اهلا وسهلا يا ابي المشاكل

مديرنا الجديد للدعاية

BMB Launches Suit Against Related Parties to Recover US$ 6.6 Million

Last Monday Bahrain Middle East Bank (BMB) confirmed the accuracy of Al Ayam newspaper report that the bank had instituted legal proceedings against 6 Kuwaitis and 2 Egyptian Companies in the Bahrain Center for Dispute Resolution.

The confirmation came via a public disclosure on the Bahrain Bourse website.

The bank seeks to recover US$ 6.6 million for a “financing loan” plus 10% interest from 4 June 2016 to the date of payment plus its other costs.

The defendants are the bank’s former Chairman, Mr. Wilson S. Benjamin; prior Vice Chairman Abdullah Ali Khalifa Al-Sabah; Tariq Ibrahim Al-Faris; Majeed Mansour Al-Sarraf; Al-Sawari Holding Company, and Al-Fawares Holding Company all of Kuwait. And Egyptian companies Lotus Investment and Real Estate Development , And Lotus Marketing Centers.

From what I’ve been told in addition to the Mr. Benjamin and Sh. Abdullah A.K. Al-Sabah—both of whom represented Al-F on the board, the other defendants are also associated with AlFawares.

That fact and the amount suggests that this “case” may well have to do with the Installment Sales Receivable Loan. That loan was a long standing related party transaction by virtue of the guarantee given by AlF.

And perhaps as well by other “virtues”. 

You’ll recall that in earlier posts I questioned why the guarantees hadn’t been called on the ISRL as well as how the 2017 write off in the loan of a major shareholder of the bank passed through auditor sign off and CBB approval.

In cases with Kuwaiti individuals and entities, savvy litigants know the value of locking down assets as soon as possible.  

Applying AA’s Corporate Fraud Detection Proposal to Wirecard - Part 1

AA's Hindsight is 20/20  Foresight Much Less

This is the first to two posts on this topic. Second post here.

In an earlier post, I proposed two measures to enhance the detection of corporate fraud.

This post and the one that follows outline how it might have been applied to Wirecard.

To start a recap of the two points in my proposal:

1. Reemphasize the auditor’s duty to identify unique material risks and vulnerabilities in a company’s business model or practices and disclose them as appropriate in the financial statements, e.g., key audit matters and/or footnotes. And as well to ensure the auditor performs the appropriate amount of audit work on these and other risks.
2. Scale audit work to risk. For example, one should not confirm the existence of Euros 1.9 billion in deposits in the same way one confirms a Euro 100,000 receivable.

Before you proceed further, it’s probably useful to take a look at my earlier post which details the proposal, its rationale, and more importantly its limitations.

That will help provide the context necessary for you to make an informed assessment of the potential efficacy of my proposal.

From that and what follows you will see that I’m under no illusion that this is a “perfect” solution—one that will detect all fraud or even all major fraud.

But it will, I think, increase the odds of detection. 

It is a necessary but not sufficient step.

Now to Wirecard.

Point One: Identification and Disclosure of Significant Business Risk

It’s pretty clear from a cursory understanding of basic accounting that the fact that WC’s Euros 1.9 billion deposits were imaginary meant that an equivalent amount of earnings were as well. 26 June post .

Recently the FT reported that a special KPMG “audit” found that Wirecard had been loss making for years. A even more dire situation. 

Let’s assume that in their review of the company’s revenues and net profit, WC’s then auditors (who were not KPMG) noticed that WC was dependent on three companies for the bulk of revenues and profits. See FT article here for details.

At this point, let’s assume there was no hint of fraud.

Because of this dependence, WC faced the risk that these third-parties might take their business to another company, leaving WC with a massive “hole” in revenues and income.

Or these companies might have future problems of their own which would then impact WC.

Now this is not something that can be dismissed with a wave of the corporate hand. “But we work through 100 partners where we don’t have licenses”.

