TD money-laundering crisis complicates succession planning

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In an earlier era, Toronto-Dominion Bank’s 67-year-old chief executive, Bharat Masrani, would already have stepped aside.

A couple years past the traditional retirement age and almost a decade into his tenure — a threshold that has informally been considered a term limit for Canadian bank CEOs — Masrani instead finds himself in the middle of a major crisis that has made speculation about his fate the buzz of Bay Street.

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Succession talk had been in the air even before TD disclosed last August that its anti-money-laundering controls were being probed by authorities in the United States, including the U.S. Department of Justice. The bank is now facing fines that analysts say could top US$2-billion due to the lapses, which according to media reports led to hundreds of millions of dollars in drug money being laundered through TD’s U.S. operations. Additional sanctions or restrictions could be a headwind on growth for years.

The bank’s ultimately fruitless pursuit of U.S. regional bank First Horizon Corp. and a number of senior-level departures appear to have kept Masrani in place through the turmoil of the past few years, and some observers expect the board to keep him in the CEO job until negotiations with multiple U.S. regulatory bodies and the Department of Justice conclude.

But others are predicting changes at the top will come sooner rather than later as expectations for stiff monetary penalties and potentially growth-stalling regulatory orders rise, forcing TD into a decision at a time when its senior ranks have already been depleted.

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“Succession at TD (is) kind of like those mushy avocados sitting on my windowsill…. The right time to eat them was quite some time ago,” said Brian Madden, chief investment officer at First Avenue Investment Counsel, which owns TD shares. “Now it’s complicated. Replace Bharat now and the board, whether explicitly or implicitly, is throwing him under the bus in the court of public opinion for what happened stateside.”

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Madden noted that the regulatory and legal probes are ongoing, with information on exactly what went wrong still to come. It would be a tough call to replace him now, Madden said, “absent clear smoking gun evidence that he is unambiguously accountable.”

“But maybe that’s what needs to be done,” he added.

John Aiken, a financial analyst at Jeffries Financial Group Inc., is among those who see the anti-money laundering (AML) failures, which the bank and Masrani have acknowledged publicly, as requiring change at the executive committee level.

A shuffle late last year — one that included the appointment of seasoned anti-money laundering (AML) executive Herbert Mazariegos, recruited from Bank of Montreal — was not dramatic enough, Aiken said in a note to clients this week.

Succession at TD (is) kind of like those mushy avocados sitting on my windowsill…. The right time to eat them was quite some time ago

Brian Madden, First Avenue Investment Counsel

Despite his prediction of changes at the top, the analyst noted that senior level departures have weakened TD’s bench strength, raising concerns the board might have to reach outside the traditional bank ranks for a successor, as Bank of Nova Scotia did when it put board member Scott Thomson, who was not a banker, in the CEO role in December 2022.

TD lost one of its presumed CEOs-in-waiting in December, when Michael Rhodes, head of the bank’s personal banking business, surprised industry watchers by departing for the CEO job at Discover Financial Services. His predecessor, Teri Currie, had also been considered CEO material before an unexpected retirement in early 2022. Another TD executive, Katy Boshart, left in April to become chief executive at Manulife Bank. And former TD Ameritrade CEO Tim Hockey, long touted as a candidate to lead the bank, left the company in February 2020.

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Madden said Riaz Ahmed, president and CEO of TD Securities and group head of wholesale banking may be the most credible and qualified internal candidate, having run a few lines of business within TD and being well known to investors as the former chief financial officer. But he noted that Ahmed is already 60 years old and said his reputation could be tarnished by the ongoing probes. Tim Wiggan, group head of wealth management and insurance, is another possible contender, Madden said, though he was only put in that role in December.

“Few of the current members of the executive committee have been in their respective roles for a significant period of time,” Aiken told clients. “It is a fine line that will need to be walked, if the bank wants to avoid similar succession issues that have plagued Scotia.”

Scotia replaced then-chief executive Brian Porter in 2022 after just over nine years, a tenure that featured the exits of several potential successors and the underperformance of the bank’s shares compared to peers.

The appointment of Thomson, a former equipment, energy and telecom executive, surprised industry watchers as it broke with the long-established pattern of selecting internal executive candidates for the top job.

