Investment bank Merrill Lynch has launched a full inquiry into the alleged fraudulent transfer of $40 million from the account of one of its leading Middle East clients. It is understood that the funds were siphoned, in six tranches, from the account of Arab International Bank (AIB) to a UBS account in Geneva.

'Merrill Lynch has paid in full its client for losses incurred as a result of an apparent misappropriation of securities by one former employee of Merrill Lynch's private banking group,' says a spokesman. 'We are pursuing both criminal and civil cases against theindividual with a view to recovering these securities.'

The former employee, Ashraf Raffa, worked for Merrill Lynch in its private banking division for 12 years before resigning in September. It is understood that he was a close friend of Atef Ibrahim, AIB's chief investment officer and an ex-employee of Merrill Lynch, and partly due to this AIB's account was reassigned to Raffa. On9 December, Raffa was arrested in Egypt and is currently awaiting trial. No charges have yet been made, but the Egyptian authorities are launching a full investigation. 'We are fairly confident that he acted alone,' says the Merrill Lynch official.

It is understood that Merrill Lynch has frozen one bank account in Switzerland, has sent an emergency team to Egypt and is preparing to launch civil suits in both Geneva and Egypt in an attempt to recover the missing assets. 'We are confident we will make substantial recoveries,' says the official.

According to internal Merrill Lynch documents obtained by the London daily Financial Times, the alleged fraud involved the use of false signatures on six letters ordering the asset transfers. Five of the six transfers were authorised with the signature of a man who had died three months before the transactions were made, and the other carried the signature of an AIB employee unauthorised to order such transactions.

The documents are also said to reveal that AIB raised concerns with Merrill Lynch over the transactions in December 1998. In reply, AIB received a fax from Raffa saying the securities were being held as collateral for other AIB positions.

The internal documents also say Merrill Lynch staff questioned the whereabouts of the missing securities in April, but the matter was treated as a reconciliation issue rather than a possible fraud, and an investigation was only launched in November. The Merrill Lynch official says all aspects of the affair are being investigated, including an examination of internal policy and procedures.

'We have full confidence in our controls - unfortunately in this there was a clear breach of trust by an employee, who went to great lengths to conceal his activities,' he says. 'The fact is his misconduct was discovered.'

The affair seems not to have damaged the relationship between Merrill Lynch and AIB. 'AIB is pleased with Merrill Lynch's response,' says a statement issued by AIB. 'We continue to enjoy a relationship with Merrill Lynch and feel they have acted honourably in this matter.'