FRAUD DETECTION & CONTROL

BANK FRAUD

© Paul Lower 2010

 Bank Fraud

Recommended course book:

Financial Services
Anti-fraud Risk and Control
Workbook
By Peter Goldmann
Published by Wiley
ISBN 978-0-470-49899-6-9000

© Paul Lower 2010

 Bank Fraud

• Anatomy of fraud

– For each type of fraud we will examine

• How the fraud is carried out

• The red flags that help to detect the fraud
• The preventative controls that should be in place

© Paul Lower 2010

 FRAUD DETECTION & CONTROL

LOAN FRAUD

© Paul Lower 2010

 Loan Fraud

• Internal loan fraud

“Loan fraud is the highest risk area for financial institutions”1

Association of Certified Fraud Examiners (ACFE)

1
Including real estate, home loans, personal loans and commercial loans

© Paul Lower 2010

 Loan Fraud

• Internal loan fraud

– Loans to “Phantom” borrowers

– Loan lapping
– Kickbacks on illegal loans
– Reciprocal loans
– Commercial loans
– Suspense account fraud

© Paul Lower 2010

 Loan Fraud

• Loans to “Phantom” borrowers

– Employees submit fictitious loan applications

• Possible with poor internal controls

• And poor compliance monitoring

© Paul Lower 2010

 Loan Fraud

• Loans to “Phantom” borrowers

– Employees submit fictitious loan applications

– Uses false name, address and other details

– Submitted to and approved by Loan Officer

• Because application appears legitimate

• Or Loan Officer is co-conspirator

© Paul Lower 2010

 Loan Fraud

• Loans to “Phantom” borrowers

– Employees submit fictitious loan applications

– Uses false name, address and other details

– Submitted to and approved by Loan Officer

– Perpetrator controls all correspondence to “borrower”

– Using an address controlled by the perpetrator

– No payments made and loans defaults

© Paul Lower 2010

 Loan Fraud

• Loan lapping

– Several ways for employees to commit lapping fraud

– Fraudster takes multiple fraudulent loans

– Uses proceeds of one to make payments on another

– Or diverts loan repayments from genuine borrowers

© Paul Lower 2010

 Loan Fraud

• Kickbacks on illegal loans

– Employee approves loan to non creditworthy borrower

– Or to an accomplice

– In return for a secret kickback

– Loan defaults and is written off

– Or may be concealed by lapping tactic

© Paul Lower 2010

 Loan Fraud

• Reciprocal loans

– Committed by dishonest Loan Officer or Manager

– In collusion with counterparts in other banks

– A loan is made to the counterpart bank

– On the understanding a reciprocal loan is made

– Allows bank to cover otherwise bad loans

© Paul Lower 2010

 Loan Fraud

Reciprocal loans and the US Savings and Loans crisis

In what the authors of the seminal work on the crisis1 called a

“macabre variation on reciprocal lending” multiple banking institutions
trade their non-performing bank loans back and forth to each other to
remove them from their books temporarily in order to make their
financial statements look less toxic than they actually were.

This fraud was perpetrated primarily to fool regulators and the credit
rating agencies.

“Big Money Crime: Fraud and Politics in the Savings & Loan Crisis”
1

Kitty Calavita et al

© Paul Lower 2010

 Loan Fraud

• Commercial loans

– Commercial loans take many forms

• Equipment loans
• Construction loans
• Working capital loans

© Paul Lower 2010

 Loan Fraud

• Commercial loans

– Commercial loans take many forms

– Fraud is a potential threat in all areas

– Commercial loan fraudsters are usually external

– But there may be collusion with internal employees

© Paul Lower 2010

 Loan Fraud

• Commercial loans

– Construction loan fraud

• Fraud is rife in the construction industry

• Often involves falsification of documentation
• To provide an inflated property valuation
• Or to trigger a ‘stage’ draw against a loan

© Paul Lower 2010

 Loan Fraud

• Commercial loans

– Working capital loan fraud

• Often committed by companies in financial trouble

• Includes creating false customer invoices
• Double counting income earning contracts
• Overvaluation of trading stock
• May involve collusion with internal employees
• Including kickbacks to “turn a blind eye”

