Scotland: John Major Endorses IndyRef#2

 

Not Peter Greaves

Yaldi!

You could have knocked me over with a feather or a perhaps more appropriately a small thistle.

I read in The Financial Times today that John Major--yes, that John Major--believes “Westminister should not refuse Scotland a referendum”.

Which I believe demonstrates quite clearly that the Conservative Party does have something to offer Scotland.

An offramp.

To be fair he did go on to natter about “constitutional reform”, “devolution”, etc.

The Unionists “strong” economic arguments for the “Union”.

And that “small” Scotland would be but a minnow in the EU and have a concomitant small voice.

That is, no doubt in contrast to today?

One final comment a quote from the FT for those who have forgotten or perhaps never knew: The writer is a former UK prime minister

Bahrain Middle East Bank - 2020 Financials and 1Q2021 Financials Still in "Limbo"

24 March BMB announced that no date had been set by its Board of Directors to review and approve the bank’s financial statements for the period ending 30 June 2020, 30 September 2020, or 31 December 2020. 

As well it announced no date had been set for Board review and approval of its 31 March 2021 financials. These cannot be approved until 2020 financials are “set”.

Clearly, there is no “good” news to report. Which suggests that the news is bad.

Not a big surprise the bank is in dire straits.

But the continued delay on the financials probably indicates that things are heading further "south".

Wirecard: More Missing Money - This Time Real Money

Recommended Not Only for Its Fine Weather
But Also for Its Banking Facilities and "Discretion"

The FT reported 24 March that sources told them that Oliver Bellenhaus, late of WireCard and Al Alam, informed investigators that in 2011 he and Jan Marsalek, Wirecard’s former CF), began a scheme to shift money out of WC into “an array” of offshore accounts of shell companies in Hong Kong and the British Virgin Islands. Said account opened in 2010.

As I read this account, I suspected that many readers would think that this is where WC’s missing Euros 1.9 billion had gone.

I don’t think that this is the case.

Why?

Because it’s hard to steal what doesn’t exist.

If press reports are correct and WC was loss making, then the Euros 1.9 billion never existed. And couldn’t therefore be stolen.

These “shifted” funds would have had to be derived from other sources. And while no doubt significant, nothing close to the former amount.

Earlier I posted a detailed explanation why fiddling with the income statement requires fiddling dollar for dollar with the balance sheet (and vice versa) in my earlier post here.

Let’s look at WC’s financials from FY 2004 though 3Q19 to see if there was evidence of income above the imaginary Euros 1.9 billion. That may have produced actual cash to be stolen.

Why that period?

Prior to 2004 Wirecard was InfoGenie, a rather small call center with negative retained earnings.

There wasn’t much to fiddle with before 2004.

As the table below shows, during that period WC reported Euros 1.919 billion in net income, paid dividends of Euros 165 million, and had other adjustments to retained earnings of Euro 15 million. The dividends were likely funded via increased liabilities rather than cash flow from operations.

So, if there were transfers of “millions” as Mr. Bellenhaus is reported to have said, where did they come from?

Two likely possibilities.

Overstatement of  Expenses/Costs

Either those recognized through the income statement (expenses) or capitalized (costs).

For the former, professional services are a frequent favorite as they don’t generate a hard asset. Or business acquisition/referral fees, processing fees. 

Perhaps, imaginary fees on the imaginary transactions with the difference here is that the latter were paid in cash.

A particularly fertile ground for the latter might be the creation of intangible assets.

What is the proof of the cost of new software, other than the bill for development, particularly if outside vendors were contracted?

In its FY 2018 annual report, WC discloses it spent some Euros 86 million in FY 2018 and Euros 98 million in FY 2017 in cash for “investments in intangible assets”.

Over the period 2016 through 2017, WC’s internally created and other intangible assets increased from Euros 181 million to Euros 252 million.

Could some of these be the result of shifting funds? We don’t know.

Overpayment for Acquisitions

Acquisitions by their nature are “chunky” unless there are periodic payments, e.g., if the newly acquired company performs above a benchmark, the sellers may be entitled to a payment reflecting the greater value of the company they sold. That of course will depend on the terms of sale.

