SIENA, Italy Monte dei Paschi misled the Bank of Italy over a 1-billion euro hybrid instrument it used to partly fund its acquisition of rival bank Antonveneta, Siena prosecutors alleged in a document reviewed by Reuters on Wednesday.
As part of their ongoing probe, prosecutors alleged in the document, dated February 1, that the Tuscan bank struck a deal which violated requirements set by the central bank over the hybrid financial instrument, known as FRESH 2008.
Monte dei Paschi is being investigated for alleged wrongdoing relating to its 2008 acquisition of Antonveneta, a smaller rival. If proved correct, the allegations by prosecutors that Monte dei Paschi misled the Bank of Italy over the true nature of part of the financing it raised would undermine the basis on which the deal was approved.
The Siena-based bank declined to comment on the allegations.
The FRESH 2008 instruments in question were essentially notes convertible into Monte dei Paschi's shares that U.S. bank JP Morgan sold to a number of investors. Bank of New York acted as an intermediary in the FRESH 2008 deal.
"(Monte dei Paschi former director general Antonio) Vigni ... and (former) CFO Marco Morelli ... failed to communicate to the Bank of Italy that they had issued an indemnity side letter to Bank of New York on the occasion of the meeting of the holders of the FRESH notes," the prosecutors said.
They also accused Monte dei Paschi of "concealing from the Bank of Italy the existence of an indemnity signed by Marco Morelli, issued on April 15, 2008, in favour of JP Morgan."
The prosecutors alleged that Vigni, Morelli and Daniele Pirondini, in his role as CFO "with the purpose of obstructing the regulator in its oversight functions ... exhibited (communicated) material facts not corresponding to the truth ... on the capital position of Banca Monte dei Paschi di Siena."
Vigni, Morelli and Pirondini are under investigation but have not been charged. Vigni was questioned by prosecutors in Siena on Wednesday.
The notes were issued as part of a deal under which JP Morgan underwrote a 950 million euro capital increase in Monte dei Paschi to help the Italian bank fund the acquisition of Antonveneta from Spain's Santander in a deal announced in November 2007 and completed in May 2008.
Prosecutors allege that the deal hid the real risks faced by Monte dei Paschi, which was already badly stretched and struggling to afford the 9 billion euro price tag for its smaller rival.
JP Morgan, Bank of New York, Vigni, Pirondini and Morelli declined to comment.
Prosecutors alleged that the indemnity documents violated requirements set by the Bank of Italy by making the FRESH 2008 work like a bond rather than an hybrid equity instrument. Monte dei Paschi needed to show the Bank of Italy that it had sufficient equity capital in place to win approval for Antonveneta takeover.
Based on the information officially received from the bank, the regulator allowed Monte dei Paschi to calculate those notes as core Tier 1 capital, a measure of a bank's financial strength which is closely monitored by regulators, boosting its financial base and allowing it to demonstrate it had sufficient capital to absorb the Antonveneta deal.
The Bank of Italy had initially raised objections about the FRESH operation, saying that in its original form it was too similar to a bond, rather than an hybrid equity instrument, and could therefore not be counted as core capital, according to official Bank of Italy documents seen by Reuters.
The Bank of Italy demanded changes to ensure that if Monte dei Paschi made no profit, it would have no financial obligations towards JP Morgan or the investors in FRESH 2008.
However, prosecutors allege that the secret agreements guaranteed coupon payments to one or more holders of the FRESH 2008, putting the financial burden squarely on Monte dei Paschi.
It was not clear which investor would have benefited from such an agreement.
The Monte dei Paschi foundation, the bank's biggest shareholder, subscribed to about half of the FRESH 2008 issue, or 490 million euros, running up big debts of its own to do so.
Its 2011 accounts show that it booked a loss of 376 million euros on the FRESH operation. A source with direct knowledge of the matter ruled out that the foundation benefited from the indemnity agreement.
Prosecutors in the city of Siena began an investigation last year into the Antonveneta deal, alleging Monte dei Paschi misled regulators.
They have since widened their probe to loss-making derivative contracts carried out by Monte dei Paschi's previous management after the bank said those could cost it 720 million euros.
The lender has already requested 3.9 billion euros in state aid, but the bailout has become controversial weeks before a February 24-25 national election.
(Reporting By Silvia Ognibene and Stefano Bernabei, writing by Silvia Aloisi and Lisa Jucca; Editing by Alexander Smith)