Goldman Sachs continues to face fallout from 1MDB scandal

Brian Cheung

Morgan Stanley downgraded Goldman Sachs’s (GS) stock to “equal-weight” on Wednesday, citing regulatory risks that could come from the U.S. Justice Department’s investigation into its role in an international corruption scandal centered around the 1Malaysia Development Bhd., a Malaysian state investment fund.

In early November, the Justice Department unsealed documents alleging that senior-level Goldman bankers Tim Leissner and Roger Ng bribed and laundered money through relationships with 1MDB, in violation of the Foreign Corrupt Practices Act.

FILE PHOTO: A view of the Goldman Sachs stall on the floor of the New York Stock Exchange in New York, U.S. on July 16, 2013. REUTERS/Brendan McDermid/File Photo
FILE PHOTO: A view of the Goldman Sachs stall on the floor of the New York Stock Exchange in New York, U.S. on July 16, 2013. REUTERS/Brendan McDermid/File Photo

1MDB was the center of a huge political scandal that engulfed former Malaysian Prime Minister Najib Razak, who was charged with funneling fund money into his personal account to purchase expensive jewelry for his wife.

The fallout appears far from over. The Wall Street Journal reported Wednesday that an Abu Dhabi sovereign wealth fund is now suing Goldman Sachs, alleging the bank had a “central role” in the scheme. The fund guaranteed $3.5 billion in bonds to 1MDB over a year and is now taking Goldman to court to “protect its business interests against an international conspiracy.” Goldman Sachs says it arranged about $6.5 billion of debt securities for 1MDB, which helped the bank pocket about $600 million in fees.

In filings dated November 2, Goldman Sachs said it is cooperating with the Justice Department and all other regulatory investigations related to 1MDB but said it cannot predict the outcome of those investigations.

Morgan Stanley is projecting fines of $1.2 billion in addition to a return of its $600 million in collected fees.

“These risks, coupled with potential headline risks in the coming months (additional lawsuits, additional regulatory probes, internal reviews), drive our Equal-weight rating,” Morgan Stanley wrote.

Goldman on the defense

Goldman did not respond to requests for comment on the latest 1MDB-related developments. Between the second and third quarters of 2018, Goldman slightly increased its reserves for existing and estimable legal matters from around $1.5 billion to $1.8 billion.

The company has also beefed up its legal team to handle the probes. The Financial Times reported November 6 that it hired former Justice Department deputy attorney general Mark Filip, who has a close friendship with the department’s current criminal division chief, Brian Benczkowski.

Michael Volkov, a former deputy assistant attorney general who knew both individuals during his time at the DOJ, told Yahoo Finance he does not think Benczkowski will recuse himself in the case.

Volkov said he could ultimately see the company signing a deferred prosecution agreement with the Justice Department, adding that the fine will depend on how many regulators get involved and whether or not Goldman cleans up its compliance program.

“They have to remediate, they have to determine the root cause of how this occurred,” said Volkov, now head of his own boutique law firm. “Then they have to address the root cause such that it can never happen again.”

“Failure to supervise”

One question that remains: how high do the compliance issues run?

David Solomon, who replaced Lloyd Blankfein as Goldman’s CEO on October 1, told Bloomberg November 15 that the two bankers, who no longer work for the bank, were rogue agents who managed to get around the company’s compliance policies.

“It’s obviously very distressing to see two former Goldman Sachs employees went so blatantly around our policies and so blatantly broke the law,” Solomon said. “We take the whole matter extremely seriously and we continue to work with the authorities as they investigate it.”

But Leissner was notably the bank’s Southeast Asia Chairman and Ng was a managing director, both high-ranking posts within the organization.

There is also speculation about whether Goldman Sachs will be charged with “failure to supervise” its employees, a label that regulators would use to punish the bank for poorly monitoring its employees’ compliance with relevant laws and regulations.

In a note November 14, Oppenheimer wrote that Goldman could face this charge given “pretty clear evidence that Goldman’s compliance programs failed dreadfully.” But ultimately the note maintains their “outperform” rating.

“We have confidence that Goldman as a firm will endure this admittedly bleak chapter,” Oppenheimer wrote.

Shares of Goldman Sachs were trading up 1.57% to $194.34 as of 12:49pm ET.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

Read more:

The FDIC finally fills its insurance fund – 10 years after the crisis

Banks are ready to tighten lending if the yield curve inverts

How Trump’s tax cuts hurt the GOP in America’s wealthy suburbs

Trump target Maxine Waters is poised to take a lead on banking regulation

Bernanke: Fed needs greater ‘lender of last resort’ authority