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Statement to the Congress.

Statement by J. Virgil Mattingly, Jr., General Counsel, and William Taylor, Staff Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, before the Subcommittee on Terrorism, Narcotics and International Communications of the Committee on Foreign Relations, U.S. Senate, August 1, 1991

We are pleased to appear before this subcommittee to describe recent developments in the case of Bank of Credit and Commerce International, S.A. and its affiliates (collectively BCCI). As has been widely reported, bank regulatory authorities in the United Kingdom, Luxembourg, Grand Cayman, the United States, and several other countries took action on July 5, 1991, to secure control of the BCCI banks as an initial step toward the liquidation of BCCI. This action was taken in response to evidence of widespread fraudulent conduct by BCCI and its management. More recently, the Federal Reserve assessed a civil money penalty of 200 million against BCCI for its unlawful acquisition of the stock of U.S. banks and its concealment of this control in regulatory filings. The Federal Reserve has also initiated actions to bar nine individuals associated with BCCI from involvement with U.S. banks. The New York County District Attorney's Office has also secured indictments against BCCI and two of its senior officers.

SUMMARY OF REMARKS

Our remarks today begin with a summary of BCCI's operations, both abroad and in the United States, and a description of the events leading to the seizure of the bank's assets. We will then discuss the effect of BCCI's seizure on two U.S. banking organizations, First American Bankshares of Washington, D.C., and Independence Bank, Encino, California, the shares of which the Board believes are controlled by BCCI. Finally, we will discuss the Board's ongoing enforcement actions and its legislative proposals strengthen the supervision of foreign banks operating in the United States.

BANK OF CREDIT AND COMMERCE INTERNATIONAL

Structure of BCCI

BCCI was founded in 1972 and until recently operated principally under the leadership and management control of individuals from Pakistan. Initial equity financing of BCCI was provided by Middle Eastern investors and Bank of America. Bank of America's ownership interest in BCCI was sold in 1980. In April 1990, to bolster BCCI's sagging financial position, the ruling family and the government of Abu Dhabi provided additional capital that increased their ownership interest in the shares of BCCI from about 30 percent to 77 percent.

BCCI's operations encompassed subsidiaries, branches, and affiliates in sixty-nine countries, principally in developing countries. BCCI, however, was not one of the largest banks in the world. Its total assets of roughly $20 billion ranked it about 200th in the world. The parent holding company, BCCI Holdings (Luxembourg) S.A., was chartered and headquartered in Luxembourg, and the two largest banking subsidiaries of the company-Bank of Credit and Commerce International S.A. and Bank of Credit and Commerce International (Overseas) Limited-were chartered in Luxembourg and the Cayman Islands respectively. Although nominally headquartered in Luxembourg, BCCI's global business was operated out of its London offices.

Under Luxembourg law, holding companies are not subject to supervision. Thus, BCCI was able to avoid consolidated home country supervision of its activities. Virtually from BCCI's formation, concerns were raised about a bank operating internationally without a home country regulator.

BCCI'S OPERATIONS IN THE UNITED STATES

BCCI has never been permitted to operate a branch in the United States that accepts deposits from the general public; nor was it permitted to operate or control an insured bank. BCCI at one time maintained state-licensed agencies in New York City, San Francisco, Los Angeles, Miami, Tampa, and Boca Raton, and representative offices in Washington, D.C. and Houston. None of these offices could accept domestic deposits. Because of actions taken by state and federal supervisory authorities as well as BCCI's plans to restructure its operations, four of the six agencies were closed by January 1991, and the remaining two had very substantially reduced their operations. The representative offices were closed by August 1990.

Under a Federal Reserve order issued earlier this year, BCCI's remaining operations in this country were scaled back, and the company was ordered to terminate its activities in the United States within a year. On July 5, 1991, the two remaining state-licensed agencies-in Los Angeles and New York City-held combined assets of approximately $250 million but less than $20 million in liabilities to unrelated creditors.

BCCI's offices in the United States were licensed and supervised on a regular basis by state authorities. As the residual supervisor of U.S. branches and agencies of foreign banks, the Federal Reserve participated in some state examinations and conducted some examinations of its own. Under the current framework governing foreign bank operations in the United States established in the International Banking Act of 1978, the states are the primary regulators of the branches and agencies they license, and the Federal Reserve is directed to rely on their reports of examination insofar as possible. As described in the last section of this testimony, the Federal Reserve believes that the time has come to require the same type of federal supervision and examination for foreign bank operations in the United States that applies to U.S. banks.

