US embassy cable - 05SANTODOMINGO3370

C O N F I D E N T I A L SECTION 01 OF 06 SANTO DOMINGO 003370 
 
SIPDIS 
 
DEPARTMENT FOR WHA, WHA/EX, WHA/CAR, HR/OE 
 
E.O. 12958: DECL: 06/24/2015 
TAGS: AMGT, KJUS, PGOV, DR, Banking 
SUBJECT: U.S. TAXPAYERS WILL LOSE MONEY IN DOMINICAN AFPS 
 
REF: A. EMAIL CORRESPONDENCE KUBISKE/ESTRADA/BOOTH MAY 05 
 
     B. 04 SANTO DOMINGO 2694 
     C. 04 STATE 070041 
     D. 03 STATE 87287 
     E. 03 SANTO DOMINGO 1476 
     F. 01 STATE 36095 
     G. 01 STATE 36080 
 
Classified By: DCM Lisa Kubiske, reasons 1.4 (b) & (d). 
 
1.  (SBU)  The USG should not invest in Dominican pension 
funds (AFPs - Administradoras de Fondos de Pensiones) because 
the likelihood of losing the funds due to fraud and 
corruption is extremely high.  Based on the current state of 
affairs in the Dominican Republic, Embassy Santo Domingo 
strongly urges the Department to authorize non-participation 
in the Local Social Security System (LSSS).  Embassy Santo 
Domingo urges the Department to concur with our request to 
place locally engaged staff pension monies into US based 
pension funds.  This cable replies to Department request 
(reftels) for information additional to that contained in 
reftel B. 
 
---------------------- 
AFPs controlled by banks 
---------------------- 
 
2.  (SBU)  AFPs in the Dominican Republic are controlled by 
privately owned Dominican banks.  Dominican banks have been 
subject to lax regulatory controls that have consistently 
failed to ensure that the banks are complying with applicable 
laws and regulations.  Dominican banks are not constrained by 
regulatory controls that limit investment in non-banking 
related industries.  In fact, investment by Dominican banks 
in media outlets, insurance companies, and securities firms 
is the norm rather than the exception.  Half a dozen 
Dominican banks control the vast majority of the financial 
dealings within the Dominican Republic. 
 
---------------------- 
Banks' role in the Dominican Republic 
---------------------- 
 
3.  (SBU)  The banking sector's domination of Dominican 
business, along with its pervasive role in financial 
transactions in the country, has put it in a position of 
great power in the country.  This power position means the 
banking industry influences not only banking related 
businesses and industries, but the judicial and executive 
branches of government as well. 
 
----------------------- 
Insider dealing 
----------------------- 
 
4.  (SBU)  The position, power and impunity of the banking 
industry allows it to engage in self-dealing transactions. 
Actions that would commonly be prosecuted in the United 
States as insider trading and corrupt practices are everyday 
occurrences and a part of "normal business practice" in the 
Dominican Republic (see below for examples).  Subjecting U.S. 
taxpayer money and the future financial well-being of USG 
employees to such a system would be negligent at best.  To 
place pension funds in Dominican banks knowing the history of 
the banks, banking industry, regulatory structure, and 
judicial system, could open the USG to civil suits by locally 
engaged staff. 
 
---------------------- 
Specific Examples ) Baninter, the first domino 
---------------------- 
 
5.  (SBU)  In 2003, three major Dominican banks failed.  In 
each of the three cases, attorneys for the Central Bank and 
Superintendent of Banks established the method in which bank 
executives operated "clandestine banks" behind the faade of 
the real banks.  In the failure of Baninter, a computer was 
used on a nightly basis to balance and reconcile a set of 
"second books" for a false entity that did not exist.  In 
essence, Baninter was printing its own money on a daily (or, 
more appropriately, a nightly) basis.  Upon the discovery of 
the scheme, the Dominican government realized that the 
failure of the bank could prove disastrous to the Dominican 
economy (eventually it did) and could be a signal that other 
banks were running similar scams that could also bankrupt the 
country (they were).  It also determined that the Baninter 
scam was not new. The false bank had been in existence for at 
least 10 years. 
 
