The Regulators 12

THE REGULATORS Introduction BCCI, which managed to penetrate every country it targeted, including the United States, was a bank which regulators always recognized as a risky institution. Having no lender of last resort and no consolidated auditor, BCCI presented a structure which to Western bank regulators was unsound, regardless of how BCCI happened to use the structure. From the beginning, regulators in the United Kingdom and the United States sought to discourage BCCI from entering their jurisdictions. Their hostility was not based on a cultural contempt for a Third World or Pakistani bank, as BCCI's chief, Agha Hasan Abedi, sometimes contended. Rather, it was based on the very structure of the bank, which was viewed, correctly, as having been deliberately created to avoid regulation. As William Taylor, then staff director of the Federal Reserve's Division of Banking Supervision and Regulation testified in May, 1991: I want to make it clear that BCCI, unlike virtually any other major international bank, was not subject to a comprehensive system of supervisory oversight by authorities in its home country. . . both the holding company for BCCI and one of its major banking subsidiaries are chartered in Luxembourg; but neither the holding company nor the subsidiary has conducted a banking business in that country. BCCI appears to manage most of its global business out of offices in London. The regulatory authorities in

Luxembourg, therefore, did not provide consolidated supervision of the BCCI organization.(1) Luxembourg was thus one of BCCI's homes, yet did not regulate it, because BCCI did not engage in banking business there. BCCI's other home, the Grand Caymans, did not regulate any bank licensed there. The Caymans lack of regulation was precisely the inducement for banks to charter themselves there.(2) BCCI's operational home, the United Kingdom, also did not regulate BCCI's activities: the UK regulator, the Bank of England, considered BCCI to be a foreign bank, based in Luxembourg and the Grand Caymans, and thus the responsibility of regulators in those countries. This neat arrangement by BCCI, together with its division of its auditing functions between two auditors, one for "Luxembourg" and the other for "Grand Caymans," ensured that BCCI's activities could not be adequately monitored by anyone. As former Comptroller of the Currency John Heimann testified: Early on in my government service, I learned one very important and fundamental lesson; namely, that those so inclined to manipulate banks for their own benefit find it easiest to do so if they operate between different supervisory regimes. Many bank swindles have been built around this practice. For example, an individual owns a bank in New York State, another bank in Belgium, a third bank in Switzerland, and still another bank in Argentina. Each of these banks is regulated by a

different Supervisor. . . For years, the same situation applied domestically. There were some who owned both state chartered and national chartered banks who moved assets between them to improve examination results. This practice was stopped during my term as Comptroller when all relevant agencies began to coordinate examinations.(3) Despite being chartered elsewhere, BCCI chose London as its operational home and headquarters, creating oversight problems that gave regulators headaches for years. The Bank of England indeed considered BCCI "the most difficult bank we have to deal with," as far back as the 1970's.(4) It repeatedly limited BCCI's ability to expand there and to gain full bank powers, even as the U.S. halted BCCI's attempts to purchase U.S. banks openly, leaving it with the legal ability only to enter the U.S. through establishing foreign branches which could not accept deposits from Americans. Yet in the face of this regulatory hostility, BCCI ultimately succeeded in developing large banking operations in both the United States and the United Kingdom anyway, through its secret ownerships of U.S. banks and its accretion of licensed deposit taking status in the UK. While BCCI did not need to bribe central officials in the United States and the United Kingdom, as it did in many other countries, its success in flourishing in both countries for so long demonstrates obvious flaws in the regulatory process. In the U.S., BCCI was able first to deceive the Federal Reserve, despite making numerous errors in the

