1 2d compliance & anti money laundering seminar 23d and 24th march 2010 riyad, kingdom of saudi...
TRANSCRIPT
1
2d Compliance & Anti Money Laundering Seminar
23d and 24th March 2010
Riyad, Kingdom of Saudi Arabia
A few considerations on financial crime
2
What is financial crime?
• Trading
• Debt
• Equity
3
What is financial crime?
• Trading
• Debt
• Equity
4
Long-term dealings /Accumulating trading losses
– A trader makes big profits and becomes a star
– His strategy is no longer questioned
– He starts losing money but tries to trade his way out of the losses in order to conceal them and go back to profit
– Losses quickly accumulate to build up massive amounts
– Leeson (Barings), Kerviel (Soc Gen)
– Lack of internal controls
– Collective greed in trading teams
5
Long-term dealings / Short and distort: taking advantage of poor internal controls on traders and lack of investigation resources of the regulator
– Traders acting in a loose cartel enter into short-selling contracts for the shares of a potentially controversial company. Number of shares: 100,000. Price: $100
– They borrow 100,000 shares from custodians who accept not to keep adequate records of it
– They sell the 100,000 shares in the cash market, resulting in high liquidity and slight drop in share price: Sale proceeds: 100,000x$95= $9,500,000
– They invent bad news and spread them to bring down the price (no e-mails, but cell phone text or internet instant messages)
– Price falls from $95 to $80– They buy 200,000 shares at $80 ($16,000,000), settle the short-selling
contract for 100,000 shares at $100 ($10,000,000), and return the borrowed 100,000 shares to the custodian
– Profit for the traders: $9,500,000 + $10,000,000 - $16,000,000 = $ 3,500,000
– Traders are often left on their own– They may use trusts and offshore centers– Regulators do not have adequate investigation resources
6
Long-term dealings /Stocks with poor liquidity, or small stock exchanges, on which a few players can exert a significant influence
• „Old-boy networks“
• The fewer players, the riskier the game
• Some emerging economies, or poorly developed economies only have a few dominant players
• Those players most often wear several hats: they own, they manage, they trade, they buy and sell to the expense of minority shareholders
• Poorly regulated exchanges
• Weak governance
• Conflicts of interest
• Private / Public collusion
7
Intra-day trading / Cross-trading: adjusting a client‘s order to a trader‘s own strategy
– A trader has to execute a sale order of a client within a day
– He executes the sale order at the lowest price and takes a speculative position buying the same amount at the same price
– He uses a trust for doing so
– Lack of internal controls
– Use of trusts and off-shore centers
8
Intra-day trading /Protected trading: a trader caps his losses with a client‘s order
– A trader has an order to sell at a $ 100 price, slightly above current $ 98 market price
– He thinks that price will go down
– He sells short at the $ 98 price
– If price goes up, he can limit his losses by „crossing“ and buying back the contracts at $100
– Lack of internal controls
– Use of trusts and off-shore centers
9
Intra-day trading /Front-running: taking advantage of knowing the client‘s order
– A trader has a substantial order to sell
– He knows that the order will probably push market price down
– He sells short for himself before executing the larger order
– After price has decreased, he buys back with a profit
– Lack of internal controls
– Use of trusts and off-shore centers
10
Intra-day trading /Use of dual accounts: the losses to the clients, the profits to the trader
– A trader controls more than one account with the same bank or broker
– At the end of trading, he allocates the best trades to his personal trust-controlled account, and the others to the bank‘s or clients‘ accounts
– Lack of internal controls
– Use of trusts and off-shore centers
11
What is financial crime?
• Trading
• Debt
• Equity
12
Corporate debt/Use of confidential client information against a client
• A commercial banker has a client with a healthy company but temporary cash problems
• Another part of the bank (local branches) is also a significant client of this company (design, architecture…)
• The banker spreads the word to the retail network which differs contracts and toughens payment terms
• The banker cannot obtain additional credit but introduces a buyer to the client
• The buyer, linked to the banker, buys the company at a cheap price
• Chinese wall broken, banking secrecy violated.
