Learning from the Citibank fraud

Learning from the Citibank fraud

Most of you are by now aware of the fraud that unfolded at a Citibank branch near New Delhi. Similar to the one in the US involving Bernard Madoff, a number of high net-worth individuals here stood to lose a part of their savings. This continues a trend in which well-heeled and seemingly knowledgeable people are being taken for a ride by investment managers, and should lead to serious introspection by the companies involved as well as regulators.

The Citi and other frauds share some common features. First, there is the use of forged documents to fool customers. Given that there is a growing market for fake PAN cards, driving licences, income tax returns, and so on, a healthy dose of scepticism is required if one is to base an investment decision on a piece of paper.

Investors also place undue reliance on their managers. Active fund managers on average add little value (a well-known study showed that a portfolio created by a monkey throwing darts at random performed as well as one created by a group of leading financial advisers). In an investment climate where outperforming the pack is extremely difficult, any scheme that promises extraordinary returns warrants close scrutiny.

You can’t wash your hands of your investment simply because you have a fund manager. Most investment frauds could have been avoided had the investors spent a few hours every month tracking their portfolio and their fund managers’ performance. One concedes that for most who have day jobs, it is difficult to spare even this much time. This underscores a somewhat jarring reality about investing—it is best suited for those who have the leisure to do it, and risky for ones who are otherwise occupied in earning a living.

The Citi fraud also highlights the danger in the fashionable view that a customer must only have one point of contact with a company. This can lead to extreme dependency on the ethical compass of one individual. In Citibank’s case, it may be a cause for introspection as to why the relationship manager single-handedly managed his customer relationships. Had others in the system been involved, warning signals of the fraud may have emerged earlier. Any definitive conclusion, however, will have to await the results of Citibank’s internal review.

On a more general level, this fraud highlights the fact that in the desire for growth, a large number of conventional risk mitigants are often obeyed only in letter and not in spirit. Regulators need to know that customer policies are in place, suspicious transactions are being reported, and the like. But the mad rush for growth can perpetuate a philosophy of doing no more than the minimal due diligence. In the Citibank case, questions asked about the source of the large funds that were flowing into the account of the accused’s relations would have immediately raised red flags.

Against this background, boards of financial services firms must introspect about the nature of their business. As lender or asset manager, the essence of banking is in its fiduciary responsibility. Critical to a bank’s functioning are control-related actions such as concurrent audits, daily reconciliations, segregation of duties, and so on. These ensure that virtually every transaction of the organization is subject to multiple checks and balances. They are also the less attractive operating aspects of the financial services business, compared with closing deals or making new investments. As a result, they are often given short shrift.

One hopes that after the Citibank incident, other organisations will reflect on the risks inherent in today’s loosely regulated investment management business.

Govind Sankaranarayanan is chief financial officer and chief operating officer, corporate affairs, Tata Capital. He writes on issues of governance.

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