Republic New York awaits report that may save HSBC bid

NEWS ANALYSIS US bank holds its breath over takeover terms after $1.5bn fraud

BELEAGUERED senior management at Republic New York are expecting to have sight early next week of an internal report into a $1.5bn securities fraud which will allow them to fend off mounting pressure for renegotiation of the terms of the bank's $10.3bn takeover by HSBC, the British-based banking giant.

Senior officials at Republic, whose share price has been hit by concern about the FBI investigation into the fraud, hope that the report by KPMG, the bank's auditors, and the top New York law firm, Sullivan & Cromwell, will confirm that Republic's senior echelons were deliberately shielded from knowledge of any illegal activity, and were as much a victim of as the 300 or so Japanese clients who claim to have lost more than $1.5bn in the alleged scam.

HSBC shares fell 3 per cent yesterday on mounting concern that the affair might result in the collapse of the deal, the biggest and most ambitious by the bank since John Bond took over as chairman last year.

John Tyse, analyst at SG Securities yesterday put out a sell note on HSBC, pointing out that the HSBC had issued new shares to pay for Republic. "The consequences of abandoning this deal are quite significant given the fact that you have increased the equity base by 12 per cent," he said.

Attempts by Republic to play down the affair were blown apart on Tuesday when Martin Armstrong, chairman of Princeton Economics, an investment firm and one of Republic's largest clients, was arrested and charged with securities fraud.

According to the sealed complaint filed by the US attorney's office for the Southern District of New York, 90 per cent of business conducted by Republic's futures division related to accounts controlled by Mr Armstrong.

Republic confirmed yesterday that the bank had, since late 1998, been running down Republic New York Securities, the part of the business in the spotlight, and intended to close it.

The US bank's internal inquiry is also seeking to establish the extent to which Republic is covered by its fraud insurance policy.

According to court documents, Mr Armstrong was running a "Ponzi" scheme, using new client money to meet shortfalls between investment performance and what he had promised earlier investors.

The money was channelled through accounts held at Republic Securities by his company, Princeton Economics which is registered in the Turks and Caicos Islands, a tax haven, but operated out of Princeton, New Jersey, and Cresvale, a Cayman Islands registered subsidiary.

Twenty-three Japanese firms have admitted losing money in Mr Armstrong's fund of which two have warned that earnings will suffer because of the losses. One of the best-known of the firms, Yakult, the yoghurt manufacturer, said yesterday it was considering taking legal action against Mr Armstrong.

HSBC has made it clear that it will press for a renegotiation of the terms of the deal if there is evidence that Republic's underlying business has been damaged by the affair. But senior officials at the bank are mindful of the risks that an attempt to push Republic too far on price might result in the collapse of what the bank still believes is fundamentally a good deal.

"It may be that the Republic share price bounces right back once the facts become clear," said one analyst yesterday.

Much of the damage to Republic's share price, now trading at 20 per cent below the $72-a-share offer price, appears to have been caused by nervous merger arbs who bought heavily into the stock when the deal was announced and now fear heavy losses if it collapses.

UK institutions are still inclined to give John Bond, the HSBC chairman, the benefit of the doubt. David Erskine at Standard Life said: "I have every confidence in the management to do the right thing."