FCPA Compliance and Ethics Blog

June 5, 2014

Citibank: Multiple Failure of Compliance as the Hammer Drops

FailureWhat is the cost of the failure to perform appropriate due diligence on a regular basis? What red flags should you look for when considering doing business with a customer, party in the sales channel or entity in the supply chain? All of these questions and more continue to swirl around Citigroup and its Mexican subsidiary Banamex over the ongoing investigation into allegations of fraud at Citi’s Mexico bank unit.

Citi had come to grief when there was a reported $400MM loss in Banamex involving the Mexican marine energy services company Oceanografía SA de CV. The problems arose after Banamex had extended $585MM in short-term credit to a company that Citi itself had warned its own bond investors was “from time to time subject to various accusations, including accusations of corrupt practices.” Oceanografía provided construction, maintenance and vessel-chartering services to the Mexican national energy company, Pemex’s exploration and production subsidiary. But Oceanografía’s fortunes, changed sharply in February of this year after it became the subject of a new government review that resulted in a suspension of Pemex contracts to Oceanografía for the next 20 months. Banamex had previously advanced as much $585 million to Oceanografía through an accounts receivable program, which would advance money to Oceanografía to provide services to Pemex. Pemex would then pay back Banamex, verifying invoices provided by Oceanografía to confirm that the work had been completed. In other words, Banamex was relying on Pemex’s ability to pay back the bank. But all of this ended when Pemex suspended its contracts with Oceanografía.

In a Wall Street Journal (WSJ) article, entitled “Citi Says Signs of Mexico Fraud Weren’t Escalated”, Christina Rexrode reported that Citi Chief Executive Officer (CEO) Michael Corbat told investors that employees “missed signs of trouble they should have recognized and elevated to superiors.” In a talk to investors Corbat was quoted as saying “There were telltales along the way” and he promised that “the bank would work on motivating and encouraging employees to raise their concerns when they notice potential problems.” But the problems ran deeper and were perhaps more systemic than simply the failure to escalate. Rexrode reported “People inside the bank have said the unit was allowed to operate as its own fiefdom, with New York employees struggling to get information about how the unit operated.” However, “A Citigroup spokesman said in a statement that “Banamex is absolutely subject to the same risk, control, anti-money-laundering and technology standards and oversight which are required throughout the company.””

These statements come on the heels of the dramatic firing of 11 Banamex employees just two weeks earlier. After meeting with the Citi Board of Directors, Corbat flew to Mexico City and terminated 11 employees. In an article in the New York Times (NYT), entitled “Citi Fires 11 More in Mexico Over Fraud”, Michael Corkery and Elisabeth Malkin reported that “Among those fired were four of the bank’s top executives in Mexico: its head of corporate banking, head institutional risk officer, head of trade finance and head of trade and treasury solutions. Some of the employees had worked at Banamex for as long as two decades and were not involved in the fraud directly. The bank fired many because they had not taken steps to detect the fraud or had ignored warning signs about the client.”

But apparently Citi expects there to be more disciplinary actions stemming form the matter. In an article in the Financial Times (FT), entitled “Citi fires 11 staff in Mexico unit”, Jude Webber, Camilla Hall and Kara Scannell reported that Corbat said in a memo to staff “Before our investigation concludes, we expect that several other employees, both inside and outside of Mexico, may receive forms of disciplinary action as well.” Two persons who may yet face such disciplinary action are “Manuel Medina-Mora, a Citi executive who oversees the Mexican operations and had his pay docked by $1.1m in March, or Javier Arrigunaga, Banamex chief executive.” Additionally, and perhaps more ominously for Citi, both the F.B.I. and prosecutors from the United States attorney’s office in Manhattan are investigating “Whether Citigroup willfully ignored possible warning signs”.