13
Structured finance / Executives of a lending bank may be shareholders of a buyer (through a trust) and approve a highly leveraged acquisition
• Buying a company with low equity is every investor‘s dream
• This dream can become reality if the lending banker is part of the acquisition scheme
• Leverage can be affected, and also the degree of protection and/or potential upside for the bank (debt-equity swaps)
• Risks will therefore be underestimated, to the potential detriment of the bank
• Lack of internal controls
• Abuse of managerial position
14
Cartels in banking
• Depending on countries, cartels can be observed on terms and conditions offered to clients for various accounts, loans or investment opportunities
• Pakistanese banks fined for agreement on fees and transformation of base accounts into fee-paying accounts
15
Project Finance /Loans pocketed by bankers
– A financial institution lends $ 7 m to a specific project
– The project only requires $ 5 m
– The project does not perform adequately
– The $ 2m are shared between the client and the executives who had approved the loan
– Due diligence was non existent
– Internal controls were non existent
– The executives used trusts and off-shore centers
16
What is financial crime?
• Trading
• Debt
• Equity
17
Private equity & IPOs /Finding new Eldorados
– When oil prices were reaching all-time highs, alternative energy markets were booming
– Companies with „new“ technologies but no industry expertise were trying to raise money, even on regulated markets
– Quite often, the managers involved had already managed dotcoms in the late 90‘s
– Collective greed and blindness
– Amnesia
– Lack of adequate due-diligence
18
Private equity & IPOs / False valuation of assets
• Inventories or receivables may receive false valuations
• In booming markets, those false valuations can help obtain debt or equity financing, or even access to an IPO
• Bankers may receive equity interests or even kick-backs to favor those companies
• Lack of internal controls
• Collective greed
19
Mergers & Acquisitions /Profits hidden before an LBO
– Managers interested in an LBO may want to hide profits from their management
– Aggressive provision and depreciation policy, as well as differed profit, may be observed
– Double language will then be adopted, one with the mother company, the other one with financial investors
– M&A advisors may help in that game
– Lack of internal controls
20
Mergers & acquisitions /The seller is the buyer
– The CFO or a top executive of the seller may be one of the shareholders of the acquiring entity through a trust
– He or she will badly negotiate the deal with the acquiring entity
– M&A advisers may be involved in the scheme
– One of the major risks of LBO deals from the seller‘s point of view
– Lack of internal controls
– Use of trusts and off-shore centers
21
Mergers & Acquisitions /Hiding a buyer to a client on a sell-mandate
• A bank obtains a sell mandate from a client
• Knowing a potential acquirer, the bank does not approach this acquirer, or in such a way that the discussions quickly abort, and the bank ends up selling the target to one of its investment funds at a reduced price
• One or two years later, the target is resold with a substantial profit
• „Chinese wall“ broken
• Fraud may be institutional, but may also result from a network of individuals (M&A banker and investor friends)
22
Mergers & Acquisitions /False urgency to buy or invest
• An investment opportunity is always limited in time
• The investor however has to conduct appropriate due-diligence, or has to be informed of the risks associated with a listed security
• Time pressure cannot be exercized on a client to the detriment of appropriate risk awareness
• Conflict of interest may be at stake if undue time pressure is exercized
23
Let us not forget AML and KYC
• The use of trade finance to obscure the illegal movement of funds includes methods to misrepresent the price, quality or quantity of goods.
• Generally these techniques rely upon collusion between the seller and buyer.• Over Invoicing: by stating price above the true value, the seller gains excess
value. • Under invoicing: by stating price below the true value, the buyer gains excess
value. • Multiple invoicing: by issuing more than one invoice for the same goods a
seller can justify the receipt of multiple payments. • Short shipping: the seller ships less than the invoiced quantity or quality of
goods. The effect is similar to over invoicing: the seller gains excess value. • Over shipping: the seller ships more than the invoiced quantity or quality of
goods. The effect is similar to under invoicing: the buyer gains excess value. • Deliberate obfuscation of the type of goods: this may simply involve
omitting information from the relevant documentation or deliberately disguising or falsifying it, so that financial flow is no longer connected to actual shipping.
• Phantom Shipping: no goods are shipped and all documentation is completely falsified.
24
Financial crime is much about making things easier and quicker…
• By-passing risk controls:– Easier trading – Easier borrowing– Easier selling and buying of companies
• Confidentiality and Chinese walls are assets but also create opportunities for quiet crime.
Importance of confidential whistle blowing and protection of whistle blowers.
4-eye policy: engagement by credit + industry
Traders: access forbidden to information system
Run tests on publicized cases (ex: Kerviel)
25
… and financial crime is not a poor performer‘s activity
• Watch the high performers.
• Watch the hard workers.
• Watch the good friends.
26
Thank you for your attention.
Stay tuned.
www.transparency.org