Anti-Money Laundering Probe Puts a Spotlight on BSP and Central Bank Governance

Stripped down to its most basic properties, grand corruption in PNG involves vast sums of money. Corruption schemes are often measured in the millions of Kina, if not tens of millions.

Corruption is also widespread within elite circles. Any one year hundreds of scams take place targeting public moneys or landowner funds. These scams syphon off hundreds of millions into private pockets.

But where does that money actually go?

It is usually transmitted from one bank account to another bank account. Quite often the stolen money is then remitted abroad to pay for properties, private school fees, and/or world travel.

Would the illicit nature of these dodgy transactions be obvious if anyone closely examined the relevant banking records. Global research has revealed that in many cases the answer is yes.

It is against this backdrop that a new national anti-money laundering regime was passed in 2015. While the phrase ‘money laundering’ conjures up images of Mexican drug cartels taking briefcases of money into Cayman Island banks, it is often much less dramatic. Money laundering can simply involve the transfer of a bribe from the Port Moresby bank account of Company A to the Port Moresby bank account of Politician B. Politician B then transfers the money to their lawyer’s escrow account in Brisbane so they can purchase real-estate in Australia. In this hypothetical case two banks and a law firm have handled dirty money.

The Anti-Money Laundering and Counter Terrorist Financing Act 2015 and the Criminal Code (Money Laundering and Terrorist Financing) (Amendment) Act 2015, place a responsibility on financial institutions such as banks to monitor customer transactions like this, and to engage in enhanced due diligence when dealing with a higher risk client or transaction.

Due diligence means that banks must take active steps to understand who the beneficial owners are of a bank account, where the account holder is higher risk the bank must in turn exercise greater levels of vigilance, and where there is an unusual payment that stands out, the bank concerned must obtain satisfactory explanation and documentation to ensure it is legally acquired moneys.

Failure to conduct appropriate levels of due diligence is an offence under the Anti-Money Laundering Act punishable by fine and/or custodial sentence. Additionally, handling the proceeds of crime is also defined as a crime under the 2015 reforms to the Criminal Code.

Complimenting this anti-money laundering regime,  under the Banks and Financial Institutions Act 2000 the central bank – i.e. the Bank of PNG – can issue prudential standards for good governance, which financial institutions are required to meet. The Bank of PNG as the regulator has a range of powers to address breaches of these standards. When exercising these regulatory powers it is essential that the Bank of PNG remains independent from private sector banks, standing at arm’s length.

With this new regulatory regime in place, last month news broke that Bank South Pacific (BSP)  has been the subject of a money laundering probe conducted by an independent unit within the Central Bank, known as the Financial Analysis and Supervision Unit or FASU. FASU issued a press release confirming its investigation. FASU also noted it had issued BSP with a formal warning under the Anti-Money Laundering Act for breaches of its provisions.

Subsequently, further news broke pointing to potential breaches of Central Bank Prudential Standards by BSP, which are a separate governance matter unrelated to anti-money laundering directives.

In today’s Tokaut Blog we will take a closer look at BSP, and the governance standards all banks in PNG must now comply with. This examination will begin by looking at potential breaches of Prudential Standards by BSP, which is a separate matter to money-laundering. We will then turn to the recent controversy over BSP’s anti-money laundering standards.

BSP and Banking Prudential Standard 300

Under the Banks and Financial Institutions Act 2000 the financial regulator (i.e. Bank of PNG) can issue Prudential Standards, which banks must comply with. The standards are designed to promote responsible governance in the banking sector.

One such standard is Banking Prudential Standard 300. It states: ‘No director [of a bank] can serve as Chairman for more than 6 consecutive years’.

Despite this standard a recent Australian Stock Exchange (ASX) Information Memorandum issued by BSP, states that Sir Kostas Constantinou has been Chairman of BSP for a decade starting in February 2011. 

A request for comment from BSP on this matter, was not responded to. However, after this apparent breach of Prudential Standard 300 was reported on by the Australian Financial Review last week, BSP issued a press release.

It states BSP ‘affirms that the tenure of its chairman, Sir Kostas Constantinou OBE, is the subject of an exemption issued by the Bank of Papua New Guinea in 2019 in relation to prudential standards on governance matters and that the Bank of Papua New Guinea has consented to Sir Kostas’ chairmanship continuing to February 2023′.

