BCCI AND ITS ACCOUNTANTS
External auditors of banks everywhere play a critical role in the self-regulatory process by which both ordinary depositors as well as players in the financial marketplace evaluate their own business performance, and that of those with whom they may place their savings or do business. In addition, in many foreign jurisdictions, external auditors of banks are relied upon by regulators to provide them with important internal information about bank practices, performing the kind of function in those countries that federal bank examiners do in the United States.
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:
It appears from the Price Waterhouse Report [of June 1991] that the accounting records [of BCCI] have completely failed and continue to fail to meet the standard required of institutions authorised under the Banking Act. It further appears that there is not [a] proper or adequate system of controls for managing the business of BCCI.(1)
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. 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.
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.
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.
As Masihur Rahman expressed his position, regarding the auditors' handling of BCCI's first set of major losses in 1985:
I used to tell the Price Waterhouse and Ernst & Whinney to please review these reports and also please keep me informed, because you are more my eyes and ears than my own inspection division . . .[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.(2)
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.(3) From Rahman's point of view, local auditors at each of BCCI's locations had the opportunity to review the underlying loan documentation from the beginning. Rahman believed that process of review was precisely what they had been hired to do and failed at. From his point of view, as chief financial officer, his job was to accept the numbers provided him and audited locally the accountants, and from there to put together the overall financial accounts of BCCI. Thus, the deceptions that took place were made possible through the auditors' failure to have looked sufficiently closely at BCCI's customer-by-customer financial records around the world, and especially in the Grand Caymans. As Rahman explained in an annotation to the report prepared by Price Waterhouse to the Bank of England in June, 1991 which helped bring about the closure of BCCI globally:
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 ICIC Overseas accounts [where some $600 million of the fraud had at BCCI had taken place] but irregularly "certified these accounts. . . It all happened in, or were initiated by Grand Cayman. . . done by a few people in an amateurish way, right under the nose of PW (Grand Cayman) and PW (UK), who had done audit of these units from their inception (1975.)(4)
Rahman further stated to the British inquiry into BCCI undertaken by Lord Justice Bingham that essentially 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. According to Rahman, 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.
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:
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 our audit of BCCI.(5)
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 use of funds from ICIC which were controlled by BCCI; use of third party funds which BCCI was managing; circular routing of funds using various BCCI affiliates; 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.(6)
In fact, many aspects of BCCI's relationship to its auditors, especially Price Waterhouse's partnerships outside the United States, were sufficiently unusual to provide evidence for both the positions expressed by Rahman and by Price Waterhouse.
Over BCCI's nineteen year existence, BCCI lent at least two Price Waterhouse partnership's funds for business projects, while those partnerships were auditing BCCI; had an affiliate make substantial payments to at least one key former Price Waterhouse official after he had had handled audits of BCCI; allegedly "took care" of Price Waterhouse partners through providing benefits to them such as the use in the Grand Caymans of a villa; according to federal regulators, made use of BCCI-Hong Kong to handle its routine banking needs in the Far East; and according to one BCCI official, may even have been compromised by mid-level BCCI employees who allegedly provided them with sexual favors for that purpose.
Moreover, when Price Waterhouse (UK) discovered massive losses at BCCI in 1985 which the bank falsely characterized as commodities trading losses, Price Waterhouse (UK) accepted BCCI's explanation and did not undertake the kind of comprehensive review of BCCI's Treasury operations in the Grand Caymans which should, even then, according to statements by various BCCI officials, have demonstrated BCCI's fraud.
After 1985, Price Waterhouse (UK) made note of and reported to BCCI's directors and officers exceptionally poor practices by many BCCI entities year after year, including BCCI's failure to keep adequate records. Nevertheless, Price Waterhouse (UK) did not inform regulators of this or other problems at BCCI until April, 1990, and continued through 1990 to sign off on BCCI's annual statements that its consolidated audits "give a true and fair view of the financial position of the group."
Moreover, Price Waterhouse (UK) according to its own audit reports was told by BCCI officials in years prior to 1990 that they had violated U.S. law in failing to inform the Federal Reserve of changes in ownership by shareholders of CCAH/First American, and in various practices relating to CCAH/First American. Yet the firm took no action to advise any regulator, let alone the Federal Reserve, of what they had knew -- or, alternatively, to resign their position as BCCI's auditors.
In defense of the auditors, it should be noted that BCCI's top officials, key major shareholders and some principal borrowers did seek to deceive them through creating false records and documents. The full nature and extent of the fraud would indeed have been difficult to penetrate, given BCCI's far-flung empire and structural complexity, and the bank's decision for its first 15 years of operation to divide responsibility for its audits between Price Waterhouse and Ernst & Whinney, thus ensuring that no one auditor had an overall view of its activities. It is also true that once Price Waterhouse recognized that the hole in BCCI's books had grown so significant that it threatened the solvency of the institution in early 1990, they brought the matter to the attention of the Bank of England. As a result, from that date forward, the Bank of England shared in whatever blame might be attached to Price Waterhouse's decisions following that date, and prior to its final certification of BCCI's books in April, 1990.
A full understanding of what took place between BCCI and its auditors has been severely impeded by the inability to obtain documents and testimony from BCCI's principal auditors, especially Price Waterhouse. While Price Waterhouse's US partnership provided full cooperation regarding its audits of BCCI activities in the United States, it took the position that it had neither any knowledge of, or responsibility for, BCCI's overall auditing, which was handled solely by their affiliated partnership in the United Kingdom, Price Waterhouse (UK).
Price Waterhouse (UK), which handled the consolidated audit of BCCI world-wide from 1987 on, and which previously was responsible for over 15 years for the audits of one of BCCI's two flag banks, BCCI Overseas (Grand Cayman), where a substantial portion of the frauds took place, refused to provide the Subcommittee with any of its voluminous audit reports pertaining to BCCI in response to the subpoena of the Committee on Foreign Relations. Price Waterhouse (UK) argued that provision of such material was precluded by British law, and that the British partnership of Price Waterhouse did not do business in the United States and could not be reached by any subpoena.
Price Waterhouse (US), which said it did not possess any documents pertaining to BCCI operations outside the United States, explained its relationship with other Price Waterhouse partnerships in other countries as one of a loose affiliation of independent partnerships linked together by a set of agreed-upon standards for audit work, but entirely separate from one another in legal responsibilities. As set forth in a Price Waterhouse (US) letter to Subcommittee staff on October 17, 1991:
[T]he 26 Price Waterhouse firms practice, directly or through affiliated Price Waterhouse firms, in more than 90 countries throughout the world. Price Waterhouse firms are separate and independent legal entities whose activities are subject to the laws and professional obligations of the country in which they practice. . .
PW-US, like other Price Waterhouse firms throughout the world, is a separate and distinct partnership. For your immediate purposes, it is appropriate to note that no partner of PW-US is a partner of the Price Waterhouse firm in the United Kingdom; each firm elects its own senior partner; neither firm controls the other; each firm separately determines to hire and terminate its own professional and administrative staff. . . each firm has its own clients; the firms do not share in each other's revenues or assets; and each separately maintains possession, custody and control over its own books and records, including work papers. The same independent and autonomous relationship exists between PW-US and the Price Waterhouse firms which practice in Luxembourg and Grand Cayman.(7)
As Price Waterhouse (US) partners explained to the Subcommittee, when Price Waterhouse, or any auditing firm, signs off on an audit and certifies that its audit represents a true and accurate picture of a company's books, the certification is not made by Price Waterhouse as a single entity, as would be true in a corporate structure. Rather, the certification is made by, and binds only the members of the partnership of the accounting firm in the country in which they themselves are certified as accountants.
In the case of BCCI, Price Waterhouse (UK), relying on work performed by its affiliates in a number of locations around the world, conducted the consolidated audit of BCCI from 1987 through 1992. During that time, many other Price Waterhouse partnerships, including Price Waterhouse (US), provided Price Waterhouse (UK) with written summaries of BCCI's financial condition locally, in accordance with their audit instructions from Price Waterhouse (UK), which were then incorporated into the consolidated accounts of the group. Questions about BCCI's activities in the Grand Caymans or Panama or Colombia could be answered only by Price Waterhouse (UK), in connection with its consolidated audits, or by the local partnerships of Price Waterhouse in those countries.
Thus, under the partnership system that all the international accounting firms use, Price Waterhouse (US) has maintained that it has no knowledge of, or responsibility for, a consolidated audit certified by any of its partnerships in other countries, including those done pertaining to BCCI. Accordingly, in response to the Committee subpoena to Price Waterhouse, Price Waterhouse (US), provided complete documentation of its work on behalf of BCCI in the United States, but no documents regarding Price Waterhouse's work on behalf of BCCI elsewhere, including its reports to BCCI's board of directors, and the background to its annual certifications of BCCI's books and records. On these critical issues, Price Waterhouse (US) referred all questions to Price Waterhouse (UK), which in turn took the position that it was legally precluded by British bank confidentiality and privacy laws from providing any of the documents subpoenaed by the Committee. In lieu of testimony or documents, Price Waterhouse (UK)'s attorney provided the Subcommittee a copy of the firm's written answers to questions from a Committee of the British House of Commons.(8)
It is worth noting, for the record, Masihur Rahman's view that for years, Price Waterhouse has held themselves out to be a global firm with uniform standards and one single responsibility. According to Rahman, Price Waterhouse brochures were submitted to BCCI repeatedly emphasizing Price Waterhouse's global integration as a critical strength of the firm.
Due to Price Waterhouse (UK)'s refusal to respond to the subpoena, the Committee has been unable to obtain a complete set of Price Waterhouse's audit reports concerning BCCI, and has had to rely on fragments of such reports obtained from the Federal Reserve and other sources amounting to a small percentage of the total work. As a result, for some years, no audit reports of any kind have been obtained. For other years, the audit reports obtained are limited to fragments of the whole. These fragments do provide some important information about Price Waterhouse's concerns about BCCI from the early 1980's on; unfortunately, the fragments exclude other critical information necessary to evaluate the history of Price Waterhouse's handling of these audits.
In reaching its conclusions, the Subcommittee has sought to make use of all available information, including the answers provided by the auditors to questions from the British House of Commons. However, given the incomplete state of the information the Subcommittee has been able to obtain, it is possible that additional documents from the auditors concerning BCCI could have changed the conclusions reached by the Subcommittee on some of these matters. It is therefore especially unfortunate that the foreign auditors refused to honor the Committee's subpoena.