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Scotia’s move also put a spotlight on the status of the other big bank CEOs, three of whom had ascended to the corner office within a year of Porter.

Royal Bank of Canada’s Dave McKay, Canadian Imperial Bank of Commerce’s Victor Dodig and Masrani all began their tenures in 2014. While some industry watchers note that RBC kept previous chief executive Gord Nixon in the role for 13 years, others are predicting another changing of the guard could be at hand as the 10-year mark nears.

The spotlight, however, is now brightest on TD, which faces a challenge that goes beyond just finding a candidate with the experience needed to fill the void that Masrani, who joined the bank as a commercial lending trainee in 1987, will leave.

It just isn’t obvious to me that Masrani has failed catastrophically at this stage

A. Scott Carson, Queen’s University

Getting rid of the top executive in a developing situation that could have implications for years to come can send the wrong signal to the market and destabilize a financial institution, particularly when there is no evidence of fraud or poor lending decisions, said A. Scott Carson, professor emeritus at Queen’s University’s Smith School of Business.

“It just isn’t obvious to me that Masrani has failed catastrophically at this stage,” said Carson, a former banker who was a vice-president and division head at Canadian Imperial Bank of Commerce in the early 1990s.

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He said what’s going on at TD bears little resemblance to corporate fraud collapses like Enron Corp. and Worldcom that sideswiped some Canadian banks in the early 2000s.

“That’s where you get rid of the CEO — and soon,” said Carson, whose expertise is in business strategy and organization.

Outside of Masrani’s age and tenure at the bank, which could have led to a graceful retirement a couple of years ago before the regulatory probes came to light, Carson said TD’s board of directors will be weighing factors including whether the problems with the bank’s AML controls were due to isolated regional circumstances or tied to a shortcomings in direction, compensation or supervision across the bank. The Wall Street Journal reported last week that employees in New York and New Jersey were bribed with gift cards by individuals who laundered hundreds of millions of dollars in proceeds from illicit drug sales by buying cashiers cheques and wiring funds to thousands of individuals.

“From a board member’s point of view, you would say, ‘OK, is this a localized (problem)? Is the real problem, the big problem where all the noise is, is it three branches?’” Carson said. “‘Is it something that regional management needs to deal with, or is it a major bank systemic issue?’”

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In a statement in response to the media reports last week, Masrani said banks are “relentlessly” targeted by criminals attempting to launder money and he acknowledged that there were “serious instances where the bank’s AML program fell short and did not effectively monitor, detect, report or respond.” But he also reiterated the bank’s message that the matters under investigation are not in any way related to TD’s good faith dealings with customers.

Masrani said the bank is in the midst of implementing a comprehensive overhaul of its U.S. and global AML program, investing more than $500 million in “program remediation and platform enhancements.” This includes investments in new technology, processes, and controls to enhance oversight across the bank, stepping up account monitoring and mandatory reviews, accelerating escalations and introducing activity prohibitions.

It’s a messy and complicated situation now … which also might make it difficult to recruit a strong external candidate if they opt to go that route

Brian Madden, First Avenue Investment Counsel

The bank has brought on hundreds of AML professionals and is unrolling new enterprise-wide training programs to improve program performance and consistency.

Carson said Masrani may have stayed in his position longer than envisioned because TD had announced a US$13.4 billion deal to buy U.S. regional bank First Horizon Corp. and was trying to navigate the close of the transaction into the first several months of last year, before the AML probes were disclosed to investors in August. The First Horizon transaction was ultimately cancelled in May 2023, with the banks citing uncertainty over the timing of regulatory clearance.

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“If they had made a big acquisition, and it was going to take two or three years to roll out, I’m not sure what would be the right time for him to leave,” said Carson. And now, with ongoing talks with three regulators and the U.S. Department of Justice, it could be an equally bad time to get rid of Masrani, a stable presence through its entire and largely successful expansion into the United States. “I’m not sure that this is, in either scenario, a good time for him to go,” Carson said.

Madden said there might have been a window after the First Horizon deal cratered last year if Masrani had groomed a clear successor, but that time has passed.

