The International Banking Corporation – Ernst and Young 2009 Investigative Report

Thanks to a reader of this blog I was shown how to obtain access to the 5 February filing by Ahmad Hamad AlGosaibi and Brothers ("AHAB") in the Supreme Court of New York relating to the case MASHREQBANK PSC vs. AL GOSAIBI, AHMED HAMAD Case # 601650/2009.

Among the many interesting exhibits to the filing (there will be at least two more posts on TIBC from this material) was what is purported to be the Ernst and Young Report on TIBC commissioned by the Central Bank of Bahrain (the "Report") in 2009.  After receipt of the Report, the CBB placed TIBC under Administration, replacing its existing management and assuming full control of the Bank.  

Let's start with an explanation for my use of the word "purported". The Report was not submitted to the Court by its author but by the defendant's (AHAB) counsel. That counsel has sworn under oath that the copy attached to the filing is "true and correct". By using the word "purported" I am not implying that counsel is misinformed or is misinforming the Court. However, I am acknowledging that I have no knowledge independent of his word that this is the E&Y Report.

The E&Y Report is contained in the 5 February 2010 filing by AHAB's counsel and is available at the Supreme Court of New York's website (http://iapps.courts.state.ny.us/webcivil/FCASMain). All the electronic filings in this case can be accessed through that website using the Case Index #601650/2009.   The Report is Exhibit 10 in Document #83.  If you initially have difficulties, keep trying.  The site appears to be temperamental.

I'll quote directly from the Report and then follow-up with some observations of my own based on the Report being an accurate reflection of the facts.   I have redacted certain names from the description below.  If you want them, you can read the Report.  In a situation like this involving multiple parties who may be accused of wrongdoing, it's also difficult to sort out whose story to believe.   And we are too far away from the facts here to sort this out.

INTRODUCTORY COMMENTS

On the chance that a reader is not familiar with this case and the larger legal issue involved. Mashreqbank has sued AHAB for failure to honor a US$150 million / SAR563.4 million FX transaction. AHAB's counterclaim is that it has been the victim of a massive fraud perpetrated by Mr. Maan AlSanea. As I read the Court filings by AHAB's counsel, they are also claiming that Mashreqbank should have been aware that the transactions were improper.

NET ASSET POSITION

The first place to start is at the end of the Report where E&Y summarizes its findings on the assets and liabilities of TIBC. This is on Page 80 in Sections 3.7.1 and 3.7.2. Using TIBC's 31 May 2009 unaudited and unreviewed financials it estimates (note that word) the potential value of assets and liabilities not linked to AHAB, AHAB's Money Exchange, Awal Bank, or of other entities allegedly under the control of Mr. Maan AlSanea. The latter are captioned "Unlinked Assets" and "Unlinked Liabilities" in the tables below. All amounts are in millions of US Dollars.

ASSETS

	All Assets	Unlinked Assets
Due from Banks and Other Financial Institutions	US$ 544.145	US$190.000
Investment Securities	US$ 461.274	US$ 9.000
Loans and Advances	US$2,154.843	-
Due from Related Parties	US$ 583.817	-
Due from Customers	US$ 25.859	-
Other Assets	US$ 45.144	US$ 5.00
TOTAL ASSETS	US$3,815.082	US$204.000

 

LIABILITIES

	All Liabilities	Unlinked Liabilities
Due to Banks and Other Financial Institutions	US$2,065.591	US$1,900.000
Due to Customers	US$ 41.475	-
Other Liabilities	US$ 57.022	US$ 57.022
Term Loans	US$ 200.000	US$ 200.000
TOTAL LIABILITIES	US$2,364.068	US$2,157.022

E&Y comments: "We have estimated he potential shortfall within TIBC to be in excess of US$2 billion."
 

OTHER FINDINGS

These are presented in the order in which they appear in the Report. Paragraph numbers as in the Report.