SUPERVISORY ACTIONS-MONEY LAUNDERING

In May 1987, a Federal Reserve examination of the Miami office of BCCI identified money laundering activities, and a criminal referral was filed with the Internal Revenue Service, the Federal Bureau of Investigation, and the U.S. Attorney in Miami. In October 1988, BCCI and several of its U.S. employees were indicted for money laundering through BCCI's Tampa, Florida, office. The Federal Reserve, with cooperation from state authorities, immediately commenced a coordinated examination of all of BCCI's U.S. offices. The examinations of the New York and Boca Raton offices revealed other money laundering activities, and additional criminal referrals were made in October and November 1988.

The examinations also revealed that internal controls and lending practices of the BCCI agencies were poor and that remedial action was required. The Federal Reserve issued a cease and desist order against BCCI in June 1989 designed to strengthen the U.S. banking operations of BCCI and to enforce compliance with currency reporting requirements.

POSTINDICTMENT PERIOD

The indictment for money laundering in the United States further weakened BCCI's already fragile reputation in the world financial community. Federal Reserve staff members were advised that BCCI was experiencing some outflow of deposits in London and was encountering difficulty in finding counterparties for its banking transactions. In addition, BCCI's auditors had raised questions about whether certain loans were collectible, which brought into sharper focus the need for fresh capital. To address these developments, the government and ruling family of Abu Dhabi in spring 1990 provided capital resources of nearly $400 million, increasing their ownership of BCCI from 30 percent to about 77 percent.

BCCI's problems, however, continued to mount. In October 1990, Price Waterhouse delivered a report to BCCI's board of directors that identified substantial additional problem loans. This report gave rise to renewed discussions between the bank and its principal shareholder and European banking authorities concerning possible approaches to a broad-based restructuring of the bank. These discussions continued into 1991.

By early 1991, information received by the Bank of England about BCCI and its activities raised fresh questions about the financial condition and integrity of the institution as a whole. In turn, this information prompted the Bank of England to commission Price Waterhouse to undertake a special audit under the provisions of British banking law. The resulting so-called section 41 report was completed and made available to the Bank of England on June 22, 1991. The Bank of England's filings in British courts indicate that the report disclosed evidence of a complex and massive fraud at BCCI, including mismanagement, substantial loan and treasury account losses, misappropriation of funds, unrecorded deposits, the creation and manipulation of fictitious accounts to conceal bank losses, and concealment from regulatory authorities of BCCI's true financial position. It was the findings of this report that led to the decision by the authorities in the United Kingdom, Luxembourg, and the Cayman Islands to seize BCCI.

THE SEIZURE OF BCCI ON JULY 5

On Friday, June 28, the Bank of England informed the Federal Reserve that the findings contained in the Price Waterhouse report made it likely that the authorities in the United Kingdom, Luxembourg, and the Cayman Islands would move during the following week to take control of the principal banks in the BCCI group. This information, while still tentative in nature, was provided to the Federal Reserve, in part, as an outgrowth of the continuing dialogue that had been occurring between the Federal Reserve and the Bank of England regarding the overall investigation into the BCCI affair but also because it was recognized that the seizure of a global bank operating around the clock in some sixty-nine countries would have to be executed with great care to avoid banking disruptions on a national or international scale.

In light of this information, the Federal Reserve promptly dispatched senior officials of the Federal Reserve Bank of New York and of the Board of Governors to London to begin the coordination of efforts that led to the seizure of the BCCI banks on July 5, 1991. With respect to that action, the primary concern of the Federal Reserve was to take all reasonable steps to ensure that the seizure of the BCCI banks did not precipitate serious disruptions in U.S. banking markets or in dollar-based payment and clearing systems here or abroad. Four factors loomed large in the deliberations of the Federal Reserve in this regard:

First, while BCCI's banking activities in the United States were very small in balance sheet terms, a large share of its global activities were conducted in dollars, which must be settled with banks in the United States. From the perspective of the Federal Reserve, and with the experience of the Herstatt failure of 1974 very much in mind, this fact made it very important that the announcement of the seizure of the BCCI banks be timed so as not to occur during normal business hours in New York-a judgment that was shared by the Bank of England and others.

Second, while the Federal Reserve was reasonably confident that the direct exposure of U.S. banks to BCCI was limited, we could not be sure-especially in the face of the multiple uncertainties about the underlying condition of BCCI-that banking exposures in other markets or to other institutions might not cause disruptions in interbank markets, payment flows, and foreign exchange transactions that could spill over into U.S. markets and institutions.

Third, there was also the danger that other banking institutions in the Gulf-institutions with no connections with BCCI and several of which have a major presence in London and New York-could come under pressure by virtue of uncertainties created by the BCCI seizure.