6.  (SBU)  The findings in the Baninter case show that the 
banking regulatory structure allowed for insider trading, 
complex fraud and the existence of an entirely false bank for 
10 years ) until the pyramid scheme finally collapsed upon 
itself.  The 10-year time frame is significant as it spanned 
the administration of three different parties in power in the 
Dominican Republic.  Also significant is the fact that to 
date only six Baninter executives have been charged with any 
type of wrongdoing.  Over a year and a half has passed since 
charges have been brought against those six, yet a trial 
against all or any is nowhere near commencement.  The case 
languished with a three-person appeals board for more than a 
year, due to defense challenges of the judges, who much 
consider the preliminary question of whether sufficient 
evidence exists against any of the six defendants to continue 
to trial. 
 
7.  (SBU)  Looking solely at the failure of Baninter, it is 
clear that: 1) although banking oversight regulations were in 
place, they were ineffective, 2) that banking mismanagement 
and fraud knows no political party, 3) that the judicial 
system is as yet unable to cope with complex fraud cases and 
is subject to outside pressures that ensure that banking 
cases do not move forward through the judicial system.  The 
USG should not invest the pension funds of its employees in a 
system that has such severe flaws. 
 
---------------------- 
More than one: Bancredito and Banco Mercantil 
---------------------- 
 
8.  (SBU)  If these practices were limited to one bank, 
perhaps the bank could be considered an anomaly - a blip on 
the screen or a mistake that the Dominican government sought 
to correct.  However, three significant banks failed in 2003, 
not just Baninter, eventually costing the equivalent of 20 
percent of the Gross Domestic Product.  Bancredito and Banco 
Mercantil were engaged in similar "false bank" schemes that 
led to their failure and eventual buyout and take over. 
Bancredito is now owned by Grupo Leon and known as Bank Leon. 
 Banco Mercantil was purchased by the Republic Bank of 
Trinidad and Tobago.  In both of these cases, the frauds went 
undetected until the Baninter fraud woke up some bank 
regulators and they went looking for similar patterns at 
other banks.  They found them, but again, not until years 
after the fraudulent activities had begun. 
 
9.  (SBU)  In the cases of Bancredito and Banco Mercantil, 
the wheels of justice grind even more slowly, so slowly that 
there is no discernible movement.  So far, formal charges 
have been made against only one executive at Banco Mercantil, 
none at Bancredito  In fact, in November 2003, when the team 
of Central Bank lawyers was ready to file criminal charges 
directly against the President and Vice President of 
Bancredito, it was ordered by then President Mejia to 
withdraw the charges. 
 
---------------------- 
Not just failed banks, but a failed system 
---------------------- 
 
10.  (SBU)  It is important to repeat that the combined 
failures of the banks totaled 20 percent of Dominican GDP for 
2003 (US $3 billion).  The failures triggered an economic 
slide that lasted 18 months with the country turning to the 
IMF for help.  By the regulatory system's failure to detect, 
the fraudulent, criminal activities of three of its banks, 
the Dominican Central Bank put itself in a precarious 
situation.  The Central Bank Governor argued that if the 
Central Bank did not guarantee the deposits of the failed 
banks above and beyond the guarantees required by law, there 
would be a run on the banks.  So, in violation of domestic 
law justified on the thin pretext that implementing 
regulations had not yet been published, the Central Bank and 
the Dominican government took the hit and paid 100% on the 
deposits.  If the regulatory structure had found the flaws 
earlier, such extreme measures would not have been necessary. 
 Some parties continue to question whether the Central Bank 
should have guaranteed the deposits beyond the requirements 
of the law.  Many attribute the Central Bank guarantees as 
the Dominican government admitting its complicity in the 
banking system failure. 
 
---------------------- 
Regulatory structure and non-transparent transactions 
---------------------- 
 
11.  (SBU)  In general, four main entities regulate the 
Dominican financial sector: the Superintendent of Banks, the 
Superintendent of Insurance, Superintendent of Securities and 
the Superintendent of Pensions.  The banks control the AFPs 
(Superintendent of Pensions), the banks own insurance 
companies (Superintendent of Insurance), the banks control 
most of the seats on the securities exchange (Superintendent 
of Securities) and the banks report to the Superintendent of 
Banks. 
 
12.  (C)  The four regulatory authorities generally do not 
share information with one another.  However, the banks have 
stakes in each of the four authorities and take advantage of 
their knowledge of what is happening in each area to 
circumvent regulations of the institutions.  For example, 
banks have traded securities through the Securities Exchange 
Market to avoid paying taxes and having to meet minimum 
reserve requirements.  Additionally, they trade bonds among 
themselves in a non-transparent process.  They have 
successfully resisted initiatives to increase transparency in 
the bond market.  All of these actions are further 
indications of insider dealing and corrupt practices by the 
Dominican banking industry. 
 
