BCCI Scandal

FOUNDER
 HISTORY

FORMATION
•Registered in Luxembourg
•7th largest private bank in the world
 COMPLEXITY

●EXPANSION IN 1970
●SPLITTING
●ACQUISITION
 UNUSUAL AUDITING SYSTEM
●Price Waterhouse were the accountants for BCCI Overseas

●While Ernst & Young audited BCCI and BCCI Holdings (London
and Luxembourg).
● Other companies such as KIFCO and ICIC were audited by
neither.
●BCCI was shut down in 1991 after Bank of England audits
revealed that fraud, improper loans and deceptive accounting
practices had been discovered
 BCCI WAS INVOLVED IN:

●Money laundering
●Tax evasion
●Bribery, smuggling, arms trafficking
●Illegal purchases of banks and real estate.
●Accused of catering to drug dealers, arms merchants
and third world dictators
 Magnitude of the fraud:
£7 billion of undeclared debts

WHAT REALLY
HAPPENED?
 HOW TO HIDE LOSSES

●Bought banks in USA

●Laundered money from tax havens
●Illicit share buying schemes
●Complex ownership structure
●Borrow from Arabs
●Loan doctoring
 CLOSURE OF BANK
●On July 5, 1991, the Bank of England closed down BCCI. Around a million investors were
affected. Amongst the customers of the bank at this time was Garrards and Mappin & Webb,
the jewellers responsible for maintaining the crown jewels and makers of the trophy for the
America's Cup.

●In 1992, United States Senators John Kerry and Hank Brown co-authored a report on BCCI,
which was delivered to the Committee on Foreign Relations. The BCCI scandal was one of a
number of crimes and disasters that influenced thinking leading to the Public Interest
Disclosure Act of 1998.

●The report found that former Defense Secretary Clark Clifford and his business partner
Robert A. Altman had been closely involved with the bank from 1978, when they were
introduced to BCCI by Bert Lance, to 1991.
•The British government also set up an independent inquiry, chaired by Lord Justice Bingham,
in 1992. Its House of Commons Paper, Inquiry into the Supervision of the Bank of Credit and
Commerce International, was published in October of that year.
Following the report, the bank's liquidators launched the Three Rivers vs. Bank of England
case, on behalf of thousands of BCCI creditors who are suing the Bank of England for its
failure to properly oversee the bank.
The BCCI creditors sought £850m in damages, claiming that the Bank of England was guilty
of misfeasance in public office. The case collapsed in November 2005, with the Bank of
England seeking to re-claim legal bills. The cost of the case to the creditors could be as high
as £100m
However, in 2002, Denis Robert and Ernest Backes, former number three of Clearstream,
described as a "bank of banks" which practices "financial clearing", discovered that the BCCI
had continued to maintain its activities after its official closure, with "microfiches" of
Clearstream illegal unpublished account
 THE C-CHASE

A typical Bollywood film story – the arrests, the indictments and the mock
wedding!
Robert Mazur (a.k.a Musella), Senior Special Agent, U.S. Customs Service
“C-Chase” was shorthand for an apartment complex called Calibre Chase
northwest of Tampa where the investigation was launched
The bait : The Columbian Accountant from Long Island
 INTRODUCTION

● MCC was a leading British Media Company

● It was listed on the London Stock Exchange and was a
constituent of the FTSE 100 Index.
● The company was established in 1964 as the British Printing
Corporation.
● In 1981 , Robert Maxwell launched a dawn raid on the company
acquiring a stake of 29% .

1964 1982 1987

British Printing British Printing and Maxwell

Corporation Communication Communication
Corporation Corporation
SANDSTORM REPORT

SUPPORT OF TERRORISM
 LEARNINGS

SENIOR MANAGEMENT
EXECUTIVES
REGULATIONS
CONFIDENCE IN BANKS
COVERING OF BAD LOANS
MAXWELL
COMMUNICATION
GROUP AND MIRRORS
GROUP
NEWSPAPER
CONTENT
• MAXWELL COMMUNICATION CORPORATES AND
MIRROR GROUP NEWPAPERS (UK) 1991
• INTRODUCTION
• DEBACLE
• REASON FOR DEBACLE
• AFTERMATH
• ANALYSIS
• ANALYSIS- FLAWS IN CORPORATE GOVERNANCE
• CHRONOLOGY OF EVENTS
 INTRODUCTION
• Maxwell Communication Corporation was a leading British Media
Company.
• It was listed on the London stock exchange and was a constituent of
the FTSE 100 Index.
• The company was established in 1964 as the British Printing
Corporation.
• In 1981 Robert Maxwell launched a dawn raid on the company
acquiring a stake of 29%. The following year he secured full control of
it.
British Printing Maxwell
British Printing and Communicatio
Corporation Communication
corporation
n Corporation
(1964) (1987)
(1982)
 Maxwell
Empire

