Corruption Related Fraud in the Financial Sector
Presentation by
Mr Tony Kwok Man wai,
Director of Investigation,
Independent Commission Against Corruption, Hong Kong
to the Financial Fraud
Seminar, Shanghai, 1995
Corruption Related Fraud in the Financial Sector
I am very pleased to have the opportunity to address you today. The topic of my talk is "Corruption Related Fraud in the Financial Sector".
The Hong Kong Independent Commission Against Corruption (ICAC) was created in 1974, out of 'demand by the Hong Kong public to fight the then very widespread corruption. I think it is fair to say that, in spite of its relatively short history, the Hong Kong ICAC is now known to most law enforcement agencies around the world. The ICAC's investigative arm, its Operations Department, has the prime object of investigating and prosecuting criminal corruption, as defined in our legislation. Experience gained during the initial years of the ICAC showed that corruption is all too frequently connected with other forms of criminal activity. As a result, the legislation was augmented to enable the Commission to investigate other criminal offences connected with, or facilitated by, corruption.
I think I should make one point very clear at the outset. The ICAC was not established to address financial sector corruption. We were essentially established to deal with corruption in the public sector. We are not an anti fraud organization. Our involvement in fraud investigation comes when there is suspicion of corruption. The major anti fraud agency in Hong Kong is the Commercial Crimes Bureau of the Hong Kong Police.
Financial fraud is undoubtedly the crime of the century. It has been estimated that in the United States white collar crime, which includes fraud and corruption, amounts to nearly 1% of Gross National Product. In 1995 a corporate fraud survey in Hong Kong conducted by an eminent firm of accountants found that nearly a third of the corporations they approached had suffered fraud in the last 12 months and nearly 80% considered fraud a serious problem for business today. In the ten years commencing 1984 ICAC has dealt with major corruption related frauds involving financial loss in excess of US$1.25 billion and the collapse of three banks.
Our experience of investigating corruption related fraud is that it can be a serious problem, costly in reputation for financial integrity and public funds, and time-consuming in investigation. Indeed many investigations cost millions of dollars each.
Types of fraud are as limitless as criminal ingenuity, but before I take you on a quick tour of ICAC's major corruption related fraud cases. I think a list of some of the fraud which, due to lack of time may force us to miss out, will be helpful. A check-list of these is also attached to this speech.
We have encountered corporate frauds, banking frauds, Letter of credit frauds, forex frauds, property frauds, Stock Exchange fraud, Insurance frauds, and credit card frauds. We have not exhausted the list. There are others out there, new types yet to be discovered.
Overseas Trust Bank
One of our early investigations involving a large bank in Hong Kong is a good example of how a large financial institution can collapse due to corruption related fraud.
The Hong Kong overseas Trust Bank, collapsed in June 1985 and had to be taken over by the Government with an injection of HK$2 billion (US$256M) in order to shore it up. Before its collapse, the bank was the third largest local bank in Hong Kong with 43 local and 8 overseas branches, with total assets amounting to HK$14 billion (US$1.8B). The investigation uncovered a trail of incompetence, reckless lending, large scale fraud, false accounting and corruption. There were two main causes for the bank's collapse. The first involved the reckless lending to bank directors for their own speculation and private business and the second involved the penetration of the bank by a criminal and his group resulting in cheque kiting on a massive scale over a period of several years. At its peak, the scheme produced US$10M daily for disposal by the Group. All the cheques in question were found to have been signed by two illiterate old men employed by the Group solely to perform this job. As the criminal required extra funds due to his increasing personal losses from gold speculation and other business failures, the cheque kite increased in site until the scheme finally collapsed when dishonoured cheques totalling about US$66.8 million were returned to the Bank.
