The Story
Toshihide Iguchi, a Kobe, Japan-born US citizen who majored
in psychology at Southwest Missouri State University, Springfield, joined
Daiwas New York branch in 1977. There he learned how to run the small back
office of the branchs securities business. Opened as an office in the 1950s,
the Daiwa New York branch began dealing in US Treasury securities as part of
Daiwas services to its pension fund customers. During the 1980s the New York
desk became a significant force in the US government debt market and was
designated as a primary market dealer in 1986.
When Iguchi was promoted to become a trader in 1984, he did
not relinquish his back-office duties. All in all, he supervised the securities
custody department at the New York branch from approximately 1977 right through
to 1995. This lack of segregation, a relatively common feature of small trading
desks in the early 1980s but already a discredited practice by the early 1990s,
led to Daiwas downfall.
Daiwas New York branch managed the custody of the US
Treasury bonds that it bought, and those that it bought on behalf of its
customers, via a sub-custody account held at Bankers Trust. Through this
account, interest on the bonds was collected and dispersed, and bonds were
transferred or sold according to the wishes of either customers or the banks
own managers. Daiwa and its customers kept track of what was happening in this
account through transaction reports from Bankers Trust that flowed through
Iguchi, in his role as head of the back office.
When Iguchi lost a few hundred thousand dollars early on in
his trading activities, he was tempted into selling off bonds in the Bankers
Trust sub-custody account to pay off his losses. Then, in the words of the FBI
agents who investigated the case: He concealed his unauthorised sales from the
custody account by falsifying Bankers Trust account statements so that the
statements would not indicate that the securities had been sold.
As he lost more money trying to trade his way back into the
black, it became hard work keeping alive this parallel series of reports. But
luckily for him, Daiwa and its internal auditors never independently confirmed
the custody account statements.
Later on, while he served his sentence, Iguchi was asked by
Time magazine whether his early actions felt like a crime. To me, it was only
a violation of internal rules, he said. I think all traders have a tendency
to fall into the same trap. You always have a way of recovering the loss. As
long as that possibility is there, you either admit your loss and lose face and
your job, or you wait a little a month or two months, or however long it
takes.
In Iguchis case it took 11 years, during which time he is
said to have forged some 30,000 trading slips, among other documents. When
customers sold off securities that Iguchi had, in fact, already sold off on his
own behalf, or when customers needed to be paid interest on long-gone
securities, Iguchi settled their accounts by selling off yet more securities
and changing yet more records. Eventually about $377 million of Daiwas
customers securities and about $733 million of Daiwas own investment
securities had been sold off by Iguchi to cover his trading losses.
As Iguchis apparent success grew he later said that at
one point his desk produced half the New York branchs nominal profits he
became something of a golden boy at Daiwa. But the losses accumulated until by
the early 1990s it was difficult for Iguchi to continue to hide them,
particularly after 1993 when Daiwa made some limited efforts to split up its
trading and back-office functions. Yet he managed to survive for another two
years before engineering his own day of reckoning.
Iguchis survival wasnt entirely down to luck. Subsequent
investigation showed that risk control lapses and cover-ups were part of the
culture of Daiwas New York operation in the 1980s and early 1990s, to a
farcical degree. For example, during the 1995 investigation of the Iguchi
affair, the bank was also charged with operating an unauthorised trading area
for securities between 1986 and 1993.
According to the charges laid against the bank by US
officials, Daiwa had gone so far as to temporarily relocate certain traders
and, when necessary, to disguise the trading room at the downtown office as a
storage room during [regulatory] examinations.
Following a regulatory rebuff in 1993, the bank had assured
regulators that traders would no longer report to Iguchi while he occupied his
role as head of the securities custody department. In fact, the branch
continued to operate without a proper division of responsibilities.
Furthermore, during the 1995 investigation, Iguchi revealed that between 1984
and 1987, other Daiwa traders had suffered major losses; these had apparently
been concealed from regulators by shifting the losses to Daiwas overseas
affiliates (FDIC, 1995).
In Iguchis confessional letters to Daiwa in mid-summer 1999
(he sent a stream of letters and notes to the bank after that initial July 13
letter) the rogue custody officer suggested that his superiors keep the losses
secret until appropriate measures could be taken to stabilise the situation.
