GERMAN LAWYERS investigating the near-collapse of the Hypo Real Estate (HRE) group are considering legal action against former board members of its Dublin-based subsidiary, Depfa plc.

Former directors of Depfa include ex-Central Bank head Maurice O’Connell and Frances Ruane, director of the Economic and Social Research Institute.

They could find themselves dragged into a bitter legal battle between Depfa parent Hypo Real Estate (HRE) and Georg Funke, its former chief executive and a former Depfa director.

“We are examining compensation suits against the entire boards of Depfa and of Hypo Real Estate,” Detlef Bauer of Gleiss Lutz, legal counsel to HRE, told The Irish Times.

Many of the risky activities carried out by the Dublin-based bank that brought HRE and Germany’s financial system to the brink of ruin last year took place when several prominent Irish businesspeople sat on the Depfa board.

O’Connell, who served for five years until 2007, could not be reached for comment; Ruane, a director for four years until 2006, declined to comment.

The HRE case against Funke and two other board members is expected to get under way in May.

It will put under a legal microscope the events of September 2008, when the collapse of Lehman Brothers in New York dried up liquidity markets worldwide.

That left HRE’s Depfa plc subsidiary in Dublin starved of short-term funds to cover its long-term loans. Such long-term credit is used to finance large public-private partnership projects like Dublin’s national conference centre.

Over two weekends at the end of September 2008, the federal government and leading German bankers agreed an emergency rescue package for the HRE group, spun off from HypoVereinsbank (HVB) as part of a takeover by Italy’s Unicredit.

The final rescue package cost €102 billion in loans and guarantees and was followed last year by full nationalisation.

In October 2008 the HRE board fired Funke, saying he had covered up the true extent of the banking group’s problems – right to the last-minute rescue negotiations.

A year on, Funke is suing his former employer for what he believes are outstanding financial entitlements, worth a reported €3.5 million.

The company is countersuing and its lawyer Bauer has assembled a list of reasons why the firing was legitimate. The indictment is a chastening catalogue of corporate incompetence.

The first claim is that, by taking-over Depfa in 2007, HRE bought a pig in a poke. Lawyers for HRE claim that Depfa was experiencing serious liquidity problems even before the €5.7 billion deal.

Documents shown to a recent parliamentary inquiry in Berlin confirm that Depfa’s liquidity problems were known before the HRE takeover and were not exclusively caused by the Lehman collapse.

Bauer is doubtful that the necessary due diligence was carried out before the deal went through.

“The takeover of such a large bank – bigger than HRE itself – took just two weeks,” he said. “After two weeks they made their decision, but anyone who knows their banking knows how complex things can be.”

As well as “gross negligence” in preparation for the Depfa purchase, HRE lawyers accuse Funke of presiding over faulty risk management procedures and “numerous breaches of Irish banking regulatory law” by Depfa.

The Irish Financial Regulator imposed a fine of €250,000 on Depfa ACS Bank, a subsidiary of Depfa plc, on December 16th last.

A German source claimed that the breach only came to light when Depfa itself approached the regulator. A settlement agreement was published by the regulator on December 22nd, denying it had any connection to inquiries by The Irish Times. Neither the regulator nor HRE would provide details on the dates or number of breaches.

But more general information about Depfa’s dealings in Dublin, and its role in the 2008 near-collapse, could come to light if Irish Depfa board members are quizzed during the HRE-Funke trial this year.

The picture that has emerged of Depfa in Germany in the last months is of a badly run institution that pursued risky business practices by exploiting weak supervision in Ireland and, in Germany, fragmented supervision and perfectly legal loopholes.

A parliamentary inquiry in Berlin threw some light on the frantic rescue of September 2008.

Perhaps the most enlightening description of Depfa came from Jochen Sanio, head of German regulator BaFin. He described it as a “pigsty” and HRE as “the root of all evil”.

Even without the benefit of hindsight, he said that Depfa’s juggling of short- and long-term liquidity and pocketing the difference in interest rates was less a business model than a “liquidity trap”.

Deutsche Bank chief Josef Ackermann, closely involved in the September 2008 rescue package, told the inquiry politely that Depfa “experienced liquidity problems that a well-run bank would never experience”.

The upcoming court battle between HRE and its former chief could put the Depfa meltdown in a new and interesting light.

To justify firing Funke without bonuses, the newly nationalised HRE has to paint him as incompetent. To do that, it will have to argue against the reasons used by the German government to explain its emergency intervention.

Politicians in Berlin explained their HRE/Depfa bailout as justified and necessary, adding that it was triggered by the Lehman collapse, which no one saw coming. That’s an argument HRE’s own lawyers appear now to call into question.

“In the banking business you have to be ready for risks whether or not they crop up,” said Bauer. “Of course no one saw Lehman coming, but Lehman caused many banks difficulties. The reasons not all bankers are being sued now is because, in comparison to HRE, they had adequate risk strategies in place.”

Berlin’s federal finance ministry – the new owner of Hypo Real Estate and Depfa – says it is interested but dispassionate about the upcoming legal battles between the Munich bank it now controls and its former chief executive. They say they are not concerned that this court case will throw a new light on last summer’s political inquiry.

“No one claims that everything was fine with HRE’s business model until that rescue weekend. However, the parliamentary inquiry’s job wasn’t to examine HRE’s business model but to look at whether the financial regulator did its job within the legislative possibilities available, and it did,” said a finance ministry spokesperson. “Of course there were gaps in the laws where the regulator didn’t have the ability to gain information.”

Just how glaring these gaps in Germany’s banking regulations were became clear with the evidence to the inquiry of German regulatory head, Sanio.

He said that HRE’s structure as a holding company rather than a mere bank enabled the institution to operate just outside the German regulator’s gaze. Those loopholes have since been closed.

Even though it has a different focus, May’s court battle is likely to bring us closer to an answer on the outstanding issue of blame.

“The boards of HRE and Depfa should have long changed its [short-term] financing strategy [before Lehman],” said HRE legal counsel Detlef Bauer. “The finance crisis was developing with new crises from month to month. There were signals for a worsening of the crisis. These signals should have been a reason to change the bank’s strategy.”

As well as the Funke trial in May, another case will be heard this year as shareholders expropriated by Berlin during its nationalisation challenge the legality of their so-called “squeeze out”.

Today, HRE presents itself as a reformed sinner. Though it still exists, its “strategic core” business has been renamed pbb Deutsche Pfandbriefbank and given a narrow focus on the Pfandbrief covered bonds market.

The entire group has plans to shed 1,000 jobs by 2013. Employing 260 people in Dublin, Depfa plc is headed by Cyril Dunne, who joined the company in 2007 as chief operating officer.