Publicly listed companies Private company

Mirror group Maxwell Communication

Robert Maxwell group

● By the end of the 1980s the Maxwell Empire, comprising more than
400 companies was loosely organized into three clusters.
 DEBACLE
● In November 1991, chairman of
the group companies Robert
Maxwell 68, was found drowned
behind his yacht.
● Global empire of publishing and
other businesses collapsed.
● Investigations revealed that
Maxwell’s group companies
owed 2.8 billion euros to its
bankers.
● Robert Maxwell created a 530 million hole in the
pension funds of 16000 employees of mirror
group newspapers.
● These pension funds were borrowed in a
desperate attempt to prop up the ailing Maxwell
Communication.
● The company went into administration following
the death of Robert Maxwell.
● The London based Maxwell communication
corporation also filed the chapter 11 bankruptcy
petition in New York.
 Reasons for Debacle
⮚Acquisition through Heavy Debt
● The borrowings were personal as well as on the
company accounts.
● The company borrowed 3 billion in 1988 to buy the US
publishers Macmillian and Official Airlines Guide.
⮚Financial Difficulties and Diversion of Funds
● The Maxwell empire kept afloat only by shifting fund
around his maze, misappropriating pensioner’s funds, and
relentless deal making.
● Despite Maxwell’s eroding financial condition, he was able
to pass annual audits.
● In 1991, Maxwell sold Pergamon and floated Mirror Group
of Newspapers as a public company.
Uncertainties following the death of Maxwell

• The stocks of Maxwell communication plunged to $2.18 on 5

November 1991 from high of $4.28 a share in April 1991 and further
dropped to $0.63.
• The decline in stock value was of special concern to Maxwell’s
creditors, most of the family’s 68% stake in the company was pledged
as collateral for loans.
 AFTERMATH
 Maxwell’s death (1991) a flood of instability with banks. The company
incurred heavy debts. His two sons Kevin and Lan struggled to hold the
empire together, but were unable to prevent collapse.
 Maxwell had used hundreds of millions of pounds from the company’s
pension funds to shore up the shares of his group and save his companies
from bankruptcy.
 There was a huge loss of pension funds for the employees. Eventually
these funds were replenished with money from banks as well as British
Government but this replenishment was limited. Pensioners received about
50% of their pension entitlement.
 The son of Maxwell, Kevin was also declared bankrupt with debts of 400
million pounds. In 1995, Maxwell’s sons Kevin and Lan and 2 other former
directors went on trial for the conspiracy to defraud, but were unanimously
acquitted by the jury in 1996.
 Flaws in Corporate Governance
● Domineering CEO
● Maxwell had a complete control over the companies of his empire.
● Personally controlled the movement of funds around his big
empire.
● Relegated all the ethical and professional standards for
commercial benefits and empire building.
● Ineffective board
● Directors and all other reputed persons did not discharge their
responsibilities effectively.
● Excessive borrowings of funds, pledging of shares to raise funds,
unrestricted and improper movement of funds, etc. took place
under the control of directors and it appeared that they were
helpless because of the dominating personality of Maxwell.
● Lack of transparency.
● Improper segregation between he company’s assets and
pension assets of employees.
● Creditors, shareholders and even the family members of Maxwell
were not fully aware of the corporate structure of the company.
● Flaws in the audit.
● The auditors of the company failed to identify the transfers
Maxwell was making from the Mirror Group pensions, even
though they were in the position of doing so.
● Companies were lodged against the auditors of the company by
institute of Chartered Accountants in England and Wales.
 Chronology of significant Events

1980-84
•Robert Maxwell’s private companies controlling interest
in British Printing Corporation (1981), Mirror Group
Newspapers and many other substantial companies.

1985 •Maxwell started transferring pension fund monies

to private companies as the borrowings.

1987
•Maxwell’s private company further incurred borrowings
of over 300 million pounds by the way of pension funds
and bank loans.
 • The company borrowed $3 billion and acquired
1988 privately owned publishing groups Macmillan and
Official Airlines Guides

• Maxwell started facing financial crisis and found

1990 it difficult to repay the borrowings of $3 billion.

• On 5th November, Robert Maxwell died, his body was found drowned behind his yacht.
• Eventually, the stock of Maxwell communication plunged to $2.18 from $4.28 a share

1991 and further dropped to $0.63.

