IBCCI’s Misgivings: Four major frauds explained in the Price Waterhouse report. 1. According to the Sandstorm Report, some $633 million of losses related to treasury trading. 2. Price Waterhouse had been doing its job, there’s no way that this $1 billion exposure [in BCCI’s Central Treasury] which was taken to $11 billion exposure in the course of 3 or 4 months [in 1985] could have happened. 3. All of BCCI’s serious treasury problems were related to the activities at Grand Cayman, which had taken place in a blatant and repetitive form over many years.
BCCI was paying its auditors $5 million per year to conduct audits which each year took nearly five months. if properly done, these audits should have uncovered the problems and forced action long before April, 1990 4. In the case of BCCI, there can be no question that the auditing process failed to work. As the Bank of England stated in determining that BCCI be closed 5. Given the demonstrable failure of the auditing process, serious questions have been raised about how and why BCCI’s outside auditors permitted BCCI to flourish as long as it did, despite fraud and other bad practices which went back many years. 6.
The record offers both support for assessing blame on BCCI’s auditors, and the suggestion that their work in the spring of 1991 was an essential component of the investigative process that ultimately forced BCCI’s closure. 7. One view of the culpability of BCCI’s accountants was expressed by BCCI’s own chief financial officer, Masihur Rahman. Rahman testified that as BCCI’s top financial official, he did not know of BCCI’s frauds prior to the spring of 1990. He testified that has the bank’s chief financial officer in London, he did not have access to any of the underlying loan information and related files at BCCI’s various field offices.
Rahman testified that he therefore relied on the work of the outside auditors, operating around the world at the local level, to review BCCI’s records at its various offices and branches, and thereby ensure their truth and accuracy. 8. At the other extreme was the position taken by BCCI’s principal auditor, Price Waterhouse (UK), that it was completely deceived by BCCI until the spring of 1990, and handled its responsibilities concerning BCCI without any fault whatsoever. 9.
If Price Waterhouse had been doing its job, there’s no way that this $1 billion exposure [in BCCI’s Central Treasury] which was taken to $11 billion exposure in the course of 3 or 4 months [in 1985] could have happened, says CFO. 10. According to Rahman, Price Waterhouse (UK) had signed off on BCCI practices year after year without issuing any red flags, until suddenly, in April, 1990, it found massive deficiencies at the bank, in which, as Senator Kerry put it, “every red flag in the world was flying,” raising the question of how Price Waterhouse could have missed all of BCCI’s bad practices previously. 1. Price Waterhouse should have known from their audit of Grand Cayman over many years that deposits of BCCI were being misused. The ‘fictitious’ loan accounts were in most cases so obviously fictitious that the year after year audit of PW should have detected most, if not all. PW not only knew about accounts where some $600 million of the fraud had at BCCI had taken place. 12. BCCI was paying its auditors $5 million per year to conduct audits which each year took nearly five months.
According to Rahman, if properly done, these audits should have uncovered the problems and forced action long before April, 1990. 13. In contrast, as Price Waterhouse expressed their position, BCCI had deceived them through colluding with shareholders and borrowers to create false documentation that mislead them. 14. The auditor’s responsibility is to design and execute an audit so as to have reasonable expectation of detecting material misstatement in the financial statements whether due to fraud, irregularity, or error.
However, common sense dictates, and it is accepted internationally, that even the best planned and executed audit will not necessarily discover a sophisticated fraud, especially one where there is collusion at the highest level of management and with third parties. Under such circumstances, it is reasonable to expect that it may take a number of annual audits before accumulating concerns change to suspicions and ultimately lead to the identification of fraud; in fact, this is what happened in audit of BCCI. 15.
Price Waterhouse found that BCCI Treasury losses had been concealed and its profits manufactured through BCCI’s failure to record deposits and other liabilities; the creation of fictitious loan accounts; the purchase and repurchase of BCCI’s own shares through nominees with buy-back arrangements; and the collusion between BCCI and major customers in supplying false confirmations to the external auditors, among other techniques. 16. $346 million related to the illegal acquisition through nominees of several US banks were identified. 17.
BCCI’s initial strategy for the United States was to infiltrate the U. S. banking system through purchasing beachhead banks in major banking centers, and then to expand the beachhead operations until BCCI had U. S. banking operations of sufficient size that they could ultimately merge with BCCI itself. 18. State regulators in New York had proven resistant to BCCI, and BCCI had successfully acquired National Bank of Georgia and FGB/First American 19. BCCI expanded in the United States by opening BCCI branch offices in regions with significant populations from the Third World engaged in rans-national commercial activity, such as Miami, Houston, Los Angeles, San Francisco, New York, and Chicago. 20. BCCI’s intention was to use these branch offices to feed depositors and banking activity to NBG and First American, expanding BCCI’s activities through pushing deposits into the federal deposit insurance system. Abedi had decided that he would work systematically to integrate the various U. S. banks BCCI now secretly owned, until the survivor was strong enough and large enough to in turn purchase BCCI 21.
