SINGAPORE (Dec 3): For nearly five years now, the unfolding 1 Malaysian Development Bhd or 1MDB scandal has had little or no impact on Wall Street even though US investment banking giant Goldman Sachs was at the core of the shenanigans and a key enabler.

New York’s financial circles hardly noticed when 1MDB helped bring down the government of former prime minister Najib Razak in May. Indeed, even the US Department of Justice (DOJ) indictments of Penang-born wheeler-dealer Low Taek Jho or Jho Low, Goldman Sachs ex-partner Tim Leissner and his deputy Roger Ng last month barely made a ripple in the financial markets.

Over the past two weeks, 1MDB was washing up on Wall Street like a tsunami. By the time the selling was done, Goldman Sachs stock was down a whopping 19%. The shares are now down over 31% from their late January peak, making Goldman by far the worst-performing large US financial stock this year.

When large stocks plummet, not just the financial media, analysts and investors, but also board members, top management and regulators, are forced to sit up and take notice. The market is saying something is rotten at Goldman Sachs and swift action is needed. When the dust around the 1MDB scandal settles, Goldman and indeed the old ways of doing business on Wall Street could change.

Here’s why Goldman is in trouble: It raised US$6.5 billion for 1MDB. The DOJ alleges that over US$3.5 billion was misappropriated from those funds by Jho Low, a close confidant of Najib. In pleading guilty to money laundering and bribery charges, Leissner blamed the 1MDB shenanigans on Goldman’s “culture” of working around internal legal and compliance controls, as it was highly focused on consummating deals. Jho Low has been charged in absentia with money laundering and violation of bribery laws by the DOJ. He remains on the run and is reportedly in hiding in China.

Another former Goldman partner, Andrea Vella, was removed in late October, and Ng, who is currently awaiting extradition to the US following his arrest in Malaysia, has yet to enter a plea. He has paid back US$29 million of his own 1MDB “windfall”. Malaysia wants all of the US$600 million in fees 1MDB paid to Goldman and restitution of a big chunk of the US$3.5 billion it lost. Attorney General Tommy Thomas said recently that reports of him filing a suit in New York claiming US$5.1 billion from Goldman were “premature”.

A flood of lawsuits is coming Goldman’s way. On Nov 22, Abu Dhabi’s state-owned International Petroleum Investment Co, and its subsidiary, Aabar, sued Goldman for its “central role” in the scandal, accusing it of enabling bribes.

The rapidly unfolding 1MDB scandal is the most serious existential crisis that the venerable Goldman (founded in 1869) has faced since the heady days of late 2008 when, at the height of the global financial crisis as the world’s largest investment bank, it reached out for help to the US Federal Reserve as well as billionaire investor Warren Buffett for additional liquidity and capital to keep itself afloat. Until recently, the sceptical narrative around Goldman and 1MDB was that the Wall Street behemoth would cut a deal with the DOJ, pay fines and turn over a new leaf just as it has after every scandal, including the global financial crisis.

Increasingly, though, there are concerns in Wall Street of regulatory sanctions, above and beyond the fines, both in the US as well in Asia. There is also the long-term reputational damage to Goldman in Asia and the Middle East. Goldman’s franchise had already been feeling the strain in Southeast Asia since the 1MDB scandal first broke five years ago. Just how much might Goldman have to pay in US regulatory fines, refunds of overcharged fees and restitution to Malaysia? “There is a wide range of outcomes on what the fines and penalties could be,” notes Betsy Graseck, analyst for Morgan Stanley. Although she has pencilled in a financial hit of only US$1.8 billion for Goldman at a minimum, Graseck notes that The Foreign Corrupt Practices Act’s (FCPA) anti-bribery provisions permit fines of up to twice the amount of fees obtained, in addition to returning the fees.

Christian Bolu, analyst for Sanford C Bernstein in New York, estimates that Goldman will have to disgorge its US$600 million fees from the 1MDB bonds, plus a minimum of US$600 million in fines under anti-money laundering laws, US$100 million in FCPA fines and at least US$810 million in restitution to the Malaysian government for losses on 1MDB. That’s US$2.11 billion in total.

Bolu says he based his estimates on recent enforcement actions around anti-money laundering laws and FCPA. In 2012, HSBC Holdings paid US$1.26 billion in fines after it settled its anti-money laundering case with the DOJ. Earlier this year, US Bancorp paid US$613 million in settlement of its own anti-money laundering case. Just two months ago, Brazil’s Petrobras settled its FCPA case by paying US$853 million in fines. Bolu notes that in its latest regulatory filings, Goldman increased “provisions” for “reasonable possible losses from US$1.5 billion in the June quarter to US$1.8 billion in the last quarter, mostly for 1MDB-related fines.

Investors see a parallel between Goldman’s involvement in the 1MDB scandal and Salomon Brothers’ Treasury bid-rigging scandal in 1991 that cost its high- flying CEO John Gutfreund his job and eventually led to the demise of the bond trading giant.