• And thereafter, in spite of considerable efforts by Robert’s son Kevin and Ian, his
empire collapsed.
WorldCom Fraud
 INTRODUCTION

 Provider of long distance phone services to businesses and residents.

 Started as small company known as “Long Distance Discount Services (LDDS)”.
 LDDS began its operations in 1984 with 200 customers in Mississippi.
 In 1985, Bernie Ebbers became its CEO.
 Ebbers Competitiveness resulted in sales of $95 million in 1998.
 LDDS became the third largest telecommunications company in the US due to
management of CEO Ebbers.
 LDDS was reluctant to use internet and preferred to send handwritten faxes.
 Relied on merger and acquisitions for cost saving and synergy gains.
 INRODUCTION- Contd.
 In May 1995, LDDS was renamed WorldCom.
 In 1996, WorldCom acquired MFS and Sidgmore
joined WorldCom to head its internet division.
 Also acquired MCI in 1998.
 Ebbers helped grew small investment into $ 30 billion
revenue producing company characterized by sixty
acquisitions of other telecom businesses in less than a
decade.
 Telecommunication Act : Deregulation in Telecom
industry.
 Many Mergers and acquisition were result of this act.
 Worlcom was not allowed to purchase sprint in 2000 because
of antitrust regulation.
 On June 25, 2002, the company revealed that it had been
involved in fraudulent reporting of its numbers by stating a $3
billion profit when infact it was half a million loss.
 After an investment was conducted, a total of $11 billion in
misstatements was revealed.
 KEY PLAYERS INVOLVED IN WORLDCOM SCAM

1. Bernard Ebbers – CEO of WorldCom. Personal

loans but didn’t repaid
2. Scott Sullivan – CFO and Secretary WorldCom.
Directed staff to make false entries.
3. Cynthia Cooper- Chief Internal auditor of
WorldCom.
I know what I don't know. To this day, I
4. Arthur Anderson LLP – Kenneth M. Avery and don't know
Melvin were the primary auditor representing their technology, and I don't know finance or
accounting.
firm in the WorldCom scandal.
I didn't have anything to apologize for

Bernard
Ebbers
 Share Prices
● Different corporate cultures of MCI &WorldCom
● Took over of MCI was finally completed in 1998 and in
that year WorldCom also took over two major companies,
Brooks Fiber and CompuServe.
● 1999: 14th largest company of US and 24th worldwide.
● Market Capitalization of WorldCom :- $115 billions
● In June 1999, WorldCom’s Share Prices at peak $ 63.5/share but year later it was
standing $46/share .
● The market seemed to sense that WorldCom’s growth had been made on the back of
its ambitious acquisitions programme.
● Once that halted, the share price would level off or begin to decline. As soon as
WorldCom began to revise downwards its growth prospects, its share price began to
fall.
 Problems Started
 In 1999, WorldCom began talks with Sprint, large telecoms provider in USA.
 In June 2000, US Justice Department blocked the deal.
 2000: Failed merger with Sprint which result in fall in share prices of WorldCom.
 The collapse of this deal meant that WorldCom would not be able to quickly expand into modern
bandwidth technology.
 Rumours that WorldCom would be subjected to takeover Bid.
 Declining TMT ( Technology, Media and Telecommunications) stocks.
 Mismatch created due to so many acquisitions 65 in total.
 Law suits initiated by irate customers in 2000 & 2001 were settled by WorldCom agreeing to pay
substantial penalties and refunds.
 Penalties of $ 96.5 million total -

2001: $88 million- settle a class action suit for dropping millions of customers from its existing calling plans and
charging them higher that usual.

2002: $8.5 million – settle state charges that it tricked some Californians into signing up for long distance and billed
others of charges without permission.
 WorldCom's loan to Ebbers
• In late 1990 personal spending beginning to increase.
• In July 1998 bought ranch in British Columbia for an estimated $66million.
• He also acquired a yacht.
• In 1999 a private company in which he had 65% stake, paid $400 million for
timberland in Alabama and Mississippi and Tennessee.
• Used $27 million loan for personal and private expenses including,
$1.8 million build a new house. $3 million in gifts
and loan to friends and family.
• In 2002, WorldCom had made loan to Ebbers amounting to $341 million.
• Interest payable on these loan was about 2.16%, which was lower than the cost to
WorldCom of actually borrowing the money.
• Reason:- Ebbers might be forced to sell large amount of his shareholdings in
WorldCom to resolve his finanacial problems and this could have negative impact on
WorldCom’s share prices. To save or help Ebbers to avoid margin call.
 EBBERS RESIGNATION

• Ebber’s position as CEO was becoming untenable.

