Statement by Herbert A. Biern, Deputy Associate Director, Division of Banking, Supervision and Regulation, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, July 17, 1996 - prime bank financial instrument fraud - Statements to the Congress - Transcript

Federal Reserve Bulletin, Sept, 1996

Statement by Herbert A. Biern, Deputy Associate Director, Division of Banking Supervision and Regulation, before the Committee on Banking, Housing, and Urban Affairs, US Senate, July 17, 1996 I am pleased to appear before the Committee on Banking, Housing, and Urban Affairs to discuss actions that the Federal Reserve has taken over the past several years to address the problem of prime bank" financial instruments and related illegal financial schemes. The Federal Reserve has taken an active role in alerting the banking industry and the public about the illicit activities of individuals trying to peddle nonexistent financial instruments here in the United States and abroad, and we have worked closely with the law enforcement community to assist their efforts to investigate and prosecute these wrongdoers.

"PRIME BANK" SCHEMES AND ADVISORIES

In late 1993, Federal Reserve staff members were alerted by domestic arid foreign banking organizations that their names were being used for apparently unlawful purposes in connection with the attempted sale of questionable financial instruments. We were also contacted by individuals who had been approached to purchase questionable, highly complex investment-type instruments.

The transactions that were brought to our attention involved notes, guarantees, letters of credit, debentures, or other seemingly legitimate types of financial instruments being issued by an unidentified "prime bank" or by a domestic or foreign banking organization that was said to be keeping the issuance of the instruments secret. The various proposals that involved "prime bank"-related financial instruments had similar characteristics:

1. The investor could realize extremely high rates of return on an instrument described as risk free.

2. The investor was buying a part of a large tranche of securities or financial instruments that was almost fully subscribed by other investors or was part of a "roll program" that automatically put the investor into an investor group of some sort.

3. The financial instrument that was being purchased was traded on a worldwide secret exchange.

4. The documentation related to a "prime bank" investment was extremely complex and difficult to comprehend.

5. A secure escrow account maintained at a "prime bank" or by an attorney would be used to hold the investors' funds, and payments into this account would be made by some sort of "key tested telex" message.

6. The financial instruments being issued were in formats purportedly approved by the International Chamber of Commerce or fully sanctioned by the Federal Reserve, the World Bank, or some other known international organization.

Some "prime bank" schemes appeared to be targeted to individuals and companies who needed loans. These potential borrowers were advised that their loans would be funded by a "prime bank" provided they paid a large, up-front fee to secure the funding. Board staff members believed that the proposed payment of unrealistic rates of return was indicative of a fraudulent scheme and contacted several banks to make sure that legitimate banking organizations were not referring to themselves as "prime banks" or using financial instruments that in any manner referred to "prime banks." Once assured that there was no legitimate use of the term "prime bank" or lawful use of a "prime bank" instrument, we drafted an interagency advisory on "prime bank" schemes and began to work through the Department of Justice's Interagency Bank Fraud Working Group to issue the pronouncement. Coordination efforts to address the problem were also initiated with some of the other twelve agencies participating in the Working Group, including the Securities and Exchange Commission (SEC), as well as with international law enforcement authorities, including Britain's Scotland Yard and Department of Trade and Industry.

On October 21, 1993, the Federal Reserve and the other federal banking agencies issued the first inter-agency advisory entitled Warning Concerning 'Prime Bank' Notes, Guarantees, and Letters of Credit and Similar Financial Instruments." The advisory, which is attached to my prepared statement, informed banking organizations and the public that the Federal Reserve and the other regulators know of no legitimate use of any "prime bank"-related financial instrument.(1) The advisory also asked the public to contact agency representatives if approached to invest in a "prime bank" instrument or pay a advance fee to secure a loan funded by a "prime bank" note, letter of credit, or other type of questionable financial instrument. The banking agencies committed to refer cases of potential illegal conduct associated with supposed "prime bank" documents to a senior official in the Washington, D.C., office of the SEC and to the local offices of the Federal Bureau of Investigation because almost all "prime bank" schemes appeared to involve fraud, including securities fraud.

The advisory prompted numerous calls and letters about "prime bank" matters. Between late 1993 and mid-1995, hundreds of inquiries were received from individuals who had been solicited to purchase "prime bank" financial instruments, from investment advisers considering potential investments on behalf of clients, and from banking organizations that had received faxed solicitations. Calls and letters came from as far away as South Africa, Germany, Australia, France, and Singapore. The correspondents were highly suspicious of the proposed schemes, and many indicated they wanted to check with the government "to be sure" that their suspicions were justified. During this period, Board staff members assisted federal prosecutors in New Jersey, Oklahoma, Virginia, and in other districts to investigate and eventually convict individuals for "prime bank" associated federal criminal law violations.