As noted above, reaching conclusions concerning the responsibility of the auditors in connection with BCCI's maintenance of its deceptions until July, 1991 have been hampered by the inability to obtain full documentation and any interviews from any of BCCI's foreign auditors. Nevertheless, the information and testimony gathered by the Subcommittee is adequate to find:
** BCCI's decision to divide its operations between two auditors, neither of whom had the right to audit all BCCI operations, was a significant mechanism by which BCCI was able to hide its frauds during its early years. For more than a decade, neither of BCCI's auditors objected to this practice.
** BCCI provided loans and financial benefits to some of its auditors, whose acceptance of these benefits creates an appearance of impropriety, based on the possibility that such benefits could in theory affect the independent judgment of the auditors involved. These benefits included loans to two Price Waterhouse partnerships in the Caribbean. In addition, there are serious questions concerning the acceptance of payments and possibly housing from BCCI or its affiliates by Price Waterhouse partners in the Grand Caymans, and possible acceptance of sexual favors provided by BCCI officials to certain persons affiliated with the firm.
** Regardless of BCCI's attempts to hide its frauds from its outside auditors, there were numerous warning bells visible to the auditors from the early years of the bank's activities, and BCCI's auditors could have and should have done more to respond to them.
** By the end of 1987, given Price Waterhouse (UK)'s knowledge about the inadequacies of BCCI's records, it had ample reason to recognize that there could be no adequate basis for certifying that it had examined BCCI's books and records and that its picture of those records were indeed a "true and fair view" of BCCI's financial state of affairs.
** The certifications by BCCI's auditors that its picture of BCCI's books were "true and fair" from December 31, 1987 forward, had the consequence of assisting BCCI in misleading depositors, regulators, investigators, and other financial institutions as to BCCI's true financial condition.
** Prior to 1990, Price Waterhouse (UK) knew of gross irregularities in BCCI's handling of loans to CCAH/First American and was told of violations of U.S. banking laws by BCCI and its borrowers in connection with CCAH/First American, and failed to advise the partners of its U.S. affiliate or any U.S. regulator.
** There is no evidence that Price Waterhouse (UK) has to this day notified Price Waterhouse (US) of the extent of the problems it found at BCCI, or of BCCI's secret ownership of CCAH/First American. Given the lack of information provided Price Waterhouse (US) by its United Kingdom affiliate, the U.S. firm performed its auditing of BCCI's U.S. branches in a manner that was professional and diligent, albeit unilluminating, concerning BCCI's true activities in the United States.
** Price Waterhouse's certification of BCCI's books and records in April, 1990 was explicitly conditioned by Price Waterhouse (UK) on the proposition that Abu Dhabi would bail BCCI out of its financial losses, and that the Bank of England, Abu Dhabi and BCCI would work with the auditors to restructure the bank and avoid its collapse. Price Waterhouse would not have made the certification but for the assurances it received from the Bank of England that its continued certification of BCCI's books was appropriate, and indeed, necessary for the bank's survival.
** The April 1990 agreement among Price Waterhouse (UK), Abu Dhabi, BCCI, and the Bank of England described above, resulted in Price Waterhouse (UK) certifying the financial picture presented in its audit of BCCI as "true and fair," with a single footnote material to the huge losses still to be dealt with, failed adequately to describe their serious nature. As a consequence, the certification was materially misleading to anyone who relied on it ignorant of the facts then mutually known to BCCI, Abu Dhabi, Price Waterhouse and the Bank of England.
** The decision by Abu Dhabi, Price Waterhouse (UK), BCCI and the Bank of England to reorganize BCCI over the duration of 1990 and 1991, rather than to advise the public of what they knew, caused substantial injury to innocent depositors and customers of BCCI who continued to do business with an institution which each of the above parties knew had engaged in fraud.
** From at least April, 1990 through November, 1990, the Government of Abu Dhabi had knowledge of BCCI's criminality and frauds which it apparently withheld from BCCI's outside auditors, contributing to the delay in the ultimate closure of the bank, and causing further injury to the bank's innocent depositors and customers.
As specified in the chapter of BCCI's criminal activity, BCCI was from its earliest days made up of multiplying layers of entities, related to one another through an impenetrable series of holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and nominee relationships. By fracturing corporate structure, record keeping, regulatory review, and audits, the complex BCCI family of entities created by Abedi was able to evade ordinary legal restrictions on the movement of capital and goods as a matter of daily practice and routine. As a result, the records of BCCI's criminal activity were buried beneath a layering that substantially impeded anyone's ability to make sense of them.
Yet, this problem was not something which developed slowly, near the end of BCCI's existence in 1991, but rather, a structure which BCCI's head, Abedi, created from the earliest days of the bank, and which was accepted for over a decade by both of BCCI's principal auditors, Price Waterhouse and Ernst & Whinney.
According to Masihur Rahman, he recognized the potential for abuse in the system developed by Abedi from the beginning, and insisted on retaining top accounting firms for BCCI as a mechanism to counter Abedi's complexities. As Rahman explained it:
Soon after formation of the bank, it started as BCCI S.A. which was the Luxembourg Bank, but within a couple of years, Mr. Abedi decided to restructure it, and the holding company was produced. It was called BCCI Holdings. And the bank underneath it, BCC S.A. was split into two parts, one bank was left with its head office in Luxembourg called BCCI S.A., and another bank was created with its head office in Grand Cayman. The BCC S.A. bank was mostly with European and Middle East locations, and BCC Overseas Bank was mostly Third World countries. . . .
Well, the more number of entities there are in any organization, obviously the more isolation you can put each section to. And if you do an intercompany position, then unless you know both companies' position, you could get half a picture. So there was that situation also . . .
Because I realized the danger of this evolving structure and the management style, I insisted that we had the best and biggest auditors. And so we from the early days had two of the biggest audit firms, Ernst & Whinney which became Ernst & Young, and Price Waterhouse.(9)
Initially, both the holding company and all BCCI's other banks other than its Grand Cayman's banking unit, BCCI Overseas, was handled by Ernst & Whinney, with BCCI Overseas in Grand Caymans as a "flag-ship" bank, handled by Price Waterhouse from its formation in 1975. According to Rahman, in an effort to deal with BCCI's "free-wheeling structure," both firms were instructed by him to notify him, as BCCI's chief financial officer, of any abnormalities they encountered at the local level in the course of their audits, as they found them, and not to wait until the end-of-the-year audit to report them. Moreover, controls were placed on BCCI's Treasury operations requiring the Treasury department of BCCI to maintain 90 percent of its deposits in a liquid form -- such as placements with prime banks and U.S. and European government securities -- and permitting the Treasury to engage in trading on no more than a maximum of 10 percent of BCCI's dollar surpluses, which would limit the exposure to about $100 million in all.
The earliest audit for which the Subcommittee has been able to obtain any records consists of a few sample pages of audit findings and recommendations from Price Waterhouse Grand Caymans to BCCI dated December 31, 1983, prepared by Price Waterhouse Grand Cayman personnel Richard W. Harris and Richard D. Fear. As of the end of 1983, the auditors found that BCCI's loan portfolio contained:
a relatively high concentration of risk to a number of prominent clients. The inherent risk associated with these major exposures is significant in the context of the capital base of the Bank particularly in cases were advances have been made on an unsecured basis.(10)
Accordingly, the auditors recommended that BCCI consider limiting the maximum loan exposure to individual clients or groups, and increasing its loan loss provisions. The pages provided the Subcommittee do include references to other problems with the bank, but the full explanation of those problems was apparently set forth on pages not obtained by the Subcommittee.
Excerpts from a report prepared in 1984 by Price Waterhouse provides a fuller account of the nature of the problems Price Waterhouse had previously found. While again the documents provided are fragmentary, they contain the following:
Although there have been marked improvements in the quality of the credit files maintained at Head Office [Grand Cayman's] we have again noted instances where the files contain inadequate financial information such that the credit worthiness of the borrow cannot be readily established.(11)
Portions of an internal control report prepared by Price Waterhouse dated April 26, 1986 concerning BCCI's Grand Caymans office described numerous additional problems pertaining to BCCI's lending practices and documentation:
We noted instances where funds had been disbursed . . . prior to the perfection of the security arrangements required . . .
Instances were noted in which items of security were not supported by independent valuations . . .
We have noted some instances where the documentation received by the Bank to create a charge or pledge over security had been accepted without any evidence of consideration having been given to its legal enforceability in the jurisdiction in which the enforcement would be made . . .
We noted instances where exposure exceeded authorized limits, occasionally by significant amounts, and also that in many such cases such excesses were caused by the accrual of interest. . .
During the course of our audit we had several requests from local auditors to review loans for which documentation was not available locally . . .
No regular reporting procedures exist at Head Office whereby senior management, the Central Credit Committee or the Board of Directors are notified of non-compliance with the terms and conditions of borrowing, particularly in relation to the non-payment of principal and interest . . .
We noted instances whereby the interest rate being applied to an account differed from that quoted . . .
We noted instances, where for general reasons of confidentiality, certain borrowers were designated with a numbered account reference rather than the account being entitled with the full name of the borrower. Whilst we have no particular objection to this practice, we found that in most instances none of the officers of the Grand Caymans office were able to correctly identify either the name of the borrower or the credit officer responsible for monitoring the account at other locations. . .(emphasis added)
We noted instances of errors occurring in the accounting records at Head Office accounting to ensure their completeness and accuracy. . .
We have noted during the past few years that the level and number of staff loans booked at Head Office has steadily increased but that regular monitoring is not carried out to ensure that the terms and conditions of such loan are being followed.(12)
Asterisks adjacent to a number of these concerns were placed by the auditors to indicate issues which they had previously raised with BCCI, in some cases for several years. Many of the concerns taken independently might not be cause for unusual concern. But taken together, they demonstrate at minimum that as early 1986, BCCI's auditors knew of a significant number of exceptionally poor practices at BCCI concerning its record keeping, treatment of interest to borrowers, handling of numbered accounts, and handling of accounts where customers were failing to pay interest or principal or both.
While Price Waterhouse may have considered BCCI's poor banking practices to be a demonstration of a lack of sophistication or professionalism on the part of BCCI, in fact, these practices, taken together, were essential mechanisms by which BCCI maintained its global frauds.
For example, BCCI's practice of simply tacking on interest to principal in cases in which loans were non-performing was necessitated by its practice of using nominees to disguise transactions in which BCCI was the real party at interest, such as BCCI's secret ownership of First American. The nominees understood from the beginning that they were not responsible for paying interest, and that BCCI would take care of it. The simplest means for BCCI to take care of it, was, so long as the auditors permitted it, to just add the interest to the principal. Then, when BCCI was ready, it would proceed against the borrower, its nominee, and "acquire" the property secured by these loans. Accordingly, BCCI often would not want any independent valuation of the secured property, because its intention from the beginning was to own or control the secured property -- such as First American -- rather than to sell the property if its "borrower" did not pay BCCI back its "loan."
