Not Ship Shape: Tanker Company Officers Embezzle Unhindered

Three bodies of auditors -- from the state, the corporation, and Arthur Andersen -- were unable to discover that high-ranking officials in a Middle Eastern oil tanker company had embezzled $100 million in 10 years. CFEs can assess what went wrong and determine red flags, and methods of prevention and detection in this high-dollar loss case.

The three top executives of the Kuwait Oil Tanker Company (KOTC) appeared to be upright conservative managers. They seemed to be calmly steering the shipping company through the rough waters of the Iran-Iraq War of the 1980s and the Persian Gulf War of the 1990s. But these trusted officers were using the company as their own personal piggy banks.

Over the course of 10 years, KOTC, and one of its wholly-owned subsidiaries, Sitka Shipping Incorporated, lost about US$100 million from embezzlement and kickback schemes perpetrated by the fraudulent triumvirate. The three bigwigs (and various accomplices) took advantage of perfect conditions for fraud. The Iran-Iraq War had created financial instability. For years, KOTC had left vacant a crucial position for overseeing fiscal operations. And auditors, which the company had hired to investigate potential financial losses, made the mistake of reporting their findings to those at the head of the company “ the fraudsters themselves. These were just some of the factors that left the officers in a perfect position to relieve the company of millions for a decade. The executives' complicated machinations were worthy of a Ludlum novel.

HISTORY OF THE OIL TANKER WAR: THE ANCHOR FOR FRAUD 

Increasing tension in the Middle East led to an "oil tanker war" between Iran and Iraq beginning in 1984 as part of the ongoing hot war between the two countries. During this period KOTC was responsible for the transportation of Kuwaiti petroleum products and crude oil exports and for its off-shore storage. It used its own tankers, and chartered tanker tonnage through its offshore subsidiaries including Sitka. KOTC also bought and sold new and second-hand tankers. During that time, Iran targeted KOTC vessels in the Persian Gulf.

In 1986, the Supreme Petroleum Council ordered the creation of a Floating Strategic Oil Reserve.1 To execute the council's order, the board of the Kuwait Petroleum Company (KPC) in May of that year instructed KOTC to charter foreign vessels to carry crude as the Floating Strategic Oil Reserve. Because of the targeting of Kuwaiti vessels, KPC recommended that Sitka, one of KOTC's confidential subsidiaries, be the chartering company for the reserve.

KOTC began working solely with the London ship brokerage firm of H. Clarkson & Co. Ltd (Clarkson) to charter ships rather than with several brokers, which would have been the norm. Capt. Timothy Stafford, KOTC's fleet operations manager; and Abdul Fattah Al Bader, KOTC's chairman and managing director, a director of KPC and president, and a director of Sitka; were to use Clarkson as chartering brokers. (The role of a chartering broker is to introduce charterers and ship owners to each other to facilitate mutually beneficial business. The agreement, which governs the relationship between the ship owner and the charterer, is called a "charterparty.")

Stafford was to report directly to Al Bader. As it turned out, Al Bader, Stafford, and Hassan Ali Qabazard, deputy managing director at KOTC, were the alleged main perpetrators of the embezzlement scheme.

SCHEMES GALORE 

The complicated fraud consisted of various nefarious transactions carried out by the three top-level KOTC officers with the assistance of the company's finance manager, Nasim Mohsin. The fraudulent transactions were grouped into four schemes.

Scheme 1: Charter arrangements and commissions 

If matters had proceeded legitimately, Sitka -- through the introduction of Clarkson -- would have been chartering directly from the real ship owners. However, Al Bader and Stafford contracted 19 vessels through Clarkson using phony nominee offshore shell companies on a fixed basis (an agreed hire “ or rental “ rate over a set period of time).

The nominee would enter into a back-to-back charterparty with Sitka on identical terms except for the rate of hire. An identical charterparty, except for the rate of hire and commission, between the nominee company and the real ship owner would ensure that any dispute or problem between the nominee company and the real ship owner would be identically reflected in the charterparty between Sitka and the nominee company.

Al Bader would decide how much more to charge Sitka than was being charged by the real ship owners to the nominee. Stafford would sign for both Sitka and the nominee with a heavily disguised signature for the nominee. From Clarkson's viewpoint, the nominee companies were KOTC. However, from KOTC's viewpoint, the nominee companies were the real ship owners. The charterparties' payments would be divvied up in one of three numbered accounts at BMB Trade and Investment Bank in Geneva, Switzerland.

The three bank accounts actually were personal accounts that Stafford had opened in Geneva with Al Bader, but each was named in the bank's record as the phony nominee companies. (Al Bader had opened a fourth account in his own name with Stafford as a signatory.)