Finally, there was the more general concern that the precedent of seizing an institution with operations in some sixty-nine countries could-by its very nature-unsettle banking markets on a global scale.

Over the course of Tuesday, July 2, and Wednesday, July 3, the Federal Reserve briefed the Treasury Department, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and others about the unfolding developments in Europe. The Federal Reserve's efforts took place in confidence, in part, because of the still uncertain course of events in Europe and, in part, to ensure that premature disclosure of information did not place some creditors of BCCI-related entities in a preferred position.

By midday Wednesday, July 3, it was increasingly clear that the seizure would, in fact, take place on Friday, July 5. In these circumstances, the Federal Reserve informed senior officials at the state banking departments in New York and California. As the licensing authorities for the BCCI agencies in New York City and Los Angeles, the state banking departments-not the Federal Reserve-were responsible for initiating the actions to close those agencies.

While the exact timing of the seizure of the BCCI banks had not yet been determined, the expectation on July 3 was that it would be timed to coincide with the close of business in New York City on July 5. A special unit was established at the Bank of England to coordinate global regulatory actions and to provide a central point of supervisory information and advice. For several days, officials from the Federal Reserve Board and from the Federal Reserve Bank of New York were stationed at the Bank of England to assist in that effort. A parallel unit, focusing particularly on payment and settlement issues, as well as activities in U.S. banking markets more generally, was established at the Federal Reserve Bank of New York. This unit and a counterpart group at the Board here in Washington were staffed sixteen hours a day during the first week after the closure.

Throughout the day of July 4, the Federal Reserve maintained close communication with the Bank of England. Based on those discussions, it was still expected that the closure would occur at the close of the business day in New York on July 5. On the evening of July 4, however, the Federal Reserve was informed that the timing of the closure was being reconsidered because of legal issues that had arisen in Luxembourg. Over the course of the night of July 4, it became apparent that the goal of effecting the seizure at the close of business New York time could not be realized. At about 2:00 a.m. Friday, July 5, the Federal Reserve was informed that the only practical options were to coordinate the seizure either at midmorning New York time or to accelerate the action so that it would precede the opening of business in New York City. The choice to accelerate the process was clear. This choice created a complicated task of getting the personnel and other arrangements in place in the early hours of the morning after the Fourth of July holiday, but it was accomplished without major problems or difficulties. Public announcements in Europe and the United States were coordinated at 8:30 a.m. New York time; the states of New York and California acted promptly; bank examination personnel were fully deployed by 8:30 a.m.; and the information-clearing centers at the Bank of England and the Federal Reserve remained operational throughout the day of July 5 and over the ensuing weekend.

Because of this effort involving the close cooperation of authorities in several countries and because the Federal Reserve and state authorities had already scaled back BCCI's limited operations in the United States, the seizure of BCCI was effected on a global scale with virtually no adverse effects on U.S. markets and institutions. As a result of earlier regulatory action, on the day the U.S. offices of BCCI were closed by the states of California and New York, BCCI was funding its business in the United States from other non-U.S. BCCI offices and not from U.S. sources. As of July 30, it appeared that less than $20 million of the $252 million in liabilities on the books of the U.S. offices of BCCI are to third parties.

THE FIRST AMERICAN BANKS AND INDEPENDENcE BANK

As the Chairman of this subcommittee, Senator Kerry, will recall, we testified on May 23 about BCCI's efforts to gain control of U.S. banks before a subcommittee of the Senate Banking, Housing, and Urban Affairs Committee. That testimony, a copy of which is attached and which we will not repeat in detail here, indicated that BCCI had used loans and nominee agreements to secretly gain control of the majority of the shares of First American Bankshares in 1982.[1] The testimony also describes continuing efforts of the Federal Reserve to detect and prevent BCCI control of First American's shares, and the violation of explicit commitments that BCCI would have no interest in the First American organization and would not fund the acquisition of First American.

On January 4, 1991, the Board authorized a formal investigation concerning whether BCCI had violated the Bank Holding Company Act by unlawfully gaining control of First American and whether false or misleading statements were made to the Board by BCCI and others to conceal BCCI's control. This investigation built on prior inquiries into a possible First AmericanBCCI link made by the Federal Reserve in 1989 and 1990.

In late 1990, the New York County District Attorney, with whom the Federal Reserve had been working, advised that he had received information about an auditor's report showing BCCI loans to shareholders of Credit and Commerce American Holdings, N.V. (CCAH), First American's parent. The Federal Reserve had been attempting for some time to determine whether such loans existed, despite having been told by BCCI as late as 1990 that it had not lent to acquire CCAH shares. As a result of the information, the Federal Reserve demanded that BCCI provide access to the auditor's report. After initial reluctance by BCCI's auditors, the Board's staff was able to review a copy of that report in London in early December 1990. The report confirmed the existence of more than $1 billion in nonperforming loans by BCCI secured by shares of CCAH. That review provided the Federal Reserve with substantive evidence of a BCCI-First American link, and the Board thereupon ordered the formal investigation.