It was a suggestion that was taken up. In the period after July 13 and before
about September 18, when Daiwa belatedly advised the Federal Reserve Board of
the loss, certain of Daiwas managers connived with Iguchi to prevent the losses
being discovered, despite a legal requirement to report misdoings immediately
to the US regulators.
For example, during September 1995, Iguchi was told to
pretend to be on holiday so that a scheduled audit would have to be postponed;
he was in fact in the New York apartment of a Daiwa manager helping to
reconstruct the trading history of his department. Daiwas managers seem to
have been hoping to transfer the loss to Japan, where it could have been dealt
with outside the scrutiny of the US regulators and markets.
After Daiwa told regulators about the loss on September 18,
Iguchi was taken to a motel and questioned directly by the US Federal Bureau of
Investigation. He told FBI agents about what had gone on in the months
following his initial confession to Daiwa, and the bank was shocked to find
itself facing a 24-count indictment for conspiracy, fraud, bank exam
obstruction, records falsification and failure to disclose federal crimes.
Daiwa argued, rightly, that not a single customer of the
bank had lost any money. At the time of the incident, Daiwa was one of Japans
top 10 banks and one of the top 20 banks in the world in terms of asset size.
Like most other Japanese, and some European, banks, it had massive hidden
profits on its balance sheet that were not accounted for due to the legitimate
historical accounting method that it employed. That gave Daiwas management
considerable freedom of action if unexpected problems arose. One of the banks
crisis management actions after Iguchi confessed was to pump back into the
defrauded account securities equivalent to those that their New York head of
custody had sold off.
But the US regulators were deeply unhappy at the attempted
cover-up, and at the way Daiwa had seemed to ignore regulatory warnings over a
number of years. They were also unhappy that at least one senior member of
Japans ministry of finance knew about the Daiwa scandal in early August and
had not informed his US regulatory counterpart.
This pushed the Daiwa scandal onto the international
political stage and led to a telephone conversation in which Japans finance
minister, Masayoshi Takemura, was obliged to make apologetic noises to US
Treasury secretary Robert Rubin for his staffs failure to pass on the
information. (The call was made only after Takemura had annoyed US officials by
denying at an earlier press conference that his ministry had failed in its
duties; his aides later denied that any formal apology had been made to Rubin.)
At a time when the Japanese banking system was already
showing signs of strain from the slowing Japanese economy and deteriorating
asset quality, many international regulators took the Daiwa scandal and its
aftermath as a sign of the continuing lack of openness in Japanese banks and
the Japanese financial system.
Meanwhile, Daiwa faced more immediate problems. In November
1995, the Federal Reserve ordered it to end all of its US operations within 90
days. By January 1996, Daiwa had agreed to sell most of its assets in the US,
totalling some $3.3 billion, to Sumitomo Bank and to sell off 15 US offices.
(Indeed, for some time after the debacle, Daiwa was rumoured to be on the verge
of merging with Sumitomo.)
In February 1996, Daiwa agreed to pay a $340 million fine
a record amount for a criminal case in the US as a way of laying to rest the
charges that US authorities had brought against it. All in all, it endured some
of the stiffest punishments ever meted out to a foreign bank operating in the
US.
By this point, senior figures at the bank had resigned or
indicated they would take early retirement. Top management said it would cut
its own pay for six months and forgo bonuses as a sign of contrition. Iguchis
nightmare was now dissipating. In October 1995, he had reached an agreement
with his US prosecutors and admitted misapplication of bank funds, false
entries in bankbooks and records, money laundering and conspiracy. Iguchi told
the judge at early hearings that by the time he confessed: After 11 years of
fruitless efforts to recover losses, my life was simply filled with guilt, fear
and deception.
He said he sent the confession letter because he
couldnt see that anyone other than himself was likely to bring the situation
to an end. In December 1996, he was sentenced in New York to four years in
prison and a $2.6 million penalty that he had little chance of paying. The
cover-up also led to one of Iguchis managers being sent to prison for a number
of months and fined a few thousand dollars.