© Paul Lower 2010

 Loan Fraud

• Suspense account fraud

– Suspense accounts hold funds temporarily

– For various reasons

• Insufficient loan documentation

• Pending closing of a loan
• Interdepartmental or wire transfers

© Paul Lower 2010

 Loan Fraud

• Suspense account fraud

– Suspense accounts hold funds temporarily

– For various reasons

– Easy for employees with authority to move the funds

• To a bogus account they control

• To the account of an external collaborator
• Or to their own deposit account

© Paul Lower 2010

 Loan Fraud

• Suspense account fraud

– Suspense accounts hold funds temporarily

– For various reasons

– Easy for employees with authority to move the funds

– Fraud concealed by falsifying ledger entries

© Paul Lower 2010

 Loan Fraud

• Suspense account fraud

– Suspense accounts are very vulnerable to fraud

• Specific anti-fraud controls necessary

• And special oversight by managers required

© Paul Lower 2010

 Loan Fraud

• Internal loan fraud

– Loans to “Phantom” borrowers

– Loan lapping
– Kickbacks on illegal loans
– Reciprocal loans
– Commercial loans
– Suspense account fraud
– Some other examples

© Paul Lower 2010

 Loan Fraud

• Red flags of loan fraud

– Two categories of red flag indicators

– Soft indicators

• Intangible behavioural signs

• Do not point to any specific type of fraud

© Paul Lower 2010

 Loan Fraud

• Red flags of loan fraud

– Two categories of red flag indicators

– Soft indicators

– Hard indicators

• Tangible pieces of evidence

• Represented by numerical oddities
• And physical evidence

© Paul Lower 2010

 Loan Fraud

• Red flags of loan fraud

– Soft indicators of loan fraud are common to all fraud

• Employee shows weak sense of ethics

– Lack of respect for “doing the right thing”
– Constantly lying and deceiving
– Undermining co-workers

© Paul Lower 2010

 Loan Fraud

• Red flags of loan fraud

– Soft indicators of loan fraud are common to all fraud

• Employee shows weak sense of ethics

• Excessive risk taking
– Borrowing heavy to fund fancy lifestyle
– Investing in highly speculative ventures

© Paul Lower 2010

 Loan Fraud

• Red flags of loan fraud

– Soft indicators of loan fraud are common to all fraud

• Employee shows weak sense of ethics

• Excessive risk taking
• Refusal to take time off
– Fears being found out whilst away from work
– Why many companies have mandatory vacation

© Paul Lower 2010

 Loan Fraud

• Red flags of loan fraud

– Soft indicators of loan fraud are common to all fraud

• Employee shows weak sense of ethics

• Excessive risk taking
• Refusal to take time off
• Coming in early / staying late
• Abuse of drugs or alcohol
• Showing off possessions beyond their means

© Paul Lower 2010

 Loan Fraud

• Hard red flags of loan fraud

– Short term volatile deposits used to fund long term

loans of questionable credit quality

– Out of area loans to previously unknown borrowers

– Loan employees personally deliver loan proceeds

– Large deposits offered in consideration for favourable

treatment on a loan but not pledged as collateral

– An excessive number of non performing loans

© Paul Lower 2010

 Loan Fraud

• Hard red flags of loan fraud

– There is missing documentation

– Employee randomly suggests change of appraisers for

property or other asset valuations

– “Borrower” asks for loan to be paid to third party

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Develop an anti-fraud culture and mindset

• Implement anti-fraud policies and procedures

• Implement and apply a code of conduct
• Train employees in fraud awareness
• Develop “whistleblower” culture

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Develop an anti-fraud culture and mindset

– Enforce vigorous hiring practices

• Go beyond basic background checks

• Follow up on references and qualifications

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Develop an anti-fraud culture and mindset

– Enforce vigorous hiring practices

– Enforce strict segregation of duties

– Enforce clear-cut delegation of authority

• Break up components of credit approval process

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Develop an anti-fraud culture and mindset

