As regulators circled, CommBank board was forced to take action

ON FRIDAY an armada of Australia’s most powerful federal agencies surrounded the Commonwealth Bank board. It was a show of coordinated regulatory force not seen since the global financial crisis. By late last week all of Australia’s key financial regulators had joined the Australian Transaction Reports and Analysis Centre (AUSTRAC) in a move that left the CBA board encircled, with no choice but to take evasive action.

The country’s largest bank spent the weekend in crisis talks and by Monday morning announced its second major symbolic move: the chief executive Ian Narev would be forced to depart. Just days earlier Narev had said he was committed to the role and was the right person to steer the bank through the Intelligent Deposit Machine (IDM) money laundering crisis. The first strategic move from CBA was the board’s decision to cut the senior management team’s bonuses for the 2017 financial year. This had done little, however, to quell the public and regulatory anger. It certainly did not defuse the demands for management accountability over the issue.

In an announcement to the market this morning Catherine Livingstone, the CBA chairman, said it was important for the bank to “deal with the speculation and questions” about Narev’s tenure. While the exact timing has not yet been decided, the board will replace Narev some time this financial year following the hunt for a successor.

“Today’s statement provides that clarity and will ensure [Ian Narev] can continue to focus, as CEO, on successfully managing the business,” Livingstone said in an Australian Securities Exchange (ASX) filing.

In a later media briefing she said the board would continue to hold Narev to account as the bank’s chief executive.

“Ian is absolutely CEO and the board will hold him to account, as it has done, in terms of all of the actions and running of the bank to make sure it is a successful business and we continue with our program of action which has been underway and involves the senior executive team and their respective groups. So everyone in the bank is committed to following through on this program of action,” she said.

Livingstone also stressed that the board had set up a committee of four directors, led by Mary Padbury, which will have oversight over the response to the AUSTRAC claims. The structure means the existing senior management team will not be able to influence that internal investigation, or the board’s response.

The first of many? 

The departure of Narev is likely to be the first scalp in a process of cultural renewal at the country’s most profitable financial institution. The next likely role to come under scrutiny will be that of David Cohen, the chief risk officer, who was also general counsel during the period in which CBA’s alleged anti-money laundering and counter terrorism financing (AML/CTF) failures occurred. Cohen has been the face of numerous CBA scandals, dating back to his appearances before the inquiry into CBA’s conduct around the Bankwest acquisition. More recently, Cohen appeared on national news program 60 Minutes to defend the bank’s conduct during the collapse of CEC Group. Whether rightly or wrongly, Cohen is perceived in the public eye as Narev’s right-hand man when crises arise and has been the public face of the bank’s response to a series of cultural failures.

Livingstone has made it clear that Cohen, and his fellow senior executives, will not have stewardship over the “mop up” from CBA’s latest reputational risk crisis.

As the Australian Securities and Investments Commission (ASIC) said following the CommInsure debacle, although CBA’s conduct may not have been illegal it was “clearly out of step with community expectations”. In the case of facilitating money laundering for ice syndicates and terrorism financing, as detailed in AUSTRAC’s litigation against the bank, the CBA’s conduct may be found to be both unlawful and deeply out of step with community expectations.

Insiders have suggested CBA is already preparing its response to AUSTRAC’s claim, as it must, but will be very keen to settle the matter without proceeding to court. Financial crime experts told Thomson Reuters Regulatory Intelligence the material contained in the statement of claim would be highly damaging to CBA’s brand should it emerge in a blow-by-blow court litigation process. The media would, of course, have enormous interest in the case, as has been seen over the past week as the drama unfolded in the public eye.

Regulatory show of force 

So how did this come about? What happened behind the scenes to invert the board’s strategy from “blame the coding team” a week ago to “batten down the hatches” on Thursday and, finally, “dismiss the CEO” on Monday?

Essentially, on Friday morning the CBA board was left with no option but to publicly begin an executive refresh when the country’s leading financial regulators linked arms in a coordinated show of force against the financial institution. In an unprecedented move Phillip Lowe, the Reserve Bank of Australia (RBA) governor, came out to describe the case as “very serious” and said management had to be held accountable. In addition, ASIC revealed that it would explore potential Corporations Act 2001 breaches, including continuous disclosure obligations, in relation to its handling of the money laundering saga. ASIC chairman Greg Medcraft’s move was largely symbolic in the context of the seriousness of AUSTRAC’s claim but he had made it clear that CBA was surrounded.

In a face-off between the Commonwealth (the government) and Commonwealth (the bank), it was clear who would prevail. At that point, the CBA board’s hand had been forced.

At a more strategic level, this was a case of the key Commonwealth government agencies and regulators reminding the banking sector who’s in charge. All of the country’s banks have been watching this drama unfold and none have come to CBA’s defence — not even through the anonymised face of the Australian Bankers’ Association. Unlike the GFC (the last time Australian regulators joined forces like this) CBA will be navigating this crisis alone.

The only member of the powerful Council of Financial Regulators (CFR) that had not spoken out on Friday was APRA. At a prudential level, risk culture failures are the most likely tool that APRA could use to pressure the board. Unlike the other regulators, however, APRA chooses not to comment publicly on matters such as these as it is bound by the strict secrecy provisions in section 56 of the Australian Prudential Regulation Authority Act 1998.

