Yes, Germany has a compliance and enforcement problem

I read with tremendous interest the FCPA Blog post, “In Germany, A weird tolerance for corporate crime.” I have long considered that a fundamental disconnect as well. Germany has a strong rule-based culture that anyone trying to jaywalk on one of its streets or throw trash in the wrong recycling bin is quick to find out. Why then the different standard at play in the white-collar arena where the costs are so much greater?

Outwardly, Germany ticks all the boxes — it has signed on to the 4th EU Anti-Money Laundering Directive, is currently serving as President of the FATF, and ostensibly has a visible financial regulatory authority in BaFin (the Federal Financial Supervisory Authority). But, as one German wag recently said, there is a clear gap between Schein und Sein (appearance and reality).

This gap, however, isn’t a recent letting down of the guard. The issues are systemic and of longstanding.

Germany has a very strong bank-driven corporate governance system that gives free rein to companies as long as they provide jobs and generate revenue. It is by and large a closed system that shuns the forms of accountability that we consider commonplace. What does that mean, in practice?

German banks and corporations do not have boards which include highly experienced non-executive directors. They have supervisory boards, in which half of the membership by law is held by labor. The other half typically includes institutional shareholders (banks, insurance companies or other German concerns) and political representatives from the heads of the local governments in which the company sits. Far from serving in an oversight or accountability role, these members have an inherent conflict of interest in safeguarding a company’s ability to maximize its room to maneuver if doing so allows it to safeguard jobs, debt repayment and the tax base. In the Volkswagen case, for example, the board was extremely reluctant to act, even in the face of egregious violations, because of the impact on jobs.

Germany’s bank-centered approach to governance has led to an underdeveloped securities market and weak minority shareholders. What that means is — in the German system, the shareholder does not come first. As a consequence, the pressure for transparency and accountability that we come to expect is underdeveloped. While this has started to change somewhat with the entry of private equity and hedge funds into the German market, resistance to shareholder activism for accountability and transparency is culturally held and deep-seated. Witness how BaFin reacted when hedge funds early on started to raise concerns about Wirecard. Instead of acting on those red flags and looking deeper at the company, BaFin began investigating the hedge funds themselves and started legal proceedings against them.

Other forces we would expect to push corporations for transparency and accountability are also blunted. Investigative journalists who have probed irregularities have found themselves the targets of BaFin investigations in the Wirecard case and in Deutsche Bank cases. Whistleblower protections exist but are in no way as robust as those in the United States. In fact, it is against the law for the employee of a company to contact a regulatory authority directly to report wrongdoing. They can be fined and punished. Instead, they are obligated to report any concerns to their immediate supervisor. The immediate supervisor, in turn, is under no obligation to forward those complaints.

Prosecutors interested in investigating corporate wrongdoing can also find themselves hamstrung. Under German law, only an individual, not a company, can be held responsible for fraud and, in any number of cases, the company can make it extremely difficult for prosecutors to have access to the information or individuals needed to build a case against.

Even if a case should wend its way through the judicial process and a judgment is handed down, court records and case decisions are not readily available in the public record. As a result, the deterrent effect from prosecuting certain bad acts, the awareness of repeated patterns of behavior by certain firms in certain industries and, a larger recognition of the extent of wrongdoing overall in German industries, is denied.

So, the more pertinent question might be —if the average German trader on the trading floor knows that he can act in a corrupt manner with impunity, be protected by his senior manager, be safeguarded by bank management and be protected by the politicians and regulatory authorities that oversee the bank’s conduct, the question is — why would he not?

While consent orders, fines and penalties impose a cost, it has been clear over the last ten years or so, that Germany, Inc. regards this as just a cost of doing business. Real reform is possible and surely the Wirecard case will bring all of these issues into stark relief, providing a roadmap for German authorities to follow. U.S., UK, and EU lawmakers, policymakers and regulators can certainly play a role in urging Germany that the time for systemic change has come.