Global AML probes on Espirito Santo Bank show convergence of financial crime enforcement

Banco Espirito Santo was a bank that once highlighted its “comprehensive international offering” by its willingness to take on clients in every corner of the globe. It may now have to respond to international authorities for money laundering activities that allegedly occurred in widespread locations, according to investigations disclosed this week.

Five different jurisdictions have opened investigations regarding Espirito Santo Bank so far, demonstrating increased collaboration, greater exchange of information, and higher expectations for enforcement actions across the globe.

The banking giant, which is part of an even larger holding company, may be one of the first, but not the last, financial institution to be simultaneously questioned by multiple jurisdictions for a series of infractions.

Widely considered the crown jewel of Portugal’s financial sector, the institution built on the Espirito Santo family name more than 100 years ago toppled in August this year. A government-requested audit revealed elements of fraud and financial irregularities and exposed major losses.

The conglomerate, perhaps in a desperate search for boosted capital, may have committed fraud and misrepresented their accounting data, leaving some subordinated creditors and current shareholders as victims of its bankruptcy.

The collapse led to a bailout from Portugal’s Central Bank under a $6.6 billion (4.9 billion euro) plan to bolster a new “good” bank, Novo Banco, with capital to make it attractive to investors, and segment off all of the rotten units of the bank – those involved in the recently revealed money laundering probes.

This “bad” bank has kept the Espirito Santo family name, perhaps as a symbol of the dynasty’s fall from grace.

Apart from the broad scope of enforcement, the Espirito Santo case may also highlight how fraud and financial misrepresentation may be linked to money laundering vulnerabilities in a financial system. In many cases in the United States and increasingly internationally as well, regulators are concluding that control weaknesses in one area of a bank could extend to units or be part of an endemic pattern.

The implementation of an effective anti-money laundering (AML) program requires an accurate and reliable accounting system. Conversely, the discovery of problematic bookkeeping may disclose transactions, which should have been reported as suspicious, allowing regulatory authorities to uncover further violations.

Authorities search for clues of crime among ruins of toppled empire

Prosecutors in Portugal, the United States, and Switzerland have opened investigations on Espirito Santo Bank regarding alleged money laundering activities occurring in locations far and wide.

The probes are raising questions about suspicious transactions, from those for a Venezuelan construction mogul who was a big client for the bank’s Miami unit, to transactions that potentially moved money out of Libya illegally for members of former leader Moammar Gadhafi’s inner circle.

Two former bank executives in Portugal from the finance department are suspects in the investigation so far.

The myriad probes around the world, some of which were reported on for the first time this week, are still under development.

Estêvão Augusto Bernardino, a Portuguese lawyer with experience in banking and commercial law, from his Lisbon office, said that as a client, it’s difficult to know what will happen with one of Portugal’s largest institutions.

Bernardino, founder and partner at Bernardino, Resende e Associados Law Firm, said that before the company went bankrupt, there were warning signs and distracting contradictions.

“A leader from the central bank came to parliament twice in July [before the collapse] and mentioned that the bank was solid and had some pillows of capital to accommodate any type of problem,” Bernardino said, including any shocks from its parent company already suffering from a fraud scandal.

Meanwhile, Espirito Santo kept selling its hefty debt to customers and increasing exposure to its parent company against the advice of more moderate detractors.

However, Portugal’s Securities Market Commission, known as the CMVM, had another opinion. The entity reported various alleged irregularities and worries regarding Espirito Santo to Portuguese prosecutors over several years, launching 20 legal probes , according to CMVM President Carlos Tavares, who stated such in recent public comments.

Another red flag before the crash was the hurried exit of Espirito Santo patriarch, Ricardo Salgado, the bank’s former chief executive and the chairman of Espirito Santo Financial Group.

He left his position at the bank in June just two months before the bailout. In July, the bank reported a $3.6 billion first-half loss, exposing gaping holes in the company’s capital strategy. It was an external audit ordered by the Bank of Portugal that unwrapped the fraud.

But one critical question that seems to be unanswered in the still-smoldering mess is why the auditors working for Espirito Santo and the Portuguese Central Bank didn’t detect the problems earlier, Bernardino said.

“Where are the people who did the audits of these accounts? The Portuguese people would like to see them speak clearly about this,” Bernardino said.

KPMG’s Lisbon office was in charge of combing through the massive institution’s accounts since 2002. Although the CMVM recommended that the bank switch auditing companies in 2011, the bank continued its relationship with the auditor. The chairman of KPMG Portugal, Sikander Sattar will be heard in the inquiry committee on Espirito Santo Bank in a hearing behind closed doors with the Portuguese parliament.