• Beginning April 2002: WorldCom was forced to announce that 3700 US –
based staff would be made redundant.
• At the end of April, Ebbers resigned and Sidgmore was named as vice-
chairman, President and CEO.
• The New York Times summed up WorldCom’s problems as follows:
“ The move reflects both WorldCom’s particular woes and the broader
turmoil in the telecommunications sector, where earnings have been decimated
by overinvestment in networks and business has yet to rebound from the
recession.”
HOW DID FRAUD HAPPEN?

The fraud was characterized mainly by the improper reduction of line costs and
false adjustments to report revenue growth.

 The Misstatement of Line Costs

 Releasing Accruals
 Capitalizing Line Costs
 Revenue
CYNTHIA COOPER: THE WHISTLE BLOWER
 In 2001:Overpayment of sales commission $930,000 by internal auditors
 In 2002, Cynthia Cooper led the audit team found dubious transactions although threatened
by CFO.
 These was related to ordinary operating expenses which were treated as capital investment.
 Cynthia dared to ask on ethical grounds to ask Sullivan about the explanation of the capital
expenditure but it was difficult for her to get satisfactory explanation from Sullivan.
 In may 2002: Sidgmore hired KPMG as WorldCom’s auditor and sacked Arthur & Andersen.
 Sullivan was asked to justify his accounting procedure in a written statement at a meeting
including Arthur & Andersen and KPMG.
 Due to her Ethical work she was chosen as “ person of the year” by times magazine.
 Sullivan was sacked as CFO on 24 June 2002.
 Two years later , it was reported that WorldCom has overstated its cash flows by more than
$ 3.8 billion during previous 5 quarters.
 One of the largest cases of false corporate book keeping.
Solomon Smith Barney

 In 1997, WorldCom gave the Salomon smith barney an

exclusive right to administer the stock option scheme.

 Employees were at risk if WorldCom’s shares declined.

 Company employees were hit-hard through the system of

stock options due to great decline in share price of
WorldCom.
 LAWSUITS AGAINST WORLDCOM:

 Congressional committee issued subpoenas to Sidgmore,

Ebbers, Sullivan and Jack Grubman ( the telecom analyst at
Salomon Smith Barney)

 In 2004, Citi group announced to pay $2.65 billion to settle

WorldCom investor lawsuits.

 Of the settlement, $1.19 billion went to investors who bought

stock in WorldCom between April 1999 and June 2002.
 BANKRUPTCY
 2002:SEC formally charged the company with defrauding investors
 On 21 July 2002, WorldCom filed for Chapter 11 bankruptcy protection.
 Size of bankruptcy -$103.9 Billion Assets filed, it would have problems on wider
economy and ramification for banks, suppliers and other telephone companies.
 Substantial numbers of employees were laid off and it was predicted that the
shareholders would receive nothing for their shares.
 For employees who also help WorldCom’s shares- the bankruptcy was a double blow.
 Legislation :Sarbanes-Oxley Act in 2002 to initiate radical corporate reforms.
 August 2002 : Another $3.3 billion in accounting irregularities.
 Sidgmore resigned & Capellas become CEO of WorldCom.
 On 16 December 2002, a compensation plan for new CEO, Michael Capellas, was
agreed by two federal judges. The compensation package would guarantee Capellas
$20 Million in cash and stock over the following three years.
 In 2005 it started operating as Verizon
 IMPACT OF FRAUD
● Shareholders: $180 Billion of shareholder value lost ( based on peak stock price).

● Debt & Preferred Stock holders: $37.5 Billion of debt and preferred stock holder
value lost.

● Company: $750 Million settlement paid to SEC.

● Employees: 57,000 employees lost jobs.

● Board of Directors: 12 Directors agreed to pay (out of pocket) a total of $25 Million to
settle securities class action case.
What are something that WorldCom executives could have done to
prevent the accounting scandal?

The main problem is not following the accounting principles. They should have followed the
following principle:
 Courage should have been developed by the employees and should not feel insecure
to highlight the issue to the internal audit team. Whistle blowing with third party
audits
.
 Executives should have changed the autocratic culture during a small mistake or
data fudging activities.

