OSC target Nesbitt ignored Bermuda's red flags on Lett
2002-09-20 17:48 PT - Street Wire
by Brent Mudry
In one of the most critical allegations in the Ontario Securities Commission's Lett case, the first serious warning that BMO Nesbitt Burns ignored about client Patrick Lett, a well-known securities violator, came from Bermuda, an offshore secrecy haven anxious to dispel its reputation as an international money laundering centre.
The Bermuda warning to Nesbitt Burns is especially notable as the Caribbean country is an even better known laundromat than Canada. This unfortunate reputation was highlighted last month, when the FBI and the RCMP unveiled their unrelated two-year-old money laundering and fund manager bribery sting, which targeted 60 Canadian and American penny stock players. The sting was dubbed Operation Bermuda Short, in honour of disgraced Thomson Kernaghan destroyer Mark Valentine and his Bermuda-based offshore front, Paul Lemmon.
On Monday, an OSC panel will review a proposed settlement agreement negotiated by Nesbitt Burns, in a high-stakes bid of damage control which should clear the cloud hanging over Nesbitt and parent Bank of Montreal. The OSC claims that Patrick Fraser Kenyon Pierrepont Lett, who singlehandedly caused the near-collapse of Gordon Capital a decade ago, opened BMO Nesbitt accounts in 1995 and deposited $21-million (U.S.) for his own clients, including several notorious offshore U.S. prime bank fraudsters and a Monaco-based offshore insider trader wanted by U.S. authorities.
BMO Nesbitt's Lett case is the first major regulatory attack on a major Bay Street brokerage over serious know-your-client deficiencies in recent memory. The case offers a textbook review of brokerage compliance breakdown, especially amid increasing regulatory scrutiny of due diligence efforts, know your client procedures and money laundering detection and prevention policies.
Nesbitt Burns, the Bay Street brokerage arm of Bank of Montreal, Canada's oldest bank, was told six years ago, in 1996, that the Monetary Authority of Bermuda had shut down an operation involving Mr. Lett which was dealing in prime bank notes. While respectable brokerages might be expected to drop dubious clients like Mr. Lett quicker than a hot potato, Nesbitt and its compliance department kept his accounts open.
If the OSC's allegations are to be believed, Nesbitt Burns waited two years, until May, 1998, to take its first significant action, when a senior compliance officer ordered the Lett accounts be closed. Even this tardy action failed, however, as Nesbitt placed restrictions on Mississauga branch manager John Dunn, who serviced Mr. Lett, and his actions in relation to the dubious client's accounts. In a fox-guarding-the-henhouse fiasco, Nesbitt relied on Mr. Dunn to police himself, and he opted to continue preparing dubious proof-of-funds letters for Mr. Lett, in defiance of the brokerage's compliance department.
The Bermuda alert came second-hand from a fairly reliable source. According to the OSC, in 1996, a member of the investigation department of the Toronto Stock Exchange advised a compliance officer at Nesbitt that he had learned of an inquiry by the Monetary Authority of Bermuda in relation to Mr. Lett and advised Nesbitt that the Bermudan regulator had shut down a dubious prime bank operation involving Mr. Lett.
While the exact date of this warning is not yet disclosed, the timing should have rung warning bells. Mr. Lett's accounts at Nesbitt Burns and Bank of Montreal, in the names of Milehouse Investment Management Ltd. and Pierrepont Trading Inc., were relatively new, having been opened with branch manager Mr. Dunn in late 1995.
In addition, in early 1996, within six months or less of these accounts being opened, a broker at another Nesbitt branch was rebuked for helping Mr. Lett issue an improper letter giving a inflated impression of the value of assets in Mr. Lett's account. This broker, at Nesbitt's flagship branch at First Canadian Place in Toronto, was told by his branch manager and his retail compliance officer never to author such a dubious letter again.
This initial Lett incident should have at least caused Nesbitt's compliance department to put Mr. Lett's account on special watch and to closely review any irregularities, or even due a due diligence review.