BCCI’s accounts and balance sheets had been manipulated to cover-up a loan of $725 million to a Pakistan based shipping company. 22. The relationship with the Gulf Group began in 1972 when it placed very large deposits with BCCI in Luxembourg and London. There was little tangible evidence of other businesses until 1976 at which time the trade finance lines and shipping loans were opened by the Group. An amount of $1. 2bn was financed to the Abu Dhabi Company (Gulf Groups) owned by Abbas Gokal . Abbas along with his other brothers used amount of money as a lever obtain short-term funding and repayment of non-BCCI bank debt. 3. This exposure of huge sums gained the attentions of Bank of England in 1977 resulting in BCCI transferring accounts to Grand Cayman in 1978 when it became apparent that the Gulf Group faced financial difficulties. This was the time when account manipulation started which is why a ‘special duties’ was assigned the duties to oversee these accounts. This ‘special duties’ department was involved in fabricating information in respect of the ‘offshore accounts’. This included the creation of profiles of the beneficial owners, financial information, false instruction letters etc. 4. Management in collusion with Gulf used sophisticated methods of deception to conceal funds flows including: * Use of gulf ‘bank’ account which received funds and then redistributed them around a number of accounts * Transfer between Gulf locations in different parts of the world to create turnover and imply debt servicing, particularly just before year ends. * Conduit accounts at external banks, under the control of BCCI officers. * Funds transfer through BCP and nostro accounts at various BCCI branches. * Use of excessive interest and charges to provide profits 5. BCCI had used $500 million of its own resource to acquire 56% of its own shares through a series of complex transactions. The final losses may well be in excess of $4 billion and Abu Dhabi’s exposure to BCCI and related activities is estimated to be some $9. 4 billion A few other misdeeds have surfaced regarding; 26. Money Laundering From the time of BCCI’s indictment on drug money laundering charges in Tampa, Florida in October, 1988, there was little doubt to anyone looking at the facts that BCCI had been used to launder drug money 27.
Bribery The recipients of funding from BCCI may not have considered the payments to be “bribes,” but simply a mechanism by which BCCI obtained what it wanted from an official, and in return the official helped BCCI, such as BCCI’s payments to two of the Gulf emirs in return for the use of their names as nominees for the purchase of First American 28. Support of Terrorism and Arms Trafficking BCCI’s support of terrorism and arms trafficking developed out of several factors.
First, as a principal financial institution for a number of Gulf sheikhdoms, with branches allover the world, it was a logical choice for terrorist organizations, who received payment at BCCI-London and other branches directly from Gulf-state patrons, and then transferred those funds wherever they wished without apparent scrutiny. Secondly, BCCI’s flexibility regarding the falsification of documentation was helpful for such activities ENRON 29. Houston Natural Gas Corporation and Internorth Inc. merged in 1985 to form Enron Corporation.
Since its conception, Enron has distinguished itself as an innovative, prominent leader in the natural gas market. Enron, headquartered in Houston, was the largest trader of natural gas and electricity in North America. Enron also market and traded other commodities, including water, paper, coal, chemicals, and fiber-optic bandwidth. The success of Enron’s aggressive strategies is demonstrated by the rise in its stock price from a split-adjusted $3. 20 per share in 1985 to $80. 63 per share on November 20, 2000. In this same period, revenues increased from $10. 3 billion to $40. 1 billion and net income improved from a loss of $54. million to $919. 0 million. 30. As a result of its ability to discover new business opportunities, transform traditional industries, and enter new ones, Fortune magazine named Enron “Most Innovative Company” for an unprecedented sixth consecutive year in 2001. 31. Enron’s focus on innovation has been demonstrated throughout its history. As a newly formed company in the mid-1980’s, Enron pioneered the trading of natural gas when natural gas markets were deregulated. When Enron entered the electricity market in 1993, it revolutionized the industry by facilitating a market to trade electricity.
Enron was also among the first energy companies to expand beyond traditional energy markets by entering the telecommunications industry. Enron even entered the e-commerce sector by partnering with leading high-tech companies to form Enron Online, a business-to-business website that facilitates the trading of commodities. 32. Enron’s events timeline: * 1985 — Houston Natural Gas merges with InterNorth to form Enron, HNG CEOKenneth Lay becomes CEO of combined company the following year * 1989 — Enron begins trading natural gas commodities 1990 — Lay hires Jeffrey Skilling to lead the company’s effort to focus on commodities trading in the deregulated markets. Andrew Fastow is one of Skilling’s first hires later that year. * June 1990 Jeff Skilling, who has been a consultant for McKinsey & Co. , joins Enron * June 11, 1991 Enron asks the Security Exchange Commission (SEC) to approve mark-to-market accounting. * Jan. 30, 1992 SEC approves mark-to-market accounting for Enron * November 1996 Richard Kinder, COO of Enron, doesn’t get CEO job, so he leaves. * December 10, 1996 Enron announces that Jeff Skilling is taking over as COO. June 28, 1999 Enron’s Board of Directors exempts CFO Andy Fastow from the company’s code of ethics so that he can run a private equity fund—LJM1—that will raise money for and do deals with Enron. The LJM Funds become one of the key tools for Enron to manage its balance sheet and make investors think that it is performing better than it is. * October 12, 1999 Enron board exempts Fastow from Enron’s code of ethics so that he can raise money for LJM2 * August 23, 2000 Stock hits all-time high of 90 dollars. Market valuation of 70 billion dollars.