Another possibility would be fees to those who sourced acquisitions for WC, provided WC financial advice, performed due diligence, etc. This presumes such charges were capitalized as part of the cost of the acquisition rather than expensed.

Expense fiddling would a better “cover” for frequently recurring transfers than acquisitions which tend to be lumpy, particularly if the same accounts were used again and again.

It’s not clear from the FT article whether the same accounts were used over and over. 

Does “array of accounts” mean a single group of accounts created in 2010? 

Or could it mean repeated creation of new accounts?

Acquisitions would allow for larger payments in a single transaction. But it would seem that these would be handled by using a different (new) account for each acquisition rather than the same accounts. 

It would (should?) look a bit suspicious to auditors –at least I hope so—if acquisitions from different sellers and in different part of the world went to the same account.

So, if I’ve read the FT article correctly, my best guess would be expense fiddling.

With Mr. Bellenhaus’ co-operation and access to WC’s accounting records, investigators should be able to calculate the amount “shifted” and what transactions were used for cover.

Presumably, the stolen amounts were used to fund the costs associated with running the income fraud as well as to compensate the key players (like Mr. Bellenhaus) for their role.

SuqAlMal Career Advice -- Manage Your Personal Career Like Big Successful Corporations

 

AA Started Learning from Others on His
First Day as an Analyst at MegaBucks Firm

Did you ever wonder how I got this prestigious position at SuqAlMal coupled with a fast paced highly remunerative career in finance?

Besides my innate abilities and willingness to put in the hours, I wasn’t too proud to learn from the successes of others as the above archival picture demonstrates.

And apply what I found to my own career.

It is a uncommon occasion indeed when I share some of those career lessons.

Consider yourself lucky. Today is definitely one of those rare days.

As we all know, or think we do, major corporations have discovered secrets to success.

Sometimes a putative business leader “genius” will put his wisdom down in one of the many tomes you’ll find in the business books celebrity section at your local bookstore.

Sometimes an academic will distill these lessons into a path to excellence.

But what if this does not happen for whatever reason?

If we look closely at companies we can discover these “success” principles and strategies on our own. We can tease them out of their actions.

More than that, we are likely to find those principles and strategies that they are trying to keep for themselves!

Once we have a hold of them, we can apply them to our own careers.

Here are two sure-fire ways to increase your bonus this year:

1. Claim a 2021 bonus based on potential highly lucrative business you will obtain in the future from existing or potential future clients that are currently unknown. (This tactic is known among the cognoscenti as the “Blueridge” or “Liberty Primary” gambits).
2. Add credibility to that claim by committing that by 2050 you will have reduced your incidence of “lost” pitches to zero. (The Pitch Climate Improvement Plan).

With these two simple tactics, you’ll be on the way not only to a larger bonus in your firm, but also it's highly likely you’ll be identified as someone with leadership potential.

Market Commentary: Berkshire Hathaway, St. Augustine, and ESG

Patron Saint of Good Works,
But Primarily Those in the Future

 Analyst Disclosures:

• Oxford Commas provided by Eton College in return for this promotional mention. 
• AA holds no investment position (either short or long) in BH. Or more precisely BRK.

Berkshire Hathaway has made what I consider puzzling (at least on their face) responses to two shareholder introduced proposals for consideration at the 2021 annual general meeting. 

Readers are invited to make their own judgments as to the motives for these responses.

You’ll find BH’s proxy materials here. 

The first proposal is that “the Company publish an annual assessment addressing how the Company manages physical and transitional climate-related risks and opportunities.” This proposal contains suggested elements in that report but gives the board “discretion” on framing the report.

Berkshire replies that:

1. The Board recognizes the importance of responsibly managing climate-related risks to both shareholders and the future of Berkshire and its operating businesses.
2. The Board regularly receives reports on the major risks and opportunities of the operating companies, including those related to climate, and discusses those risks and opportunities. 
3. Berkshire manages its operating businesses on an unusually decentralized basis. There are few centralized or integrated business functions. (At the BH level).
4. We want our managers to do the right things and we give them enormous latitude to do that; consistent with our business model, each subsidiary is independently responsible for identifying and managing the risks and opportunities associated with their business, including those related to climate change. 