13.  (C)  Additionally, the top-level management practices of 
at least two of the four regulatory entities are highly 
questionable.  Both the Superintendent of Pensions and the 
Superintendent of Securities have made public proposals to 
invest AFP funds in financially troubled sectors or projects. 
 The proposals are inappropriate on two levels: 1) proposals 
of this nature should not be made by the heads of oversight 
and regulatory authorities, e.g. the Superintendent of 
Securities should not be giving investment advice, and 2) 
even if making proposals of this type were proper, the 
proposals themselves are poor financial risks recognizable to 
even novice investors. 
 
14.  (C)  The Superintendent of Pensions suggested that AFP 
funds be used to help finance the debt-ridden and crippled 
electricity sector.  With lengthy daily power outages in 
parts of the country and government debts to the main 
electricity companies totaling in the hundreds of millions of 
dollars, the electricity sector continues to struggle.  It is 
seen by most as a financial black hole ) investment in this 
sector is like investing at blackjack tables, with little 
chance that the electricity producers will hit 21 in the 
foreseeable future.  The Superintendent of Pensions also 
suggested that the pension funds be used for mortgage 
financing ) an investment not permitted under the social 
security regulations.  The Superintendent of Securities 
wanted to invest AFP funds in an ill-conceived metro project. 
 His suggestion to use the pension funds was made after no 
other sources of public funds could be identified due to the 
staggering cost of a project that would provide minimal 
benefits to the Dominican Republic.  Fortunately these 
proposals have been rejected; however, they are clearly 
indicative that the Superintendents either do not know their 
jobs or are using their positions to inappropriately attempt 
to invest AFP funds in costly and risky projects. 
 
---------------------- 
Scheming by public and private entities ) AFPs at risk 
---------------------- 
 
15.  (SBU)  As an example of how AFPs are subject to misuse 
by both public and private entities, the Monetary Board voted 
to order the AFPs to invest in Central Bank certificates of 
deposit.  The move was made in an effort to use AFP funds to 
pay off the certificates acquired by the Central Bank when it 
bailed out Baninter ) in essence privately held CDs now 
coming due.  The move was in direct contravention to the 
Social Security law which does not establish Central Bank CDs 
as permissible investments by AFPs.  That raid by the 
government was stopped, in large part due to public outcry by 
the business sector (the banks) who were not willing to give 
up there own little profit making enterprise. 
 
16.  (SBU)  The banks had a self interest in preserving for 
themselves the profits earned  from the Central Bank CDs ) 
they did not want the government to use the AFPs to buy up 
CDs that they could purchase to improve their financial 
positions.  The Central Bank CDs (at that time) were 
attractive to many because they were paying approximately 50% 
interest.  By contrast, commercial bank CDs paid 
approximately 25% interest.  With conditions of 30-40% 
inflation at the time, the Central Bank CDs were one of the 
only investments that offered a significant positive rate of 
return on investment when adjusted for inflation.  The banks 
did not want to allow the government to directly invest AFPs 
funds in Central Bank CDs because the remaining alternative 
required the AFPs to buy commercial bank CDs.  The banks then 
took the monies invested by the AFPs in their CDs, and turned 
around and bought Central Bank CDs, ensuring that the banks 
retained the profits. 
 
17.  (C)  This example is indicative of the way in which both 
government and the banks wish to take advantage of the 
relatively new AFP system.  The government attempted to have 
the AFPs invest in instruments that the law did not deem as 
permissible investments and the banks conspired to prevent 
direct AFP investment in profitable instruments.  Either way 
the AFPs lose and so does any employee whose pension is 
subject to the AFPs. 
 
---------------------- 
Lack of Confidence ) defrauding the stakeholders 
---------------------- 
 
18.  (C)  The insider games played by the banks in the 
Dominican Republic have led to eroded confidence in the AFP 
system.  The labor representative to the Dominican Social 
Security System told us that of the 1.2 million Dominicans 
allegedly enrolled in the AFP system, payments are being made 
on behalf of only 500,000 of them.  He added that of the 
payments being made, many are only partial payments. 
Employees are unable to monitor whether their employers are 
transferring money supposedly deducted from their salaries to 
be placed in the pension funds.  Employers have caught on to 
the lack of regulation and oversight and commonly underreport 
salaries so that their AFP employer contributions are lower. 
Although the USG would comply with all rules and regulations, 
the pervasive fraud by the business sector in regard to the 
AFPs weakens the system. 
 