Similarly, the practice of BCCI officials not being able to identify the borrower behind a numbered account, or the BCCI officer responsible for monitoring the account at other locations, would have been a logical means of compartmentalizing knowledge about accounts in order to limit the possible criminal exposure of the officials and the bank for irregular loans or drug money laundering. To the extent that an official monitoring a numbered account cannot identify a customer, he cannot very well know the quality of his credit or the source of the customer's funds. To the extent that the official cannot identify the other bank officials involved in monitoring the account, they can each claim that they are not responsible for the recovery of this loan, or in a drug-related case, did not possess adequate knowledge to recognize that the funds they were moving were laundered funds.
Without speculating on the possible reasons for these deficiencies, or expressing any concerns that these deficiencies might not be inadvertent on the part of BCCI, the auditors made a number of recommendations to BCCI in 1986 on how to correct them:
We recommend that efforts be made to obtain current financial and other supporting information in respect to all borrowers. . .
We recommend that, except in the most exceptional circumstances, funds should not be disbursed prior to the perfection of any required security arrangements. . .
We recommend that independent valuations be obtained on a regular periodic basis to enable the adequacy of security to be properly monitored. . .
We recommend that all charge or pledge documentation be approved by the legal department before funds are disbursed . . .
We recommend that loans should not be allowed to be drawn down in excess of approved limits prior to increased facilities being sanctioned in writing. . .
We again recommend that, in accordance with the group policy, interest on loans against which there is a specific loan loss provision is always created to reserve and not to income . . .
We again recommend that the Central Credit Division take positive steps to ensure that branch managers throughout the Bank are fully aware that they are responsible locally for maintaining complete credit files for all loans. . .
We recommend that procedures be introduced to enable management to readily identify non-performing loans. . .
We recommend that all credit files contain written authorization to support the interest rate being applied to an account. . .
We recommend that the Head Office manager maintain a private register of borrowers using numbered accounts. . .
We again recommend that procedures be introduced to monitor and control staff loans and advances.(13)
These recommendations, if followed by BCCI, and if insisted upon by Price Waterhouse, backed up by the threat of qualifying the accounts, or by the threat of resignation, would have limited BCCI's ability to continue to engage in many of the deceptions that were essential for its continued survival -- including the use of nominees to own BCCI's secretly-held subsidiaries, such as First American and the Independence Bank. In practice, BCCI continued over its remaining five years of life to abide by few of these recommendations, with the result that the auditors repeated them year after year, with ever greater specificity, while continuing to sign off year after year on BCCI's accounts, concluding that their audit reports represented a "fair and true" picture of BCCI's actual financial status when in fact they did not.
In 1985, BCCI and its auditors faced the first major crisis of the bank. The crisis came in one of BCCI's flag-ship operations -- BCCI Overseas (Grand Caymans), which had been audited from its inception by Price Waterhouse. The crisis was acute and involved BCCI's Central Treasury. It required the recognition of a loss of approximately $500 million, the equivalent of the bank's entire capitalization. BCCI characterized the loss as due to as trading losses in the securities and commodities markets, ostensibly brought about through unauthorized trades by a junior BCCI officer, Ziauddin Akbar, who had been placed to run the Treasury Department by BCCI CEO Abedi.
By the account of BCCI chief financial officer Rahman, Abedi and Naqvi had permitted Akbar to take "very, very large exposures," in securities and commodities trading, in what was actually a Ponzi scheme, in which front-end commissions received, representing offsets against liabilities under open futures contracts, were treated as profits rather than as offsets, and actual losses were hidden through BCCI taking ever-larger futures positions in securities and commodities trades to create offsets against the past losses; plus additional "profit" as and when required; until by the autumn of 1985 the forward exposures had become $11 billion against a board approved limit of $1 billion. According to Rahman:
This was done by not more than two or three of the executives in the treasury division directly under Mr. Naqvi.(14)
These huge losses imperiled BCCI on several accounts. First, they had nearly wiped out the capital of the bank, and BCCI would have to find ways to recapitalize. Second, they suggested recklessness on the part of BCCI's top officials, and made many wonder what had prompted the recklessness. But most dangerous of all, these losses could have prompted a thorough review of all BCCI's books and records from the beginning by BCCI's auditors, a review which would have brought down the bank if the auditors had discovered the frauds involved.
As Ziauddin Akbar later told associates, the truth was that the losses had taken place over a number of years and were in fact not really losses at all, but falsified bookkeeping instituted by Abedi and Naqvi to inflate BCCI's books and show phony profits. According to Akbar, he agreed to be the scapegoat for the losses in an effort to avoid a situation in which the auditors would conclude that there been systematic fraud at BCCI, conducted at the top. In fact, the auditors wrongly concluded that the losses had taken place over a short period, and that did not force the further review of BCCI documents which would likely have revealed the years of systematic and massive fraud in the bank's books.(15)
Instead, Price Waterhouse, working closely with Abedi and Naqvi, agreed to the shift of $150 million from the ICIC Staff Foundation/Trust to meet part of this loss, and then splitting the balance of the loss into three years on technical grounds. Akbar was fired, and BCCI was saved.
Nevertheless, recognition of the losses was costly for BCCI. The losses became a significant factor in the decision soon thereafter of BCCI's regulators in Luxembourg, the Institut Monetaire Luxembourgeois (IML) to notify BCCI's other regulators that the Luxembourg authority was unhappy with its responsibility for monitoring BCCI while BCCI actually was headquartered in London. Moreover, it brought about a crisis among the auditors themselves.
According to Ernst & Whinney, the Treasury losses had caused it to doubt whether the auditors could trust BCCI and Naqvi, although Price Waterhouse's confidence in Naqvi remained unshaken. As Ernst & Whinney told the British House of Commons:
PW say that "Until Price Waterhouse exposed him [in 1990], Naqvi enjoyed the respect and engendered the confidence of all those who met him". E&W's confidence in Mr Naqvi was shaken when it was told for the first time on 13 February 1986 of the problems in the Treasury Division of BCCI Overseas and of his involvement therein.(16)
In May 1986, Ernst & Whinney advised BCCI that unless they were permitted to assume responsibility for the whole audit and BCCI's management style were changed and its record keeping systems were improved, they would resign from their commission as auditors for BCCI. In addition to the Treasury losses, Ernst & Whinney were concerned about "a marked reluctance by both Mr. Abedi and the board of BCCI Holdings to take prompt action to disclose these [Treasury losses] to the regulators, to disclose them in the group accounts in a manner satisfactory to E&W and to discipline those responsible." Finally, Ernst & Whinney had advised BCCI that if it were to continue to act as the bank's auditors, BCCI needed to achieve "a marked improvement in the financial and managerial controls exercised throughout the group."(17)
Over the following several months, BCCI, Ernst & Whinney and Price Waterhouse had extensive discussions about the changes which needed to be implemented, and had mutually agreed about the nature of the changes to be put into effect.(18) Nevertheless, for reasons which Ernst & Whinney has declined to specify, it resigned from further work auditing for BCCI, leaving Price Waterhouse for the first time in the position of being BCCI's sole global, consolidated auditor. At the time of Ernst & Whinney's withdrawal, it was auditor to 12 of BCCI's various subsidiaries and affiliates, and Price Waterhouse was auditor for the remaining 19.(19)
Year after year, BCCI's auditors continued to find evidence of poor banking practices and imprudent lending on issues unrelated to the massive Treasury losses. In its end of year report for 1987, Price Waterhouse noted numerous concerns on accounts involving close to $1 billion of exposure to BCCI involving many of the accounts which regulators would later conclude involved front-men. Yet no action was taken by Price Waterhouse, by BCCI's directors, or by regulators who later received these reports, to require any concrete action by BCCI, backed up by sanctions for any failure to comply, to correct the obvious banking irregularities.
For example, in its 1987 audit of accounts pertaining to the Gokal brothers and their shipping empire, the Gulf Group, Price Waterhouse found that exposure to the group amounted to $318 million -- or 23 percent of BCCI's capital base, with exposure rising every year, repayment performance "below expectations," security held against the lending likely unenforceable, and financial information regarding the loans "inadequate." Three years later, Price Waterhouse would conclude that on many of the Gokal related loans, the financial information was not merely "inadequate" but non-existent. Price Waterhouse also found that "cash allocations to [some Gokal] accounts appear to be arbitrary and, as a result of this and the lack of formal repayment schedules, it is difficult to assess the underlying performance of each account."(20)
In the same set of audits, Price Waterhouse found that BCCI faced exposure on loans to former Saudi intelligence chief Kamal Adham of over $200 million, involving large, unsecured exposures, "poor interest repayment performance," "no evidence of long term repayment schedule," "other related exposures with BCCI/ICIC," and that bank documents showed little evidence of regular contact between BCCI and Adham.(21) Worse, Price Waterhouse found that many of the shares Adham had in the First American Bank, CCAH, were pledge as security for loans BCCI had made to other BCCI borrowers. Nevertheless, Price Waterhouse did not require that the loans to Adham -- or to the Gokal brothers -- be classified or that BCCI make "provision" against them, so long as BCCI promised to correct the problems in the account in the future, which BCCI of course did not do.
The audit of the Adham accounts mirrored that of the audit of the accounts of his successor at Saudi intelligence, Abdul Raouf Khalil. In its end of the year audit for 1987, Price Waterhouse described the situation in the following terms:
AR Khalil is a Saudi Arabian national who has had facilities with the bank for a number of years. In the past the bank operated a large investment trading portfolio on his behalf, however this ceased in 1985 and he now channels his trading activities into Capcom Financial Services Limited, an independently managed investment house with a paid up capital of f25m of which he owns 20%.
Little is known publicly about Khalil, however he is the owner of a substantial museum of Arabian artifacts in Jeddah reputed to be worth some $350m. This value is inherently subjective, but it is understood that he is attempting to arrange the sale of the museum to the Saudi Arabian authorities.
- Lack of documented evidence of contact with borrower for 1987
- Balance confirmation outstanding
-Lack of evidence of long term repayment schedule
-Lack of formal documentation to secure CCAH shares . . .(22)
Price Waterhouse expressed its anxieties about the Khalil account, but once again, decided that it would not force BCCI to classify any of the loans to Khalil as doubtful or bad, or require BCCI to make provision in a manner that would be reflected in its public audit, again so long as BCCI promised to clean up the problems in the future:
We remain concerned about his account however no provision will be required for 1987 providing:
- the account balance is confirmed to us by the borrower
- interest for 1987 is fully repaid
For the future we require:
- full loan files to be maintained to include all details of correspondence, meetings and other pertinent evidence of the monitoring the account
- adherence to an agreed repayment schedule
- formalization of security arrangements.(23)
In the months that followed, BCCI did not undertake any of the promised reforms, but Price Waterhouse took no action to force BCCI's hand for another two years.