course of its takeover of Financial General Bankshares that provided obvious warnings of its intentions. It then was permitted to merge that bank, renamed First American, with National Bank of Georgia, which the Federal Reserve also knew to be associated with BCCI. It then was permitted to expand further into Florida, despite further warning signs to the Federal Reserve about the identity between BCCI's shareholders and those of First American. Even after it was indicted on drug money laundering charges, the Federal Reserve undertook only limited investigative efforts. The Federal Reserve's extensive current investigation of BCCI began after the Federal Reserve was notified by the New York District Attorney that BCCI had massive loans securing First American's stock which had never been disclosed to the Federal Reserve. As late as the spring of 1991, after the Federal Reserve understood that BCCI and many of First American's shareholders had lied to the regulators, and that BCCI itself was involved in massive fraud, the Federal Reserve still took no position as to whether BCCI should be closed globally, so long as the bank was shut down in the United States. In the UK, the Bank of England took minimal steps to investigate the bank until it was notified by BCCI's auditors in early 1990 that BCCI had engaged in fraud. Even then, the Bank of England's approach to the problems posed by BCCI was not to close BCCI, but to find ways to keep BCCI alive and thus avoid embarrassing financial losses. In order to prevent BCCI from collapse, the Bank of England arranged with BCCI's auditors, with the government of Abu

Dhabi, and with BCCI itself to keep secret what it had learned about BCCI. The Bank of England simultaneously committed itself to an agreement with Abu Dhabi whereby if Abu Dhabi would guarantee BCCI's losses, the Bank of England would lend its hand to helping BCCI survive, and with BCCI auditors that they would certify BCCI's books and accounts for another year, in return for Abu Dhabi's guarantee. The Bank of England even agreed to permit BCCI to restructure in the form of three banks, headquartered in three different jurisdictions -precisely the structure already identified as the key to BCCI's previous success in evading regulation. Finally, as part of its agreements with Abu Dhabi, the Bank of England encouraged BCCI to move its headquarters and officers out of British jurisdiction to Abu Dhabi, along with its records, a move which later deprived investigators in the US, as well as the UK, with essential information about what BCCI had done. Together, these actions by the regulators highlight the lack of accountability that still exists internationally in dealing with financial institutions as they cross national borders. BCCI's homes in Luxembourg and the Grand Caymans were not responsible for keeping track of what BCCI was doing. Neither was the United Kingdom, where BCCI was actually headquartered. So far as the Federal Reserve was concerned, BCCI's activities in the U.S. were limited to small state-chartered branch offices over which it had no jurisdiction whatsoever. Yet even after each of these authorities knew that BCCI had losses amounting to billions of dollars, none of the regulators had a picture of BCCI's whole operations,

none of the regulators considered BCCI to primarily their problem, and each of the regulators remained prepared to permit BCCI to continue to survive if its survival meant that the interests of their country were protected. In the case of the Federal Reserve, this meant leaving it to the Bank of England to make judgments concerning whether BCCI would continue to exist or not, so long as BCCI withdrew entirely from the United States and the Abu Dhabi government continued to provide funds to help prop up the now shaky First American Bank. In the case of the Bank of England, this meant planning to permit BCCI to reopen as three "independent" banks so long as Abu Dhabi was willing to put in the cash necessary to prevent the bank from collapsing. That judgment by the Bank of England only changed at the end of June, 1991 when two simultaneous factors converged -- the announcement by Price Waterhouse in its Section 41 report that it was impossible to tell how deep, or how far, BCCI's frauds might ultimately extend -- and the fact that BCCI might shortly be indicted by the New York District Attorney as an example of organized crime, an indictment that would cause the collapse of the bank in any case. Thus, in the end, it was not the regulatory process itself that brought about the exposure and removal of BCCI from either the United States or the United Kingdom. In both cases, the ultimate regulatory action was prompted by the criminal investigation brought by a local district attorney, Manhattan

prosecutor Robert Morgenthau. But for Morgenthau's investigation, the Federal Reserve may well never have learned from the Bank of England, Price Waterhouse, Abu Dhabi, or anyone else that reports prepared by BCCI's auditors showed massive loans against the shares of CCAH/First American, information that caused them to open the investigation that swiftly led to BCCI's closure in the United States. But for Morgenthau's investigation, the Bank of England might well have proceeded with BCCI's restructuring regardless of the new revelations about fraud, and simply hoped for the best.

