May 21, 1999
Merrill Wished Upon a Star Banker
But Wound Up in a Singapore Sling
By DARREN MCDERMOTT and SARA WEBB
Staff Reporters of THE WALL STREET JOURNAL
When Merrill Lynch & Co. won a fraud case against its former star private
banker in Singapore last week, it largely brought to a close an
embarrassing episode for the Wall Street securities firm.
Singapore's High Court found that
Kevin Wallace, once the banker to
many of Southeast Asia's wealthiest
tycoons, had engaged in
unauthorized trading. It ordered him
to pay Merrill $25.2 million to cover
settlement payments the firm made
to his clients.
Yet one question remains: How
could a single banker circumvent
Merrill's accounting, compliance and
auditing operations -- in the case of
some clients, for several years?
Previously undisclosed documents filed in connection with the case, along
with testimony last week, detail how Mr. Wallace allegedly forged account
statements, intercepted client mail and kept his clients and his supervisors
from reviewing account activity together. In affidavits and in court, senior
Merrill executives acknowledged that their compliance systems had been
compromised, and the firm says changes have since been made.
How could Merrill not have known earlier? It
was only after Mr. Wallace left the firm in
1997 that Merrill realized something was
amiss, Merrill officials say. "We were not aware at all" of Mr. Wallace's
unauthorized activities, his boss, Syed Elias Bin Abdul Rahman Alhabshi,
testified. Mr. Elias described the former banker as "very dominating,"
adding that Mr. Wallace prevented him meeting alone with Mr. Wallace's
clients, and possibly had found a way to intercept clients' faxes to the
firm.
Mr. Wallace, through his lawyers, denied unauthorized trading and forgery,
but acknowledged putting his own money into clients' accounts to make up
for losses.
Mr. Wallace's alleged deeds pale in comparison with those of others
accused of being "rogue" traders or bankers. Nick Leeson, who brought
down Barings PLC in 1994 with losses of $1.38 billion from unauthorized
trading, is in a Singapore jail cell. And Yasuo Hamanaka, whose illicit
copper trades cost Sumitomo Corp. $2.6 billion in losses, was sentenced
to eight years in prison for fraud and forgery. Mr. Wallace's whereabouts,
on the other hand, aren't known; his lawyer said last week that Mr.
Wallace had been in Spain but that he wasn't sure where the banker is
now. That could make it difficult for Merrill to get back all of its money.
A Harvard Business School graduate, Mr. Wallace, now 48 years old,
had more than a decade of experience as an investment banker in Asia
when he joined Merrill Lynch in Singapore in late 1990. Merrill was
pushing hard to grab private-banking business from European banks; Mr.
Wallace seemed an ideal envoy between Asia's new rich and Merrill's
financial firepower. As word spread, Mr. Wallace's client list grew to
include top Indonesian tycoons; he was sometimes seen in the company of
former President Suharto's son Bambang Trihatmodjo.
Mr. Wallace generated significant profits for Merrill, and was rewarded
with a generous compensation package based largely on commissions on
trading in his clients' accounts. Between 1993 and 1997, Merrill paid him
a
total of $13.5 million, according to a report by receivers investigating
his
world-wide assets.
Merrill had warned Mr. Wallace as early as 1993 about "certain breaches
of internal policies and internal regulations," Raymundo Yu, Merrill's
head
of private banking in Asia, said in an affidavit. But Merrill spokesman
Bill
Halldin said the firm wasn't alerted to any "wrongdoing" until April 1997,
when Merrill discovered Mr. Wallace had breached its rules by placing
shares in a Malaysian company into some of his clients' accounts. The
company, Country Heights Bhd., wasn't on the firm's research list, and
the
transaction wasn't a Merrill-led venture, which meant Mr. Wallace wasn't
supposed to buy the shares at all.
Mr. Wallace was asked to resign. After he left in May 1997, Merrill told
the court, the company found several cases of unauthorized trading, which
led to substantial losses for some clients. The firm said Mr. Wallace
doctored account statements so that clients weren't aware of the true value
of their portfolios; he forged clients' signatures to make it look as though
he
had their approval for transactions and, in some cases, to take out loans
against their portfolios.
Altogether, about 40 of Mr. Wallace's 160 clients complained about his
handling of their accounts, Merrill said. Account statements and trading
records show that he used clients' money to trade often in a variety of
risky
stocks. None of those clients had given the requisite permission, Merrill
said.