The Subcommittee was not able to obtain any of Price Waterhouse (UK)'s reports to BCCI covering the period between December, 1987 through December, 1988, which includes the date of the indictment of BCCI and seven of its officers on drug money laundering charges by the U.S. Attorney in Tampa in October 1988, following a "sting" by the Customs Service.
Audit reports to BCCI from Price Waterhouse dated November 17, 1989, demonstrate that BCCI had made very little progress in responding to any of Price Waterhouse's expressed concerns, but that relations between Price Waterhouse and BCCI had remained cordial and cooperative, and that Price Waterhouse felt at the time that BCCI was actually "performing reasonably."
The audit report begins with the following sanguine assessment:
Overall the bank has performed reasonably over the past year considering the significant repercussions that could have resulted from the US indictment. The Group has continued to remain relatively liquid and also attract some new business.(24)
While over the course of the report, Price Waterhouse reiterated several of the concerns it had previously expressed in various other audit reports taking place over the previous six years, its overall tone was of an auditor reporting that outstanding issues were in the process of being resolved. While not free of all warnings and caveats, this 1989 interim report did indeed, consistent with Masihur Rahman's testimony, imply that no obvious major problems existed.
The Subcommittee does not have any coherent account of why, suddenly, Price Waterhouse began in the spring of 1990 to shift from its previous position of politely making recommendations to BCCI to change its behavior, to aggressive criticism of practices at the bank that for the most part it had already been aware of for years. However, the consequences for both Price Waterhouse and BCCI were obvious. Under British law, Price Waterhouse in finding gross irregularities at BCCI, would now be able to report these findings to the Bank of England, and thereby share any responsibility for BCCI's future.
In the April 1990 audit report, Price Waterhouse found that all the previous practices it had condemned and recommended be corrected, had instead persisted and worsened. Among Price Waterhouse's findings was the recognition that BCCI's lending in connection was among serious problems facing BCCI. As Price Waterhouse noted:
** BCCI faced more than $850 billion of exposure in connection with lending for First American (CCAH). BCCI's practices regarding these loans were atrocious. The number of shares pledged by some borrowers had been changing from year to year. BCCI held blank transfer deeds and powers of attorney on the shares that allowed it to transfer them at will, against lending that had been for First American itself, or any other lending to First American's shareholders. Worse, BCCI's were giving conflicting stories about whether BCCI itself owned First American or not. In past years, Price Waterhouse stated, they had been told that BCCI held all the shares of First American, and not simply those pledged as security on lending. This year, they were saying the reverse.(25)
** Many of the loans for First American had never been reduced to writing with loan agreements involving the shareholders, so there was no real way to determine what the terms of the lending were supposed to be, or whether the shareholders had actually authorized them.
** The files maintained by the bank concerning the $850 billion in lending against First American were sparse, with little evidence of customers acknowledging decisions concerning their "investments," let alone directing them.
** Interest was not being serviced on loans for First American. And the interest charges BCCI was crediting on the First American loans were substantial, without evidence that the shareholders had agreed to the interest charges.
** Audits of two companies, Midgulf and Rubstone, who had secured loans from BCCI against their ownership of stock in First American, had been certified by representatives of BCCI shareholder Mohammed Hammoud, yet now BCCI was stating that Hammoud did not own those companies, and it was not clear who, if anyone, did.
** In the past, management had told the auditors that they had not reported all the changes in share holdings in First American to federal regulators as required by law.
Price Waterhouse thus acknowledged for the first time that there were serious questions as to who owned First American, and that it had known from past representations by BCCI management that the bank was violating U.S. laws in failing to tell regulators about changes in ownership when they occurred.
Other findings of the new audit reports by Price Waterhouse were equally damning. Price Waterhouse found that there had been little or no direct contact with Saudi intelligence figure A. R. Khalil since 1985. Yet Khalil had still somehow purchased an additional 57,748 shares of BCCI in April 1989 in a rights offering, with money loaned by BCCI. Price Waterhouse found this disturbing, given "an apparent breakdown in the relationship between the borrower and the bank," and the fact that Khalil had not made any interest payments in five years on previous borrowing from BCCI. Price Waterhouse also found that documentation to support Khalil's borrowings from BCCI was absent, and representations by various BCCI officers about his relationship with the bank were "inconsistent." Price Waterhouse found it impossible to determine whether Khalil still owned the 13,250 shares of First American/CCAH attributed to him, which BCCI held as security against $120 million it had ostensibly lent Khalil.(26)
The new Price Waterhouse reports on BCCI's relationship with the Gokal brothers and their Gulf shipping group, who together owed BCCI over $400 million, were similarly dismal. Price Waterhouse noted in addition to the kind of problems described above, violations of Indian and Pakistani exchange control violations in connection with loans to the Gokals, and statements by BCCI management that the auditors should look to the relationship of trust between the Gokals and BCCI's top officials rather than to any documents in determining BCCI's ability to recover its lending to the Gokals.(27)
Concerning BCCI's banking arm in Kuwait, the Kuwait International Finance Company (KIFCO), Price Waterhouse found that placements recorded by BCCI with KIFCO were inconsistent with Kifco's financial statements regarding the same transactions. Price Waterhouse noted that the principal mechanism for repaying Kifco's loans from BCCI was a mysterious Kuwaiti entity called "the IZ company for Exchange," and that "we now have suspicions as to the propriety of the transactions." Price Waterhouse noted that it had requested access to KIFCO's records which had been denied.(28)
Concerning BCCI's relationship with its Swiss banking representative (and secretly held subsidiary) Banque de Commerce et de Placements SA (BCP), Price Waterhouse stated "Swiss secrecy laws have prevented us from being provided with information relating to customer accounts by the incumbent auditors," and described a number of transactions involving BCCI, its affiliates, and BCP, which Price Waterhouse could not penetrate.(29)
Concerning BCCI front-man Mohammed Hammoud, Price Waterhouse noted that it had no evidence that Hammoud owned any of the companies to which BCCI and its Grand Caymans affiliate ICIC had lent some $110 million. Worse, various companies which had BCCI officials had previously said were owned by Hammoud were now being claimed by BCCI officials not be owned by Hammoud, but by others, who in turn reiterated that Hammoud did own the companies. Finally, Hammoud supposedly now owned 2.6 million shares of BCCI itself, but there were no records backing up this purported ownership.(30)
Concerning the Saigol family, who now owed BCCI $44 million, Price Waterhouse found that there was no evidence that loans or interest on loans were being repaid. Worse, BCCI had lied about the Saigol accounts to the auditors in the past:
Representations previously given about the beneficial ownership of companies to which new loans were extended in Bahrain in 1989 have been false. The loans have been given, in part, to repay delinquent loans in other locations.(31)
The reporting on lending to other prominent BCCI shareholders such as Ghaith Pharaon, the bin Mahfouz family, and members of the Abu Dhabi royal family raised similarly serious problems.
In total, the new audit reports by Price Waterhouse -- the first of which reached BCCI acting head Swaleh Naqvi in February, 1990 -- were devastating, and raised fundamental questions as to whether the bank could -- or should -- survive. And yet the information in the audits was different from previous audit reports largely in tone and detail rather than in substance. All but one or two of the issues identified had been raised by the auditors before, and reasons for the sudden shift in attitude remain obscure.
Price Waterhouse's own account of the sudden change is unilluminating. As it told a committee of the British House of Commons in February, 1992:
Our 1987 and 1988 audits revealed imprudent lending: during the 1989 audit we identified that, contrary to management's previous assurances, further lending had been permitted on the major customer accounts where the credit risk was already heavily concentrated. Additionally, around this time, Price Waterhouse identified certain loan transactions in a number of locations for which senior management were unable to provide adequate explanation. Price Waterhouse communicated concerns about these matters and their implications on the credibility of management to the Bank of England early in 1990.(32)
What appears to have happened is that the auditors had spent many years detailing record keeping, documentation, and other problems with BCCI's lending practices, without having had any appreciable impact on change those practices, while each year receiving approximately $5 million for their audit work. By early 1990, it was becoming increasingly clear that the lending problems were so severe that the auditors themselves might be held at risk if they did not alert authorities. What is striking is Price Waterhouse's decision to notify the Bank of England "early in 1990," before it notified BCCI's own board of directors of the problems, and without telling BCCI it had reached out to the regulators. As the visible financial hole at the heart of BCCI grew ever larger, the relationship between BCCI and Price Waterhouse had finally snapped.
BCCI chief financial officer Rahman testified that he was shocked by the sudden change in attitude by Price Waterhouse, as well as by some of the information provided to him by them in their new reports, which he received on March 14, 1990:
In the usual process, the whole world audit was completed in the month of February, 1990. . .my wife and family were planning to go on holiday the later part of March, April. And when I received a call on a weekend from Price Waterhouse saying that they wanted to meet me, the partners, and -- I was a bit hesitant because I had been seeing all the partners throughout the last few months and I did not know what it was that they wanted to bring up. Anyway, I went to their office and they produced for me a whole list of what they thought was irregularities, illegalities, and misuse of funds.(33)
According to Rahman, the problem cases identified were exactly those Price Waterhouse had identified for years, but this time the attitude of the auditors was completely different.
Senator Kerry: Now, the irregularities and problems that they put forward to you had been in existence for several prior years, had they not?
Mr. Rahman: Yes. All the names that they listed were names which had appeared in prior years. . .
Senator Kerry: Some were fronts?
Mr. Rahman: Some were fronts, obviously. . . . They presented this list of huge problems whose potential loss could be $1 billion, plus. . . . They said the only thing before we go to the regulator . . . is that we can allow you to have an inquiry of your own from all our findings, and come up with your interpretation and facts.(34)
Price Waterhouse was now taking the hard line with BCCI that it had no choice but to notify the regulators, when in fact, they had already been notified. All that BCCI could do was supplement Price Waterhouse's reporting with its own analysis, which Price Waterhouse urged Rahman to undertake as head of a BCCI interim task force.
Rahman testified that as chief financial officer of a $22 billion concern, he had previously been relying year after year on the auditors reports in preparing BCCI's overall books, and had never been permitted to look at the underlying documentation himself. Now, as he began for the first time reviewing the underlying documentation on the loans, he was shocked at what he found. On the one hand, Price Waterhouse's criticisms of BCCI's operations were valid. On the other hand, from Rahman's point of view, these obvious frauds and illegal acts should have been brought to his attention years previously, and the auditors should not have permitted the practices to go on so long.
