BDA - MACAU'S DISGRACED BANK LACKS COMMITMENT TO

S E C R E T SECTION 01 OF 05 HONG KONG 000459 SIPDIS SIPDIS STATE FOR EAP/CM, EAP/K, EEB/ESC; TREASURY FOR GLASER/FOWLER; DOJ FOR SCHWARZ/WEBER E.O. 12958: DECL: 03/10/2033 TAGS: ECON EFIN PREL KJUS MC SUBJECT: BDA - MACAU'S DISGRACED BANK LACKS COMMITMENT TO PREVENT MONEY LAUNDERING REF: A. 07 HONG KONG 2430 ¶B. 07 HONG KONG 2567 ¶C. 07 HONG KONG 2904 HONG KONG 00000459 001.2 OF 005 Classified By: E/P Chief Laurent Charbonnet, Reasons 1.4 b/d ¶1. (C) Summary: In the course of a March 3-7 Government Accountability Office (GAO) visit, Hong Kong and Macau government officials and private sector players criticized section 311 of the Patriot Act as a blunt and unwieldy tool and the U.S. handling of the Banco Delta Asia (BDA) case as non-transparent. While all recognized the need for mechanisms to prevent money laundering, they agreed that the September 2005 announcement effectively shut BDA out of the financial system before it had the opportunity to address Treasury concerns and that the path to redemption was never clear. Macau and Hong Kong regulators prefer to resolve problems in less public ways that allow for corrective measures and do not threaten the reputation of local financial systems. Efforts to raise the standard of BDA's Anti-Money Laundering (AML) regime have made only modest progress. A lack of qualified compliance personnel, limited funds for technology solutions, uncertainty about the bank's future, an insular bank culture, and what appears to be a lack of commitment by bank management have conspired to limit improvements. BDA's AML protocols remain far below industry norms and prospects for improvement look slight. End Summary. ¶2. (C) Comment: It is clear that BDA's AML protocols were virtually non-existent prior to its designation and remain far below local standards today. While the Administrative Committee (AC) appointed to manage BDA made some efforts to raise AML standards and implement FATF 40 recommended procedures at BDA, these efforts effectively stopped once the bank returned to the original owners. Senior BDA management continues to feel victimized and appears unwilling to devote real resources to changing the culture of the bank or raising AML compliance standards. Grumbling from the major shareholder, Stanley Au, has set the tone for the rest of the bank management and staff. Until there is evidence that the culture of the bank has changed to embrace AML procedures and other international banking standards, there appears little reason to consider any review of BDA's Section 311 status. BDA may be able to survive for the timebeing in the hothouse of Macau's sizzling economic boom, even without correspondent banking relationships and access to international currency business. End Comment. ============================================= = GAO Looks at Global Section 311 Implementation ============================================= = ¶3. (U) Government Accountability Office (GAO) officials, accompanied by Econoff, met with Consul General Cunningham and members of the U.S. Consulate General in Hong Kong, Hong Kong and Macau government officials, and private sector companies to discuss implementation of Section 311 of the USA Patriot Act against Banco Delta Asia (BDA),a Macau bank that maintained a substantial number of North Korean accounts linked to money laundering of proliferation proceeds. BDA is part of the Delta Asia Group. (Note: Section 311 of the Patriot Act allows U.S. Treasury to designate foreign jurisdictions or institutions as posing a "primary money laundering concern" and impose additional record-keeping, reporting and identification requirements on institutions or their customers. Treasury can also prohibit the opening of correspondent accounts with banks in the U.S. End Note.) Section 311 has been imposed 16 times since the measure was passed in 2002, most recently against BDA in 2005, according to GAO materials. ¶4. (C) The GAO team's questions focused on the process of implementing Section 311, how government and private entities, including the listed bank, interacted with U.S. and local authorities and what steps BDA took to respond to Treasury's concerns about its AML regime and ownership. During the team's discussions, private and public sector interlocutors repeatedly raised two points: 1) the 311 process is a valuable tool, but in its application to BDA was an overly blunt instrument that did not allow the bank the opportunity to address Treasury concerns, nor was there a clear and consistent message about what the bank needed to do HONG KONG 00000459 002.2 OF 005 to escape sanctions; and 2) BDA is not demonstrating any substantive commitment to improve its AML regime and internal controls. The final GAO report on the 311 process is likely to be made public by September 2008. ====================================== Section 311 a Blunt Tool in BDA's Case ====================================== ¶5. (C) Interlocutors (with the exception of BDA officials) agreed that Section 311 is a valuable tool, but argued that it was not used as effectively as possible in this case. Deloitte Touche Tomatsu (DTT),the Macau Monetary Authority (AMCM),the Hong Kong Monetary Authority (HKMA),the Administrative Committee (AC) appointed by AMCM to run the bank after its assets were frozen, and Ernst & Young (E&Y) criticized the process by which Treasury announced its notice of proposed rule-making, noting that the notice led immediately to a bank run and the near-immediate suspension of all of BDA's correspondent banking relationships. AMCM and the Macau government were notified only 24 hours in advance of the announcement; BDA's Chief Operations Officer claimed to have learned of the action only when told by AMCM, making it impossible for the bank to take steps to cooperate with the relevant authorities