1. Paragraph 10:1: "Management alleged that Mr. AlSanea directed the day to day management of TIBC and we could find no evidence that Mr. Al Sanea was appointed as a delegated officer through a power of attorney to act on behalf of Ahmad Hamad AlGosaibi & Brothers Partnership." 
2. Paragraph 10:2: "We found no evidence of any formal business links between the Saad Group and TIBC, although transactions were of a related party nature". 
3. Paragraph 10:3: "We could find no evidence, nor could TIBC management provide documentary proof of Mr. Al Sanea's appointment to the Excom, no could we find any delegation of authority issued to him by the AlGosaibi family to act on their behalf as representative of the Excom or any other decision making forum." 
4. Paragraph 10.4: "We found evidence suggesting that the CEO had significant business interests outside of TIBC and was remunerated through a compensation based upon the amount of credit he was able to secure for TIBC, the Ahmad Hamad AlGosaibi & Brothers Co Partnership and Saad entities." 
5. Paragraph 10:5: "We found evidence that the final Swift authorization for the release of payments was controlled and managed by persons or a company other than TIBC. In addition we found that the SWIFT transfer authorizations were effected by individuals not employed by TIBC and from a premises outside of Bahrain. It was also confirmed by our Technology Security Risk Services that the application was accessed through the utilization of "PcAnywhere" software."  AA: See Point 23 re Paragraph 86.  
6. Paragraph 11: "TIBC at first alleged that all loan documents were created and provided by or via the Exchange ("Ahmad Hamad AlGosaibi and Brothers Co. Partnership – Finance, Development & Investment") for verification and administration at TIBC. It was however established hereafter that the Exchange and/or the Saad Group provided only the CR's, identities and passports from which the loan applications were created. We found no prior correspondence relating to the loan values and other requirements". 
7. Paragraph 12: "The signatures contained in the loan files of the executive chairman are questionable, and additional investigation in this regard will be required". 
8. Paragraph 13: "We obtained documents allegedly removed from the TIBC premises by an employee out of fear of the CBB investigation, and that these documents included official information regarding the signing of the Bank reference letters and e-mail correspondence". 
9. Paragraph 14: "We were unable to verify the existence of the borrowers listed with TIBC through telephonic interviews and physical verification. In the spirit of co-operation Deloitte provided us with a draft of their "drive by" visits to the addresses listed with the Exchange related to the loan clients, which indicated that the premises were not occupied by the borrowers or used for trade purposes". 
10. Paragraph 15: "We could verify or authenticate the deeds of property provided as collateral by alleged prospective borrowers. It is alleged that these documents were inspected by [COO/CRO] and [TIBC External Auditors] at some time, but this could not be verified as fact, and further thereto it is our assumption that these deeds were not authenticated by these entities through the First Notary Public Department". (AA: I have removed the names of the two parties and replaced with generic descriptions of their roles) 
11.  Paragraph 16: "TIBC were well aware of their cash flow problems by October 2008, but that they failed to call on matured loans, and that they instead affected additional loans and roll overs to the detriment of the Bank." 
12. Paragraph 17: "Loan applications were created on behalf of some AlGosaibi family members, and we could find no evidence that they have applied for loans or signed application forms." 
13. Paragraph 18: "We could find no evidence of any application for loans being made by any customer directly through TIBC or indirectly through the Exchange. From evidence it would seem that even the client applications were created at TIBC in most instances and that these were created by [name removed of TIBC Officer]." 
14. Paragraph 19: "The evidence contained herein could be indicative that internal collusion to commit an offense had taken place in the loan book process, and that [TIBC Officer name removed], [TIBC Officer name removed], [TIBC Officer name removed] and [TIBC Officer name removed] must reasonably have known that the loans created for this transfer of excess capital to the Exchange were irregular in that no application was made to them by any client for those amounts paid and the funds were not received by the clients intended." 
15. Paragraph 21: "We could find no evidence to confirm the existence of the Saudi Investment portfolio valued at circa $400 million as at 31 May 2009." 
16. Paragraph 22: "TIBC last obtained a confirmation of the existence of the equity investments as at 31 December 2007 as part of the year end audit process. We noted that the correspondence was sent by [name of officer at a Saudi Bank and name of bank removed by AA] and in this regard found that it is similar to the signature used on the loan documentation reviewed by Ernst and Young. We also note that the confirmation was sent "with [AA: presumably without} any responsibility on the part of [acronym of Saudi Bank removed] or its officers." However, it is alleged that [acronym of Saudi Bank removed] are the appointed custodians. We were told by [TIBC officer name] that no confirmation was sent to [name of External Auditors of TIBC] for the 31 December 2008 audit."
17. Paragraphs 24 through 26 deal with alleged deficiencies in reconciliations of nostro accounts. Paragraph 24 (nostro records did not accurately reflect all transactions). Paragraph 25 (a Saad entity reconciled TIBC's account at Citibank). Paragraph 26 (certain accounts were not reconciled though there were not copies of bank statements or balance confirmations). 
18. Paragraphs 27 through 33 deal with failed trades. 
19. Paragraphs 34 -35 deal with access to electronic records. E&Y alleges "resistance from TIBC's IT vendor to provide technical assistance" and "significant stalling from TIBC management" (Paragraph 34). 
20. At this point we are at page 10 in an 88 page report. 
21. Paragraph 53 deals with Board meetings. It's divided into six subsections. 53.6 reads "[CEO – name removed by AA] stated that he had no interaction with any of the directors since the inception of the Bank, except for Mr. AlSanea, and to his knowledge none of the AlGosaibi family ever attended a Board meeting in person in Bahrain". 
22. Paragraph 59: "It is alleged by [name of CEO removed] that major decisions and his day to day actions were directed by Mr. Al Sanea and that this had been ongoing since the inception of the Bank through the use of memoranda addressed to either Mr. Al Sanea directly or to the Excom. 
23. Paragraph 86: "We were informed by [name of CEO removed] that to his understanding all SWIFT approvals were made from the SAAD Group Offices." 
24. Paragraphs 110 through 119 detail Service Level Agreements between TIBC and the Exchange. Paragraph 119 states "From the contents of these three SLA's it is evident the SLA dated 1 July 2003 was applicable to the loan book which was intended to be managed and maintained by the Exchange. As such the content also creates the impression that the documents related to the application, and complete client relation should have been managed by the Exchange, without excluding TIBC's responsibility to perform proper due diligence". 
25. Paragraph 170: "Deloitte provided us with a draft of their relationship analysis of the loan clients to TIBC, the Exchange, Mr. Al Sanea and Saad Trading. The analysis alleges that the majority of the loan clients are either known to Mr. Al Sanea or employed by his business enterprises." 

