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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.