According to proper banking practice, the return of those dishonoured cheques should have prompted the bank to take legal action immediately to recover the loss and to make provisions against the full amount due from the Group or for the loss in the account to be written off by charging it against the bank's profits for the year. However, 'the bank was persuaded by the criminal not to take legal action against him on the grounds that to take proper action against the loss would alert the public and threaten a run on the bank. The bank therefore agreed. A cover up then took place by the bank directors and the criminal conspiring to create false loans purportedly given to bogus companies set up by the criminal's associates. The proceeds of the loans were used to cover up the cheque kite loss. To avoid detection these loans were subsequently repaid by the creation of fresh bogus loans until at the time of the bank's collapse, the loans, together with accrued interest, amounted to US$89.5M.
The story does not end here, however. In order to cover the numerous expenses of his business empire, the criminal used his finance company as a vehicle to obtain money market lines from banks and other financial institutions and funds received were channelled into his private companies. To disguise this illegal funding, bogus loans were created in the books of his finance company in order to balance the money market line. The finance company was eventually liquidated with recorded liabilities HK$91 million (US$11m). On the collapse of his finance company, the criminal fled to America from where he was subsequently extradited back to Hong Kong to face charges of conspiracy to defraud the bank. One of the heaviest sentences ever imposed by a single judge in a commercial fraud case in Hong Kong was meted out when the criminal was sentenced to 8 years’ imprisonment.
Bumiputra/Carrian Case
In 1985, the ICAC commenced investigation into allegations of a massive fraud and corruption relating to the advancing of largely unsecured loans by a bank to the now defunct Carrian Group of Companies, a public-listed company. On the collapse of the Group, the bank's loss amounted to US$850M.
The fraud involved secret, unsecured loans made by Bumiputra Malaysia Finance Ltd., the Hong Kong subsidiary of the Bank Bumiputra Malaysia Berhad, to the Carrian Group in 1981-82. The key people in the fraud knew that such loans should not have been authorized. A web of deceit concealed their true nature. Shell companies not traceable to Carrian were formed to handle the breath-taking sums of money. When it was thought that the deception might be discovered, seven further companies were formed and their names substituted for the ones formerly used. The fraud only came to light in 1983 when Carrian crashed after the collapse of property prices in Hong Kong.
In February 1994 a former director of the bank, Rais Saniman, was extradited from France to Hong Kong after having been sought by the ICAC for seven years. He was charged with two counts of conspiracy to defraud the bank of a total of US$238M and three counts of criminal deception involving a further HK$13M. He was sentenced to five years in prison in March this year.
There were two other notable defendants that have been dealt with in this case. Mohammed Shamsudin, a former director of BMFL was sentenced to 4 1/2 years' imprisonment in 1987. This sentence was later reviewed and increased to 10 years. Lorrain Osman, another BMFL official, was sentenced to 12 months' imprisonment in 1993 after spending 7 years in British jails fighting extradition with 10 writs of habeas corpus.
In another Carrian-related case, Ewan Launder, the former Hong Kong chief executive of Wardley, a subsidiary of the Hong Kong Bank, has been arrested in England and is now awaiting extradition to Hong Kong. Launder for six years, in a chase that had taken us across three continents. We expect him to be extradited to Hong Kong by the end of this year.
The Ka Wah Bank
Enquiries into alleged criminal activities of former directors of the Ka Wah Bank began in November 1986. Research of bank files revealed that in mid-1986, $4,543 million of a total loan balance of $4,930 million was non-performing of which $3,704 million was owed by Malaysian or Singapore registered companies or national of those companies.
Checks were made on 1,385 persons and 478 companies. And enquiries in Malaysia, Singapore, Thailand, Australia, USA and Canada revealed that bank facilities amounting to hundreds of millions of Hong Kong dollars had been granted in the names of business associates and employees of companies controlled by four persons. Many of those associates and employees were unaware that their names had been used. Cash withdrawals from the accounts of those whose names had been used were matched by cash deposits into the accounts of the four.
A former director of the Ka Wah Bank who was also the company secretary was subsequently sentenced to 2 years' imprisonment. Two of the four other suspects were arrested in Kuala Lumpur and Singapore in June 1987. Both elected to return voluntarily to Hong Kong. One was eventually sentenced to 5 1/2 years.