Al Bader and Stafford would then transfer the amounts due to the real ship owners (less the uplift “ the secret difference between what was being charged Sitka and the real ship owners) into the ship owners' bank accounts, and then transfer the uplift to the fourth account “ Al Baders personal account. That stolen money accumulated and Al Bader, Qabazard, and Stafford quickly became rich men.

The flow of "address" commission payments (an address commission is the amount a charterer will charge the ship owner to cover its chartering department costs) to Clarkson was another tasty source of funds that the officers tapped.

For each charterparty, Clarkson would charge the ship owners a commission of 2.5 percent (the normal commission/brokerage rate for Clarkson was 1.25 percent -- the standard rate). Al Bader had told Clarkson that KOTC was setting up a "strategic fund," which would be financed by an additional commission of 1.25 percent. In November 1986, Clarkson opened an internal ledger account for the payment of those address commissions.

Between November 1986 and December 1987, the additional address commissions were credited to that internal ledger account. Clarkson would then pay those funds in accordance with the instructions of the three perpetrators in cash and traveler's checks. The KOTC board didn't discuss these schemes and Al Bader never mentioned them. Al Bader knew that Sitka would be liable to pay hire to the nominee companies, but he never explained to Sitka's board why it was necessary to pay at a level more than the market rate. And he didn't disclose that KOTC/Sitka were entitled to address commissions that were being charged.

Scheme 2: Vessel sale and purchase transactions and vessel construction 

In 1988, Al Bader told Clarkson that KOTC was in the market for new and second-hand vessels. Al Bader and Qabazard told Clarkson that as with the Sitka chartering program, the sale and purchase transactions would spur extra commission payments to be paid into Clarkson ledger accounts. KOTC would buy and sell ships through Clarkson, and Clarkson, under instruction, would divert some of the commission to the fraudulent officers. When KOTC sold the tanker Al Rawadatain for scrap, Clarkson collected US$20,676.34 from the buyers and US$99,246.45 from KOTC. Qabazard fraudulently inserted a 3 percent commission clause into the sale and purchase agreement.

A Clarkson internal memo indicated that it would be receiving US$99,245 from KOTC in addition to Clarkson's regular KOTC account. Qabazard, KOTC's deputy managing director, collected the US$99,245 and £35,000 held by Clarkson generated from a previous commission in traveler's checks when he came to London for the hand over of the vessel. This was the first of many occasions when Clarkson gave checks and cash to Qabazard (and Al Bader and Stafford) in traveler's checks and cash from these transactions.

In a later deal, KOTC agreed to pay Clarkson a commission of 3 percent “ US$1.8 million “ for the purchase of two second-hand tankers. As with the first transaction, Clarkson's actual commission was less “ US$270,000 for each vessel “which left a total of US$1.26 million to be deposited to Al Bader's account in Geneva. Clarkson also transferred the US$6 million commission it received from the seller on the two vessels to Al Bader's account. A few days later, Al Bader transferred US$1.41 million of those monies to Qabazard's London account.

Clarkson similarly diverted monies from construction of new vessels. KOTC would pay Clarkson US$300,000 per vessel for appraising the market for construction. In one of many deals, Clarkson duly received its $600,000 for a pair of new vessels but transferred US$550,000 of it to another Al Bader Geneva account, "Gulf Shipping." Clarkson later sent millions more to Gulf Shipping out of its commissions from the builders.

Scheme 3: Diversion of war-risk premium rebates  

As an owner of vessels trading in the Persian Gulf, KOTC's hull underwriters required it to pay additional war-risk premiums. (Whenever a vessel enters a war zone, it must buy war-risk insurance to protect against damage to the ship or cargo from an act of war.)

The London brokers, Sedgwick Marine & Cargo Ltd. (Sedgwick), handled its insurance business. When vessels completed voyages in a war zone without loss, the vessels often were qualified for rebates of the premiums. Qabazard arranged to have Sedgwick give any premium rebates to Clarkson as agents for KOTC. Between September 1990 and June 1992, Sedgwick paid rebates to Clarkson totaling US$6,026,803. Of that amount, transfers totaling US$6,009,048 went to Gulf Shipping. Sedgwick gave the balance, more or less, to Qabazard in cash and traveler's checks.

Sedgwick continued to transfer rebates of premium to Clarkson throughout the Iran-Iraq war and after Kuwait was liberated at the end of February 1991 until February 1992. Sedgwick made the final payment of US$17,754.66 to Qabazard in 1992 in traveler's checks.

Scheme 4: Various transactions including use of false invoices and withdrawals  

Beginning in December 1985, Al Bader drew checks from KOTC bank accounts to cover the purchase of large amounts of traveler's checks “ hundreds of thousands of dollars per withdrawal. A messenger collected some of these traveler's checks from the banks; Nasim Mohsin, Qabazard's assistant, signed for others, and Qabazard also made withdrawals. KOTC's files don't contain any documents explaining the purchase of these traveler's checks and the banks merely recorded "transfers."