That investigation, as it progressed over the next several months, uncovered evidence of extensive and secret loan and nominee arrangements between BCCI and customers of BCCI designed to allow BCCI to acquire in the name of these customers the stock of the First American banking organization as well as other depository institutions in the United States. These arrangements in many cases involved sham loans to the BCCI customers with side agreements that the customers would not be required to repay or service the loans and that BCCI could sell the shares and retain the profits. In return for their services, the customers received fees and indemnities. These nominee arrangements are described in detail in the Board's civil money penalty and prohibition actions of July 12 and 29, 1991.

Many of these CCAH loans were never serviced or repaid except through other loans from BCCI. From the evidence available, it appears that these arrangements, particularly in later years, enabled BCCI to generate hundreds of millions of dollars in fictitious profits to cover massive losses in its trading and lending accounts.

THE BOARD's CEASE AND DESIST ORDERS

As a result of information acquired in the early stages of the Board's investigation, the Board on January 22, 1991, made criminal referrals to the Department of Justice and proposed a cease and desist order for BCCI. The cease and desist order, which was joined in by the New York banking authorities and consented to by BCCI on March 4, had four principal components: requiring BCCI to divest promptly its CCAH shares; ending business transactions between BCCI and the First American banks; ensuring that BCCI had sufficient liquid assets to cover liabilities in the U.S. agencies; and terminating BCCI's residual business presence in the United States.

The order required BCCI promptly to divest its interest in CCAH through a plan to be submitted to the Board for its approval. The order, and a similar one against CCAH, also prohibited transactions between BCCI and the First American banks (other than capital injections into the banks and certain clearing transactions in the ordinary course of business). After entry of the order, the Federal Reserve Bank of Richmond informed the First American Bank of New York that its clearing transactions for BCCI should be wound down and terminated before the end of 1991.

The Board's investigation continued after issuance of the March 4 order and discovered further evidence indicating that BCCI also had acted through a nominee, Ghaith Pharaon, to acquire the Independence Bank, Encino, California, in violation of the Bank Holding Company Act. On May 3, the Board issued a second cease and desist order requiring BCCI to submit to the Board a plan for the divestiture of any shares of Independence Bank within its control. A criminal referral relating to this violation was also filed.

In conjunction with the investigation, the Board has also taken steps to monitor through the examination process the operations of the First American banks and to determine any relationship with BCCI. Examinations and special reviews were undertaken by the Federal Reserve and other federal and state banking authorities in January 1991. These efforts continue.

IMPLEMENTATION OF THE ORDERS

As a result of the orders, transactions between BCCI and the First American banks and Independence Bank have been steadily eliminated. The relationship between BCCI and the First American Bank of New York-with which BCCI had maintained a correspondent relationship-was wound down substantially by July 5.

Events have made the requirement that BCCI divest the shares of CCAH under its control more difficult to achieve. On May 3, BCCI submitted to the Board a proposed divestiture plan for the CCAH shares, and on July 3, BCCI submitted a divestiture plan for the Independence Bank shares. The CCAH plan called for transfer of the shares of CCAH held by BCCI, and possibly shares held by other CCAH shareholders, to a trust administered by an independent trustee acceptable to the Board. The trustee would vote the stock and negotiate its sale within a time frame agreed to by the Board. We found the trust arrangement to be acceptable but considered the proposal to be deficient because it failed to set forth the timing of the sale-specifically, there were no guarantees that the divestiture would be a prompt one, as required in the Board's order. We therefore rejected BCCI's proposal by letter of May 10, and required BCCI to submit within ten days a revised plan that addressed this concern.

On May 20, BCCI did submit a revised plan, which also relied on a trust arrangement. Although this new plan did not contain a timetable, it did contain details and conditions that appeared to expedite the sale. A preliminary draft of the trust agreement was submitted by BCCI on June 20.

Implementation of BCCI's proposed divestiture plans has been delayed by the seizure of BCCI by regulatory authorities. After those authorities seized control of BCCI on July 5, the officers and directors of BCCI were no longer able to negotiate or effectuate a divestiture of CCAH or Independence Bank stock on behalf of BCCI.