This response arguably prompts more questions than it actually answers. First, by 2019, when the exemption was issued, BSP had apparently already been in breach of the Prudential Standard for two years. Second, BSP does not explain what exceptional occurrence would warrant this special exemption. Third, the Bank of PNG has not explained the rationale that motivated it to grant this exemption.

It would also appear that Sir Kostas’ 12 year tenure on the BSP Board, which started in April 2009, contravenes the bank’s own Board Charter which states in section 4.2 ‘a Director is not permitted to hold office for a period exceeding 3 terms of 3 years or 9 years whichever is the lesser’.

These potential contraventions of Prudential Standards and BSP’s own Board Charter would be matters of note in isolation. Arguably it is of greater concern that this takes place against a backdrop where BSP has significant financial exposure to Sir Kostas and the entities he controls.

The ASX Information Memorandum published by BSP disclosed that as at 31/12/2020 there are on its books, K394,760,000 in loans and receivables from Sir Kostas and entities he controls. There is a further K178,808,000 in loans and receivables from entities in which Sir Kostas is a Director. In total, there is over half a billion in exposure to entities controlled by Sir Kostas, or entities in which he has significant involvement.

Prudential Standards place limits on how exposed a bank in PNG can be to a related party. There is no allegation being made here that the current level exposure is in breach of these limits. This is a complex calculation that would require specialist analysis. Our request for comment from BSP on this matter was not responded to.

While these governance matters are not connected to anti-money laundering, they have prompted concerns over broader governance standards within the nation’s banks, at a time when there is growing pressure for the financial sector to significantly strengthen its compliance cultures. And this expectation has come to a head most recently with the BSP/FASU clash.

Money Laundering Standards

With regard to potential breaches of anti-money laundering regulations, BSP has issued a separate press release. It disputes the findings of FASU.

Subsequently the Central Bank also issued a press release. It defends BSP, and launches a broadside against FASU, casting some doubts over how rigorous the Central Bank is prepared to be as regulator.

It is difficult to understand the rationale underpinning Governor Bakani’s assertion that FASU’s public stance undermines the stability of the financial system in PNG. Some of the largest banks in the globe based in financial centres such as the US, UK, Germany, and Switzerland have been subjected to significant fines and even prosecutions over money-laundering. Far from causing chaos, this proactivity from regulators helps to allay market concerns over lax regulators allowing weak compliance cultures to fester.

FASU’s commitment to rigorously overseeing the nation’s anti-money laundering code would appear to be a positive market signal that will underpin stability in the financial system.

Though FASU’s well argued concerns do point to the risks banks in PNG face if they continue to fall short of regulatory requirements.

The relevant criminal law is set out in 508B and 508C of the Criminal Code Act. The Central Bank summarises these provisions:

The general nature of the offence is that a person who deals (widely defined to include conceals, disguises, converts, transfers, receives, uses etc) in criminal property (defined to include property of “every kind” derived directly or indirectly from criminal conduct) and who knows or reasonably ought to know that the property is criminal property is guilty of money laundering. There is a related offence (Section 508C) of dealing with property reasonably suspected of being criminal property.

 An example of suspicious activity is given in 508C ‘the value of the property involved is grossly disproportionate to the person’s lawful income and expenditure over a reasonable period of time within which the act occurs’.

In other words, if a bank transfers a significant sum of money into the account of an MP, involving amounts which are clearly highly irregular, they are at risk of prosecution under this reform to the criminal code.

Complimenting this provision, under the Anti-Money Laundering and Counter Terrorist Financing Act 2015, any institution that fails to conduct enhanced due diligence on high risk clients, such as politically exposed persons, can be fined up to K1 million. What this means is that banks for instance, must proactively and rigorously monitor bank accounts beneficially owned by politically exposed persons to ensure the funds are from legitimate sources.

Accordingly, a bank such as BSP, has an active duty to scrutinise transactions taking place through its financial scaffolding. Where it fails to do this it can be fined under the Anti-Money Laundering and Counter Terrorist Financing Act 2015. There is also the potential for banks to face criminal prosecution if they actually handle the proceeds of crime, and failed to conduct adequate due diligence.