What red flags did Citi miss and for how long? One clue was reported in the NYT article, which noted that Oceanografía “is known among Mexican investors as politically connected but financially troubled. Credit rating firms in the United States, corporate bond investors and Mexican lawmakers have raised concerns about Oceanografía. In 2009, United States ratings firm Fitch warned about Oceanografía’s high leverage and poor cash flow generation. Fitch eventually withdrew its ratings because the company was not supplying enough information. In 2008, Standard & Poor’s noted that Mexico’s congress had investigated accusations of improper deals between Oceanografía and Pemex, though no wrongdoing was proved. Still, Oceanografía grew to become one of Banamex’s 10 largest corporate clients. The fraud erased 19 percent of the unit’s banking profits last year.”

These troubles were seemingly magnified in Mexico when the CEO of Oceanografía, Amado Yáñez Osuna, was arrested and charged with violating Mexican banking laws. In a WSJ article, entitled “Oil-Tinged Graft Scandal Roils Mexico, Laurence Iliff and Amy Gutherie reported “The arrest deepens a scandal that has sent shock waves across Mexico’s political landscape. That put a spotlight on long-simmering allegations that the country’s former ruling National Action Party, known as PAN, used Pemex to favor Oceanografía and other contractors during the party’s 12 years in power, which ended with the 2012 election of President Enrique Peña Nieto of the Institutional Revolutionary Party (PRI).” Further, during those “12 years, Oceanografía’s contracts with the oil monopoly swelled from a few million dollars a year to hundreds of millions of dollars, according to a review of the contracts by The Wall Street Journal. Most of the contracts were obtained in public bids, although some were assigned directly without bids, including one contract for about $65 million in the final months of the Calderón administration.”

The case took a far more ominous turn when authorities when Mexican authorities announced last week that they had issued arrest warrants for multiple Banamex executives. In an article in the FT entitled, “Mexico issues fresh set of Banamex arrest warrants” Jude Webber reported that “Mexico has issues more arrest warrants – including an unspecified number for staff at Citigroup’s Banamex unit – a day after detaining the owner of the oil services company at the centre of a $400m alleged fraud scandal that has rocked the bank since its disclosure there months ago.” In an article in the NYT entitled, “Mexico Authorizes Arrests In Fraud at Citigroup Unit” Elisabeth Malkin and Michael Corkery reported, “Attorney General Jesús Murillo Karam of Mexico confirmed on Friday that the authorities were seeking the former executives. He declined to say how many were involved.” Yes, there are warrants, but I won’t say who,” Mr. Murillo Karam told reporters.” Apparently not even Citigroup knows whose arrests may be imminent.

What are the lessons for the compliance practitioner? Three keys points are controls, escalation and oversight. What type of internal controls, or lack thereof, allowed one company to obtain such credit on what were basically receivables financing? What about allowing the Banamex unit to basically run its own show with little to no oversight from the corporate headquarters? Corkery and Malkin reported, “Citigroup is keen to demonstrate to regulators and investigators in the United States and in Mexico that it is cracking down on its employees for not catching the fraud. But the breadth of the punishment could also suggest that the bank, despite assurances that the fraud is confined this case, has had widespread problems with controls and oversight across its Mexican unit.” Moreover, in his memo to staff, Corbat said, ““we are reviewing our controls and processes in Mexico and strengthening any area we think falls short of our global standards or best practices.”” Corbat also noted Citi was looking at ways to encourage employees to increase escalation of issues earlier.

Moreover with these now imminent arrests of Banamex executives, Citi may be facing more serious charges in the US. Leaving aside the inane argument of a ‘rogue business unit’ it may be that the US parent choose not to look too closely at its high-flying and very profitable Mexican subsidiary. If, as it seems from the newspaper accounts, that Oceanografía was well known for the business tactic of under-bidding for contract and then making up the differences in cost overruns, this may not bode well for the Banamex executives or Citigroup. Likewise if there was one company that Banamex did business with, which engaged in such behavior, there may other similarly situated companies once a detailed investigation of the Citigroup unit is concluded.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014


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