The Task Force report prepared by Rahman and three other BCCI officers during March 1990, began by acknowledging BCCI's failures, but criticized Price Waterhouse for taking so long in alerting management to how bad the problem was:
The Task Force after many hours of interviews with the concerned Accounts Executives . . . and reviewing many files and documents made available to it (most of which were of very poor quality) . . . confirms the 'concern' of PW in many of the referred cases . . . The Task Force simultaneously expresses considerable surprise and disappointment at such obvious flaws in basic banking procedures and documentation. The Task Force feels that the annual audit thereof should have easily detected and corrected such haphazard transaction several years ago.
The Task Force concludes that there is little doubt from the sparse records available and inadequate explanations given by the Accounts Executives/Officers that there must be some 'interlocking' arrangements between the shareholders of both BCCI Holdings (Lux) SA and CCAH whereby in several cases 'nominee' routes may have been taken to front each others investment in these two banking groups with corresponding loans being drawn from BCCI (& ICIC) to fund such 'interim' holdings. . .
It took the Task Force only a few days to note that nearly each of these cases had common patterns of initiation, activity, fund flow, weak documentation and vague explanations from the concerned account officers which any reasonable audit process should have tracked down, identified and stopped forthwith. That is extended over so many years is a great disappointment to the Task Force -- particularly since their initiations was all rom the same source in Grand Caymans (and London).(35)
Thus, as of April, 1990, both Price Waterhouse and BCCI's senior financial official, Rahman, had explicitly recognized, in writing, BCCI's dire financial condition, its poor lending practices, and its frauds in connection with First American and other matters. Ironically, in the weeks to come, it would be Rahman who would voluntarily resign his commission and leave BCCI, and the auditors who would stay and try to find a way to save the bank.
On April 18, 1990, Price Waterhouse provided a report to the Bank of England which stated that a number of financial transactions at BCCI booked in its Grand Caymans affiliates and other offshore banks were "false and deceitful," and that it was impossible at the present time to determine just how far the fraud reached. Thus, a critical decision had to be made. Either BCCI had to be closed down now, or the Bank of England itself had to give its assent to keeping it open in some new form as a means of avoiding losses to BCCI's million or more depositors. New management needed to be installed. New financing had to be found, and the holes in BCCI's books had to be plugged.
The obvious solution was to ask Sheikh Zayed and the government of Abu Dhabi to take over the bank. As Zayed and the Al Nayhan family who ruled Abu Dhabi had been major depositors of BCCI, and had long had billions in family finances handled by BCCI, they stood to lose as much as anyone if the bank collapsed. Accordingly, Abu Dhabi would have to be told the truth about BCCI's perilous condition, and asked to commit funds to keeping the bank solvent.
A series of urgent meetings were held in Abu Dhabi and Luxembourg, beginning in March, 1990, in which Naqvi confessed his errors and resigned from his position as CEO at BCCI. A new management team was brought in. Unfortunately, rather than constituting a strong group of banking professionals, the new team was headed by a long-time Abu Dhabi insider from BCCI itself, Zafar Iqbal, the former head of BCCI's branch in the United Arab Emirates, the Bank of Credit and Commerce Emirates, or BCCE, who had long had a close personal relationship with important members of the royal family of Abu Dhabi arising out of his provision of intimate personal services for them in Pakistan and elsewhere. Within the bank, Iqbal was not considered to be an expert on much besides pleasing the Abu Dhabi royal family. BCCI junior officers knew him as the man who had for years provided "singing and dancing girls" to the royal family, and related personal services.(36) BCCI operations were moved, with the apparent approval of the Bank of England, to Abu Dhabi, along with all of BCCI's most important records. And assurances were given to Price Waterhouse that Abu Dhabi would back BCCI all the way.
These assurances were needed because Price Waterhouse was threatening to refuse to sign-off once again on BCCI's books with an unqualified audit report, and relations between the auditors and BCCI had deteriorated substantially after BCCI's directors had criticized the auditors for providing their audit reports to the Bank of England. On April 20, a meeting was held in Luxembourg with the shareholders in which Price Waterhouse made a dire presentation, and during which Abu Dhabi representatives advised Price Waterhouse that Abu Dhabi would make an open-ended financial commitment to bail out BCCI. As Price Waterhouse stated to the chairman of the Abu Dhabi Finance Department on April 25, 1990:
Your representative, HE G Al Mazrui, has confirmed to use that you are fully aware of the nature and magnitude of the uncertainties and prepared to provide the necessary financial support in the event that losses arise from realisation of these loans.(37)
In return for Abu Dhabi bankrolling BCCI's restructuring, Price Waterhouse would agree to certify BCCI's books, subject to a single caveat -- that the basis of the preparation of the certification was Abu Dhabi's intention to maintain BCCI's capital base while it reorganized and restructured. Instead of telling the world the truth -- that the consolidated accounts reported by Price Waterhouse in April 1990 did not in fact give a "true and fair view of the financial position of the group at December 31, 1989," Price Waterhouse contends that it did, using the Abu Dhabi commitment as its justification for so doing.
In justification of this decision, Price Waterhouse stated the following:
The circumstances existing in the last week of April 1990, when Price Waterhouse had to decide on the form of report on the accounts of BCCI for the year ended 31 December 1989, were extremely complex as there was material uncertainty about the recoverability of significant loans and advances shown in the balance sheet. Significant matters taken into account including the following:
-- The Abu Dhabi Government had given a commitment to indemnify BCCI against loss either by taking over balances at no loss to BCCI or by contributing equivalent funds to make good any losses incurred on the loans and advances in question;
-- the Government of Abu Dhabi and related institutions had taken a controlling (over 77 per cent) interest in BCCI and stated their intention to make further share acquisitions and to reorganize and restructure BCCI;
-- the Bank of England the Institut Monetaire Luxembourgeois had been informed of all the uncertainties known to Price Waterhouse and of the financial support commitment by the Government of Abu Dhabi and had decided to allow BCCI to continue to operate;
-- whilst evidence of certain false and deceitful transactions had been discovered we believed the extent of these transactions to be limited to a small number of specific situations;
-- the individuals in management who were thought to have been responsible were to be removed.(38)
Accordingly, after receiving these sign-offs from everyone else involved, including most importantly the Bank of England, Price Waterhouse signed off once again on BCCI's books stating:
In our opinion, the consolidated accounts give a true and fair view of the financial position of the group at December 31, 1989 and the results of its operations and changes in financial position for the year ended in accordance with International Accounting Standards.(39)
The certification was subject to a small footnote, listed as Note 1 in BCCI's annual report, which cited that the "Basis of Preparation" for the Price Waterhouse report was the fact that "the Government of Abu Dhabi has subscribed US$400 million for new shares and acquiring a major holding from an existing shareholder such that together with related institutions they now hold over 77 per cent of the share capital of the holding company. They have advised the directors of their intention to maintain the group's capital base whilst the reorganization and restructuring necessary for its continued development is undertaken." Price Waterhouse also charged off a loan loss for BCCI of $600 million, a loss for the year of nearly $500 million, and a reduction in shareholders equity of approximately 50 per cent, from $886 million to $424 million. In so doing, Price Waterhouse for the first time recognized losses that had in actuality, taken place over many preceding years.
By agreement, Price Waterhouse, Abu Dhabi, BCCI, and the Bank of England had in effect agreed upon a plan in which they would each keep the true state of affairs at BCCI secret in return for cooperation with one another in trying to restructure the bank to avoid a catastrophic multi-billion dollar collapse. Thus to some extent, from April 1990 forward, BCCI's British auditors, Abu Dhabi owners, and British regulators, had now become BCCI's partners, not in crime, but in cover-up. The goal was not to ignore BCCI's wrongdoing, but to prevent disclosure of the wrongdoing from closing the bank. Rather than permitting ordinary depositors to find out for themselves the true state of BCCI's finances, the Bank of England, Price Waterhouse, Abu Dhabi and BCCI had together colluded to deprive the public of the information necessary for them to reach any reasonable judgment on the matter, because the alternative would have been BCCI's collapse.
For its part, in June, 1990, Price Waterhouse was actually to file another report with the Bank of England, known as a Section 39 report, finding that BCCI's systems and controls were satisfactory -- findings that Price Waterhouse would have to entirely abandon just five months later.
In April, 1990, Naqvi and the other chief officers who resigned with him from their positions in BCCI were placed under house arrest in Abu Dhabi, as Abu Dhabi took formal control of BCCI. Unfortunately, as it did so, it did not disclose to Price Waterhouse certain information that it now had about the extent of the fraud at BCCI, and it took positions that had the clear intention of seeking to sweep the true nature of BCCI's problems under the rug, and to avoid the disclosure to BCCI's regulators of what had really taken place. Essentially, Abu Dhabi was now seeking to make certain that the money it was spending on BCCI would suffice to keep secret the relationship between Abu Dhabi and other Arab shareholders in BCCI, even, as necessary, from Price Waterhouse, the outside auditors for the bank it now owned.
In September, 1990, Price Waterhouse learned that BCCI had concealed further lending of over $500 million to its major customs by "parking" that lending with a Middle Eastern bank, namely, the National Commercial Bank of Saudi Arabia controlled by Khalid bin Mahfouz, the most powerful banker in the Middle East, who was later indicted in the United States in connection with his activities pertaining to BCCI and First American. This was bad enough, but was worse was the fact that since Naqvi's removal, the practice had continued, "with the knowledge and approval of the Board representative of the controlling shareholders" -- the government of Abu Dhabi. The auditors had begun to realize that Abu Dhabi was now colluding with BCCI in continuing fraudulent practices, and in hiding them from Price Waterhouse.
According to Price Waterhouse, worse was to come. Since March or April, 1990, Naqvi, who had personally handled many of BCCI's frauds, had been living under house arrest in Abu Dhabi. Incredibly, Abu Dhabi had decided to retain Naqvi as a consultant to advise them on BCCI, and were giving him access to BCCI's documents. Even more incredibly, Naqvi was said to be maintaining some 6,000 files personally in Abu Dhabi, whose very existence had still never been disclosed to the auditors. For months, as Price Waterhouse continued its efforts to review BCCI's books, it had been lied to by BCCI and it was finding, by Abu Dhabi, kept in ignorance of some of the bank's most vital records, and only stumbling onto the fact of their existence in November, 1990.
As Price Waterhouse described it, when they confronted Abu Dhabi with their concerns about Naqvi, and a request to review the files he controlled, they were told by Abu Dhabi authorities that the auditors could not have access to them, and that they would remain under the control of the discredited Naqvi:
Price Waterhouse's report to the directors of 3 October 1990 revealed that management may have colluded with some of BCCI's major customers to misstate or disguise the underlying purpose of significant transactions. Following this, the controlling shareholders of BCCI [Abu Dhabi], under pressure from Price Waterhouse, agreed to a full investigation of the problem accounts and to enforce the resignations of Abedi and Naqvi as directors.