Salomon was rescued by Buffett nearly 27 years ago, not as a passive investor — the way he helped saved Goldman 17 years later — but as an active interim chairman of the board who helped guide the venerable investment house to safety before exiting at a nice profit. (Salomon was bought by insurer Travelers Group which merged with Citicorp in the late 1990s to create Citigroup. Citi, in turn, sold the brokerage and wealth management unit to Morgan Stanley in the aftermath of the 2009 financial crisis.)

Like Goldman’s dismissal of 1MDB, Salomon’s bid-rigging scandal, which was initially rejected by its board as something just confined to a rogue bond trader, eventually spread all the way to the top, ultimately becoming a criminal investigation, encircling its powerful helmsman Gutfreund when it became clear he had been repeatedly alerted about the bond auctions scam but had refused to act until after the scandal became public.

That is exactly what is happening at Goldman.

Essentially, the 1MDB scandal has moved from wrongdoings by upper mid-tier executives — Leissner, Vella and Ng— to what looks potentially like a criminal “cover-up” stage where the key is not just when Goldman’s top honchos first got a whiff of the foul 1MDB stench, or exactly what they knew, but whether they deliberately tried to hide material information about the 1MDB scandal and their own involvement in it from the board, investors and other stakeholders and, indeed, have been lying about the ongoing cover-up for months, if not years.

It is now clear from Leissner’s testimony that Goldman’s then CEO and current chairman Lloyd Blankfein was reportedly at two separate meetings with Jho Low and Leissner, the first one as far back as in 2009, which was also attended by Najib, apart from a one-on-one meeting with Jho Low, and another meeting with Jho Low and Aabar CEO Mohamed Ahmed Badawy Al-Husseiny. As recently as a few months ago, Blankfein was feigning ignorance. Initially, he did not recall meeting Jho Low. Then he admitted meeting him but only because the chubby Penang-born fugitive had accompanied Najib and Leissner to their meetings.

For months, Goldman’s top honchos have also distanced themselves from Jho Low and Najib as well as know ledge of any malfeasance and bribery. Now, it turns out that they knew a lot more than they have been letting on for some time.

It seems unlikely that Goldman cutting a deal with the DOJ and agreeing to pay fines will allow its top brass to walk away unscathed. Going by the Gutfreund precedent, heads will have to roll. Six months ago, just after the Malaysian elections that ousted Najib’s government, and before Blankfein stepped down as CEO in September, Goldman probably still had the option of coming clean, admitting to malfeasance and negligence, paying fines, making restitution to Malaysia, and moving on. That easy option may have lapsed. Now, there is the matter of six additional months of cover-up, which involves not only Blankfein but also the current CEO David Salomon who took over the reins on Oct 1 and has been as vociferous in his denials as his predecessor.

Clearly, not only has the 1MDB cover-up been going on for a while now, it involved not just one or two but almost the entire top brass of Goldman at one point or another. Indeed, it was the prolonged cover-up of the bond action scam by one of its “Big Swinging Dick” traders that brought down Salomon Brothers and not the scandal itself.

Fines are not the only hit Goldman will take. Bernstein’s Bolu argues that reputational damage inflicted by the 1MDB debacle could drive Goldman’s new management team to tighten its new business approval process, especially in higher-risk emerging-market regions. In 2010, when the US Securities and Exchange Commission fined it US$550 million for pre-crisis subprime mortgage collateralised debt obligation- related issues to address the reputational fallout, Goldman formed a Business Standard Committee which recommended a tighter transaction approval process in the trading businesses. Bolu notes that constrained risk appetite is partly to blame for market share declines in its fixed income, currencies and commodities business over the last five years.

Morgan Stanley’s Graseck says her main concern is how long it will take to resolve the issue, what the fines and penalties could be and what costs Goldman will have to incur to satisfy regulators. Goldman could also potentially face a temporary ban on advisory work or capital raising in Asia. Earlier this year, Hong Kong regulators banned UBS Group from sponsoring IPOs for 18 months, after an investigation into the Swiss bank’s role in certain listings on its stock exchange. But analysts argue such regulatory action would barely make a dent since Asia accounts for just 12% of Goldman’s profits.

Whether Goldman takes a hit of over US$2.1 billion — about US$1.5 billion in fines and a US$600 million payout to Malaysia, the base case being cited by Wall Street analysts — or is forced to fork out up to US$6 billion (US$4.5 billion in a payout to Malaysia and another US$1.5 billion or so in fines plus sanctions), is moot.

What is clear, however, is that the iconic investment bank’s franchise is likely to take a big hit, quite aside from the hefty fines, and it will take years, probably even decades, to shake off its reputation, described in a 2009 profile by Rolling Stone magazine, as a “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”. — The Edge Malaysia

This story appears in The Edge Singapore (Issue 859, week of Dec 2) which is on sale now. Subscribe here