To demonstrate how these reforms work in practice the conviction of former MP, Philip Kikala, is a salient example. This case took place before the amendments to the Criminal Code. So there is no suggestion here that BSP breached the criminal law in any way, or any other regulation. Nonetheless, for educational purposes this case provides a vivid example of the transactions BSP must now alert the authorities too.

The case of Philip Kikala

Philip Kikala was the sitting Member of Parliament for Lagaip-Porgera from 2007 to 2012. As MP he was also Chairman of the Joint District Planning and Budget Priorities Committee.

MP in K1 million DSIP fraud: The State -v- Phillip Kikala | PNGi

On 19 January 2011, Kikala registered a company West Rural Industries Limited, and opened an account with BSP, on which he was the sole signatory. Six months later Kikala chaired a meeting of the Joint District Planning and Budget Priorities Committee, where he informed the committee that a K1 million district support improvement grant was available. The committee resolved that a significant portion of the grant would go to West Rural Industries Limited.

Following submission of further documentation by Kikala the Department of Implementation and Rural Development paid to West Rural Industries a sum of K790,000. This money was deposited into the West Rural Industries’ BSP account on 6 March 2012, which local MP Kikala was sole signatory too.

On 21 March 2012 an additional cheque of K80,000 was paid into the BSP account. Then on 19 April 2012 K128,000 was paid into the West Rural Industries BSP account. The National Court claims this was a supposedly a ‘project management fee’ paid for out of the District’s Discretionary Grant. A further K109,100 was paid into the same BSP account, again from the District’s Discretionary Grant. The court notes none of these funds were acquitted or any project work done.

As a result the National Court was satisfied that these moneys were dishonestly applied to Kikala’s own use, or the use of others, and he was duly convicted.

These incidents took place before the anti-money laundering reforms were introduced into the Criminal Code, so there is no allegation being made here that BSP committed a criminal offence when processing these transactions on behalf of West Rural Industries. But had this conduct taken place today, the bank would appear to be in extremely risky territory.

First, the signatory to the account was a politically exposed person, i.e. Member of Parliament for Lagaip-Porgera. Because MPs are at a higher risk of being involved in corruption, the bank is under an obligation to conduct enhanced due diligence on all transactions involving their accounts. Also added to this, Philip Kikala was West Rural Industries’ sole Director, and the two company shareholders Philip Junior and Nema Philip both shared the same address details as Philip Kikala. Finally West Rural Industries had submitted no annual return to the corporate registrar, and gave all the appearances of being a shell company.

Set against this high risk backdrop, large volumes of money were then being paid into this bank account from a district discretionary grant in Kikala’s constituency, which would appear an especially overt red flag. Large payments were also made from a District Support Improvement Grant. In current regulatory conditions, BSP would be obliged to thoroughly investigate these highly suspicious transactions in order to ensure it is not handling the proceeds of crime. If it failed to do this, it would be at risk of prosecution under the Criminal Code Act or the 2015 Anti-Money Laundering law.

Ongoing Vigilence

If we fast forward to 2021, there are numerous instances on the public record where information exists that should put the banks on notice, so they use additional rigour when handling particular accounts and transactions.

A simple search of PNGi Portal would alert banking compliance officers to the fact that some of their high profile customers have been credibly implicated by Commissions of Inquiry and Public Accounts Committee inquiries in corruption, fraud, misappropriation and money laundering.

Additionally, media investigations and well publicised prosecutions, are further red flags that bank compliance officers should be registering and using to engender an intelligence based approach to risk detection, that ensures their bank is in compliance with all anti-money laundering requirements.

And in this regard, rather than being slammed by the Central Bank, FASU should be commended for taking a public stance on compliance rigour. Unless FASU and other responsible agencies are empowered to take robust action against wrongdoing, weak compliance cultures will fester. In that scenario PNG really does face risks of financial catastrophe.

Much like a climate denier, who blames scientists for causing global anxiety over catastrophic climate change, the Central Bank is castigating FASU for alerting the public to real risks that exist within the nation’s financial system. This is time and effort better expended on tackling these risks, rather than shooting the messenger.