As I read this, BH admits it has the requested information in one form or the other (point #2) but pleads (point #3) that they don’t have the staff at the holding company level to compile such a report. 

Apparently, hiring a third party to compile such a report would be a large and extravagant expense. Note that is my assumption. BH did not say this.

Interestingly in arguing against adoption of this proposal BH then goes on to recite the climate related achievements of some subsidiaries in some detail. 

In light of the above comments about the small size of BH’s central staff, I wonder who prepared these. 

Could it possibly be the same folks who prepare information on financial performance at the subsidiary level? Note my assumption is that it is staff at those subsidiary companies.

In point #1 BH “recognizes” the “importance” of these issues and in point #4, it “wants” the managers of its subsidiaries to do the “right things”, but as also outlined in point #4 isn’t going to interfere with the discretion entrusted to the operating company managers.

BH's position on climate issues seems to AA to be similar to St. Augustine who reportedly recognized the danger of sin, and ardently wanted to do something about his own personal situation, but not today.

AA wonders at least rhetorically, and hope you do too, if the Board takes same approach on operating company financial performance. It “recognizes” the importance of good financial performance, “wants” good performance, but lets the operating companies “independently manage” financial performance.

The second shareholder proposal requested that “Berkshire Hathaway holding companies annually publish reports assessing their diversity and inclusion efforts, at reasonable expense and excluding proprietary information 

BH’s Board responded that:

1. Berkshire’s commitment to diversity, equity and inclusion and the effectiveness of our companies’ related programs starts with our leaders, including our Board of Directors on which three female and two ethnically diverse members serve. 
2. Mr. Buffett, Berkshire’s Chairman and CEO has set the “tone at the top” for Berkshire and its employees for over 50 years. During this period of time, Mr. Buffett has a record of opposing efforts, seen or unseen, to suppress diversity or religious inclusion. 
3. All of Berkshire’s leaders – whether in our operating businesses or on our Board – are extraordinarily qualified, committed to our culture and focused on ensuring long-term success for shareholders.
4. The proposal’s supporting statement indicates that “investors seek quantitative, comparable data to understand the effectiveness of the Berkshire Hathaway companies’ diversity, equity and inclusion programs,” improperly suggesting that there is a standardized technique for each of Berkshire’s more than 60 operating businesses to address diversity, equity and inclusion. 
5. Berkshire’s operating businesses represent dissimilar industries operating in multiple locations throughout the world. It would be unreasonable to ask for uniform, quantitative reporting for the purposes of comparing such dissimilar operations in different geographic locations. 

Again, as I read points #1 and #2, BH both recognizes and supports diversity and inclusion. Though I’d guess that as outlined above in the discussion on climate, the Board really doesn’t do anything to interfere with the subsidiaries’ operations.

Also I'd like to call to your attention another demonstration of why many call Mr. Buffett the Oracle of Omaha: he apparently can see both the seen and the unseen.

Point #3 was puzzling.

AA wonders if it is designed to calm the potential worries that some shareholders might have after reading point #2. All that diversity. Is my money really safe? 

I’d also note that two of BH’s directors would qualify as senior citizens. So score a few more diversity points for the Company.

Points #4 and #5 raise a question about how BH is able to provide reporting on its financial performance. 

I mention this because BH’s 60 companies operate in “different geographic locations” and “different industries” in “multiple locations in the world”. 

As a consequence, it is highly likely they are using different languages, different accounting systems, to say nothing of accounting principles, and are subject to different laws. 

It sounds an impossible task, but if you take a look at BH’s 2020 Annual Report, you will see a rather extensive discussion on BNSF, BHE, and other of BH’s companies.

Were these prepared by the 26 central staff in Omaha who, if this is the case, might be the modern day equivalent of the 300 Spartans? 

Or were they prepared by the subsidiaries themselves?

Couldn’t that be a solution if only in part to the shareholder proposal? 

The subsidiaries prepare such reports. 