The fraudsters also stole money with false invoices. In one instance, Qabazard, on behalf of Sitka, requested from a bank that held KOTC accounts US$215,699.38 in traveler's checks less the bank's commission. Investigators later found in Sitka's files a forged Clarkson invoice to KOTC for a brokerage commission in the amount of US$215,699.38 and a document falsely purporting to be a copy of a letter from Qabazard to the bank directing it to remit the same amount to Clarkson's London bank in payment for the bogus invoice. There was no payment to Clarkson, but the traveler’s checks were picked up with Al Bader signing the purchase slips for most of them and Qabazard signing for the balance. They later carried out several false invoice transactions involving the three vessels chartered to run the oil shuttle service outside the Strait of Hormuz.

THE DISCOVERY 

At the end of February 1991, Kuwaitis, including KOTC officials, returned to their country after liberation during the Gulf War. Al Bader had left Kuwait in late August 1990 in the first month of the invasion. Quabazard had been outside Kuwait at the time of the invasion. Stafford had left the company in 1989.

Al Bader and Qabazard resumed their previous positions at KOTC. Mohsin didn't return from Jordan where he had fled. Al Bader retired on Jan. 29, 1992. Qabazard resigned in April 1992 and then tried to withdraw his resignation but wasn't allowed to. He finally left KOTC in June 1992.

For reasons not discussed in the final court judgment, shortly after Abdullah Al Roumi was appointed the new chairman of KOTC (and after a revelation by an ex-KOTC board member), Nader Sultan, a relative of Al Bader, told Al Roumi of Al Bader's confession to him about his indiscretions involving a chartered vessel. Al Roumi, Al Bader's successor, discovered the illegal back-to-back charter arrangements and the differences in rates of rent.

Later in the year, according to the judgment, other schemes were "brought to his attention" and Al Roumi began to see how they had been used to transfer funds away from KOTC.

In December 1992, Al Roumi visited with officials at Clarkson in London. Al Roumi then reported his findings to the KPC board on Jan. 4, 1993; with the approval of the board, he reported the possible crimes to prosecuting authorities who began investigating. Al Bader escaped to London on Jan. 5 of that year. Qabazard was arrested two days later in Kuwait, held in custody for a year, and then released on bail. During 1993, the prosecuting authorities interviewed many witnesses related to the matter but not Al Bader, who was still in London, or Stafford, who escaped to Australia. Qabazard was interviewed a number of times. All three fraudsters were convicted in Kuwait, but the judgment was set aside on a technicality The ex-minister of oil was also accused and is awaiting the results of an investigation by the Special Committee of the Ministers' Court.

LESSONS LEARNED  

We need to look back and assess the clues that might have tipped off auditors sooner. Hindsight allows us to discern what steps could have been taken to discover the fraud earlier.

An auditor or fraud examiner reading the description of a decade-long campaign by senior officers to divert funds for their own use must know there were red flags all along the way.

The first lesson is that the fraud wasn't discovered until Al Bader resigned and was replaced. When Al Bader, the chairman, and Qabazard, his deputy, were at KOTC, they were able to conceal evidence of the frauds and divert or thwart investigations. Internal structural controls, such as requiring multiple approvals for transactions and dividing responsibilities for the financial function, might have helped prevent or detect the crimes. The few men involved, particularly Al Bader and his director of finance, had nearly complete control, which left the organization wide open for fraud. KOTC's position of a deputy managing director, who would lead the operations department, remained vacant throughout the 1980s. Not filling key control positions isn't a new fraud risk for embezzlement schemes. Management should have filled this position years before.

Of course, the company was operating in war time as an extension of the Kuwaiti government. That government gave KOTC sensitive work, which required utmost confidentiality. The company also organized the Floating Strategic Oil Reserve with which it didn't wish to be publicly associated. However, such responsibilities and the use of unconventional means, with the accompanying necessity of secrecy and limited knowledge within an organization, is fertile ground for fraud. If such activities are deemed necessary, then whatever financial vigilance that can be tolerated should be deployed. Companies, governmental, and quasi-governmental agencies have developed controls. One example is an internal audit function that gives a unit access to such projects with appropriate secrecy safeguards.

More pedestrian audit procedures might have picked up clues worth pursuing. The standard practice of requesting statement and invoice confirmations for audit test periods, for example, would have permitted comparison of invoices on file with those on file with vendors such as Clarkson. Given the pervasiveness of the forged invoices on these accounts such confirmation work probably would have disclosed the inflated invoice amounts. A red flag that would have appeared in such an exercise would have been the absence of any originally received invoices from the file.