The other absconded and he, together with the two remaining suspects, and a woman who removed documents from the suspects' offices in Kuala Lumpur relating to fraudulent loans, are now the subjects of Interpol action and the authorities in Malaysia and Singapore have been alerted to their activities in those countries.
The Stock Exchange Case
Hong Kong, as you are aware, is one of the largest financial centres in the world and the Hong Kong Stock Exchange is a major part of that system. Thus, to investigate the Chairman of the Stock Exchange must be regarded as a major investigation. It necessarily needed to be carried out with great care as it could have a great impact on the Hong Kong's economic and political stability. A lot of time was therefore taken in developing the investigation in a highly covered manner before the Chairman and his associates were arrested in January 1988. Evidence revealed that he had been accepting advantages in the form of preferential share allocation in relation to the listing of new companies in the Stock Exchange. He was subsequently found guilty of corruption and was sentenced to a total of 4 years' imprisonment. This case was a major investigative achievement. It resulted in significant beneficial changes in the management of the Stock Exchange of Hong Kong, the setting up of an independent watchdog organization, known as the Security and Futures Commission and a vast improvement in the conduct of investment business in Hong Kong.
Credit Card Fraud
In the early 1990's, Hong Kong became the focus of an explosion of counterfeit credit card fraud. ICAC investigations rapidly established that, in order to manufacture counterfeit credit cards, criminals were paying bribes to the staff of Hong Kong hotels and retail establishments in order to obtain the details of bona fide credit card holders. The losses incurred were enormous, amounting to hundreds of millions of HK dollars. Hong Kong's tourist industry was hard hit by the bad publicity generated. As the illegal businesses became more sophisticated, the criminal managed to infiltrate the banking system itself, paying bribes to bank staff to obtain data. Huge losses were being incurred in Hong Kong by the credit card companies and at one time 32% of world credit card crime was being committed in Hong Kong. Worse still, Hong Kong criminals were travelling around the world using counterfeit credit cards and estimates had Hong Kong criminals responsible for 75% of world credit card fraud.
In response to this problem ICAC set up a Task Force to investigate and arrest the offenders. Over 100 persons were prosecuted in Hong Kong and many other were prosecuted elsewhere in the world following intelligence sharing with other agencies. Over the following two years, initiatives by the Operations Department and the Corruption Prevention Department led to the implementation of computer software which limited the availability of data to staff thus reducing the corruption opportunities. In addition, the activities of the Task Force and the sentences imposed on the criminals were widely publicized making vulnerable staff aware of the risk of arrest. Members of the Task Force also lectured to numerous industry groups and law enforcement gatherings to publicize the problem and educate the interested parties.
I am pleased to be able to say that our strategy worked and, although credit card crime has not been eradicated from Hong Kong, it has been drastically curtailed and we no longer find ourselves at the head of the list for credit card fraud.
Investigation of Corruption-Fraud Cases
Investigations into the type of fraud cases which I have just described are complex and extremely difficult. Unlike the normal criminal investigation, we do not start off with a scene of crime and carry on to seek' the suspect. What we often have is * merely a report by a member of the public that something is not quite right. We have probably the most difficult crime to detect and prosecute successfully.