Who better prepared to put their efforts and results in the appropriate regional and industry context?

Perhaps, with the requirement that only a few of BH’s 60 subsidiaries report each year.

With the focus on the major subsidiaries.

Where there is a will there is a way or so AA was told by his parents.

On the wider topic of ESG itself, here’s a link to an interesting piece at Bloomberg from January 2020 which analyzes the differences between what investors profess and what they do.

Two salient points therein:

1. Berkshire tends to score low on ESG (even below Amazon) due to lack of reporting and its holdings of coal-fired utilities. Mr. Buffett’s Friedmanite skepticism dogmatism on ESG may also be a factor.
2. Most investors who claim that ESG is a key element in their investing philosophy do not practice what they preach. If an investment has a high return, ESG concerns vanish. Virtue is apparently not its own reward. Even more interesting those who claim they would shun an investment in Amazon because of concerns about workers’ rights, would definitely shop there. There are a lot of St. Augustines about, it would seem.

Market Commentary: Greensill -- The Critical Difference between Insurance and a Guarantee and Why It Matters

 

An Unhappy Outcome

Since I haven’t seen anything on this topic in re Greensill, I thought I’d offer a few thoughts on how the fundamental difference between (1) a guarantee of payment and (2) an insurance policy affects the Greensill “situation”. 

And how it might motivate actions by participants in this unhappy event.

The difference between these two instruments is frequently misunderstood, including by supposed finance professionals. Hopefully, this post will fill in any extant knowledge gaps.

A guarantee of payment (as opposed to a guarantee of collection) is a legally binding obligation by the guarantor to make payment to the guaranteed party if the debtor does not make a scheduled payment. Proof of the debtor’s non payment is generally fairly “easy” to make. Usually then the guarantor makes payment without undue delay.

An insurance contract is a legally binding obligation by the insurance company to pay the policyholder if the policyholder submits a valid claim.

Keep those last two words in mind. 

The insurance company reviews the policy conditions, the insured’s (or policyholder’s) actions, and makes the initial determination of the validity of the claim. Some policyholders have been known to complain that such assessments seem to move at a glacial pace.

As that should imply, the insurance company has more legal defenses against payment than a guarantor. And its payment is not as fast given the time to review the claim.

The insurance policy spells out the conditions for validity.

For example, in obtaining the policy, did the policyholder make a material misrepresentation or fail to disclose material information that would reasonably have caused the insurance company to refuse to write the policy? In such a case the entire policy is invalid.

Did the policyholder fail to take reasonable steps to prevent the loss?

For example, if he left his Maybach unlocked with the key in the ignition and his insurance company knew this fact, they would likely decline the claim for theft.

If she routinely stored gasoline in her villa and filed a claim for fire damage and the insurance company knew this fact, the result would be the same.

Did the policyholder take reasonable steps to mitigate damages?

When the fire broke out, did she call the fire department? Or just let the villa burn down?

If his trade counterparty was in financial difficulty and he should have been aware, did he shorten payment terms, ask for collateral, lower his credit limit for aggregate outstandings?

There may also be other specific policy exclusions: strike, riot, civil commotion, actions of political entities, foreign exchange controls, etc.

We can therefore expect that Tokio Marine and other insurance companies will be carefully reviewing their obligations under any outstanding policies on Greensill related debt. 

I saw in today's FT (23 March) that Tokio Marine had opined that the policies might not be valid. 

Today (2 April) the FT reported that Grant Thorton acting as administrator for Greensill had been unable to verify certain invoices underpinning loans to Liberty Commodities - part of Mr. Gupta's group.  

Actually, the article says that several firms whose names appeared on invoices denied any commercial relationship with Liberty.  You can guess that this means that any "insurance" on these invoices is invalid.

One would of course have to review the actual policies and the respective governing laws to determine the defenses the insurance companies might have.

But I wonder if it’s possible that policies issued in excess of underwriting limits might be one? 

Part of that might turn on whether Mr. Brereton was working for Greensill (as an insurance broker) or for Tokio Marine (as its employed underwriter).

