Deutsche Bank AG will pay $55 million to settle the SEC investigation into whether the bank masked financial losses by failing to update the market value of leveraged super senior trades, a form of credit default swap. Previous media reports have suggested that DB avoided a bailout during the financial crisis because it didn’t mark to market its derivatives position in this product to properly account for the gap risk.
The settlement could very well result in a payout under the SEC whistleblower program, because there are reports that at least three individuals inside the company went to the securities regulator to report the accounting fraud.
The derivatives transaction was complex and hedged, though there was a risk that the value of Deutsche Bank’s losses would exceed the value of the collateral put up by the counterparty when hedged the transaction. This would expose DB to gap risk.
During the height of the financial crisis in 2008 as the markets deteriorated, DB changed the way it measured gap risk and later measured the gap risk for accounting purposes as essentially $0. The internal estimates that were not reported on the financial books, however, put the gap risk at between $1.5 billion and $3.3 billion during that time period.
As a result, the financial institution’s books and records were inaccurate and the bank had inadequate internal accounting controls. The accounting control law is the same one used by the SEC in bribery cases from the Foreign Corrupt Practices Act.
Deutsche Bank neither admitted nor denied the SEC’s findings.