Data and Use of Information Technology
One prime lead in fraud investigations is the 'money trail' - financial records of the passing and transfer of money. This can be a long trail and the task of tracing takes much time and effort. In the Overseas Trust Bank case which I mentioned earlier, we seized a total of 75 cabinets of documents, each one of which had to be examined and analysed for evidence. At the subsequent committal proceedings, 33 volumes of documents consisting of 12,000 pages and over 8,100 documentary evidences were tendered. In the Bumiputra/Carrian investigation more than 42 officers had interviewed 385 witnesses both in Hong Kong and abroad, taking 808 statements/affidavits and seized and examined over 4 million documents, demonstrating the vast amount of resources required when investigating fraud related corruption. In another case, the prosecution papers were so voluminous that, stacked in a single column, the papers measured over 5 metres in height. The reason I mention this is to highlight the difficulties that investigating officers would face if they were to try to manage these large volumes of paper exhibits by the conventional manual indexing methods. In our experience, a computer system is indispensable for a fraud investigation of any size. Aside from assisting in the indexing and retrieval of exhibits, a computer system would be of tremendous value for the analysis of financial data as well as multi-factor matching to identify key-links in the evidence. The computer system should be available to the investigators at an early stage of an investigation so that information is fed into the system as and when it comes to light. Back-record conversion of data in the middle of a complex investigation is not only tedious but renders the whole system ineffective as the investigators would not have access to the most up-to-date information.
The Investigation Team and Accountant Support
The formation of a proper investigation team is important. If at all possible, officers posted to the team should remain in the team until the completion of the enquiry in order to ensure continuity. In the Overseas Trust Bank case, we had a team of professional accountants as well as a senior lawyer attached to the team. We found this to be a highly successful combination. Indeed we now have two Chartered accountants employed as investigators in the ICAC and their expertise have time and again been proved to be of invaluable assistance in corruption-fraud investigations.
International Liaison and Mutual Assistance
Corruption and fraud recognize no territorial frontiers and are not constrained by territorial boundaries and jurisdictions. This represented one of the greatest obstacles to effective investigation and prosecution. Many governments have now recognized the need for legislation affording international mutual assistance. The use and acceptance of Letters of Requests between the judicial authorities of different jurisdictions for obtaining evidence is becoming relatively common. In addition to legislation, it is necessary that law enforcement agencies world-wide are prepared to co-operate and offer mutual support in the exchange of intelligence and active assistance wherever possible.
Prevention and Early identification of Fraud
"Give an inch - take a mile" is an often used adage which can very appropriately be applied to employees in corruption and fraud. Not all dishonest employees are criminals at heart. Many simply take advantage of existing opportunities in the system. Quite often management unknowingly encourages corruption and fraud by ignoring or overlooking loopholes provided by loose control systems, vague accountability and reporting policies, unstructured work procedures and undefined corporate culture guidelines. In order to actively prevent fraud and corruption, the following preventive measures are suggested:
- Bring in
systems controls, a security system and internal and external complaints
system. Act upon such complaints and let it be known such complaints will be acted on.
- Define clear policies, guidelines, levels of responsibilities, codes of conduct and conflicts of interest.
- Rotate postings and conduct exit interviews of staff who are leaving.
- Foster a clean corporate culture, in which honest mistakes and their consequences are accepted, recognized and properly rectified. However, a strong message should be promulgated that "Dishonesty is not tolerated".
CHECK-LIST
Common types of corruption-related fraud investigations dealt with by ICAC:
1.
Corporate Fraud
�� Intra-group paper transactions
�� Asset stripping
�� Non-repayable loans
2.
Banking Fraud
�� Cheque kiting
�� High risk loans
�� Cover-ups of bad debts
�� Bogus debtors
3.
Property Fraud
�� Confirmor fraud
�� Price manipulation
�� Kickbacks to representative of purchaser/vendor
4.
Forex Fraud
�� Rate manipulation
�� illegal commissions
�� Bogus trading
5.
Stock Exchange Fraud
�� Listing of new shares
�� Illegal commissions
�� False market
�� Insider trading
6.
L/C Fraud
�� Bogus shipment
�� Forged CIF documents
�� False bank guarantee
7.
Insurance Fraud
�� Bogus policy holders
�� Fraudulent claims
8.
Cellular Phone Fraud
�� Phone cloning
�� Leakage of customer confidential information
9.
Credit Card Fraud
�� Collusion with hotel/shop staff to obtain client information or card
in-prints
�� Recruitment of forged card users
�� Making/possessing false instruments
�� Apply for credit card using false particulars