The fact is that if the business with these 3 companies didn’t exist, WC’s revenues and net profit would be vastly different.

Under my proposal, the auditors would have had to insist that WC disclose this “material” reliance on third parties. The auditors would have also had to treat this dependence as a “key audit matter”.

The latter would require enhanced audit measures to analyze the risks of this dependency. For example, to determine how much discretion those third parties had to redirect the business elsewhere, what sort of pressures they might bring to force WC to accept reductions in compensation, etc. What were the risks that these companies faced to their business.

WC no doubt would have made arguments against disclosure of this dependency in its financials citing business confidentiality, maintenance of a competitive advantage, etc. If the “secret” of its third party relationships were revealed, a competitor might poach them. And so on.

The resulting compromise might have been something like “WC’s historical and future profitability has been and remains critically dependent on business flow from 3 third party firms.”

In reviewing this relationship, the auditors should also have noticed that these third parties had been granted access to WC funds (the imaginary escrow accounts).

Or, if the business reliance were not disclosed or overlooked by the auditors, the single fact that the third parties had access to WC’s escrow accounts should have raised further investigation on the accounts.

An investigation which could have led to the auditors discovering WC’s dependence on the third parties for the bulk of revenues and profit.

Assuming that this more detailed work were done, then the fraud might have been caught years earlier.

According to information that the FT was given, at one point AlAlam owed WC an amount roughly equal to one year’s net income.

That certainly qualifies as a material risk.

The two banks that held the accounts BDO and Bank of the Philippine Islands are the largest and third largest in the Republic of the Philippines (ROP) by total assets.

Big fish but small pond.

As of 31 December 2018, BDO had total consolidated assets of US$62 billion equivalent and total shareholders’ equity of US$7 billion equivalent. BPI’s comparable figures were US$43 billion and US$5 billion equivalent.

As of the same date, Deutsche Bank had roughly Euros889 billion in total assets and some Euros55 billion in equity. Bank of America some US$2.4 trillion in assets and US$265 billion in equity.

Euros 1.9 billion in deposits with the Philippine banks should raise credit risk issues as well as other more practical ones, e.g., liquidity.. To be fair an escrow/trust account structure would address some of these.

Beyond that is the issue of country and regulatory risk.

The ROP is judged to have defects in its legal and financial sector supervisory system. See the US Government’s 2019 INSCR issued in March 2019 (page 157 and following) and the 2019 Asia/Pacific Group on Monetary Laundering Mutual Evaluation Report (page 10 points 8 and 9).

Based on the foregoing, WC was taking several significant risks with its “arrangements” for the escrow accounts.

Recognition of that “fact” would require that the auditors perform additional measures to review that credit and risks.

With respect to the three parties, that would mean an investigation of the conditions of their access, the reasonableness of amounts that they were permitted to access, the escrow agreement’s effective protections, etc..

As well, the auditors would have to review the credit exposure to the two Philippine banks who “held” the deposits and regulatory and credit issues related to the choice of the ROP as the “depository” country.

That doesn’t mean that the auditors would necessarily determine if the decision were the right one.

After their review, they might note “issues” surrounding the credit decision for public disclosure. And equally important factor these risks into their audit plan.

At the very minimum it would seem that the third party access—which seems not to be a usual business practice—would warrant disclosure by a sentence or two in the note to the financial statement about cash and banks.

These disclosure should alerted investors, analysts, other market participants to these risks and hopefully triggered questions.

But there’s a critical dependency. Warnings are of little utility if they are missed for whatever reason.

However, this “finding” should also have resulted in the auditor having greater focus on these issues in conducting the audit. And thus provide a back-up in the case market participants were somnolent or in throes of irrational exuberance.

The resulting effect on audit work is very important because the auditor has access to more information than outside parties. Thus, there is more likelihood that the auditor will have more success in “pulling on a loose thread” and unraveling a fraud.

In the next post, I'll look at some enhanced audit measures that the auditors could have employed.