HSBC Holdings Plc, Europe’s biggest lender, was warned by auditors KPMG LLP that entrusting as much as $8 billion in client funds to Bernie Madoff opened it up to "fraud and operational risks," Bloomberg News reported.  Not once, but twice - in 2006 and 2008 reports.  

HSBC hired KPMG to review how Madoff invested and accounted for the funds, for which HSBC served as custodian.  In 2006, HSBC was custodian for 8 funds that had invested $2bn with Madoff;  by 2008, the bank was custodian for 12 funds with as much as $8bn invested. 

KPMG reported 25 such risks in 2006, and another 28 risks in 2008:  

KPMG's 2/16/06 Report.   In the 56-page report, 25 "fraud and related operational risks were identified throughout the process whereby Madoff LLC receive, check and account for client funds."  The limited controls in place "may not prevent fraud or error occurring on client accounts if management or staff at Madoff LLC either override controls or undertake activities where appropriate controls are not in place." 

KPMG's 9/8/08 Report.   In the 66-page report, 28 risks were cited and described in the same words as the 2006 document. 

Risk #2 identified by KPMG ... was that "BLM embezzles client funds," and to prevent it, KPMG recommended in both 2006 and 2008 that HSBC "establish a process to monitor monthly statements" and reconcile them with contributions from clients.  KPMG didn’t perform tests to check that risk.

Fraud Risk #5 in 2006 ... was that "client cash is diverted for personal gain."  Risk #18 was ...  that "trade is a sham in order to divert client cash," adding that there were concerns "Madoff LLC falsely reports buy/sell trades without actually executing in order to earn commissions" and "BLM falsifies accounting records which are provided to HSBC."

    Trustee Picard Sues HSBC.   Irving Picard, the trustee liquidating Bernard L. Madoff Investment Securities LLC, sued HSBC and a dozen feeder funds for $9 billion in December.  The suit, in part, was based on the KPMG reports and alleges the bank knew of concerns Madoff’s business was a fraud and didn’t protect investors.  KPMG’s reports haven’t been made public.

However, it's known that KPMG's reports didn’t provide evidence that the identified risks had materialized, or that signs of actual fraud had been found.  KPMG further told HSBC that :no allegations of fraud or misconduct have been raised."  HSBC confirmed hiring KPMG in 2005 and 2008 to review Madoff’s firm, adding it now believed Madoff had tricked the auditors.

"It appears from U.S. government filings that Madoff and his employees foiled these reviews by, among other things, providing forged documentation to KPMG."

"KPMG did not conclude in either of its reports that a fraud was being committed by Madoff."

"HSBC did not know that a fraud was being committed and lost $1 billion of its own assets as a victim."

For further details, go to:   [Bloomberg, 3/18, "HSBC Was Told.."]