As well one can imagine Credit Suisse fund managers' angst over the difference between insurance and a guarantee as well as potential liabilities that might arise from potential "defects" in disclosures in selling documents vis-a-vis disgruntled clients whose attorneys will be going over said documents carefully.

Keep up to date on developments.  

The FT continues to follow the Greensill saga with an interesting article on Mr. Brereton earlier this week.

Market Commentary: Tesla "Loses" One-Third of Its Value

 

Make Sure Your Weighing Machine is Properly Calibrated

Just a few days ago, I read courtesy of Reuters that Tesla had lost one-third of its value. 

Shocked, I rushed to read how such a loss had occurred.

Had Brother Musk misplaced or “lost” the “code” to Tesla’s Bitcoin account?

Did meteors strike Tesla’s factories, wiping out needed capital assets?

Did Lucid leapfrog Tesla's self-driving technology?

I read on.

Rather the article was about the decline in the price of Tesla stock.

The writer of the headline apparently is a naive adherent of the efficient market theory conflating stock prices with value.

So what is the point?

There is a difference between the price of a stock and its (intrinsic) value.

Many tragedies in the investment world have occurred because of a conflation of the two.

Market sentiment plays a large part in the price of a stock.

One day an NMC or a Wirecard are flying high. The next day they are not.

When 911 occurred, prices on the NYSE dropped dramatically forcing the closure of the market.

In both cases there was a wide gap between value (reality) and price (sentiment).

Prior to the price decline NMC and Wirecard had high prices, but no value, unless one were to count negative numbers.

In the second case, the stocks on the NYSE as a general group did not suffer any real loss of value. Their prices just diverged from value.

Earlier this year, one of my colleagues gave me a JPMorgan research piece on Tesla which posited a value of some USD 160 or so a share.

JPM had computed the value using multiple “different” methods, though as Aswath might tell you many of these seemingly independent methods are really fundamentally linked.

I found it entertaining but not convincing reading. The JPM research piece not the Professor's. 

A sum of the parts analysis in a distressed sale might have been more illuminating.

Market Commentary: Bill Gates on Biden's USD 1.9 Trillion Covid Relief Bill

Answers to All Your Questions

Announcing a new feature here at SAM: AA’s trenchant commentary on news and developments in the "market".

I saw on the internet about two weeks ago a Fareed Zakaria interview in which he asked Bill Gates to opine on the Biden USD 1.9 trillion stimulus plan.

I was surprised.

Prior to that, I hadn’t known that Bill Gates was an expert on economics.

As Phil Rosenzweig can tell you, success in one field, particularly one in which an individual makes billions, automatically confers unique knowledge in almost every other field on that individual or at least the appearance of such knowledge.

Often such knowledge is attributed by folks who one hopes should know better.

Given Fareed’s academic and professional focus on foreign affairs, I was surprised that he did not seize the opportunity with Bill to heal an unfortunate rift in the Middle East by asking Bill to provide the definitive analysis of the meaning of “غَدِيْر خُمّ “ and “أَهْل ٱلْكِسَاء‎ “.

Or perhaps give his solution to the Korea issue.

Sadly, for whatever reason, he did not.

One or is that two for the “missed opportunities” file?

I, of course, would have had my own set of different questions.

Before outlining these, I need to make a material disclosure.

Devoted readers of this blog (I’m counting bots so I can use the plural) know that there is a bit of bad blood between Bill and me.

Sometime back I was expecting advice from him on what I should be having for dinner, hoping to draw on another area of his wide ranging expertise after my foray in a mall bookstore's business books section.

Advice that sadly never came.

Madame Arqala, as she so often does, did rescue me on that occasion.

Despite a bit of lingering rancor on that failure, I would have straightaway asked Bill what strategy he would employ as Arsenal’s new head coach to ensure that they repeatedly won the Premier League, the Champions League, etc.

All in the hopes that Brother Stan was watching. Or might see the interview later on the VAR.

I'd probably have moved on from there to ask him to opine on a sharp difference between my elder wiser brother (expert in many thing Asian though clearly not on pizza) and me over the best pizza:  deep dish or thin crust. 

Or perhaps why the last two words in the fourth verse of Surah 112 did not have the same terminal vowels. 