– Enforce vigorous hiring practices

– Enforce strict segregation of duties

– Enforce clear-cut delegation of authority

– Take care to separate bad credit from loan fraud

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Carry out rigorous due diligence

• Know your customer

– Obtain trade, credit and character references
– Confirm existence of legal entities
– Credit agency reports
– For larger loans use background checks

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Carry out rigorous due diligence

• Know your customer

• Know your documents
– Review customer supplied documents
– Oral confirmation of employment evidence
– Confirm addresses in telephone books
– Match address on all supporting documents

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Implement post-closing quality controls

• Ensures loan process generates quality loans

• Reverify income, employment, bank statements
• Review all collateral documents
• Check all signatures for consistency
• Ensure compliance with your lending standards

© Paul Lower 2010

 Loan Fraud

• Preventing employee loan fraud

– Conduct regular loan portfolio reviews

• Helps detect any frauds that slipped through

• Check any payment delinquency
• Check loans for geographic concentration
• Check exception reports – loans outside guidelines
• Track addresses of declined loans on for three
months for any reapplication

© Paul Lower 2010

 Loan Fraud

• Mortgage loan fraud

© Paul Lower 2010

 Loan Fraud

MORTGAGE LOAN FRAUD

Mortgage fraud started making the news in 2007
So called subprime lending showed first signs of
abuse by criminally minded “players” including:
Builders and property developers
Mortage brokers
Property valuers
Loan underwriters
Bank executives

© Paul Lower 2010

 Loan Fraud

MORTGAGE LOAN FRAUD

Adding to the frenzy was an army of securities
professionals, including Lehman Brothers and
Goldman Sachs, packaging risky loans in to
marketable investment products.
The collapse of the subprime mortgage market
plunged the developed world in to financial crisis and
precipitated the fall of firms like Lehman Brothers.

© Paul Lower 2010

 Loan Fraud

MORTGAGE LOAN FRAUD

According to some estimates1
“
about 75% of all subprime loan applications sent by
mortgage brokers to lenders were either misleading,
incorrect or downright fraudulent”

1
Richard Bitner, subprime lender

© Paul Lower 2010

 Loan Fraud

MORTGAGE LOAN FRAUD

According to Bitner common deceptions included

Applying as an occupier rather than pure investor

Falsifying borrowers employment history

Hiding critical information that would affect approval

Falsifying self-certified earnings

© Paul Lower 2010

 Loan Fraud

MORTGAGE LOAN FRAUD

But although the subprime mortgage crisis hit world
headlines it was not was by no means the beginning
of mortgage fraud.
Mortgage fraud has been around much longer and
takes several forms.

© Paul Lower 2010

 Loan Fraud

• Mortgage fraud

– “Straw buyer” fraud

– Chunking frauds

– Equity skimming fraud

© Paul Lower 2010

 Loan Fraud

• “Straw buyer” mortgage fraud

– Straw buyers are loan applicants used by fraudsters

• Chosen for their good credit rating

• No intention of occupying the property
• But compensated for making the application
• Offered a flat fee or share of the profit

© Paul Lower 2010

 Loan Fraud

• “Straw buyer” mortgage fraud

– Straw buyers are loan applicants used by fraudsters

– Sometimes operates as internal bank fraud

• Straw buyer is approached by dishonest banker

• Offered generous terms to buy bank’s property

© Paul Lower 2010

 Loan Fraud

• “Straw buyer” mortgage fraud

– Straw buyers are loan applicants used by fraudsters

– Sometimes operates as internal bank fraud

– False appraisal used to inflate value the property

– Property sold to third party at inflated price

– Fraudster and straw buyer share proceeds

© Paul Lower 2010

 Loan Fraud

• Chunking mortgage fraud

– Victims are gullible investors and lenders

– Victims are persuaded to make or front applications

– Several variations to chunking fraud

– In all cases lender is left with unrecoverable loan

– Victim is left facing recovery proceedings

© Paul Lower 2010

 Loan Fraud

• Chunking mortgage fraud

– Several variations to chunking fraud: one variation

• Fraudster gets inflated valuation for rundown home

• Victim assumes rent will cover repayments
• Victim takes out mortgage on ‘investment’ home
• No tenant or rent ever materialises
• Fraudster pockets proceeds of home sale
• Victim and bank both lose out