An Investigative Committee comprising representatives from Price Waterhouse, E&W Middle East Firm (who were auditors of the Abu Dhabi Government interests), two firms of lawyers and the Abu Dhabi Government was established in November 1990 to supervisor the investigation into the problem accounts. Price Waterhouse were advised by senior BCCI management that Naqvi had been retained as an "advisor" to provide explanations to the Abu Dhabi Government and that they could not have access to files being used by him. Price Waterhouse made clear to the controlling shareholders that without access to Naqvi and the files he was using there could be no investigation.
Ultimately access was granted and we were shocked to find that Naqvi was holding around 6,000 files. After initial steps to secure the files, a preliminary review revealed that amongst them were details of transactions and agreements not previously disclosed to us despite management's prior assurances that they had provided all relevant information to Price Waterhouse.(40)
For reasons the auditors could not fathom, Abu Dhabi had placed Naqvi, a principal architect of BCCI's frauds, in charge of BCCI's most important and secret records without telling them. For the past eight months, Naqvi and Abu Dhabi had maintained exclusive control of those records, with essentially unlimited opportunities to destroy them or falsify them throughout that time. By the time Price Waterhouse finally obtained access to these records in November and December, 1990, it found massive fraud in the materials that still existed. But the auditors had no way of determining the extent to which those documents were already cleansed of any material damaging to the new owners of BCCI, along with any other material which Abu Dhabi or Naqvi wanted hidden forever.
Throughout the remainder of 1990, and the spring of 1991, BCCI, Abu Dhabi, and the Bank of England continued to work on a restructuring of BCCI as a means of saving the bank, with the intention of collapsing its dozens of entities into three banks, to be based in London, Abu Dhabi, and Hong Kong. At the same time, Price Waterhouse continued to provide each of them with the information that the fraud at BCCI was massive, and that the losses associated with the fraud were mounting into the billions. All the while, BCCI, Abu Dhabi, the Bank of England, and Price Waterhouse worked together to keep what they knew about BCCI secret. The secrecy had become critical now that they all knew about the ongoing criminal investigation into BCCI taking place in New York City by the District Attorney. Each made a strenuous effort to prevent the District Attorney from obtaining the Price Waterhouse audit reports which contained the information that if known would destroy BCCI. But by late 1990, the District Attorney, after months of effort, had obtained some of the audit reports, and appeared to be narrowing in on an indictment of BCCI.
Oddly enough, Price Waterhouse continued to resist finding that fraud had taken place for many months after the information available to it provided ample basis for such a conclusion. As late as its October, 1990 report to the Bank of England, the auditors avoided concluding that BCCI was involved in fraud, and suggested that they believed that the restructuring and remedial efforts being taken would be adequate to solve the bank's problems.
During December, 1990, at the very time that the New York District Attorney had obtained some of the most critical of its earlier audit reports, Price Waterhouse completed its initial review of the formally hidden Naqvi files. In that review, Price Waterhouse found evidence of phony loans and hidden deposits amounting to hundreds of millions of dollars, nominee arrangements, hold harmless agreements relieving borrowers of any obligation to repay loans, and other, similarly criminal practices at the bank. Again, to Price Waterhouse's shock, Abu Dhabi had known of these practices since at least April, 1990, and never disclosed them to the auditors.(41)
The implications of these findings for BCCI's future were devastating. If there were in fact deposits that had been made to BCCI amounting to hundreds of millions that had never been recorded at the bank, how was anyone to ever determine what claims by BCCI depositors might be real, and what claims might be phony? Price Waterhouse decided that it dare not put this information in writing, and would confine itself to reporting it orally to the Bank of England, which it did in January 1991. In response, Abu Dhabi again agreed to make good any losses in connection with these unrecorded deposits.
In the months that followed, Price Waterhouse began tracing the circuitous routing of funds between BCCI and its Grand Caymans affiliate, ICIC, and found additional fraudulent activity amounting to as much as $1 billion through this mechanism alone. In March, the Bank of England commissioned it formally to investigate BCCI under Section 41 of the UK's Banking Act. Finally, on June 22, 1991, Price Waterhouse delivered a draft report to the Bank of England, known under British law as a Section 41 report, demonstrating that "fraud on a significant scale had been committed and that it had involved a significant number of people both inside and outside the bank."(42) Nine days later, at the direction of the Bank of England, BCCI's offices around the world were closed down and BCCI ceased to exist.
Given the limited extent of BCCI's official activities in the United States, which were limited to state-licensed local branches and representative offices, and not licensed to accept deposits in the United States, the audit activities of BCCI's United States outside auditors, Price Waterhouse (US), were extremely narrow in scope. As noted above, Price Waterhouse (US) responded to a subpoena by the Committee by providing all requested documents and full cooperation regarding any materials it possessed regarding BCCI in the United States.
These documents demonstrate that over the course of that audit relationship, Price Waterhouse (US) did find that BCCI's U.S. offices maintained inadequate documentation on many of their loans, and engaged in other sloppy banking practices. But the documents provided by Price Waterhouse (US) to the Subcommittee also confirmed that Price Waterhouse (US) handled its auditing of BCCI's U.S. activities professionally and diligently, albeit within the narrow confines of its commission from its UK partnership.
Such a finding might be odd, given BCCI's extensive involvement in this period in laundering funds from Latin America and the Caribbean. But until the spring of 1989, the Price Waterhouse (US) audits were designed to look only at lending practices and overall bookkeeping issues, rather than the issue of whether BCCI might be laundering funds from abroad. Moreover, given Price Waterhouse (US)'s ignorance of BCCI's true relationships with First American, the Independence Bank, and other entities, there would have been any number of improper activities by BCCI in the United States in the aggregate that would fall outside the ordinary purview of auditors.
In early 1989, after BCCI had been indicted on money laundering charges in Tampa, Price Waterhouse (US) was selected by BCCI to create a compliance program under which BCCI would submit to extremely rigorous standards for the handling of transactions from abroad which were designed to trace and stop money laundering. The compliance program was put into place under a June 1989 Memoranda of Understanding with the Federal Reserve, which permitted BCCI to stay open in the United States only if it developed policies to insure its compliance with Bank Security Act and anti-money laundering regulations.
The Price Waterhouse compliance program, designed to be state-of-the-art, for the first time established a comprehensive anti-money laundering regime at BCCI, and forced BCCI's U.S. offices to become ever more careful in handling funds from foreigners. Its implementation was effective, and its results positive in terms of compliance with U.S. law for BCCI's U.S. branches, but very negative in terms of BCCI's U.S. cash-flow. As Price Waterhouse (UK) noted in November, 1989:
We understand there has been a noticeable drop in the funds transferred from other BCCI locations to the US agencies because of this onerous requirement to obtain the necessary details from their customers. Most of their US dollar transactions formerly with the US agencies are being routed to third party banks. Management are investigating this matter to satisfy themselves that there is nothing untoward in such transactions.(43)
By insisting the BCCI's offices in the US document where their funds were coming from, Price Waterhouse had ended the ability of the U.S. offices to engage in profitable activity. BCCI's business dried up, demonstrating the degree to which the US operations had been functioning largely to launder dirty money from other countries in the first place.
However, there were substantial limitations the effectiveness of the compliance effort undertaken by Price Waterhouse, which were built into its design by BCCI. Originally, Price Waterhouse (US) had proposed to BCCI the establishment of a very broad global review of the bank's procedures to insure that the bank was able to stop laundering money world-wide, and turn BCCI into bank that rigorously honored the laws of every country in which it did business. On February 1, 1989, Price Waterhouse (US) wrote Robert Altman to propose to:
Work with BCCI officials on an immediate to medium term plan to regularize the bank's regulatory and supervisory status on a global consolidated basis. This would necessitate visiting key supervisors around the world and learn of their concerns and expectations and provide the framework to enable BCCI to meet these expectations.(44)
The naive approach by Price Waterhouse (US) was of course, incompatible with BCCI's survival. BCCI could tolerate such a program in any case. But by 1989, the UK auditors already knew of dozens of problems that BCCI was supposed to have cleaned up and had failed to rectify. That failure was because the practices were ones which BCCI relied upon for its continued survival. If BCCI had agreed to permit Price Waterhouse (US) to undertake this court, Price Waterhouse (US) would have swiftly learned of these practices, and possibly have been forced to tell U.S. regulators about them. But there was an even more direct problem. The information already contained in Price Waterhouse (UK)'s audits, that there had been massive lending by BCCI on CCAH shares and securing those shares, contained the great secret that BCCI effectively owned controlled First in violation of U.S. laws. Such a confrontation with reality was obviously not in BCCI's interests, or in the interest of Altman himself. The terms of engagement were swiftly narrowed to include only an anti-money laundering compliance program focused on the particular BCCI entities that had been implicated in the C-Chase sting in Tampa. The narrower engagement was signed by Price Waterhouse and sent to Altman, as BCCI's attorney, on March 9, 1989.(45) For this engagement, together with its regular audits of BCCI branches, Price Waterhouse (US) received approximately $4.5 million per year.(46)
Thus, before hiring the Price Waterhouse (US), BCCI and Altman narrowed the framework for their efforts, with the result that they were sufficiently narrow to preclude Price Waterhouse (US) from learning of problems at BCCI in the United States already known to Price Waterhouse (UK), but apparently never communicated to their US affiliated partnership.
One especially troubling aspect of BCCI's relationship to its accountants was its practice of providing them with loans. While the Subcommittee has not been able to determine the complete extent of this practice, the Subcommittee has received documentation of at least two such instances -- the first involving a 1987 loan of BDS $587,000 to Price Waterhouse's partners in Barbados, the second involving a loan of $17,000 to Price Waterhouse's partners in Panama in 1984, increased to $50,000 a year later.(47)
Even within BCCI, this practice was controversial. When Price Waterhouse applied for the Panama loan, BCCI official A. M. Akbar wrote Amjad Awan, then head of BCCI's Panama branch, to express his concern about the propriety of lending money to one's auditors:
The firm is our auditors and we do not consider it proper to sanction or enhance the limit of USDLR 50,000.00 to our own auditor. However, we shall re-exam the matter on receipt of your justification as well as your confirmation that local laws does not prohibit loans & advances to the company's auditors.(48)
In response, Awan advised Akbar that "there are no restrictions about advances to company auditors [which] may be allowed" and the lending was approved.
Separately, regulatory reviews of the books and records of Capcom Financial Services Ltd., BCCI's commodities trading affiliate, showed payments of $100,000 by Capcom to former Price Waterhouse Grand Caymans partner Richard Fear in the three years since he left Price Waterhouse in 1986. Fear had previously handled audits of the books of BCCI in the Grand Caymans, the location of many of the worst frauds at BCCI.
