 2010. Deutsche Bank denied the allegation, saying its probe of the matter showed no wrongdoing. The U.S. Securities and Exchange Commission declined to comment on the investigation.

Closer Scrutiny

The world’s largest banks have become the subject of probes from Japan to Canada as regulators intensify scrutiny of the industry. This week, HSBC Holdings Plc (HSBA), the U.K.’s biggest bank, agreed to pay $1.92 billion to settle U.S. probes of money laundering in the largest such deal on record. Standard Chartered Plc (STAN) agreed Dec. 10 to pay $327 million of fines after regulators alleged it violated U.S. sanctions with Iran.

“There are quite a lot of banks around Europe and the world with a hangover from legacy issues from what happened in the crisis,” said Simon Adamson, a debt analyst with CreditSights Ltd. in London. “The fallout from the crisis will be an ongoing risk for investors. It’s going to be difficult for a while to know what the consequences are going to be for banks like Deutsche Bank.”

Police Raid

Tax inspectors carrying computer equipment and files entered elevators at Deutsche Bank’s headquarters in central Frankfurt on Dec. 12 after a swoop by hundreds of police.

The five arrested employees appeared in a city court yesterday, accused of obstruction of justice and money laundering in a probe of unpaid sales taxes on the CO2 certificates. Four remain behind bars and twenty more are under investigation. Deutsche Bank says it took account of a potential fine by not claiming back about 310 million euros ($410 million) in tax refunds.

Raids were also conducted in Berlin and Dusseldorf and about 500 federal police and tax investigators were involved, Guenter Wittig, a spokesman for the Frankfurt General Prosecutor, said in a statement. The authorities also raided private homes.

“The pressure is building on them,” said Christopher Wheeler, an analyst with London-based Mediobanca SpA (MB) who recommends clients sell Deutsche Bank shares. “All bank management is doing is saying ‘this is terrible, but don’t worry, it’ll blow over.’ It has in the past but they’re facing a lot of things that haven’t gone away.”

‘Timely Manner’

Prosecutors say Deutsche Bank failed to correct its 2009 tax statement quickly enough, according to the bank. The company holds that any errors in the statement regarding tax on CO2, which Fitschen and Krause signed, were corrected in a timely manner. It “continues to fully cooperate with the authorities,” according to a Dec. 12 statement from the lender.

Fitschen, 64, said he “asked questions” before submitting the tax declaration in 2010. The difference between that statement and a corrected version in 2011 was about 150 million euros, he said, according to Handelsblatt.

Fitschen and Jain, 49, took over as co-chiefs from Josef Ackermann, 64.

Deutsche Bank estimates potential litigation losses for which it hasn’t set aside provisions to be 2.5 billion euros at the end of September, according to its report on the third quarter. The bank doesn’t break that figure down.

The bank is also under investigation for potentially manipulating the London interbank offered rate between 2005 and 2011, a time when Jain was head of its investment-banking arm.

Rigging Rates

Regulators from Canada to Switzerland are seeking to discover whether more than a dozen banks colluded to rig the rate, the benchmark for more than $300 trillion of securities, to make profit or hide their true cost of borrowing.

Barclays Plc (BARC) was fined 290 million pounds ($466.9 million) in July. UBS AG (UBSN)may be charged more than $1 billion by U.S. and U.K. regulators, according to a person familiar with the probe who asked not to be identified because the matter is private.

Banks in Europe and the U.S. may face another five years of litigation and probes on various issues as regulators process past misdeeds and seek to tap the firms as a source of income, said Wheeler.

“Banks have deep pockets and things that were swept under the carpet during the boom years are being pulled out during the crisis as a means of extracting cash either by governments or individuals,” he said.

Less Capital

Deutsche Bank’s core Tier 1 capital ratio, a measure of financial strength, stood at 10.7 percent at the end of September, according to company filings. That’s lower than competitors Barclays,Credit Suisse Group AG (CSGN) and UBS, data compiled by Bloomberg Industries show.

The German bank plans to boost capital to at least 8 percent of assets weighted by risk under stricter Basel III rules by the end of March 2013 and to more than 10 percent two years later. Its biggest competitors will reach similar levels months or years sooner, according to forecasts from the banks.

Even so, Deutsche Bank is the largest lender in Europe’s biggest economy and is likely to weather whatever regulatory issues arise.

“The good news is their clients don’t seem all that bothered,” said Wheeler. “They are sitting in Germany with a AAA rating behind them.”

Deutsche Bank is no stranger to controversies involving its senior management, said Dieter Hein, an analyst with research company Fairesearch GmbH in Kronberg, near Frankfurt.

“Fitschen’s two predecessors, Ackermann and Breuer, both have been accused of breach of law,” he said. “It’s unlikely Fitschen will leave his job due to the accusation, even though this shows how bad the corporate governance of the bank is.”

Victory Sign

Ackermann is still trying to shake off an image from 2004. He was photographed by Germany’s media flashing a victory sign during a trial to determine whether it was unlawful for him and five co-defendants to approve more than 57 million euros of bonuses for executives at German mobile-phone company Mannesmann AG during its takeover by Vodafone Group Plc. (VOD) It was the nation’s first criminal probe into excessive pay.

Rolf Breuer, who made way for Ackermann in 2002, helped spark a wave of litigation by Germany’s Kirch family, which owned a group of media companies, with comments he made in an interview on Bloomberg Television that year.

Regulatory fines and litigation such as the Kirch case could wipe out Deutsche Bank’s profit and slow its efforts to retain equity to meet capital goals, said Wheeler at Mediobanca.

The Kirch family has filed lawsuits contending that Deutsche Bank secretly plotted to bring about the demise of its media empire. A Munich-based court said Nov. 16 that Deutsche Bank may have to pay as much as 1.5 billion euros in the case tied to the collapse of the Kirch group. Legal proceedings are due to continue today.

“There could well be more to come,” Adamson of CreditSights said. “We may see action on the Libor manipulation investigation for quite a few banks and Deutsche may well be dragged into that as well. At the moment it’s a very uncertain situation.”

Bloomberg