© Paul Lower 2010

 Loan Fraud

• Equity skimming mortgage fraud

– Fraudster buys one or more homes with 80% mortgage

– Properties are rented out to genuine families

– Fraudster never makes repayment against mortgage

– Fraudster recovers 20% equity from rental income

– Continues to collect rent until bank forecloses

– Lending bank is left with unrecoverable mortgage

© Paul Lower 2010

 Loan Fraud

• Red flags of mortgage fraud

– Property valuation substantially higher than market

– Valuation fee unusually high

– No real estate agent involved

– Address discrepancies with loan file

– Pay stubs are handwritten or “home-made”

– Documentation has deletions or alterations

© Paul Lower 2010

 Loan Fraud

• Preventing mortgage fraud

– Same measures as preventing loan fraud

– Plus some specific additional checks

• Ensure managers aware of latest mortgage scams

• Ensure mortgage funds go through escrow
accounts
• Double check borrower is occupying property
• Double check identification of borrower

© Paul Lower 2010

 FRAUD DETECTION & CONTROL

EMPLOYEE LEVEL FRAUD

© Paul Lower 2010

 Employee Level Fraud

• Scale of employee level fraud

– Many ways for bank employees to commit fraud

– Loan fraud is the area of highest risk1

1
Association of Certified Fraud Examiners (ACFE)

© Paul Lower 2010

 Employee Level Fraud

• Scale of employee level fraud

– Many ways for bank employees to commit fraud

– Loan fraud is the area of highest risk

– But embezzlement remains high on the list

– Two categories of employee fraud for banks

• Looting customer accounts

• Exploiting weaknesses in operations

© Paul Lower 2010

 Employee Level Fraud

• Two types of employee fraud

– Looting customer accounts

• Theft from customer accounts

• Dormant account fraud
• Cashier theft of cash or “Skimming”
• Cheque fraud

© Paul Lower 2010

 Employee Level Fraud

• Two types of employee fraud

– Looting customer accounts

– Exploiting weaknesses in operations

• Theft of consignment items

• Invoicing fraud

© Paul Lower 2010

 Employee Level Fraud

• Theft from customer accounts

– Employees divert funds from customer accounts

– Fraud is then concealed with false records

– Hudson Savings Bank fell victim to this scheme

© Paul Lower 2010

 Employee Level Fraud
CASE STUDY
When bank employees have too much control over
customer accounts
Milton Pereira, former management of Hudson City Bank, was
convicted on charges of embezzling more than $650,000 from his
former employer to fund his gambling and credit card debts.
Over seven years Pereira tampered with more than 60 customer
accounts by executing thousands of fraudulent debits and credits

© Paul Lower 2010

 Employee Level Fraud
CASE STUDY
When bank employees have too much control over
customer accounts
How he did it:
Pereira repeatedly withdrew funds from customer accounts and
transferred them to accounts he had created and controlled and from
which he illegally withdrew funds.
He evaded detection by moving funds between accounts and
preventing customers from receiving statements.

© Paul Lower 2010

 Employee Level Fraud
CASE STUDY
When bank employees have too much control over
customer accounts
How he was found out:
When a few customers became aware of unauthorised activity on
their accounts, Pereira corrected the “errors” by transferring funds
from other customers’ accounts.
Then he sent letters to the customers to tell them there had been an
error in the bank’s system that caused the error and that this had
subsequently been “corrected”.
Some of the customers remained suspicious and the ensuing police
and FBI investigation uncovered Pereira’s fraudulent scheme.
Pereira was tried and sentenced to two years in prison.

© Paul Lower 2010

 Employee Level Fraud
CASE STUDY
When bank employees have too much control over
customer accounts

How could this fraud have been prevented?

Which controls should have been in place to prevent it?