Another standard practice is individual testing of transactions over a set materiality threshold. Surely in this category, the vessel purchase and sale transactions also probably warranted, and might have had, their own audit function. Audits of material transactions might have turned up differences, for example, in commissions paid by KOTC and confirmations received by Clarkson. Clarkson's financial department normally would respond to an audit confirmation request, and such a response might have revealed figures that didn't agree. Auditors might have also developed an inquiry based upon benchmark testing such as commissions falling outside of the accepted range in the industry.

An audit should include an inventory of all subsidiaries including nominees and shelf companies. Ordinary sampling might have brought the use of their accounts to light. Given the size of the transactions run through some of the subsidiaries mentioned, materiality requirements might have identified certain accounts for scrutiny.

Internal procedures requiring good record keeping are generally needed for effective audits. For example, the court's judgment noted that the withdrawals from the KOTC and Sitka accounts would have appeared in bank statements, and would have been apparent to auditors. However, given the companies' systems, there was apparently no record to compare to the statements to determine the stated purposes for the withdrawals.

Of course, we would think that large numbers and amounts of cash withdrawals would be a red flag we should investigate. In the environment at the time, however, the court judgment observed that traveler's checks were in wide use for various accepted purposes. Just the same, like corporate expense and petty cash accounts, such a practice is an obvious candidate for abuse and thus deserving of specific controls. If, for example, records were required to be made for withdrawals in cash or traveler's checks over a certain amount (not to mention dual signature requirements) and for the delivery of cash or traveler's checks to related company accounts and employees' accounts, an audit trail would exist to review such withdrawals. Category testing of susceptible transaction and expense categories and random detailed testing of cash withdrawals also could have spotted trouble.

THE TRIUMVIRATE RULED 

An analysis of the operational structure of KOTC and its audit functions and controls lay out a blueprint of how the fraudsters perpetrated these crimes that were undetected for so long.

At the time of these events, Al Bader, as chairman and managing director of KOTC, had Qabazard, as deputy managing director of administration and finance, reporting directly to him. Qabazard, in turn, received all financial data from his assistant and accomplice, Nasim Mohsin, who acted as finance manager. This triumvirate retained complete control of all financial information because the position of deputy managing director for operations and projects, a position through which much of the incriminating data would flow, was left conveniently vacant. Thus, Al Bader and his cohorts were at liberty to conduct business as they wished without fear of oversight.

The auditors didn't see any alerts of the continuous fraud at KOTC. During the period of the fraud, three independent entities purportedly were auditing KOTC's activities. One was the State Audit Bureau, which had full authority to examine and investigate all aspects of KOTC's activities. Regrettably, the bureau would submit its year-end audit draft report directly to KOTC's management for its comments to any raised issues. This scenario created the perfect opportunity for Al Bader and Qabazard to deflect any issues that might impinge upon their fraudulent operations.

Similarly, the internal audit conducted by KOTC's parent, KPC, was forwarded to KOTC's management for their answer to any queries. Again, this was a perfect setup for Al Bader and his cronies to absolve themselves from any incriminating issue which might have cropped up.

The external auditor was equally susceptible to the control of Al Bader. The external Kuwaiti audit firm was associated with Arthur Andersen and their work went only to a KOTC board of management totally dominated by Al Bader.

Taken together, we see an entity whose management unilaterally maintained control of the company, and were, in effect, accountable to no one “ where procedures blighted the auditors' entire function, which allowed management to thwart their purpose. In essence, the lack of a managerial structure subject to accountability and no truly independent audit control allowed this fraud to fester and grow without fear. This case history remains a cautionary tale of what can ensue when fundamentals of managerial structure and financial oversight aren't followed.

As part of Kuwait's nationalization effort, it created several public entities or bodies whose purpose was to set policies for and monitor the activities of the crucial oil sector including the Supreme Petroleum Council (SPC). This council, established by the 1974 Amiri Decree, is tasked with setting the general policies of the oil sector within the framework of the national economic and social development plan. In 1986, the nationalization process culminated with the formation of the Ministry of Oil separately from the Ministry of Commerce & Industry. The Ministry of Oil makes policies “ in conjunction with the SPC “ and supervises all public institutions that are related to the oil sector in Kuwait. So the minister of oil is the chairman of the Kuwait Petroleum Company and a SPC member. To date, this remains the corporate and governmental structure of the Kuwaiti oil sector.  

Alan Van Praag, J.D., is a partner with Eaton & Van Winkle of New York, N.Y. He has practiced in the fields of admiralty, international, and domestic commercial law for more than 35 years. 

Mark Aspinall is a partner with Waterson Hicks of London. He specializes in commodities, shipping, trade finance and international fraud. Both Van Praag and Aspinall are representatives of KOTC.  

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