Behind the scenes, however, it is highly likely that APRA has also signalled to Livingstone and the CBA board that they need to take decisive action over these failures of risk culture.

The invisible hand 

The invisible hand behind this coordinated push, it should be noted, was the Australian Federal Police (AFP). The agency has been fighting the insidious meth trade for years, citing it as Australia’s most destructive illicit drug. And all the while CBA allowed A$8.9 billion to move through its IDM cash conduit without basic controls such as threshold transaction reports (TTRs).

As a source told Thomson Reuters Regulatory Intelligence: “International drug syndicates have two concerns: getting the drugs in and getting the money out.”

In many jurisdictions, banks that have been facilitating the second arm of the drug trade (laundering the proceeds of crime) have been treated as complicit in the underlying criminal activity. Some financial crime experts have said, on condition of anonymity, that CBA should consider itself lucky that it is only facing a civil action.

AUSTRAC’s 450-page statement of claim details just A$77 million worth of alleged illegal funds transfers, all of which were the subject of separate AFP criminal trials. This is just the tip of the iceberg for illicit cash flows through so-called smart ATMs. Due to the alleged failure of CBA to put controls in place, especially around its open conduit to Hong Kong, no one will ever know exactly how much of the A$8.9 billion that moved through its IDMs represented the proceeds of crime.

It would appear that Paul Jevtovic, the previous AUSTRAC chief executive, used his deep AFP background, understanding and connections to leverage those criminal investigations into a bombshell civil AML/CTF claim.

The criminal standard of the AFP’s underlying investigations will leave CBA with very little wriggle room. It can argue the issues around the fringes, such as “what was the point at which suspicion should have been formed?” Or “was it appropriate for CBA to only file one SMR for each account every 90 days, regardless of the number of suspicious transactions that occurred?” But the broader claim itself, the internal documents and the surveillance footage of things like “smurfs” pulling up milk crates and pumping cash into ATMs until they were full, or jammed, will prove damning for CBA.

At the end of the day, the less serious alleged offences (the failure to file 53,506 TTRs over three years) are a non-subjective matter. Under a strict reading of the AML/CTF Act, the technical breaches or “coding errors” that CBA has already acknowledged could be grounds for a potential multi-billion dollar penalty. In this context, CBA will have a very strong motivation to settle with AUSTRAC.

The only ace that CBA may have up its sleeve is if it can adduce evidence that accounts were left open under orders from the AFP. This is a complex legal issue, as detailed in the recent AUSTRAC consultation on a safe harbour regime for reporting entities. Having said that, it is highly unlikely that the claim would have been drafted in the way it was if this defence was available to CBA, or if the bank had been genuinely cooperating with authorities to identify the drug cartels that were exploiting its controls.

In any event, even if CBA had kept accounts open under AFP requests, there are enough other alleged failures in the AUSTRAC claim (from “coding errors” that went unnoticed for three years, to suppressing or ignoring SMRs) to make the case a compelling one for the Federal Court to consider.

And besides, even if CBA was cooperating with the AFP, it would still have an obligation to report every TTR and SMR to AUSTRAC.

A turning point for financial crime compliance 

At a broader level, the “smart laundromat” scandal will prove to be a turning point for financial crime compliance in Australia. As I said during an extended interview with Geraldine Doogue on ABC Radio National on Saturday, this case will be the trigger for all financial institutions to regard AUSTRAC as one of Australia’s most formidable financial regulators.

The public profile of the smart laundromat scandal is also likely to be the trigger for the extension of Australia’s money laundering regime to cover gatekeeper institutions. During the course of this regulatory drama the Australian public have made clear their contempt for any business that facilitates the illicit drug trade (particularly ice trafficking, the drug that’s ripping apart families in many of our most vulnerable communities) or terrorism. This is the political trigger the federal government has needed to push through its controversial reforms.

The question that Australia needs to ask is this: if the country’s largest (by deposits) and most respected bank is ultimately found to have facilitated drug cartels and terrorism financing, what are the risks associated with real estate agents, accountants and lawyers?

It is highly likely that the Turnbull government will make an announcement on these legislative reforms while the CBA scandal is fresh in people’s minds — and in the media.

Paddy Oliver, one of Australia’s leading anti-money laundering commentators, has seen this dynamic play out in the UK, where he advised the legal sector on the rollout of AML regulation for designated non-financial businesses and professions (DNFBPs). He said the CBA case, in combination with a number of recent ML and TF scandals, would make it very difficult for lawyers and other sectors to oppose the tranche two laws.

“The reputational damage from the Panama Papers led New Zealand to act very quickly to introduce phase two of its AML/CFT regime. Now in Australia the involvement of CBA in a major money laundering litigation could have a similar effect. It will be very hard for the Law Council and other legal industry bodies to continue to argue against the need for reform in this climate,” Oliver said.

“The accounting and real estate peak bodies have accepted the need for the reforms. Perhaps it is time for all business sectors that are used by money launders and the financiers of terrorism to work together for the common societal good?”

Disclosure: CBA was approached with a “right of reply” on this article.