© Paul Lower 2010

 Employee Level Fraud
CASE STUDY
When bank employees have too much control over
customer accounts
Surprise audits of fund transfers might have revealed red flags of
unusual patterns in accounts being looted by Pereira and an
unusually high number of credits to the accounts he controlled.
Sampling of suppressed statements by auditors or regional
managers should have pointed to Pereira as being responsible for
requesting the statements to be held.
Use automated fraud pattern detection software; ensure IT
professionals set up to include flagging bank manager activity.
Thorough background checks on Pereira might have revealed his
personal debt and gambling problems

© Paul Lower 2010

 Employee Level Fraud
CASE STUDY
When bank employees have too much control over
customer accounts
Insist on mandatory vacation at all staff levels so that relief
employees have the opportunity to uncover fraud in the course of
their normal work.
Carry out employee fraud awareness training.
Maintain confidential employee hotline and encourage whistleblowing
by suspicious employees.

© Paul Lower 2010

 Employee Level Fraud

• Dormant account fraud

– Accounts usually considered dormant after inactivity for

longer than 12 months and contact lost with owner

– Most dormant accounts have small balances

– Larger balances are attractive to fraudsters

– Fraudulent employee makes entries to the account

– And steals the money

– Detection is avoided because owner does not monitor

© Paul Lower 2010

 Employee Level Fraud

• Cashier fraud and “Skimming”

– Most common form of theft at branch level

– Two main types of cashier theft

• Theft of cash assigned to a cashier by that cashier

• Theft of assigned cash by another employee

© Paul Lower 2010

 Employee Level Fraud

• Cashier fraud and “Skimming”

– Most common form of theft at branch level

– Two main types of cashier theft

– Specified cash amounts assigned daily to cashiers

– Skimming fraud frequently involves Senior Cashier

• Senior Cashier has access to additional amounts

• Senior Cashier has the authority over cash activity

© Paul Lower 2010

 Employee Level Fraud

Cashier Skimming – variation 1

At the end of the day the Senior Cashier bags cash to be transferred.
The bag is labelled as containing a greater amount of cash than it
contains and this amount is recorded as having been transferred.
The Cashier pockets the difference between the two amounts

Cashier Skimming – variation 2

The Cashier plastic wraps a pack of paper currency with a $20 note
at each end of the package. The notes in between are singles.

© Paul Lower 2010

 Employee Level Fraud

Cashier Skimming – variation 3

The Senior Cashier steals cash which he or she then records has
having been transferred to another Cashier or another branch.

© Paul Lower 2010

 Employee Level Fraud

• Cheque fraud

– Common form of bank fraud in several forms

• Creating forged cheques

• Theft and forgery of blank cheques
• Cheque interception
• Hidden cheque fraud

© Paul Lower 2010

 Employee Level Fraud

• Cheque fraud

– Creating forged cheques

• Often employees without cheque signing authority

• Several ways to forge or alter a cheque
– In most cases payee name is altered

© Paul Lower 2010

 Employee Level Fraud

• Cheque fraud

– Theft and forgery of blank cheques

• Blank cheque made out to fraudster

• Or fraudster makes cheque out to accomplice
• Forgeries often clumsy and conspicuous
• But many banks fail to scrutinise properly

© Paul Lower 2010

 Employee Level Fraud

• Cheque fraud

– Cheque interception and forgery

• Legitimate cheques intercepted by fraudster

• Genuine payee name replaced with their own
• Usually conspicuous amendments
• But requires scrutiny by honest cashier

© Paul Lower 2010

 Employee Level Fraud

• Cheque fraud

– Hidden cheque fraud

• Forged cheque concealed with legitimate cheques

• Aim is to “camouflage” cheque as normal
• Relies on approver missing clues to forgery
• Better chance of avoiding being caught out

© Paul Lower 2010

 Employee Level Fraud

• Theft of consignment items

– Various types of consignment items

• Travellers cheques
• Cashier’s cheques
• Money orders

© Paul Lower 2010

 Employee Level Fraud

• Theft of consignment items

– Various types of consignment items

– Easy for dishonest employees to steal

– Relatively easy to convert them in to cash

– May attempt to conceal by falsifying records

© Paul Lower 2010

 Employee Level Fraud

• Red flags of embezzlement

– Unusually high levels of bagged cash

– Currency wrapped in plastic when usually not

– High frequency of cashier transfers

– Customer complaints about declining bank balances

– Customer complaints about frequent bank errors

– Dormant accounts suddenly showing activity

© Paul Lower 2010

 Employee Level Fraud

• Preventing embezzlement

– Looting customer accounts

• Monitor activity on all employee accounts

• Immediately investigate all customer complaints
about unusual or unauthorised account activity
• Investigate unusually frequent withdrawals or
transfers on customer accounts