Both Capcom's head, Ziauddin Akbar, and former Price Waterhouse partner Fear, had been held at fault in connection with BCCI's massive trading losses in 1985, described above, which were discovered in 1986. At the time, Akbar was the head of BCCI's Treasury, and therefore held responsible for the losses, and Fear was the principal person responsible for insuring the propriety of BCCI Grand Cayman's books and records.
In late June, 1992, at the behest of the Serious Fraud Office of the United Kingdom, Royal Cayman Islands police conducted dawn raids of Price Waterhouse officers in the Grand Caymans, as well as the home of Fear and a second Price Waterhouse partner there, as well as the office of Price Waterhouse's local Grand Caymans attorney, conducting searches for records.
In late February, the Subcommittee requested copies of any reports or memoranda created by Price Waterhouse concerning Fear and BCCI, and related documents. Price Waterhouse refused to provide the documents requested, stating that in its view it was "inappropriate to produce the work product of its lawyers for examination by any governmental or private third-party," and that in any case, "Mr. Fear's participation [in PW's investigation] was predicated upon implicit understandings of confidentiality." However, despite the "implicit understandings of confidentiality" Price Waterhouse reached with Fear, Price Waterhouse did advise the Subcommittee that it had concluded Fear was innocent of wrongdoing in accepting funds from BCCI's affiliate, Capcom. According to Price Waterhouse (UK):
Richard Fear left the employment of PW-UK in July, 1986. . . PW-UK first became aware of the payments to Mr. Fear mentioned in the Wall Street Journal article, in September, 1991.
Upon learning of the payments, PW-UK obtained Richard Fear's agreement to cooperate in an inquiry by lawyers acting for PW-UK. Counsel for PW-UK had discussions on the subject with Richard Fear and ascertained from looking at various records which he showed to them that the payments were indeed made in two installments in July and August 1988 by Capcom Financial Services Limited ("Capcom"). The payments, which totalled $100,000, were stated to be for referral to Capcom of potential clients requiring brokerage or investment services.
We understand that the United Kingdom Serious Fraud Office ("SFO") has investigated the circumstances in which the payments were made and has interviewed Mr. Fear. We further understand that the SFO has concluded its investigation with respect to Mr. Fear and the matter is not being pursued.
Based on all the above, PW-UK concluded that these payments by Capcom to Richard Fear, which were made two years after he had ceased to be employed by PW-UK, were unconnected with any work that he did on the audit of BCCI or while at PW-UK.(49)
According to press accounts, Fear's alleged receipt of funds from Capcom remains under investigation by the British Serious Fraud Office.
In sworn testimony before the Subcommittee on July 30, 1992, Akbar Bilgrami, formerly head of BCCI's Latin American and Caribbean region and convicted in the Tampa money laundering case, stated that he had been informed by other BCCI officials that Price Waterhouse in the Grand Caymans had been "taken care of." Bilgrami said he did not have details as to how the auditors had been taken care of, other than that it was his understanding that BCCI had provided one or more of them with the use of a villa.(50)
Robert Bench, a partner in Price Waterhouse (US), had minimal involvement in any BCCI affair while at Price Waterhouse, becoming responsible for some assistance to BCCI in early 1989 in connection with the compliance program instituted by Price Waterhouse for BCCI as part of BCCI's first consent decree with the Federal Reserve following its indictment on money laundering charges in October, 1988.
However, in his previous positions as a senior official of the U.S. Comptroller of the Currency during the late 1970's to the mid 1980's, Bench was exposed on two occasions to important information regarding BCCI which, taken together, raise questions as to Bench's handling of BCCI affairs as a partner at Price Waterhouse.
First, in 1978, as Associate Deputy Comptroller for International Banking, Bench was provided with information about a variety of shoddy banking practices at BCCI, including BCCI's use of nominees, by an OCC bank examiner working under him, Joseph Vaez. The memorandum prepared by Vaez and provided to Bench was a clear warning signal to OCC, as well as the Bank of America, which still had an ownership interest in BCCI, that BCCI was a danger to anyone involved with it. As the Vaez memorandum noted, if the Bank of America did not sever its relationship with BCCI, the OCC might well classify its entire investment in BCCI.(51)
Second, in 1985, Bench was provided a report by the CIA concerning BCCI that detailed BCCI's plans for the United States. This memorandum, described in detail in the chapter on BCCI's ties to the intelligence community, contained striking information, including the fact that BCCI secretly owned First American.
Bench testified that he had only a very limited memory of the 1985 report:
I do recall reviewing a classified piece of information that dealt with BCCI. . . it was somewhere in the middle of the '82 to '87 period. I feel comfortable about that. . . I recall receiving a document from the CIA that dealt with BCCI. To the best of my recollection it didn't deal with First American and it didn't deal with anything in the United States. There is an action step that I took within the office on that information . . . which was to look at this information in terms of LCD [Lesser Developed Country] debt.(52)
In staff interviews prior to this testimony, Bench emphasized that he had no memory whatsoever of having ever been advised that BCCI held interests in any financial institution in the United States, let alone First American.(53)
In fact, the memorandum provided Bench by the CIA focused significantly on BCCI's plans in the United States, including its ownership of a Washington, D.C., based, multistate bank holding company that Bench would have surely known was First American.
Obviously, this was information that the Federal Reserve should have had and did not have at the time that Bench was participating in BCCI's compliance program in connection with its consent decree with the Federal Reserve following its money-laundering indictment.
Bench testified that he had no memory of the 1978 memorandum prepared by Joseph Vaez for him at OCC, and that his memory of the 1985 memorandum was almost equally dim.(54) According to Bench, based on his lack of memory of either memorandum, there was no reason for him to have connected any of the information in them to his ongoing work on BCCI compliance years later at Price Waterhouse.
During that compliance work, Bench travelled to London twice to meet with BCCI officials in London, including Abedi and Naqvi, and provided technical assistance to BCCI in the United Kingdom and the U.S. in anti-money laundering matters, "under the direction of Robert Altman."(55) At the time, Altman was not only BCCI's attorney, but the President of First American. Yet according to Bench, it never occurred to him that there might be a relationship between the two institutions that needed to be understood to determine whether BCCI was truly complying with the Federal Reserve's requirements.
According to Bench, the reason for this was that the focus of the compliance effort solely focused on money laundering. As he testified:
Senator, to the best of my recollection, there was no linkage whatsoever, in any of the work we did or any of the discussions we had, with First American . . . I don't recall any First American issues . . . it was very clear that in this exercise Mr. Altman and Mr. Clifford were lawyer for BCCI.(56)
At the time Bench met with BCCI officials and Price Waterhouse (UK) partners in London, both the BCCI officials and the British accountants knew that BCCI has massive loans on First American secured by First American's shares. Bench himself had been told by the CIA that BCCI owned First American back in 1985. Thus, Bench's personal obliviousness to this issue as a partner of Price Waterhouse (US) raises obvious questions. If Bench had remembered, recognized, or understood the information that was available to him from his days at the OCC, or reviewed any of the recent audit reports at Price Waterhouse (UK) to BCCI's directors, Bench would have had the truth in front of him concerning BCCI's secret ownership of First American. Price Waterhouse (US) and BCCI would have been ethically required to tell the Federal Reserve the truth. And the Federal Reserve would have learned about BCCI's ownership of First American as of the spring of 1989 -- almost two years earlier than the time it actually learned of the relationship.
Instead, according to Bench's testimony, he never focused his attention on the BCCI-First American relationship in any respect, and so confined himself to advising BCCI on how to improve its practices to avoid being used to launder drug money. Bench's approach was narrow and incurious at best.
From the beginning, BCCI's fractured system of banking, involving a multiplicity of entities spanning the globe, posed an obvious challenge to auditors responsible for providing a base-line of protection to those relying on its annual certifications of BCCI, which the auditors failed to meet.
The auditors' options in responding to this problem were quite clear. First, they could respond by highlighting problems, and working with BCCI to solve them, an approach applied through the first 15 years of BCCI's existence. Second, when BCCI failed to respond to their recommendations, the auditors could respond by resigning, an option adopted by Ernst & Whinney in 1986. Price Waterhouse, for reasons that are not clear, but which may relate to the $5 million a year being generated by BCCI-related work, remained with BCCI, and signed off on BCCI's books year after year until early 1990. At that time, recognizing that the financial hole inside the bank required emergency action, Price Waterhouse sought to avoid the risk of being destroyed together with BCCI by taking the information it had developed to the British regulators, and seeking further guidance from them.
The auditors' role also created special problems for those investigating BCCI. BCCI's consolidated audits were based on the work product from auditors around the world. Yet those investigating BCCI in the U.S. found that the local partnership of the auditing firm involved possessed none of the information it requires, and contended it had no power to obtain any of the information it requires.
This problem raises squarely the question of whether remedial legislation is necessary to require international accounting firms to include as a condition of their relationship with foreign affiliated partnerships, that these foreign partnerships agree to provide information in response to valid subpoenas in the United States on cases affecting the United States.
Additional institutional issues arose regarding the auditors' role in BCCI's failure in the UK. In the UK, the issue is whether external auditors have responsibilities to depositors, customers, and the general public independent of their duty to a bank's shareholders.
When an external auditor certifies the financial statement of a business, it is simultaneously providing different services to different audiences.
For the shareholders of the institution it is certifying, it is providing what is supposed to be a clear, full, and fair description of the actual performance of the business to assist the shareholder in determining the value of his investment, the performance of the company, and the strength of the company's management, as well as assurances that the company has no untoward risks from violations of law or regulatory compliance.
To anyone else, an annual certification represents what may be the principal means by which an outsider can evaluate the safety of entering into a transaction with a business. An annual report tells a would-be depositor in a bank about the health of the bank and its business, its level of capital, its past returns on investment, its areas of difficulty. In reviewing such a report's audit certification, an outsider is assuming the reputation for expertise of the auditor, and focusing not on the quality of the audit, but on the information the ostensible neutral and complete audit is providing.
Thus, true and accurate financial statements, certified by reputable accounting firms, are at the heart of the self-regulatory process of financial markets throughout the world. In the United States, this seldom has significant implications because first, depositors are insured by the federal government and therefore need not worry about a bank's solvency, so long as they maintain less than $100,000 per account; and second, the United States conducts independent bank examinations by seasoned examiners employed by bank regulators. Outside the United States, however, bank deposits remain largely uninsured, and outside auditors, rather than bank examiners, are relied upon to insure that reliable financial information is provided to the markets.