“It’s a messy and complicated situation now … which also might make it difficult to recruit a strong external candidate if they opt to go that route,” he said.

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Rajesh Vijayaraghavan, an assistant professor at the University of British Columbia’s Sauder School of Business, said the bank’s board may want Masrani to stick around while the money-laundering probes conclude, though he said any further revelations and reputational risk for the bank will also play into the decision.

Vijayaraghavan, who worked in global risk management at Bank of America Merrill Lynch from 2006 until 2011, echoed Carson in flagging that it’s possible that the current problems at TD are concentrated in one region, which wouldn’t be entirely surprising for a bank that has grown in the U.S. through a series of acquisitions of both branches and consumer loan and deposit portfolios.

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“It may very well be … a bank that was bought through a legacy merger,” he said. “It might have been quickly integrated or sometimes, you know, if you grow quickly, that’s also problematic because you have not revisited your risk practices.”

Even if that is the case, it may not be enough stop regulators from imposing limits on TD’s growth in the U.S., which could extend for several years, according to analysts. Aiken, the Jeffries analyst, now believes a consent order from regulators could constrain TD’s growth in the U.S. for five years or more and spill over into prohibitions on mergers and acquisitions in wealth management or other segments of the financial services sector.

“In addition, we believe that these ongoing issues could place headwinds on organic growth,” Aiken wrote in his note to clients Monday. “It is not hard to imagine that the regulators would not be willing to … allow TD to open additional branches until the AML issues were resolved to their satisfaction.”

Given the lack of communication from the company, we’re left to speculate that the likely replacement will be an external banker

Anthony Visano, Kingwest & Company

Such constraints on growth would tarnish Masrani’s legacy and could potentially damage the bank’s prospects more than hefty fines. Aiken pointed out that TD has enough excess capital that it could take a hit of more than US$7 billion before having to raise additional capital in the markets. Investors won’t be happy, though, as they would envision that money better spent on share buybacks, the analyst wrote.

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Gabriel Dechaine, an analyst at National Bank of Canada, said in a note to his clients last week that, in a worst-case scenario, TD’s future annual earnings potential could be reduced by $1 billion, or seven per cent of forecast earnings in present value dollars. His calculations include the financial impact of a cap on asset growth, higher compliance costs, foregone earnings on excess capital and five years in the regulatory “penalty box.”

As for how TD comes out the other side of this, Vijayaraghavan said Masrani and the board have taken actions that demonstrate a serious desire to fix the problems decisively — including recruiting an experienced global AML executive who reports directly to the CEO and committing significant funds to the overhaul.

A positive sign from a risk perspective is that there is notable overlap between TD’s audit and risk committees, which should ensure reports about anti-money-laundering activities are not “siloed” at the board level. Vijayaraghavan added that the bank’s public-facing information and regulatory filings indicate, for the most part, that the culture and “tone at the top” was that AML controls should be taken seriously.

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That could have an impact on how TD fares in its home market, where banks must follow guidance on anti-money-laundering controls and culture set out by the Office of the Superintendent of Financial Institutions. OSFI shares responsibility for cracking down on money-laundering and terrorist financing with the Financial Transactions and Reports Analysis Centre of Canada, which dinged three of Canada’s big banks, including TD, in recent months with administrative penalties of less than $10 million each for infractions found during compliance reviews.

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Ultimately, for TD, letting its regulatory issues force its hand on succession could be the bigger mistake.

Masrani came to the job as a seasoned banker and TD veteran, having run the U.S. bank and having served as a senior executive in roles across the bank’s global footprint, including as chief risk officer, CEO of TD Waterhouse in Europe, country head for India and head of corporate banking in Canada.

Anthony Visano, managing director at Kingwest & Company, a longtime TD shareholder, said there has been no indication from the bank about who might bring the necessary chops.

“We have no visibility into CEO candidates,” he said. “Given the lack of communication from the company, we’re left to speculate that the likely replacement will be an external banker.”

Whether top candidates will want to start the job until the dust has settled is an open question.

As Madden put it: “Who wants to spend their first two years wrangling with regulators cleaning up your predecessor’s mess?”

• Email: bshecter@postmedia.com

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