Yet Mr. Wallace's trading didn't set off alarm bells. Merrill's spokesman,
Mr. Halldin, maintained it is difficult for any firm to detect unauthorized
trades in an account without input from the client. He said it is common
for
a client to call up his or her banker and authorize a trade over the phone,
and those conversations aren't taped. "The clients here were persuaded
by
Mr. Wallace that they didn't have to look at documents from Merrill Lynch
or that they were incorrect," he said.
Trading records show that Mr. Wallace made some spectacular blunders;
in one case, he bought shares in Bre-X Minerals Ltd., the scandal-plagued
Canadian gold-mining company, at US$22 per share, holding the stock
until it was virtually worthless.
Many clients weren't aware of the losses in their accounts until after
Mr.
Wallace left Merrill, the company's records show. One client, code-named
JJA, was the subject of an internal Merrill memo dated June 1997. "Mr.
JJA has received our latest summary of investments and was shocked that
his equity has dwindled to just over US$100,000," the memo said. "He
said Kevin [Wallace] had visited him in Sri Lanka about a month and a half
ago or two months ago, and he went through the statement with him, and
he had about US$1.4 million in the account."
In the case of a client code-named AM, Mr. Wallace assured AM that her
money was in U.S. bonds receiving "14% [interest per annum] without
capital risk," according to a letter from Mr. Wallace to AM. But, during
the five years he managed AM's account, it had losses of nearly US$4.9
million in a variety of stocks and bonds, according to trading records.
All
this during a global stock boom and before Asia's financial crisis took
its
toll on stocks.
There were warning signs. One client received two margin-maintenance
reminders, or requests for additional sums that Merrill holds as insurance
against trading by clients with borrowed money, even though this client
had
specified that the account was not to engage in frequent trading. But the
client was satisfied by a call from Mr. Wallace saying the reminders were
a
mistake, according to correspondence between the client and Merrill.
How did Mr. Wallace maintain seemingly complete control over the
account information his clients received?
A central problem stemmed from his clients' desire for secrecy. Distrustful
of local postal services and worried about their wealth being more widely
known, many clients requested a "hold-all-mail" policy that provided for
Mr. Wallace to hand-carry account statements to them. Though the
account statements were issued by a separate Merrill division, that
arrangement enabled Mr. Wallace to alter statements before he passed
them to his clients, Merrill said in court.
In his affidavit, Mr. Wallace said he wasn't alone in having access to
the
accounts and so could not have manipulated them as Merrill alleges. "I
was
not the sole source of information to clients concerning their accounts
and
all transactions concerning the accounts would be approved by my branch
manager or his deputy," Mr. Wallace said. His boss, Mr. Elias, would
have seen daily trading records and monthly client statements, Mr. Wallace
added.
Mr. Elias, 55, who has since retired, testified that it wasn't so simple.
Mr.
Wallace "insisted his clients were very confidential, high-net-worth
individuals" in Indonesia, he said, adding that Mr. Wallace was adamant
that Mr. Elias could only meet Mr. Wallace's clients in his presence.
"As a matter of routine I would request meeting clients once a month,"
Mr.
Elias told the court. He would arrange to go to Jakarta for one or two
days to meet with six or seven clients, but "when I got there, there's
always
a message the client has called up to say he's meeting with a minister,"
or
could not get together for some other reason.
And even though Mr. Elias was able to see daily trading reports, he said
in
court that these reports simply pick up what is on the trading tickets;
the
reports would not flag tickets for trades that hadn't been authorized.
Mr. Elias was supposed to authorize all outgoing correspondence to
clients, but Mr. Wallace sent and received faxes directly, Merrill said.
Even though the room where faxes arrived was locked, Mr. Elias testified,
"We suspect very strongly that faxes were taken away before we could
check them ... . We were not aware at all" of what was going on.
Mr. Wallace said in his affidavit that it's "inconceivable" he could have
manipulated trading and account statements "on an independent basis
within an organization such as the plaintiff's company without an entire
network within the company knowing exactly what was going on."
Mr. Halldin of Merrill said the firm has "strengthened our procedures in
terms of delivery" of statements and has made other changes in its
private-client operations, although he wouldn't disclose details. But he
rejected the notion that Merrill should have been expected to prevent the
losses: "When an employee is intent on committing a fraud, no system, no
matter how good, can always prevent that."