Internal Bank Fraud & Embezzlement: Lessons from the Trenches

1. Internal Bank Fraud & Embezzlement:Lessons from the Trenches Presented by Angela Morelock, CPA, CFE, ABV, Certified Forensic Accountant®

3. Cost of Fraud & Abuse • $652 billion annually • 5% of revenues • 42% recover nothing after fraud is discovered

9. Banking & Financial Services • Not surprisingly, two of the three most common schemes in the banking and financial services industry were cash larceny and skimming. These schemes generally involve the physical theft of incoming cash and cash on hand (for example, in a vault). • Among the 23 non-cash cases in this industry, the most common type of scheme involved the theft of proprietary information about bank customers.

10. Profile of Fraud Perpetrator • Male or female • No prior criminal history (<8%) • Well liked by co-workers • Likes to give gifts/compulsive shopper • Gambling problems not unusual • Long-term employee • Rationalizes: Starts small or “borrows” • Lifestyle clues

11. Characteristics to Watch – Bank Specific • Credit problems • NSF in personal accounts • Unusual transactions in personal accounts • Management override of internal controls • Less experienced employees unknowingly aid • Second person signs off on transaction based on trust

12. Cash Schemes • Stealing cash funds processed or on hand • Not recording & stealing the cash receipts • Underringing & stealing the difference in cash receipts • Altering bank deposits

13. Loans Receivable Schemes • Lapping • Fictitious loans • Manipulation of loan master file • Bogus write-offs • Kickbacks • Straw loans • Undisclosed interests

14. Accounts Payable & Purchasing • Personal bills • Fictitious suppliers • Kickbacks • Ordering personal items • Petty cash funds • Employee expense accounts • Corporate credit cards

15. Payroll Schemes • Ghost employees • Manipulated time records • Unclaimed payroll checks • Writing extra payroll or bonus checks • Withholding fraud • W-2 fraud

16. Theft of Intellectual Property • IP inventory • Protecting IP • Ways IP leaves the organization • Responding to a suspected issue

17. Examples From the Trenches

18. Example #1- Bankruptcy/Loan Fraud Investigation • Hired by large national bank • Publicly traded manufacturer of printing presses • Bank loans total approx. $5 mil. • Value of assets approx. $2.5 mil.

19. Example #1- Bankruptcy/Loan Fraud Investigation • Told June 2000 – bank won’t renew LOC • Volatile earnings (losing money) • Negative retained earnings of $14.9 million • Declining industry

20. Example #1- Bankruptcy/Loan Fraud Investigation • On COD with most vendors • Officers poor reputation in community • Change in auditors due to disagreement over going concern modification – from Andersen to local firm

24. Example #2 – Fictitious Loan Investigation • Hired by Community Bank • Primarily family owned • Suspicions of bogus loans being recorded by President/CEO • Mother is Chairman of the Board • Father is bank counsel

25. Example #2 – Fictitious Loan Investigation • Known that President/CEO living high lifestyle & has significant debt • Owns $2 mil. yacht in Florida • Unusual transactions in personal account of President/CEO

26. Electronic Loan File Analysis - TIN

27. Additional Electronic Analysis & Loan Review • Sort for all family member addresses • Reviewed loan files of all family loans • Several nominee loans in violation of Reg. O

28. Review of President/CEO Personal Accounts • Fictitious loans prevented overdrafts in personal accounts when debt payments were due • Numerous large deposits that would have been an evident problem if account review was being conducted

29. Example #3 – Branch Bank President Relationships with Customers and Then Some • Trying to collect bad loan • Receive info that branch bank president has ownership interest with borrower • Nothing disclosed on president’s required disclosures & conflict of interest forms

30. Example #3 – Branch Bank President Relationships with Customers and Then Some • President was partners with two lending customers • Partnership agreements, tax returns and various books & records located in president’s office • Partnership agreements signed by the president • Tax returns show 50% owner • Bank records show president signed checks

31. Partnership #1 – An Equipment Company • $250,000 LOC to the president’s partner personally • Approved by the president • Balance of $201,988 • Draws were going to checking account of the partnership president has 50% interest in • Cashier checks were layered in between • Checks to president out of partnership account

32. Partnership #1 – An Equipment Company • Cashier’s checks for $8,000 and $20,181 payable to president • Deposited in his personal account • Remitter was the partnership • $20,000 of $20,181 used to pay off two personal loans the president had with the bank he worked for

33. Partnership #2 – A Cattle Company • Partnership agreement in President’s office • Loan documents from other banks that the President had signed as a partner • Canceled checks – President was signer • Balance sheet for the partnership with the President’s signature (indicated as partner)

34. Partnership #2 – A Cattle Company • Bank has made three loans to his partner in this venture • Approved and originated by the President • Total $92,929 • All are delinquent • Checks payable to this partnership were deposited in President’s personal account

35. Partnership #2 – A Cattle Company • Checks were also written to the President from the partnership account • Checks from the partnership account were signed by the President • Deposited in his personal account • $13,000 of loan proceeds to partner (cashier’s check) cashed by President

36. Partnership #2 – A Cattle Company • President originated loans to cover overdrafts in his partner’s personal account

37. And Then Some. . . • Loans to other customers where same day the customer wrote a check to the President • Checks from those customers deposited in President’s personal account • Loans total $671,306 – all delinquent • One customer bought a truck the day after a loan was made . . .

38. And Then Some. . . • Proceeds of other loans were used to buy used cars from the President • Checks from those customers deposited in President’s personal account • $19,000 in ATM withdrawals at casinos from President’s account • 75 cash deposits in President’s account total more than $80,000 less than two years

39. And Then Some. . . • Many, many cashier’s check transactions by the President • Payable to himself, partnerships or family members • Then split into other cashier’s checks • Often split a 3rd time • A little cash taken out each time

40. Things To Be Alert To • PO Boxes • Unusual items being passed at teller line • Suspense accounts don’t reconcile • Trust activity w/o proper authorization • TIN used on accts with different names • No phone • Business account w/ no business phone

41. Things To Be Alert To • Transactions brought directly to proof • Loans to employees not meeting requirements • Insiders loaning personal funds to customers or borrowing from customers • Insiders appear to give or receive favors to (from) customers • Insiders involved in business that borrows from the bank

42. Things To Be Alert To • Insider with heavy debt that appears to require most or all of salary • Financing of insider sale of personal assets to a third party • Insider relationship with “shady” characters or “high rollers” • Insider keeps unusual number of customer files at their desk

43. Things To Be Alert To • Insider making payments on another borrower’s loans • Insider frequently takes documents outside bank for customer signature • Insider processes transactions in absence of customer as “special favors” • Changes to loan master file due dates

44. 10The sum of percentages in this chart exceeds 100% because in some cases respondents identified more than one detection method. The same is true for all charts in this Report showing how occupational frauds were detected.

46. Five Things to Remember • Review personal accounts of employees and officers • Have an electronic analysis of loan master file • Train tellers not to accept unusual transactions from insiders • Encourage questioning & reporting unusual transactions – have a confidential hotline • Be aware of relationships between insiders and loan customers

47. Questions?

48. Angela Morelock, CPA, CFE, ABV, Certified Forensic Accountant® BKD, LLP 901 E. St. Louis Street Springfield, MO 65801-1190 Phone: 417-865-8701 Fax: 417-865-0682 E-mail: amorelock@bkd.com Contact Information