Findings: The U.S. Regulators ** When the Federal Reserve approved the take over of Financial General Bankshares by CCAH in 1981, it had substantial circumstantial evidence before it to suggest that BCCI was behind the bank's purchase. The Federal Reserve chose not to act on that evidence because of the specific representations that were made to it by CCAH's shareholders and lawyers, that BCCI was neither financing nor directing the take over. These representations were untrue and the Federal Reserve would not have approved the CCAH application but for the false statements made to it. ** In approving the CCAH application, the Federal Reserve relied upon representations from the Central Intelligence Agency, State Department, and other U.S. agencies that they had no objections to or concerns about the Middle Eastern shareholders who were purporting to purchase shares in the bank. The Federal Reserve also relied upon the reputation for

integrity of BCCI's lawyers, especially that of former Secretary of Defense Clark Clifford and former Federal Reserve counsel Baldwin Tuttle. Assurances provided the Federal Reserve by the CIA and State Department, and by both attorneys, had a material impact on the Federal Reserve's willingness to approve the CCAH application despite its concerns about BCCI's possible involvement. ** In 1981, the Office of the Comptroller of the Currency had additional information, from reports concerning BCCI's role in the Bank of America and the National Bank of Georgia, concerning BCCI's possible use of nominee arrangements and alter egos to purchase banks on its behalf in the United States, which it failed to pass on to the Federal Reserve. This failure was inadvertent, not intentional. ** In approving the CCAH application, the Federal Reserve permitted BCCI and its attorneys to carve out a seeming loophole in the commitment that BCCI not be involved in financing or controlling CCAH's activities. This loophole permitted BCCI act as an investment advisor and information conduit to CCAH's shareholders. The Federal Reserve's decision to accept this arrangement allowed BCCI and its attorneys and agents to use these permitted activities as a cover for the true nature of BCCI's ownership of CCAH and the First American Banks. ** After approving the CCAH application in 1981, the Federal Reserve received few indicators about BCCI's possible to involvement in CCAH/First American. However, at several critical junctures, especially the purchase by First American of the National Bank of

Georgia from Ghaith Pharaon in 1986, there were obvious warnings signs that could have been investigated and which were not, until late 1990. ** As a foreign bank whose branches were chartered by state banking authorities, BCCI largely escaped the Federal Reserve's scrutiny regarding its criminal activities in the United States unrelated to its interest in CCAH/First American. This gap in regulatory oversight has since been closed by the passage of the Foreign Bank Supervision Enhancement Act of 1991. ** The U.S. Treasury Department failed to provide the Federal Reserve with information it received concerning BCCI's ownership of First American in 1985 and 1986 from the CIA. However, IRS agents did provide important information to the Federal Reserve on this issue in early 1989, which the Federal Reserve failed adequately to investigate at the time. ** The FDIC approved Ghaith Pharaon's purchase of the Independence Bank in 1985 knowing him to be a shareholder of BCCI and knowing that he was placing a senior BCCI officer in charge of the bank, and failed to confer with the Federal Reserve or the OCC regarding their previous experiences with Pharaon and BCCI. ** Once the Federal Reserve commenced a formal investigation of BCCI and First American on January 3, 1991, its investigation of BCCI and First American was aggressive and diligent. Its decisions to force BCCI out of the United States and to divest itself of

First American were prompt. The charges it brought against the parties involved with BCCI in violating federal banking standards were improper fully justified by the record. Its investigations have over the past year contributed substantially to public understanding to date of what took place. ** Even after the Federal Reserve understood the nature and scope of BCCI's frauds, it did not seek to have BCCI closed globally. This position was in some measure the consequence of the Federal Reserve's need to secure the cooperation of BCCI's majority shareholders, the government and royal family of Abu Dhabi, in providing some $190 million to prop up First American Bank and prevent an embarrassing collapse. However, Federal Reserve investigators did actively work in the spring of 1991 to have BCCI's top management removed, including the then head of BCCI, Zafar Iqbal, who had close ties to the Abu Dhabi shareholders. ** In investigating BCCI, the Federal Reserve's efforts were hampered by examples of lack of cooperation by foreign governments, including most significantly the Serious Fraud Office in the United Kingdom and, since the closure of BCCI on July 5, 1991, the government of Abu Dhabi. ** The Federal Reserve has fully cooperated with the Subcommittee in its investigative efforts, providing essential information, documentation, and assistance in obtaining access to witnesses. This cooperation was unique among federal agencies, and materially assisted the Subcommittee's work.