KPMG is one of the few large accounting firms left relatively unscathed by recent auditing flubs that have dented the image of companies including Deloitte and PriceWaterhouse Coopers. Regulators have penalized both firms for trying to water down or protect the institutions they are charged with auditing to uncover incorrect or illegal activities.

Despite the warning signs, the ultimate fiasco shocked the Portuguese banking sector and Europe’s delicate financial markets, with Portugal’s main stock market benchmark falling 22 percent since the fall of the bank.

A globalized and corporate ‘Ponzi Scheme’ with legs all over the world

Before the disintegration of the conglomerate, the bank made an impact by being the only or first lender in parts of the world that other western banks didn’t dare to deal with.

According to people familiar with CEO Salgado’s business practices, he made personal connections in countries like Angola and Brazil, former Portuguese colonies, as well as politically sensitive places like Venezuela and Libya to create an open space for his business.

In 2005, the bank was found to have held accounts for the family of Chilean dictator Augusto Pinochet at a time when all other banks had frozen those assets.

Deriving profit through high-risk accounts seemed to be a good strategy until now, that the bank has essentially fallen from grace. The Miami, Libya and Angola units of the bank, which are under investigation for alleged money laundering activities, have been moved to the “bad bank.”

The New York District Attorney’s Office, which is looking into the activity in the Miami unit of the bank, declined to provide more details on the investigation and could not confirm the identity of the Venezuelan client alleged to have committed the infraction.

The Miami unit’s spokeswoman also declined to comment, besides saying that the bank has operated separately from its parent bank company for years, acting as an individual financial entity licensed by the state.

Although the outcome of the five money laundering investigations on different continents may seem unpredictable, the origin might be in plain sight, according to experts on the banking sector and financial crime.

Giovanni Di Sanzo, a private banker at BAC Florida Bank with 30 years of financial crime compliance expertise sees links between the bank’s fraud and the widespread money laundering schemes.

Di Sanzo calls the web a “globalized Ponzi scheme” where the bank is willing to do whatever it takes to sustain their bankrupt components, including incurring debt while falsifying account data, taking money in and out of countries illegally, and structuring for tax fraud.

“I call it an ‘international Ponzi scheme perfected for corporations,’ because Ponzi would take money without caring about the cost of paying for his debt to ‘save’ the situation,” Di Sanzo explains the comparison.

“The situation would repeat itself with a new responsibility of paying the last lender, which definitively is what has made the Espirito Santo family broke,” he said.

Increasing global investigations shows comprehensive compliance strategies are crucial for financial institutions

While the money laundering activity may not have been conducted by the Espirito Santo family or executive board directly, Di Sanzo believes it may be a cascading effect of the fraud and debt weighing down the bank.

Part of that is the heightened scrutiny from regulators on the institutions anti-money laundering (AML) program, exposing weaknesses in the institution, according to Luis Rivera, a partner at MRW Consulting Group in Fort Lauderdale, Florida.

Rivera has three decades of investigative and analytical experience, particularly in  criminal investigations.  He said regulatory supervision may also expose transactions which may have required suspicious activity reporting.

“A robust and effective compliance strategy should ensure that the financial institution can comply with requirements such as know-your-customer, aggregation of multiple transactions, international wires, and more,” Rivera said.

However, one such compliance strategy may be easier said than done for an expansive operation in different countries like Espirito Santo.

The variety of requirements and diversity of regulations makes a holistic compliance strategy challenging, to say the least, especially when it comes to sharing information and implementing uniform rules.

“The investigatory bodies in different jurisdictions will apply their law to legal standards that apply to that jurisdiction, making international investigations very challenging,” Rivera said.

However complicated and intense the legal process may be, it’s clear from both enforcers and the public that it is a new era of accountability for institutions, even those who are deemed too big to fail.

Matthew Galluzzo, a former New York District Attorney and now a criminal defense and civil rights lawyer with experience in financial fraud cases, said that agencies worldwide will often overlap on one case, especially if there’s a possibility of forfeiture.

“There’s an incentive for someone to get there first if there’s a huge financial penalty,” Galluzzo said, “and if the crime happened in the jurisdiction, there’s a variety of ways to get back the funds.”

Galluzzo said probes on large banks usually begin with a whistleblower inside the bank who alerts an agency to something suspicious, or if another regulatory authority is already investigating, which is most likely the case in this worldwide series of investigations.

Bernardino said that it is important for European authorities to coordinate with other investigative and regulatory agencies. As Portuguese authorities investigate, Bernardino says the public is very interested in knowing that the new bank system will work and that their money is secure.

“For us, it’s important that everything is clarified because we are paying the bill, regarding their inquiries on the bank’s taxes. The money will come from our pockets.”

“But I believe… I need to believe, that the new bank can be successful,” Bernardino said.

“We are doing our job in Portugal – cleaning house.”