The July 5 seizure order does not void the Board's divestiture orders, however. The orders remain fully effective and legally binding. The seizure shifts the task of implementing the orders from BCCI to the receivers for BCCI. We have been in contact with the receivers, explaining to them the need to achieve total divestiture as soon as possible, and requesting that they submit promptly a revised divestiture plan. The receivers have indicated a desire to cooperate with the Federal Reserve to achieve divestiture, and our discussions are continuing. The Board is also exploring other avenues to regularize the ownership of CCAH and Independence.

ENFORCEMENT

The Board's investigation of the BCCI matter is continuing and is the most comprehensive in our experience. As part of its investigation, the Board is proceeding with enforcement actions as the evidence to support such actions is accumulated. On July 12, the Board issued a notice of intent to bar from U.S. banking the individuals participating in the Independence Bank violation. Those individuals are Agha Hasan Abedi and Swaleh Naqvi, two former senior officers of BCCI; Kemal Shoaib, a former officer of BCCI and the former chairman of Independence Bank; and Ghaith Pharaon, the owner of record of Independence Bank and a shareholder of BCCI.

More recently, on July 29, the Board issued a Notice of Assessment of $200 million in civil money penalties against BCCI for its illegal acquisition of CCAH, the National Bank of Georgia, and CenTrust Savings Bank. The Board also issued a notice of intent to bar permanently nine individuals associated with BCCI from any future involvement with U.S. banking organizations. On the same day, the District Attorney's Office for the County of New York secured indictments of BCCI.

The Board is continuing to cooperate with law enforcement agencies, and will, of course, consult those agencies before taking enforcement action so as to avoid prejudicing any criminal investigation. Thus, at the request of the U.S. Attorney for the District of Columbia, the Board has deferred temporarily the assessment of substantial civil money penalties against the individuals already charged, pending completion of the U.S. Attorney's criminal inquiry. CURRENT STATUS

As of July 6, 1991, governments of eighteen countries were known to have closed or restricted the activities of BCCI operations in their jurisdictions. By July 29, 1991, a total of forty-four countries had closed BCCI offices in their respective jurisdictions. BCCI offices continued to be open under varying degrees of regulatory presence in twenty-five other countries as of the same date. Although complete information is not yet available, it appears that governments of some developing countries could have some exposure to BCCI.

LEGISLATIVE INITIATIVES

As a result of the BCCI matter and other recent compliance problems with foreign banks, the Board reviewed the statutes, regulations, and supervisory policies governing foreign bank operations in the United States. To help prevent problems such as those presented by BCCI from recurring, the Board has sent to the Congress a set of proposals to strengthen the supervision and regulation of foreign banks operating in this country. Those proposals, collected as the Foreign Bank Supervision Enhancement Act of 1991, were introduced in the Senate as S. 1019 by Senators Riegle, Kerry, and Gam, and are to be considered as part of the comprehensive banking reform proposal currently before the Senate Banking Committee.

This legislation would establish uniform federal standards for entry and expansion of foreign banks in the United States, including, importantly, a requirement of consolidated home country supervision and the application of the same financial, managerial, and operational standards that govern U.S. banks. The proposal would also grant regulators the power to terminate the activities of a foreign bank that is engaging in illegal, unsafe, or unsound practices. Regulators would be provided with the information-gathering tools necessary to carry out their supervisory responsibilities.

As this case amply demonstrates, continuing consolidated supervisory oversight of a bank's operations is essential to maintaining the integrity of the bank's operations and preventing adverse effects on the financial system. BCCI operated without a supervisor that could demand consolidated financial reports; this method of operation was critical to its ability to carry out the manipulation of its books and the concealment of its actual financial condition.

The proposed foreign bank legislation is intended to ensure that no other foreign bank may participate in this country's banking system unless the books and records showing the financial condition of that organization are open to inspection by a home country supervisor and the bank is supervised on a consolidated basis. The legislation provides the regulatory tools needed to implement this policy.

CONCLUSION

The Federal Reserve is monitoring the BCCI situation closely and will continue to cooperate with federal, state, and foreign bank supervisors and law enforcement agencies. Further information concerning the extent of BCCI's fraudulent activities and the individuals involved may come to light as the numerous investigations under way progress.

Our immediate goal is to make the current separation in fact between BCCI and CCAH and Independence a complete separation in law so that these banks can be relieved of any taint that they might be suffering from an association with BCCI. In the coming weeks, we will be working with British, Cayman, and Luxembourg authorities toward that end.

1. The attachments to this statement are available on request from Publications Services, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.
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Title Annotation:policy statements by members of the Federal Reserve System
Author:Taylor, William (American government official)
Publication:Federal Reserve Bulletin
Article Type:Transcript
Date:Oct 1, 1991
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