---------------------- 
What our sources tell us about fraud and corruption 
---------------------- 
 
19.  (SBU)  Throughout a very busy 2003 and 2004 when the 
bank frauds were discovered and made public, Embassy officers 
heard over and over again that those responsible would not be 
punished.  We were told that the cases would be swept under 
the rug and would disappear from memory soon.  We were told 
that the bank executives paid off everybody, political 
leaders in all parties, business associates, and 
non-governmental organizations (who accepted funds not 
knowing of the fraudulent activities), to ensure that they 
would not be subject to penalties.  Consistently we were told 
that the judicial system could not handle cases of complex 
fraud and that those charged had the means to ensure that 
they would not be found civilly or criminally liable.  Those 
early words from Dominican counterparts at all levels of 
Dominican society now sound prophetic.  The banking failures 
are no longer headline news, those few charged with criminal 
activity remain free, civil cases are not moving forward and 
for the Dominican on the street, Baninter is already a 
memory.  In recent public comments, President Fernandez 
avoided mention of "fraud" or criminal activity in the 
banking sector, mentioning instead poor economic management 
by the previous government and mistaken policies by bank 
managers. 
 
20.  (SBU)  We hear similar comments about the banks and 
AFPs.  "The AFPs are a good idea, but they are being 
manipulated."  "The banks have too much power throughout the 
financial sector."  "You cannot count on the AFPs for a 
pension."  The fraud and corruption that take place in the 
Dominican Republic ensure that U.S. taxpayer money placed in 
AFPs will be placed in the hands of white collar criminals 
who have little fear of being caught or prosecuted. 
 
---------------------- 
What it means to USG employees 
---------------------- 
 
21.  (SBU)  Although no longer headline news, the bank 
failures weigh heavily on the minds of some Dominicans ) 
particularly those of the relatively small middle class.  The 
wealthy have their investments in the Dominican Republic and 
overseas (in dollars and not affected by the local economy), 
the poor have no investments and the middle class have lost 
the most and have the most to lose.  That is where the USG 
locally engaged staff fit into the picture.  Most are from 
the small and struggling middle class ) they are the most 
likely to feel the affects of bank failures and pension 
losses.  They are not in a position to make overseas 
investments in dollars, nor would they have adequate 
retirement support without adequate pensions.  Pension funds 
in the United States are not guaranteed to grow to the level 
necessary to support our local staff, but they represent a 
far better risk than investing in the local bank-controlled 
AFPs.  Our locally engaged staff has made it clear that they 
do not want to risk their retirement funds in a system in 
which Dominican banks control their future; the overwhelming 
majority voted in November 2003 to pursue this request for 
putting their funds into the Global Plan, despite the 
possibility that the request could be turned down. 
 
---------------------- 
Banks not just in the banking business 
---------------------- 
 
22.  (SBU)  In some countries, where oversight or regulatory 
boards are ineffective, as it is in the case of the banking 
industry in the Dominican Republic, the press can be relied 
upon to take over the "watchdog" role.  That is not the case 
in the Dominican Republic.  Even if the press had staff 
qualified to delve into the minutiae of banking regulation, 
the Dominican media outlets are owned and controlled by the 
Dominican banks.  Lack of reporting or under-reporting on the 
failed banks mentioned above clearly demonstrated the 
unwillingness of the bank-owned media to report on negative 
bank dealings.  There is no reason to expect that the press 
would serve as a watchdog on other bank dealings, such as 
those with the AFPs. 
 
---------------------- 
Corruption ) at all levels and for all purposes 
---------------------- 
23.  (U)  The AFPs, the banking industry, the financial 
sector and the press are permeated by the norms of Dominican 
society.  Corruption is a way of life in the Dominican 
Republic.  In the most recent Transparency International 
Perception index issued in October 2004, the Dominican 
Republic scored a 2.9 on a scale of 1 to 10 ) tying with 
Iran and Romania and ranked worse than China, Jamaica, 
Colombia, Mexico, Cuba, El Salvador and Belize.  In the 
latest version of the World Economic Forum National 
Competitive Index, under the sub-category "Irregular Payments 
in Government Policymaking," the Dominican Republic ranked 
90th out of 102 surveyed countries, worse than Nigeria, Kenya 
and Panama. 
 
