Danske Bank Money Laundering: Net Worth Method Analysis

Introduction: The Danske Bank Scandal and Net Worth Theory

Madinger (2006) points out that the net worth method is among the most commonly used techniques in forensic accounting when it comes to detecting illegal income, such as that generated through money laundering. The case of Danske Bank and its money laundering activities from 2007 to 2015 — conducted through an Estonian branch where a quarter of a trillion dollars flowed — is a prime example of a situation in which the net worth method could be applied to investigate corporate fraud.

As Schwab (1961) states, the net worth theory rests upon the idea that if one's net increase exceeds the income reported, the corporation has understated its income. Additionally, "if there is no increase in net worth but if the taxpayer has expended larger amounts than his reported income on nondeductible items, there has been an understatement of income" (p. 78). With Danske Bank, billions were passing through its Estonian branch from several different sources in dozens of different currencies. If net worth is the difference between assets and liabilities — which equals equity — then one can begin with the equity of the firm and move on from there. With Danske Bank, any increase in equity must be the result of income. The first steps in addressing the red flags at Danske would therefore be to:

1. Obtain the bank's records
2. Gather information from the bank's informants, i.e., cooperating individuals
3. Assess loan applications, financial statements, and tax returns
4. Catalogue assets, liabilities, and expenses

These steps provide the foundation for proceeding into the next stage of investigation (Madinger, 2006).

Initial Investigation Steps and Asset Assessment

This phase begins by examining assets valued at cost without accounting for depreciation or appreciation. With Danske, "the Estonian branch generated 11 per cent of Danske's total profits before tax that year, despite only accounting for 0.5 per cent of the bank's assets" (Milne & Winter, 2018). In other words, assets were not aligning with income. Because 99% of the branch's customers were non-Estonian residents, this was another significant signal of money laundering.

After examining assets, the next step is to use the same accounting techniques that the subject was using. All items pertaining to the calculation should be included in the investigation, even if they do not change from one year to the next (IRS, 2017). Cash on hand and expenses can become particular problem areas. In Danske's case, the company was engaging in mirror trading involving many billions of dollars per year in order to move money out of countries such as Russia. The extent to which cash on hand figured into these transactions must be established, and that is where interviews with individuals involved become essential.

Cash Transactions, Whistleblowers, and Holdings Analysis

Danske had a whistleblower who exposed the money laundering scheme, and this individual would be the first person a forensic accountant would want to interview, as he could lead investigators to the figures that explain what was taking place. Identifying the starting point of the fraud is necessary before proceeding further, and cash on hand is a logical place to begin. Holding funds or assets is one method banks use to conceal the source of money and obscure ownership.

Examining how the Estonian branch was holding money — and identifying who was delivering the money and allowing it to pass through — would be the next step in determining what Danske was doing. With so many non-resident customers, it would be evident that the branch was facilitating activity outside the scope of normal, legal banking. Money was being funneled through the branch, and this pattern could be made apparent by scrutinizing the holdings.

Larger cash transactions are required by regulation to be reported, but the branch was not complying. Investigating the reason for this regulatory failure would be a critical next step. Why was the branch permitted to flout regulation and remain non-compliant? The situation was compounded by the fact that the branch manager had become CEO of Danske during the period when the laundering was taking place — yet another sign of a deliberate cover-up.

Conclusion: Forensic Accounting and Regulatory Red Flags

The net worth method is thus a useful way to uncover the facts of a corporation's holdings and its net worth — that is, equity — which must be connected to income but in a money laundering situation cannot be directly linked without revealing what the bank was really doing. Concealment mechanisms such as currency swaps and mirror trading become necessary to deceive regulators. Because the bank was clearly not even attempting to remain in compliance with regulations — for example, by failing to report large deposits from non-resident customers — there should have been an immediate red flag for regulators and auditors alike.

The forensic accountant should interview all individuals involved and, critically, should prioritize any whistleblowers, as they can provide direct, firsthand knowledge of the true situation. Investigating money laundering is not solely an exercise in examining the books; it also requires speaking with those who have direct knowledge of what occurred. Together, documentary analysis and human testimony form the most complete investigative approach.

References

IRS. (2017). Internal Revenue Manual, Part 9, Chapter 5, Section 9. Retrieved from https://www.irs.gov/irm/part9/irm_09-005-009

Madinger, J. (2006). Money laundering: A guide for criminal investigators. CRC Press.

Milne, R., & Winter, D. (2018). Danske: anatomy of a money laundering scandal. Retrieved from https://www.ft.com/content/519ad6ae-bcd8-11e8-94b2-17176fbf93f5

Schwab, R. D. (1961). The civil aspects of the net worth method. Wm. & Mary L. Rev., 3, 65.