to address concerns before effectively being shut down. ¶6. (C) Clint Stinger, DTT's head of Forensic and Dispute Services, applauded the effect of the announcement on other banks in the region, noting that as banks rushed to reduce their risk exposure by cutting any business ties with BDA, compliance officers and regulators began paying much closer attention to customer due diligence rules. For BDA, however, the announcement of proposed rulemaking was an immediate disaster. There appeared to be no effort to exert pressure on BDA to change its behavior prior to the announcement, said Stinger. He noted also that the proposed and final rulings listed different concerns about the bank, suggesting that there was no clear road to redemption for BDA. =========================================== Banking Regulators Prefer Quiet Cooperation =========================================== ¶7. (C) DTT's criticisms were echoed, albeit in milder fashion, by AMCM and HKMA, who suggested that additional advance notice of the 311 designation of BDA would have given the regulators more time to prepare to take concerted measures to protect the banking system in both locales. HKMA noted that 311 was a very heavy tool, in that as soon as a proposed rule is announced, the full effect of the designation is felt by the subject institution or jurisdiction. Arthur Yuen, Executive Director for Banking Supervision at HKMA, suggested that Treasury could work through banking regulators to resolve concerns before taking such severe actions. He added that the allegations against BDA and Delta Asia Group's Hong Kong-based financial services company, Delta Asia Credit (DAC),were never explicitly made public. Doing so could prevent potential loss of confidence in the banking system. In this case, BDA and DAC are small, but designation of a large institution could have real effects on an economy, particularly in a small jurisdiction like Macau or Hong Kong, said Yuen. He suggested closer cooperation with international partners, like HKMA, could achieve the same objectives with less potential for lasting damage. ¶8. (C) AMCM's Chief Executive Anselmo Teng noted that the Macau authorities were surprised by the decision to announce the proposed rule as no one from the U.S. government had previously discussed concerns about BDA with AMCM. He added that AMCM had been aware of BDA's North Korea business since 2001 and had advised the bank to reduce its risk exposure by scaling back this business, but that AMCM monitoring had shown no evidence of money laundering. AMCM responded to the run on BDA by appointing an Administrative Committee (AC) of outside legal, regulatory and banking experts, charging them with keeping the bank operational and improving BDA's AML regime. Macau authorities cooperated closely with the U.S. Treasury to facilitate the investigation of BDA and the transfer of funds from designated accounts to North Korea. Teng added that it was unfortunate that BDA had to be HONG KONG 00000459 003.4 OF 005 returned to its original ownership. Ideally, the bank could have been sold to another owner, but given that the Ernst & Young audit found no evidence of malfeasance and no criminal charges had been brought against the original owner, Stanley Au, the AMCM was required by law to return the bank to Au's control after two years. AMCM continues to closely monitor BDA's performance and will conduct an audit of the bank's AML procedures in 2008. ============================================= === AC Criticizes Non-Transparent 311 Implementation ============================================= === ¶9. (C) Members of the Administrative Committee (AC) appointed by AMCM were sharply critical of the 311 process as applied to BDA. Heculino De Sousa, CEO of Banco Nacional Ultramarino (BNU) and an AC member said that the announcement of the proposed rule prompted immediate reactions from customers and correspondent banks, giving BDA no opportunity to defend itself or make necessary changes to address Treasury concerns. The AC members expected that their appointment and efforts to improve AML procedures would give correspondent banks enough comfort to resume business dealings with BDA, but that was not the case. De Sousa complained that the AC had taken significant steps to address BDA's AML weaknesses, including hiring E&Y and DTT to review the bank's AML regime and draft improvements, but claimed that Treasury never communicated directly or indirectly conditions for the rule to be revoked. The AC was surprised by Treasury's announcement of the final rule in March 2007. It was clear then, he said, that the disposition of the North Korean funds and the ownership of the bank were the real issues, not the AML regime. ============================================= == BDA's Pre-311 AML Regime Virtually Non-existent ============================================= == ¶10. (C) When the AC took control of the bank, their first priority was to review AML controls, hire a compliance officer and devise a plan to improve BDA's AML compliance. Rob Morris, Ernst & Young's head of Investigation and Dispute Services, led a team hired by the AC to conduct an audit of BDA's internal AML practices. While E&Y found no evidence of criminal malfeasance, Morris was highly critical of the lack of AML-related controls at the bank. Records were not computerized, there was no regular reporting of suspicious transactions or accounts, and staff lacked training in basic customer due diligence protocols. ¶11. (C) The AC also engaged DTT to develop a new, international-standard AML regime. DTT based their recommendations on the Financial Action Task Force (FATF) 40 recommendations, HKMA regulations, and standard international practice. When a compliance officer was finally installed at BDA, DTT conducted risk assessment training with the members of BDA's senior