24.  (C)  Low scores in international rankings on corruption 
don't compare with seeing and hearing of corruption on a 
daily basis.  The current District Attorney for Santo Domingo 
was recently in the news when it was discovered that he was 
driving an SUV reported stolen in the United States.  We have 
credible information that the Vice President of the Supreme 
Court accepts bribes.  We know that members of the military 
and police are involved in smuggling of drugs and people.  We 
requested and received Department concurrence in the 
revocation of visas of high-ranking (including cabinet-level) 
government officials.  We continue to closely monitor ongoing 
corruption cases in hopes that they will be more successful 
than prior corruption cases brought before the Dominican 
courts (see paragraph 25 below). 
 
25.  (SBU)  Corruption touches all strata of society.  What 
is most disturbing, however, is the high level corruption by 
businesspersons, government officials and members of the 
judiciary.  Anecdotal evidence of this type of corruption is 
heard on every street corner and at every gathering in the 
country.  Obtaining proof and convictions is a different 
matter.  In a USAID funded study, a Dominican civil society 
organization documented 227 corruption cases that entered the 
judicial system between the years of 1983 and 2003.  Of those 
cases, only one resulted in a conviction (later overturned on 
appeal) and only six even made it to trial.  The system is 
broken, putting U.S. taxpayer money into it will result in 
significant losses. 
 
---------------------- 
USAID's role with the AFP system 
---------------------- 
 
26.  (SBU)  In Ref B, Embassy Santo Domingo explained that 
USAID was well-positioned to judge whether the Embassy should 
participate in the LSSS because of USAID's role in helping 
develop the system.  USAID provides technical assistance to 
and works, as a partner, with the Dominican Government as a 
whole and, more directly, with the regulatory bodies.  USAID 
provides significant financial support to the civil society 
organizations that monitor, identify, document and attempt to 
combat corruption.  Although USAID's ultimate goal is to see 
a pension system and a government regulatory structure that 
will succeed, USAID has unique insights into the widespread 
corruption and the failings of the system. 
 
27.  (SBU)  A significant part of USAID's portfolio is to 
combat corruption by identifying it and strengthening 
government institutions, regulatory bodies and civil society 
groups so that they can resist and fight corruption.  USAID 
is deeply involved in analyzing institutional weaknesses, 
advocating improvements and marshaling support for them 
through local non-government organizations, and providing 
training (for example, courses for new judges at the judicial 
school).  USAID funding made possible the analysis of 
judicial results on corruption cases.  These efforts and 
contacts give USAID and Embassy Santo Domingo an inside view 
as the USG seeks to alter Dominican practices.  As of now, 
Dominican institutions and the government have not 
demonstrated sufficient evidence of political will to 
implement reforms to warrant entrusting our pension funds to 
them. 
 
28.  (SBU)  In terms of knowledge about the AFP system, USAID 
has a technical advisor at the Ministry of Finance who helped 
the government and the private sector design the Securities 
Exchange Market.  As a result, USAID has extensive knowledge 
of how the regulatory institutions that oversee the LSSS 
function, and USAID representatives meet regularly with many 
of those institutions to discuss ways of strengthening the 
institutions (which gives USAID insights into the weaknesses 
of those institutions). 
 
29.  (SBU)  Recently, the labor representative to the 
Dominican Social Security System, approached USAID to seek 
support for legislation that would require greater 
transparency in the AFP system.  The legislation seeks to 
give employees greater access to information about 
investments that the AFPs are making and greater information 
about employer contributions to the AFPs.  Due to funding 
limitations, USAID is not able to provide the requested 
support. 
 
---------------------- 
Conclusion 
---------------------- 
 
30.  (SBU)  AFPs in the Dominican Republic put U.S. taxpayer 
money and the future financial well-being of USG employees at 
extreme risk.  Corruption, self-dealing, insider trading and 
the non-transparency of regulatory entities guarantee that 
U.S. taxpayer money will be siphoned off in one way or 
another by unscrupulous and potentially criminal business 
practices.  The USG should not invest its funds in such a 
system.  Embassy Santo Domingo reiterates its request to 
terminate its existing pension plan and its request for 
Department concurrence to place locally engaged staff pension 
monies into US based pension funds. 
HERTELL