While full details of Bermuda's probe into Mr. Lett are not known, one of his two Nesbitt-account holding companies, Milehouse Investment Management was registered in the offshore haven.
In July, 2000, Milehouse was on a lengthy list of companies cited by Bermuda's Registrar of Companies for review of their continuing business operations. "The Registrar of Companies has reason to believe that the companies ... are not carrying on business nor are in operation," states the agency in a formal published notice. While delinquent corporate registry filings are hardly a crime, and are commonplace in Canada as well, the Bermudan registrar only published its delinquency list after it sent the companies, including Mr. Lett's Milehouse, an initial letter and a second letter, the latter by registered mail, without any response.
While Canada is at the forefront of international attacks on money laundering, with various initiatives, including new legislation, officials in Bermuda have quite a bit to say on the topic. D. Munro Sutherland, the Superintendent of Banking, Trust and Investment of the Bermuda Monetary Authority, addressed the industry issue at a speech he gave on April 15 at a conference entitled Challenges to KYC (Know Your Client) in the Electronic Age.
"Long before the crystallisation of the current concerns about proceeds of crime and misuse of the financial system by criminals and launderers, Bermuda was already making careful checks before allowing people to use the facilities of the island. That approach has continued up to the present day," Mr. Sutherland told the conference audience.
Mr. Sutherland notes that a series of his country's laws and regulations, leading up to The Proceeds of Crime Act 1997 and The Proceeds of Crime (Money Laundering) Regulations 1998, impose a standard of KYC and related obligations on the offshore haven's financial institutions.
"Part of our financial supervision therefore involves checking that the systems and internal controls within licensed financial institutions are operating effectively. And as part of that responsibility, we now undertake routine checks on the specific effectiveness of their anti-money laundering procedures. Typically, we ask institutions to complete an initial questionnaire focussing on anti- money laundering procedures, particularly those pertaining to KYC," This response is then used to tailor an anti-money laundering portion of a subsequent on-site visit by the Bermuda authority.
"Bermuda is a small jurisdiction with, as I said earlier, a history of taking great care to know its customers ... (with) a first class record of co-operation between the authorities and the financial sector," Mr. Sutherland told the conference. "However, there are no grounds for complacency."
"There is also now, as you all appreciate very well, a pressing need to ensure that controls imposed to prevent proceeds of crime from being turned into "clean" money, can be adapted and enhanced to deal with terrorist funds that may be "clean" to begin with, but that are intended to be used for a criminal purpose."
Mr. Sutherland also drew attention to a recent international paper setting and developing standards for customer due diligence in the banking sector, prepared by the Basel Committee, comprising the G10 countries plus Switzerland, the the Offshore Group of Banking Supervisors.
"Banks … are required to develop clear customer acceptance policies, including defining the characteristics which should make customers unacceptable. And they need to have systematic procedures for verifying identities and for reviewing the completeness and accuracy of information on their customer base and on account holders' business profiles. All these aspects need to be considered expressly by bank Boards, and also to be fully covered in internal audit and compliance programs."
In addition, the Bermudan official stressed the importance of continuing due diligence. "'Customer due diligence,', particularly where we are referring to an ongoing account relationship between a bank and its customers, has two separate aspects - first, customer identification at account opening, and secondly - once the relationship is in place - ensuring sufficient ongoing knowledge of the customer and his business to be able to conduct meaningful monitoring for signs that an account is no longer conforming to the expected pattern of business and may be used for illicit purposes," he stated.
After reviewing international and domestic developments on know-your-client, account monitoring and other issues, Mr. Sutherland then told the audience how his country is serious about its reputation.
"Bermuda will be continuing to work to ensure that it plays its full part in protecting the international financial system against misuse and thereby maintains its reputation as a clean and safe place to do business."
Bermuda's unheeded warning to Nesbitt Burns about Mr. Lett in 1996 became a cornerstone of the OSC's prosecution six years later. |