Eventually I’d probably have asked Bill to comment on SolarWinds and Microsoft Exchange.

Why these events happened?

What Microsoft could or should have done to prevent them?

Perhaps, an area where his skills might be more profitably employed.

لأبي المشاكل

يا صديقي هل رأيت بعض أقاربك؟

 

Citibank's USD 902 Million Revlon Payment - What's Not in the News

 

You’ve probably been reading about the mistaken USD 900 million payment made by Citibank acting as agent for Revlon.

As as well as the decision by the US District Court, Southern District of New York, that the lenders to Revlon who received Citibank’s erroneous payments of principal were not legally obligated to return the funds.

Let’s take a closer look as I think some details of the story haven’t been highlighter. 

Here’s the link to the 105 page decision.

As a starter it's a good introduction.

It’s well worth a read as it explains the background and facts of the erroneous payment and the legal precedent Banque Worms vs Bank of America International (Banque Worms) which “led” the court to its judgment.

Banque Worms establishes the right of creditor who receives funds in error from a debtor or the debtor’s agent to retain the funds and apply them against the debtor’s outstandings as long as the lender had no knowledge of the error when it received the payment.

This precedent thus overrides the concept of equity that typically governs payments received in error: if one receives funds in error, one is obligated to return the funds.

Background and Some Clarifications

The “USD 900 million” payment was actually for approximately USD 902 million: approximately USD 894 million in principal and USD 7.8 million in interest. Citibank received funds from Revlon for the (authorized) interest payment, but used its own funds for the (erroneous) principal payment.

Citibank were able to recover about USD 390 million from the principal payment, reducing its loss to some USD 504 million. 

The USD 894 million principal payment was made to two groups of lenders. Allocations are based on my calculations using data in the court decision.

1. The first group received USD 341 million. They were involved in a non-cash exchange of one Revlon debt for another (a “roll up”). Based on the terms of the exchange, they were not to receive any principal payments. Thus, they would not be able to resort to the Banque Worms precedent cited above. This group returned the full USD 341 million in principal payments they received.

2. The second group received USD 553 million. This group was not involved in the debt exchange. Therefore, they had no right to any interest or principal. Under Banque Worms they had a legal defense to retaining the funds because they did not “know” the transfer was in error when it was received. An important part of the refusenik lenders’ defense was that they were unaware of the “roll up” involving the first group. Some lenders in this group returned USD 49 million either because they or they agents were unaware of the possible Banque Worms defense or decided to return funds despite such knowledge. 

At first blush, this sounds like a case of human error.

A “fat” finger, a misplaced decimal point, or an error in calculation.

But there’s more to the story than that.

Each lender received a principal payment in the exact amount of its principal balance as well as the exact amount of interest due it to the date of the payment – which was not an interest payment date.

The error was due to a combination of factors – human plus limitations in Citibank’s perhaps inaptly-named Flexcube system.

Citi was attempting to perform a complicated and uncommon transaction. 

1. The first “bit” of complexity was that this was a “roll-up” transaction. Some lenders were exchanging existing Revlon debt (positions in the 2016 Revlon loan) for positions in other Revlon debt.

2. The second “bit” of complexity was that not all of the lenders in the 2016 Revlon debt were participating in the “roll-up”.

The lenders participating in the roll-up—whose positions were managed by Angelo Gordon (the Angelo Gordon Lenders)--were entitled to a cash payment of interest on the existing debt up to the date of the “roll-up”. They were, however, not entitled to any cash payment for principal. Revlon owed this group USD 341 million in principal.

Those lenders not participating in the roll-up were not entitled to any cash payment of either interest or principal. Revlon owed this group USD 553 million in principal.

What were the problems? And what were the “issues” surrounding Citibank’s systems?

Citi’s system could not process an interest payment to just the Angelo Gordon Lenders.

All lenders had to be paid interest.

To get the exchange done, Revlon agreed to pay (cash) interest to all lenders. Some USD 7.8 million.

If my calculations are right, Revlon paid approximately USD 4.9 million in interest to the non Angelo Gordon lenders. Interest that it did not have to pay on that day.  