management and conducted four reviews of the bank's AML policy implementation. Head of Forensic Services Stinger said that DTT cooperated closely with the AC, and characterized the bank staff as engaged but uncertain about AML training. He added that there was clearly no champion within the bank for improved AML policies and that he did not see the cultural change necessary to ensure that any AML improvements would remain in place. ¶12. (C) The AC had considerable difficulty finding anyone willing to take responsibility for compliance at BDA. After more than a year of searching, Carla Jacinto, a Portuguese lawyer at the Macau firm Jorge Neto Valente (and a junior colleague of AC member Maria de Lourdes Costa),reluctantly took the position in November 2006. Jacinto, who had no previous banking experience, began by conducting a review of BDA's AML compliance procedures. While the bank had procedures on the books, these were often disregarded by the staff, she said. Jacinto and her assistant drafted new AML policies based on the DTT report and conducted training for bank staff. The strong internal culture and the uncertainty about the future ownership of the bank made the staff reluctant to change past operational practices, according to Jacinto. She advised the AC that the bank needed to upgrade its technology in order to comply with modern AML requirements and hired a Hong Kong banking software developer HONG KONG 00000459 004.2 OF 005 to provide some additional reporting capabilities, but the cost of installing comprehensive systems was prohibitive. Jacinto stepped down when the bank was returned to its original ownership but did some training of returning management. She characterized the BDA management as aware of the need for improved AML compliance but she was not confident that they were aggressively implementing new measures. ¶13. (C) Paulyne Yao, Managing Director of TA Consultants, (the software developer hired by the AC to upgrade BDA's AML reporting capabilities) explained that her company has been providing IT services to banks and financial institutions in Hong Kong for almost 30 years and counts many of the large international banks among its clients. BDA purchased a retail banking transaction accounting system from TA Consultants in 1994, but installed only three minor upgrades between 1994 and 2006. In August 2006, the AC requested AML reporting software and TA Consultants installed a simple enhancement allowing bank staff to run elementary daily reports of unusually large or otherwise suspicious transactions. Yao noted that BDA had provided a list of requests, but in the end had chosen the least costly and sophisticated option. BDA's IT systems are far below the industry standard for Hong Kong and Macau, she said. ===================================== BDA's Questionable Commitment to AML ===================================== ¶14. (C) Since the bank reverted to the control of its primary shareholder Stanley Au in September 2007, DTT has not conducted additional reviews of the bank's AML practices, despite meeting with the senior management to brief them on DTT's work to date. Although DTT still has a contractual obligation to finish its report, BDA has not requested additional reviews nor have they asked that the report be completed. The bank has brought back most of its previous management, meaning an updated report would require new reviews of all the senior management. The contract requires the final report to be provided not only to the bank but also to FinCen, perhaps one reason BDA has not been aggressively following up, suggested Stinger. ¶15. (C) BDA's Chief Operating Officer Kenneth Wong told the GAO team that the senior management had no role in the operations of the bank while the AC was in charge, but confirmed that most of the senior managers returned when the Macau government handed the bank back to Stanley Au. The group now has two compliance officers responsible for improving AML systems in BDA, said Wong. (Note: these two are long-time staff of BDA, and one, Bosco AuYeung, served as Group Compliance Officer prior to the Section 311 designation.) All staff and management have been required to participate in training sessions and take a 10 question quiz on the bank's AML procedures. Those who fail the quiz must take the training again until they pass. BDA management is planning for compulsory yearly training courses beginning in ¶2008. ¶16. (C) Delta Asia's Group Compliance Officer Bosco AuYeung discussed BDA's current AML procedures, including the creation of daily reports, including comparing account-holders names against terrorist lists from OFAC and the UN. When matches are found, the bank reviews the records to determine whether the account holders are likely to be the persons listed on the watch lists. So far, the bank hasn't identified anyone, said AuYeung. The bank has also sent out forms to 30,000 BDA customers requesting additional data to comply with "Know Your Customer" guidelines and had received several back, he said. TA Consultants and other companies have approached BDA to offer comprehensive AML software packages, but BDA has not made any purchases. ¶17. (C) Wong noted that since the final ruling on Section 311 was announced in March 2007, BDA has not been allowed to conduct any foreign currency business, including Hong Kong dollars. BDA is currently limited to doing business only in Macau and only in local currency (the pataca). Their business now focuses on providing mortgage and consumer loans to the local market. Wong said BDA's deposits had grown by almost 20% in the last six months. Macau's booming economy HONG KONG 00000459 005.2 OF 005 (2007 real GDP growth topped 28%) means that BDA can still make a profit in Macau. But it is not clear how BDA will survive when Macau's growth slows from this unsustainable rate. Cunningham