Unfortunately, the accounting profession generally has regarded its primary responsibilities as being to shareholders of a company, rather than to potential customers, creditors, or others who might have an interest in obtaining accurate information concerning a company. In the case of a bank, this approach is potentially quite dangerous for uninsured depositors, as it leaves them in the position of having to rely on the work of auditors whose principal duties are not to them, but to those who have placed capital in the bank. This result is especially unfortunate as depositors provide the preponderance of funds used by banks -- typically 90 to 95 percent -- while working capital tends to be limited to 10 percent of a bank's assets or less.
In the case of BCCI, the duty Price Waterhouse viewed itself to owe was to BCCI's shareholders -- a small number of Middle Eastern sheikhs most of whom were in fact not real shareholders at all, but nominees, who were not even paying interest to BCCI on its lending to them in their capacity as nominees. Thus, Price Waterhouse in fact wound up owing a duty principally to the people who were deceiving it.
Moreover, even apart from the nominee issue, because BCCI was a bank, the vast preponderance of its funds came not from capital contributions for stock, but from its one million or more depositors, to whom it surely also had a duty. As Professor Richard Dale of the University of Southampton has noted, this problem was inherent in the system of regulation in the United Kingdom:
BCCI's 1989 accounts were not qualified, even though the auditors were aware of serious problems the nature of which had been reported to the bank's majority shareholders. In explaining the decision not to qualify, the auditors have argued that in general terms a bank's accounts cannot be qualified without risking a collapse in confidence and a potentially calamitous withdrawal of deposits. While this approach may be consistent with an auditor's established legal obligation to shareholders, it is not necessarily in the interests of existing depositors, cannot be in the interests of prospective depositors and is difficult to justify on public policy grounds. . . For the banking system as a whole the absence of credible financial information is likely to mean an increased incidence of destablising bank runs.(57)
Thus, under the system as it stood in 1990 and 1991, Price Waterhouse (UK) was in the unenviable position of having to try to keep BCCI open, even as it uncovered ever more information demonstrating that the only fit conclusion to BCCI's existence was its swift termination. Only a few choices presented themselves. Once again, Price Waterhouse could have resigned its commission as BCCI's auditors, a choice available to it from the beginning. Or it could do as it belatedly did, and make use of a provision of British law that enabled it to advise the regulators of its findings of improper banking practices in early 1990, and seek the regulators' advice on how to proceed further. When it chose the latter course, it obtained the comfort of knowing that its every action was being reviewed contemporaneously by regulators at the Bank of England who would share ultimate responsibility for whatever happened.
The BCCI case raises the issue of whether the current structure for accounting firms as independent partnerships, with authority and liability limited to the nation in which they are licensed, is appropriate and adequate to meet the challenges posed by an international financial marketplace.
One of the great difficulties in uncovering BCCI's fraud for regulators and investigators was the fact that its frauds were carried out through diverse and widespread jurisdictions spanning the globe, while its activities were audited by local accounting partnerships.
Arguably, the current system by which one partnership of an accounting firm sets out audit instructions to all of its global affiliated partnerships in other countries, for them to carry out its instructions, should be adequate to maintain the standards of an audit that would be carried out within the borders of one country. But in cases where something goes wrong, as in BCCI, the structure leaves those injured in countries other than that in which the accounting firm is licensed, in a difficult situation. The firm responsible for the consolidated audit may be located in a jurisdiction with strong financial confidentiality and privacy laws that preclude disclosure of essential information. It may, as Price Waterhouse (UK) did, contend that it does not do business in a jurisdiction in which people have been injured by its handling of audits, and may even refuse, as Price Waterhouse (UK) did, to honor subpoenas issued to it. Such a result is against public policy, and new structures for international accounting firms need to be considered to avoid a recurrence.
One efficient approach that could be adopted unilaterally by the United States, would be to require accounting partnerships, as a condition of being licensed in the United States, or as a condition of being permitted to have their certifications relied upon by any government agency, to reach agreements with its foreign affiliated entities insuring that they will respond to authorized subpoenas in the United States, and provide information as required by U.S. law.
A second approach would rely on the major accounting firms to modify their partnership agreements without being explicitly required by government to do so, as a matter of self-regulation, to insure the availability of documents from their affiliates in accord with the domestic law of the countries in which they are licensed. Thus, a firm such as Price Waterhouse (US) would seek to amend the Memorandum of Association and Bye-Laws of Price Waterhouse World Firm Limited (PWWF) to reach a new binding understanding among it and its affiliates. Under that new binding understanding, if Price Waterhouse (US) received a legal subpoena in the United States concerning documents possessed by any of its affiliates, the affiliates would have to provide that information to U.S. authorities, subject to the requirements of the laws of their jurisdictions. While such a change would not solve all problems in countries which retain strict financial secrecy laws, it would provide a mechanism by which lawful U.S. subpoenas could be cooperatively enforced in many cases.
A third approach would be legislation prohibiting the use or reliance by any federal agency on an audit prepared by any accounting firm not licensed in the United States. This approach would dramatically reduce the risk to the United States from certifications by foreign accounting firms who do not view themselves to be subject to U.S. subpoenas, such as Price Waterhouse (UK). On the other hand, it could well impose some substantial additional costs on firms, especially foreign firms, whose consolidated audits are prepared by non-U.S. auditors, and further hearings and comments on the proposal would be appropriate.
1. Affidavit of John Bartlett, Bank of England, July 5, 1991.
2. S. Hrg. 102-350 Pt. 1 p. 498 and 500.
3. S. Hrg. 102-350 Pt. 1 p. 516.
4. Commentary, Massihur Rahman, Price Waterhouse Section 41 Report to the Bank of England, June, 1991.
5. Memorandum submitted by Price Waterhouse in response to questions from the British Treasury and Civil Service Committee of the House of Commons; provided to the Subcommittee by counsel to Price Waterhouse (UK), February 5, 1992, Answer 1.
6. Section 41 Report, Price Waterhouse, Bank of England, June 1991.
7. Letter, Gilbert Simonetti, Jr., Price Waterhouse, to Jonathan Winer, Subcommittee staff, October 17, 1991.
8. For the record, Price Waterhouse (UK) did offer to provide the Subcommittee with the opportunity to interview Price Waterhouse (UK) partners in London without the provision of the subpoenaed documents, an offer precluded by Subcommittee rules regarding staff travel, and which, in the absence of the provision of the subpoenaed documents would have been of marginal utility in any case.
9. S. Hrg. 102-350 Pt. 1 p. 496.
10. Price Waterhouse Grand Caymans papers dated December 31, 1983.
11. "Commentary on the Independent Examination of the Accounts of Bank of Credit and Commerce International (Overseas) Ltd. for the year ended 31 December 1984," Price Waterhouse Grand Caymans.
12. "Internal Control Report," 28 April 1986, Bank of Credit and Commerce International (Overseas) Ltd., S. Hrg. 102-350 Pt. 4. pp. 152-155.
13. Price Waterhouse report to BCCI, id, S. Hrg. 102-350 Pt. 4 pp. 152-155.
14. S. Hrg. 102-350 Pt. 1 p. 500.
15. Staff interviews, Akbar Bilgrami and Amjad Awan, July 20-30, 1992.
16. Memorandum submitted by Ernst & Young in reply to Questions from the Treasury and Civil Service Committee, February 21, 1992, p. 102.
17. Memorandum submitted by Ernst & Young in reply to Questions of House of Commons Committee on Treasury and Civil Service, February 21, 1991, p. 101, Fourth Report, Banking Supervision and BCCI.
19. Memorandum submitted by Ernst & Young in reply to Questions from the Treasury and Civil Service Committee of the House of Commons, February 21, 1992.
20. Price Waterhouse Audit Report, "Our Large Exposures," December, 1987, BCCI, Subcommittee document.
22. Id, re "AR Khalil."
24. S. Hrg. 102-350 Pt 1 p. 264.
25. S. Hrg. 102-350 Pt. 1 p. 307.
26. S. Hrg. 102-350 Pt. 1 pp. 314-316.
27. S. Hrg. 102-350 Pt. 1 pp. 317-324, 332-343.
28. S. Hrg. 102-350 Pt. 1 p. 352.
29. S. Hrg. 102-350 Pt. 1 p. 353.
30. S. Hrg. 102-350 Pt. 1 pp. 356-358.
31. S. Hrg. 102-350 Pt. 1 p. 360.
32. Memorandum submitted by Price Waterhouse in reply to Questions from the Committee on Treasury and Civil Service, February 5, 1992.
33. S. Hrg. 102-350 Pt. 1 p. 518.
34. S. Hrg. 102-350 Pt. 1 pp. 518-520.
35. S. Hrg. 102-350 Pt. 1 pp. 450-458.
36. Staff interviews, Nazir Chinoy, Abdur Sakhia, Akbar Bilgrami.
37. S. Hrg. 102-350 Pt. 1 p. 481.
38. Memorandum submitted by Price Waterhouse in reply to Questions from the House of Commons Committee on Treasury and Civil Service, February 5, 1992.
39. BCCI Annual Report For the Year 1989, dated April 1990.
40. Memorandum submitted by Price Waterhouse in reply to Questions from the House of Commons Committee on Treasury and Civil Service, February 5, 1991.
41. Memorandum submitted by Price Waterhouse in reply to Questions from the House of Commons Committee on Treasury and Civil Service, February 5, 1991.
42. Id. Price Waterhouse's findings of the Section 41 report are reviewed in some detail in the chapter concerning BCCI's criminality.
43. S. Hrg. 102-350 Pt. 1 p. 279.
44. S. Hrg. 102-350 Pt. 4 p. 50.
45. S. Hrg. 102-350 Pt. 4 p. 53.
46. S. Hrg. 102-350 Pt. 4 p. 92.
47. BCCI Loan documents obtained by Subcommittee; some reprinted in S. Hrg. 102-350 Pt. 2 pp. 624-629.
48. BCCI Documents, Federal Reserve, Miami, obtained pursuant to Committee subpoena.
49. Letter, James E. Tolan to Jonathan Winer, March 4, 1992.
50. Bilgrami testimony, S. Hrg. 102-350 Pt. 6, July 30, 1992, and staff interviews, July 20-29, 1992.
51. S. Hrg. 102-350 Pt. 4 pp. 15-23.
52. Testimony Bench, S. Hrg. 102-350 Pt. 4 pp. 36-37.
53. Staff interview, Bench, February 14, 1992.
54. S. Hrg. 102-350 Pt. 4 pp. 36, 85.
55. S. Hrg. 102- 350 Pt. 4 p. 86.
56. S. Hrg. 102-350 Pt. 4 p. 89-91.
57. Professor Richard Dale, Minutes of Evidence Taken Before the Treasury and Civil Service Committee, id, January 15, 1992, p. 4.
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