 Accounting executives should do cross-internal audit among the employees within

the same department, instead of formal audit.
Key Lessons Learned- Ethical Values Violated
 Unethical work culture
 Pressurising employees to manipulate accounts.
 No productive outlay for employee dissent
 Employees who played along were rewarded; others were
threatened
 Fudged up the accounts & mislead the various stakeholders.
 Unreasonable loans to CEO at low interest rate
 Organizational structure (hierarchal, command and control)
 Corporate culture no free will to employees
 Leadership problems
ENRON AND
ANDERSEN
SCANDAL
 ABOUT ENRON
● Enron was an energy-trading and utilities company based in
Houston, Texas, that perpetrated one of the biggest accounting
frauds in history.
● Enron was an energy company formed in 1985 following a merger
between Houston Natural Gas Company and Omaha-based
InterNorth Incorporated.
● After the merger, Kenneth Lay, who had been the chief executive
officer (CEO) of Houston Natural Gas, became Enron's CEO and
chairman. 
WHAT MADE IT A SCANDAL?
● During 2001, after a series of revelations involving irregular accounting procedures
bordering on fraud perpetrated throughout the 1990s involving Enron and its
accounting company Arthur Anderson, Enron suffered the largest chapter11
bankruptcy in history.
● Some highlights of scandal are-

○ $30 million of self dealing by the Chief Financial Officer

○ $700 Million of Net earnings disappeared

○ $1.2 Billion of equity shares disappeared

○ Over $4 billion hidden liabilities.

● Debts and losses were put into entities formed offshore that were not included in
the company’s financial statements.
 KEY PLAYERS

●Kenneth Lay
○Enron founder and former CEO
○Lay took up the reins at Enron in 1986. In August 2001, he has resumed
leadership after Skilling resigned. Lay resigned again in January 2002.He drew
down his $4 Million Enron credit line repeatedly and then repaid the company
with the Enron shares after becoming the focus of the anger of employees ,
stockholders and pension fund holders who lost billions of dollars in the disaster.
●Jeffrey Skilling
○Former Chief Executive , President and Chief Operating Officer.
○He joined Enron in 1990 from the consultancy firm McKinsey , where he had
developed financial instruments to trade gas contracts.
● Andrew Fastow
○ Former Chief Financial Officer.

○ He was fired in October 2001 , when Enron made losses

amounting to $600 million.
● David Duncan

○ Enron’s Chief Auditor at Andersen

○ His job was to check Enron’s accounts.He is accused of ordering

the shredding of thousands of Enron related documents.
● Enron’s accounting firm- Arthur Andersen
○ Arthur Andersen, was Enron’s auditing firm.

○ Its job was to check that the company’s accounts

were a fair reflection of what was really going on.

 WHISTLE BLOWER-
Sherron Watkins

● Sherron Watkins (born August 28, 1959) was Vice President of

Corporate Development at the Enron Corporation.
● In August 2001, Watkins alerted then-Enron CEO Kenneth Lay of
accounting irregularities in financial reports.
● However, Watkins has been criticized for not reporting the fraud to
government authorities and not speaking up publicly sooner about her
concerns, as her memo did not reach the public until five months after
it was written.
 What went wrong?

● Auditing and Accounting issues

● SPE(Special Purpose Entities)
● Pension issues
● Banking issues
● Energy Derivative issues
 So why did the scandal happen?
● Due to the lack of corporate social responsibility , situation , ethics and
get-it-done business pragmatism.
● Due to the large discrepancies of attempting to match profits and cash
, investors were typically given false or misleading reports as it was
difficult to estimate cost and viability of contracts.
● Atmosphere of market euphoria and corporate arrogance
● High risk deals that went sour.
● Deceptive reporting practices – lack of transparency in reporting
financial affairs.
● Excessive interest in maintaining stock prices.
 IMPACT OF FRAUD

● Impact on employees
● Impact on shareholders
● Impact on competitors
● Impact on customers
● Impact on government
 AMENDMENTS DONE AFTER SCANDAL

● The Enron scandal was certainly enough to show the American public
and its representatives in congress that the new compliance standards
for auditing and public accounting were needed. Since the Enron
collapse an array of new laws and regulations has been adopted to
tighten corporate oversight.
 The Sarbanes-Oxley Act of 2002
● The act heightened the consequences for destroying , altering or fabricating
financial record , or for trying to defraud shareholders.
● This act aims at public accounting firms that participate in audits of
corporation.
 Financial Accounting Standards Board

● The Financial Accounting Standards Board (FASB) sets accounting rules for
public and private companies and nonprofits in the United States.
 Companies to report
leases
● The Financial Accounting Standards Board, the body that sets accounting
rules, has issued a final rule that changes how companies account for most of
their leases.
 Charges in SPE 3% Rule

● SPE 3% Rule: Rule permitting Special Purpose Entities created by a firm to be

treated as “off-balance sheet” , i.e. no required consolidation with the firm’s
balance sheet – as long as 3% of the total capital of the SPE was owned
independently of the firm.
 LESSONS LEARNED FROM SCANDAL

● Related to auditing
● Related to Board of Directors
● Related to SPE(Special Purpose Entity)
● Other lessons