The BoP scam

Recently, the arrest of the owners of the accused involved in the fraud case of the Bank of Punjab have raised many questions in the mind of investors, depositors, general public and the regulators alike. In this case, the father and the son are the main accused in the BoP scam, in which over nine billion rupees were lent to the company without any proper security.
The total fraud may surpass 20 billion rupees, if the interest amount on this loan is taken into account. The present total paid-up capital of the said bank is Rs 5.287 billion. In case this loan is not refunded, there was the likelihood that the bank would have collapsed without the provincial government's assistance to inject additional capital to make the bank solvent. It is only because of these arrests that there is hope that some part of the loans may be recovered from them and that too with the help of our independent judiciary. They may also be helpful to unfold the true story of this mega-fraud.
It remains a mystery that a fraud of such a magnitude took place in the bank that was owned by the Punjab Government and no one ever took notice of this fraud. There were no whistle blowers from within or outside the bank. It was highlighted the first time in 2007 when the bank's external auditors refused to sign the audited accounts without any qualification and insisted that the provision should be made for these loans as there were no sufficient and reliable guarantees to support the loan. Consequently, the Audited Report was signed by the auditors with the exception relating to these loans. Despite this exception, the top management of the bank, including the board of directors, insisted that that the loans were not toxic and did not make provisions for these toxic loans for the year 2007. The relevant comments of the auditors, appearing the in 2007 audit report, are being reproduced here for ready reference.
"In our opinion, except for the effect of such adjustments, if any, as might have been determined to be necessary, had we been able to ascertain the amount of provision required against the aforesaid advances, the consolidated financial statements examined by us, based on fifteen branches and the returns referred to above, received from the branches which have been found adequate for the purposes of our audit, present fairly the financial position of The Bank of Punjab and its subsidiary company Punjab Modaraba Services (Private) Limited as at December 31, 2007..."
In another observation made by the auditors, under note 11.2, it is stated that
"Advances include Rs 8,620,866 (thousands) due from three companies which were restructured for period of seven years, including two years grace period. The management also caused a legal and financial due diligence by a legal counsel and an independent firm of chartered accountants, respectively. The management considers that the amount is fully secured/collateralized and recoverable, hence no provision against it is required, in terms of a time-based criteria, as stated in the Prudential Regulations of the State Bank of Pakistan."
It is interesting to observe that during the year 2007, the said bank declared a net profit, after taxes, of rupees 4.4 billion, out of which a bonus was declared at the rate of 25% of the paid up capital despite the fact that there were serious exceptions relating to huge unsecured advances given to the three parties mentioned in the audited report of 2007. Had proper provisioning been done during the 2007 operations, the bank would not have issued 25% bonus shares to its shareholder.
In 2008, things changed and the bank showed a total provision of non-performing loans to the extent of 18.864 billion rupees, including the doubtful and restructured loans given to three parties, without adequate securities for which reference was made in the accounts of 2007. After providing this provision for NPLs, the bank showed a net loss of 10.059 billion rupees after providing for a total provision of 18.864 billion on account of non-performing loans. This reveals that the bank had to write off the entire current years profit and the carried forward profits from the previous years to off set the current year losses due to these bad loans.
The impact of this huge loss resulted in delaying the release of the 2008 account and an injection of rupees 10 billion rupees by the provincial government of the Punjab through a Board of Directors meeting held on June 04, 2009, mainly to compensate the bank for this fraud and to support the equity of the bank, being a majority shareholder.
It should be observed that the auditors mentioned some reservations, though in a mild manner, that the three loans were seen to be doubtful and may have lacked proper security, yet the board of directors approved the financial results for 2007 without any whistle blowing. There seems to be enough evidence that the senior management of the bank, the board of directors and the provincial government were grossly negligent in their task of overseeing the bad loans specifically to these three parties, as there seemed to be no evidence on record that any one of them objected to this state of affairs.
The accused disclosed vital information relating to all those who took their share in this scam. According to them, the Chairman of the bank, along with other officials was also involved and received his share in this fraud. He, too, has been arrested in the US recently. Though till now, he has been consistently claiming his innocence.
Who has been negligent in this fraud will be debated in the context of several facts that may be unearthed during the trials of these accused, but there is visible negligence on the part of Provincial government's authorities, the directors, their appointees and the regulators alike and we would discuss this aspect of the case here.
The Bank of Punjab had a board of directors, duly appointed by the Punjab Government, to perform an oversight role as per the Companies Ordinance 1984. The government of Punjab was fully responsible to nominate persons as directors for the Board at the time when this fraud took place. Therefore, it seems that the then-provincial government acted negligently in appointing directors who were not capable and trustworthy. In many cases, they did not have the necessary qualifications and experience to hold the office of a director of a bank. In this specific case, the State Bank of Pakistan and the SECP also failed in their task to ensure that the persons nominated were the persons fit for the job. Therefore, those who accorded approvals for these nominations were negligent and must be brought to justice for failing to exercise due care for was desired from them.
Time and again, the mode of appointment of directors for publicly held companies have been debated in the electronic and print media and it is a unanimous public view that these appointments are being made, by the respective authorities, to please their friends and relatives, irrespective of the fact whether they are fit for the position or not. Every now and then, we hear stories of these government appointees not performing their proper functions as "watch dogs" to protect the interests of the shareholders. In the present case also, the directors appointed in the Bank of Punjab compromised their role because some of the biggest recipients of loans were some of the directors or their friends. These directors were directly or indirectly interested parties and there was a clear evidence of conflict of interest. This situation was a clear violation of the corporate governance rules, Companies Ordinance 1984 and State Bank of Pakistan Rules. The Punjab government, being the majority shareholder with a 51% stake in equity was highly negligent in allowing these persons to sit on the Board of the Bank and not taking any serious view of the irregularities in the bank.
Furthermore, the provincial government did not act when the auditors of the bank refused to sign the annual accounts for 2007, on the exception that the said loans were not backed by reliable securities. This signifies that some of the government high-ups were either grossly negligent or they were also involved in this scam. Their names should also be made public and they should also be taken to justice. Why was the Chairman of the bank allowed to function remains a mystery and should be unearthed.
The Companies Ordinance 1984 of Pakistan and the British Companies Act 2006, as amended, does not make any distinction between executive and non-executive directors, relating to their legal duties and liabilities arising out of these appointments. These two categories of directors are treated alike and therefore, no distinction has ever been made regarding negligence in their fiduciary duty of skill and care. This has been decided in numerous court cases.
Directors responsibility has been clarified in City Equitable Life Assurance v Bowley (2003-2006), where it was held that in considering the duty of care to be exercised when a director wishes to delegate certain functions, the test was that the directors have ,both collective and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company's business to enable them to properly discharge their duties. It seems that the entire Board of directors failed to perform this legal responsibility, which is evident from the approval of the 2007 accounts. The exercise of delegating the director's power does not absolve a director from the duty to supervise the discharge of the delegated function.
With the latest developments emerging from regulatory and legislative measures and the requirements of the business communities, where recent collapses of well-reputed corporations were the result of huge loses to shareholders and investors, it was generally felt that directors acted carelessly and did not protect the interest of shareholders in preventing these losses. In some cases, they in fact, were the cause of these losses. This perception changed the entire thinking relating to the issue of director's liabilities. Therefore, severe penalties were imposed upon careless directors world-wide. It remains to be seen why the negligent directors were not made party to this mega scam in this case.