In effect it prepaid this amount of interest. 

Small beer perhaps, but perhaps not so small for a company in Revlon's financial position.  

As well as, perhaps, opening itself to the charge of creditor preference were the egg to fall off the proverbial spoon. 

Further complicating matters, to achieve the “roll up”, the principal balances of the Angelo Gordon Lenders in the 2016 Revlon term loan had to be reduced.

Citi’s system required this be achieved using a principal payment.

To do this without the movement of cash, the principal payment would have to be made using internal Citi “wash accounts” (General Ledger accounts). The amount of the principal payment would be funded by debiting an internal Citi G/L account. Then the principal payments to each roll-up lender would be “paid” into an internal Citi G/L account. Then (presumably) each lender’s principal payment would be be used to purchase an equivalent amount in the other Revlon facility.

But there was the same problem as before.

Citi’s system could not apply this mechanism to only the Angelo Gordon Lenders.

All lenders would have to be “repaid”.

That means that the non participating lenders’ shares of the 2016 loan would have to be "repaid" using the Citibank G/Ls as above. But with a key difference. In the final step instead of “purchasing” shares in another Revlon loan, these lenders would “repurchase” their shares in the 2016 loan.

That wasn’t the only wrinkle.

To ensure that interest payments would be made in cash and that the principal payments would not, Citi’s ABTF (Asset Based and Transitional Finance Team) had to check three boxes on the Flexcube payment system: FUND, FRONT, and PRINCIPAL to override the standard settlement instructions. They also had to input the related G/L account numbers in each of the three fields associated with these boxes

You can see a “screen shot” of Citi’s Flexcube system on page 13 Figure 1.

This seems a rather complicated system. Unnecessarily complicated.

One that is not intuitive. What does FRONT mean? What does FUND? And thus subject to mistake.

Citi’s agents (Wipro) checked the box “override default settlement instructions” next to PRINCIPAL as well they input the internal G/L in the required field.

They did not do the same for FUND and FRONT.

There are two possibilities here. 

The first case: If settlement instructions means the details of where Citi was to pay the funds (to the creditors) then it would appear Flexcube “ignored” the two override inputs for PRINCIPAL.

I would have expected it to decline the transaction with a note “incomplete” or “inconsistent instructions”.

Also if the standard settlement instructions for the principal payment were “overridden”, shouldn’t the system have been unable to make the payment as presumably it did not have other settlement instructions?  

The second and more likely case: Settlement instructions meant the accounts that Citi should debit (the debtor's), the system processed a payment against an internal Citi G/L account that was it seems (note that caveat) designed for non-cash transactions.  

With 10/10 hindsight, it would seem that ideally the system should have been programmed to refuse such a transaction.  

Or perhaps more likely programmed to raise a warning -- You are attempting to make an external cash payment against an internal non-cash account.

As well, it would have been ideal if the warning message associated with the final release of funds had been more explicit. For example, “You are about to release an external cash payment of USD 902 million: USD 894 million in principal and USD 7.8 million in interest”.

Somehow the fact that Citibank had not received USD 894 million from Revlon and was “going out of pocket” was not reflected in Flexcube.  

Typically agent banks require a borrower to remit funds to a special “loan agent” account to cover loan repayments and only release payments to lenders when receipt of funds is confirmed. Banque Worms is one reason why.  

There are of course other reasons. The Agent wants to be certain it has received the funds and that the funds are in an account under its control, not the borrower's account.

As indicated above, and with admitted 20/20 hindsight, it seems there were several steps in the process where a fail safe mechanism in Flexcube could have prevented the payment.

That being said, the human element is not innocent here.

Citi’s Flexcube manual contained detailed instructions.

The three Citi employees charged with input of the payment, checking of details, and authorization (release) apparently assumed that checking the PRINCIPAL box and inputting the G/L number was all that was required.

The fact that this wasn’t a common transaction, that Citi’s mistakenly named Flexcube required workarounds to complete the transaction, that the size of the transaction was "large", and that Revlon’s credit was weak should have prompted additional steps by Citi’s staff.