Some comments. These are predicated on the assumption that the Report is reasonably accurate as to its description. 

Here are a few things that deviate from the banking practice I am familiar with. Of course, sometimes there is a sound reason why there is a deviation. If we were given the reasons for these practices, we might be able to better understand why they were adopted. 

1. Generally CEOs are not involved in the mechanics of releasing payments. That is, the operational step of inputting a password into a funds transfer system like Swift which then transmits the payment instructions to the bank's correspondent. Depending on the size of a transaction and a bank's internal control system a CEO might sign the approval for a payment, but then the bank's Operations Department would input the payment into the funds transfer system and release the payment. The procedure E&Y describes at TIBC would be to give greater control to executive management. What would be interesting to understand would be why such control was needed. 
2. According to the internal control principles I've been taught one never allows another person to use one's password. Each authorized party should have his or her own unique password. It's unclear to me why there was this alleged departure from this standard. 
3. While I had understood from TIBC's 2008 Annual Report that the Exchange acted as collateral management agent and nominee for the Saudi Investment Portfolio, I was surprised to see the role ascribed to them in the Report with respect to credit origination and relationship management.  TIBC seems to have been operating more as an investor than a commercial bank.
4. I was also surprised to read the statement attributed to one of TIBC's officers that no confirm for the Bank's Saudi Investment Portfolio was obtained for Fiscal 2008 by the Bank's external auditors. It would be interesting to know if this is true. And if true, what the reason was? 
5. Just a short "end note".   What is quoted above is a report.  It is not a judicial determination of guilt or innocence.  Merely a report. 

 Post on Hibis Europe Limited Report on Awal Bank here.