Heard on the Street

Chase Manhattan 'Checkbook' Goes Awry,
Prompts Inquiry

By PAUL BECKETT
Staff Reporter of THE WALL STREET JOURNAL

NEW YORK -- Tellers in branches of Chase Manhattan, the nation's
third-largest bank, readily give instructions on how to balance a checkbook.

Maybe the bank itself could use a lesson or two.

The Securities and Exchange Commission is investigating why Chase has a
discrepancy in an internal tracking system, the equivalent of an in-house
checkbook, that started at more than $40 billion -- yes, billion -- according to
people familiar with the matter.

                           The problem accumulated over as many as
                           10 years in Chase's Capital Markets
                           Fiduciary Services division, which is hired
                           by companies and municipalities to pay
                           interest and principal on corporate and
                           municipal bonds. By the end of September,
                           the discrepancy was whittled down to
                           about $14 billion. It stands at under $5
                           billion now, after Chase spent months on
                           the painstaking process of picking through
                           thousands of bond issues. People familiar
                           with the matter say the reconciliation should
                           be completed by the end of the first quarter
                           next year.

The SEC's investigation comes at a time when the agency is taking a keen
interest in company internal accounting issues that go beyond the basics of
financial reporting on which most investors depend.

Yet the discrepancy isn't likely to affect Chase's reported financial results, and
no restatement of earnings is expected. Nor have any customer funds been lost.
Indeed, in the course of its digging to reconcile the problem, Chase realized it
had overpaid $7 million in interest on some bonds that Chase should have
called. The bank will absorb that $7 million as a loss, people familiar with the
matter say.

"We are cooperating with all of the regulatory authorities, and we do not
believe the impact on our financial statements will be material," says Marc
Shapiro, a Chase vice chairman, in an interview.

Still, the bank, with the help of its auditors, PricewaterhouseCoopers, has been
working hard to solve the problem, which was uncovered during an internal
audit more than a year ago, when PricewaterhouseCoopers recommended that
the reconciliation take place.

Such a large snafu could prove embarrassing and raises prickly questions about
the bank's internal tracking systems. Chase is one of the biggest participants in
the industry for servicing corporate and municipal bonds. Moreover, it is widely
viewed as having good internal controls and prides itself on its internal
discipline. But that reputation already was called into question by a separate
incident recently.

Last week, Chase revealed that a portion of its trading accounts had been
improperly inflated by the misstatement of foreign-exchange transactions. A
trader, Christopher Goggins, was dismissed. Mr. Goggins didn't return calls
seeking comment.

Chase said the foreign-exchange problem would
result in a reduction of $40 million in its trading
profit in the fourth quarter and that it is conducting
an investigation into the matter. On the New York
Stock Exchange Monday at 4 p.m. Monday,
Chase shares closed down $1.875 to $84.375.
They stood at $87.25 when Chase announced the misstatement Nov. 1.

The roots of the reconciliation issue in the fiduciary-services division, part of the
Chase Global Services unit, has been traced to the way Chase used
BondMaster, a software system used by Chase and many other big banks,
according to people familiar with the matter. Indeed, Chase not only had its
own reconciliation problem but has inherited similar problems from its 1996
merger with Chemical Banking and from bond portfolios it has acquired.

Made by SunGard Data Systems, Wayne, Penn., BondMaster allows banks
to keep track electronically of when they should pay interest and principal
payments to bondholders on behalf of companies and municipalities. The
companies and municipalities give banks the money to pay the bondholders and
also pay a fee to the bank for the payment service.

But in tracking how many bonds were outstanding to be serviced, Chase's
system recorded the amount of bonds that had been originally authorized by the
company or municipality. That failed to take into consideration any bonds that
had been paid off, or whether the actual amount of bonds issued was different
from the amount that the issuer authorized.

So Chase's BondMaster showed there were $40 billion-worth of bonds
outstanding that Chase ought to be servicing, when in fact the bonds either
hadn't been issued or had already been redeemed, people familiar with the
matter say. The discrepancy was found in about 6,500 of the 45,000 bond
issues serviced in the fiduciary-services division, these people say. At that point,
Chase realized it had a serious weakness in its internal tracking system and set
out to correct it.

In simple terms, it was the equivalent of not recording transactions in the front
of your checkbook, even though your account balance and statement recorded
them correctly.

Chase was recording the data correctly elsewhere in the division, where
account managers use both paper and computer records to keep track of
payments and the correct numbers of bonds outstanding. Chase also has other
outside checks on its payments record: Companies and municipalities keep
track of what payments the bank should be making on their behalf; and
bondholders typically track when their payments are due.

The SEC's regional office in Chicago has been investigating the issue for the
past several months, people familiar with the matter say. A spokesman for the
SEC declined to comment, citing the commission's policy to neither confirm nor
deny the existence of investigations.

In a quarterly filing with the SEC late Monday, Chase acknowledged that it has
"some deficiencies in the computerized bond record-keeping system" in its
fiduciary services division.

"Because of these deficiencies, Chase is currently unable to confirm through a
complete reconciliation of the relevant accounts that the value of bonds that
could potentially be presented for payment does not exceed the amount of cash
on hand for the payment of such bonds," the filing said.

Chase added that the SEC was looking into the issue to determine whether
there have been "violations of its transfer agency record-keeping or reporting
regulations."

Some people familiar with the matter maintain Chase's problem is of little
financial significance, because Chase's public reporting likely won't be affected.
Chase is keeping the Federal Reserve informed of the problem, these people
say, but it is not viewed as an issue of bank safety and soundness, which is the
Fed's primary concern. A spokesman for the Federal Reserve declined to
comment.

But Chase is taking the matter seriously enough to bring an in-house technology
expert to complete the reconciliation and make sure such problems don't arise
again. The bank recently named John Irvine, a Chase veteran who has worked
in several other technology-heavy areas of the bank such as foreign exchange,
as director of operations and technology for Capital Markets Fiduciary
Services.

Write to Paul Beckett at paul.beckett@wsj.com2
 

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