International financial fraud is growing and is likely to increase in the future. The reasons: rapid internationalization of banking, financial deregulation, and the entry of banks from developing countries into more sophisticated international capital markets, says Robert F. Brodegaard, a managing partner with the New York law firm of Thacher Proffitt & Wood.
Mr. Brodegaard should know. For the past several years, he has spent a good part of his time tracking international fraud in order to recover assets for bilked investors, including banks.
New Varieties
His job isn't easy. First, new types of international banking fraud have arrived in the United States only recently and have received little publicity.
Second, many investors or financial institutions discover they have been duped long after the swindlers have disappeared, making it almost impossible to recover any of the money.
"The more time goes by, the harder it is to recover assets," Mr. Brodegaard says. "You also need luck and a fair amount of savvy."
The Wall Street lawyer lists "prime bank notes" and fraudulent letters of credit purportedly traded in a secondary market as among the main instruments being usealto perpetrate international fraud. The American Banker highlighted some of these practices last month.
He is not the only one worried about the rapid spread of international. financial fraud. The Federal Reserve System and other financial supervisory agencies sent out an interagency memorandum in October warning about "an increase in the attempted use of questionable financial instruments in connection with complex and possibly illegal schemes."
The Commercial Crime Bureau of the International Chamber of Commerce warned from London in January about a "dramatic increase" in worldwide financial fraud.
International financial frauds are hardly new. Some, like fictitious Caribbean-based offshore banks selling high-yield certificates of deposit to gullible investors, resurface regularly.
Pyramid Schemes
One that often seems to appear and disappear is the pyramid scheme - in which funds from the last investors arc used to pay off the first ones. Then there are variations on the "ready, willing, and able" scheme in which a swindler pretends to arrange a loan for a fee and then disappears with fees and down payments.
Finally, there are counterfeit bank drafts and U.S. letters of credit that have been used by con artists to purchase goods.
Now, regulators and investigators like Mr. Brodegaard are more worried than ever because the collapse of restrictions on cross-border transactions in developing markets in Eastern Europe, Latin America, and Asia has made international financial fraud much easier.
$1.2 Billion Czech Fraud
In one of the biggest seams to date, for example, $1.2 billion in guarantees issued by the Praguebased Banka Bohemia to back fictitious instruments known as prime bank notes were sold through brokers in Britain, Germany, Switzerland, and the United States.
Sources said Banka Bohemia officials were bribed into issuing the guarantees. The Czech bank has disavowed and voided the instruments. Roughly half have been recovered.
An estimated $600 million worth are still floating around, however. About half of those are believed to be in the United States. Among the known victims: the New York-based National Council of Churches of Christ, which reportedly invested nearly $8 million in the fictitious instruments.
In another case, fraudsters got a branch of the Agricultural Bank of China in Hebei Province to issue $10 billion wortll of backup letters of credit to guarantee letters of credit issued by a phantom Russian bank.
Preying on the Naive
The Chinese bank's letters of credit were subsequently sold or exchanged against goods in other pans of the world equally unfamiliar with banking instruments.
"You have a situation where fraudsters are plying their trade in less sophisticated markets with sophisticated instruments," Mr. Brodegaard says.
"International banking is fairly straightfoward for those who deal in it on a day-to-day basis, but it does have complexities that can be used to prey on institutions and investors that don't understand them."
Typically, swindlers operate from nonexistent or shell companies set up in a variety of locations around the world. They also target countries where regulatory supervision and internal controls at financial institutions are weak, and aim for companies where employees can be bribed into a deal.
"The trick is to do it someplace where it won't be spotted quickly," says Mr. Brodegaard.
Swindlers are also getting away with increasingly large amounts. Typically, the schemes involving fictitious bank instruments demand high initial investments of as much as $2 million or more, Mr. Brodegaard points out.
"People are sometimes more readily fooled by a bogus scheme involving millions of dollars than they would be by one involving $50," he observes.
In fact, some of the people defrauded are relatively sophisticated. In February, for example, the Securities and Exchange Commission charged a Mesa, Ariz., man with taking $2 million from a well-known Vancouver media executive, Frank Griffiths, to purchase nonexistent bank instruments.
In another case, the Naurn Phosphate Royalties Trust $12 million on false bank instruments purchased through Australian law firm.
Intricate gnockoffs
The latest frauds also rely on sophisticated structures and use complex documents which either are, or closely resemble bona fide bank instruments.
In many instances, the phony instruments are given added credibility by selected or fictitious references to international legal guidelines, such as codes issued by the Paris-based International Chamber of Commerce.
Mr. Brodegaard has had had ampie opportunity to develop his interest in international fraud. The 45-year old lawyer, who graduated from Colgate University and Cornell Law School, joined Thacher Profitt as a partner in 1988 after 13 years at Weil, Gotshal & Manges.
In one of his more adventurous cases, he helped recover a substantial portion of funds spent by a Swiss portfolio manager who fobbed off worthless stock in a Rocky Mountain mining company to unsuspecting clients.
As part of its effort to fight financial seams, Thacher Proffitt provides specialized advice to financial institutions and investors.
"In all of these prime bank instrument transactions there comes a vanishing point in the deal where the investor loses control over the money or the documentation," he says.
"If at any time they don't let you have control of the documentation or the dollars... your antennae have to go up." up."