FERC (the Federal Energy Regulatory Commission) orders an investigation into strategies designed to drive electricity prices up in California * December 13, 2000 Enron announces that President and COO Jeffrey Skilling will take over as chief executive in February. Kenneth Lay will remain as chairman. * Late 2000 Enron uses “aggressive” accounting to declare 53 million dollars in earnings for broadband on a collapsing deal that hadn’t earned a penny in profit. * August 14, 2001 Skilling’s resignation announcement. In evening, analyst and investor conference call.
Skilling: “The company is in great shape…” Lay: “Company is in the strongest shape that it’s ever been in. ” Lay is named CEO 33. What went wrong- Corporate governance : The purpose of Corporate governance is to act as a ‘gatekeeper’. ENRON lacked proper surveillance on the part of its Board of Directors, Auditors and Investors. 34. Inappropriate Tools: * Mark to market: As a public company, Enron was subject to external sources of governance including market pressures, oversight by government regulators, and oversight by private entities including auditors, equity analysts, and credit rating agencies.
This method requires that once a long-term contract was signed, the amount of which the asset theoretically will sell on the future market is reported on the current financial statement. In order to keep appeasing the investors to create a consistent profiting situation in the company, Enron traders were pressured to forecast high future cash flows and low discount rate on the long-term contract with Enron. The difference between the calculated net present value and the originally paid value was regarded as the profit of Enron. In fact, the net present value reported by Enron might not happen during the future years of the long-term contract.
An overly optimistic projection was set forth. * SPE—Special Purpose Entity: Accounting rule allow a company to exclude a SPE from its own financial statements if an independent party has control of the SPE, and if this independent party owns at least 3 percent of the SPE. Enron needed to find a way to hide the debt since high debt levels would lower the investment grade and trigger banks to recall money. Using the Enron’s stock as collateral, the SPE, which was headed by the CFO, Fastow, borrowed large sums of money. And this money was used to balance Enron’s overvalued contracts.
Thus, the SPE enabled Enron to convert loans and assets burdened with debt obligations into income. In addition, the taking over by the SPE made Enron transfer more stock to SPE. However, the debt and assets purchased by the SPE, which was actually burdened with large amount of debts, were not reported on Enron’s financial report. The shareholders were then misled that debt was not increasing and the revenue was even increasing. 35. Fiduciary failure: The BOD was unable to live up to their fiduciary responsibilities. By having no proper check on the conflict of interest. 36. Conflict of Interest: Enron hired and paid its own auditors.
That was a conflict of interest built into the legal system because the auditor had an incentive not to issue an unfavorable report on the company that is paying him or her. The Board allowed conflicts of interests with the partnerships it held, and did not keep a proper oversight of the partnerships. There was also a basic lack of communication on the part of the Board to review the related party transactions. SPE’s served as a major conflict of interest. E. g. the committee failed to recognize clear elements that indicated the downfall, such as Anderson communicating that Enron was ‘pushing the limits’ since 1999.
Also, 3000 Special entities, out of which 800 were organized in tax havens. 37. High Risk Accounting: Enron’s Audits committee failed not only to guarantee the independence of the External Auditorsbut also to maintain proper accounting practices in accordance with the interest of the shareholders. It furthermore, approved transactions that were entirely designed to cover up the debts and over-stated revenues, instead of focusing on the economic outputs. Corporate Culture: Utter lack of Interest, specifically by the Board of Directors, on off-the-book financials. They had a general culture of being defensive.
They would rather cover up their own failures, than acknowledge it. Jeffery Skilling is reported to have said, “I’ve never not been successful at business or work… ever! ”Furthermore, the corporate culture did not allow open dissent. The Board was also inadequately informed; hence their decision making was clouded, and obsolete. 38. Extensive Compensation to the Executives: The Company paid millions of dollars in deferred salaries and bonuses to midlevel and high-level executives still working in late November, just before the Dec. 2 bankruptcy filing, which forced the company to suspend all such payments.
But a number of employees who had retired or recently left the company were denied similar payments. 39. Lack of Independence: Financial ties between the Board of Director and Enron and also financial ties between the external auditors and Enron. The Board was also relying too much on their auditors. They were not entirely independent, which led to variation in their process of information disclosure. They clearly shred information. 40. Transparency: The management was not transparent and truthful about the position of the company. They had a general culture of being ‘the best’ at everything, hence, they denied exposing their failures.
Enron did not live up to their duty of full disclosure and good faith. The Board did not communicate effectively with its auditors from Arthur Andersen. The idea that Enron’s employed accounting techniques were “aggressive”, wasn’t conversed clearly enough. E. g. When the CEO disclosed to the employees that the stock price was to rise, there is whatsoever no evidence of him disclosing that he was selling stock as well. Only the investigation surrounding Enron’s bankruptcy enabled shareholders to learn of the CEO stock sell-off before February 14, 2002 which is when the sell-off would otherwise have been disclosed.
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