© Paul Lower 2010

 Employee Level Fraud

• Preventing embezzlement

– Dormant account fraud

• Flag all accounts with no activity for 12 months

whose owners cannot be contacted
• Have at least two supervisory level employees
investigate any postings to these accounts

© Paul Lower 2010

 Employee Level Fraud

• Preventing embezzlement

– Cashier Skimming

• Conduct surprise monthly manual cash counts

• Check ALL cashiers at least quarterly
• Reconcile all accounts to cashier records

© Paul Lower 2010

 Employee Level Fraud

• Red flags of cheque fraud

– Unusual number of voided cheques

– Cancelled cheques show signs of tampering

– Signatures are missing or appear forged

– Customer complain about payments not being credited

– Misspellings or errors on cheques

© Paul Lower 2010

 Employee Level Fraud

• Preventing cheque fraud

– Secure all cheques and enforce dual control of stock

– Enforce cheque amounts signature thresholds

– Insist on and check full supporting documentation for

cheques paying bank’s own expenses

– Conduct prompt bank reconciliations

– Encourage and reward employee vigilance

© Paul Lower 2010

 FRAUD DETECTION & CONTROL

MANAGEMENT LEVEL FRAUD

© Paul Lower 2010

 Management Level Fraud

• Fraud at senior management level

– Occurs less frequently than employee level fraud

– But when it occurs losses tend to be greater

• Management has greater authority

• Possibly better knowledge of systems
• Better equipped to execute complex frauds

© Paul Lower 2010

 Management Level Fraud

• Types of management level fraud

– Same as employee fraud but on a larger scale

• Cheque fraud
• Skimming
• Looting customer accounts
• Loan fraud – approving loans to oneself
• Loan fraud – kickback schemes & bribery
• Illegal financial transactions and corruption

© Paul Lower 2010

 Management Level Fraud

• Types of management level fraud cont..

– Financial statement fraud causes a decrease in market

value of stock of approximately 500 to 1,000 times the
amount of the fraud.

$7 million fraud $2 billion drop in

stock value

© Paul Lower 2010

 Management Incentives

• Meeting market expectations

– Stock prices are tied to meeting earnings forecasts

– Focus is on short-term performance only

– Companies are heavily punished for not meeting

forecasts

– Executives have been endowed with hundreds of

millions of dollars worth of stock options—far exceeds
compensation (tied to stock price)

– Performance is based on earnings & stock price

© Paul Lower 2010

 Management Disclosure Fraud

• Meeting market expectations

– Overall misrepresentations about the nature of the

company or its products, usually made through news
reports, interviews, annual reports, and elsewhere

– Misrepresentations in the management discussions and

other non-financial statement sections of annual
reports, 10-Ks, 10-Qs, and other reports

– Misrepresentations in the footnotes to the financial

statements

© Paul Lower 2010

 Role of Credit Reference Agencies

• Independent credit agencies play a part

– The three major credit rating agencies—Moody’s,
Standard & Poor’s and Fitch/IBCA—received
substantial fees from Enron
– Just weeks prior to Enron’s bankruptcy filing—after
most of the negative news was out and Enron’s stock
was trading for $3 per share—all three agencies still
gave investment grade ratings to Enron’s debt.

© Paul Lower 2010

 Role of Auditors

• They must be independent

– Auditors must not provide internal and external audits.
Anderson was paid $52 million in 2000 by Enron, the
majority for non-audit related consulting services.
– Auditors must not be solely reliant on one client. Enron was
Andersen’s second largest client and kept a whole floor of
auditors assigned at Enron year around
– Auditors must not have been employed by the client CFOs
and controllers were former Andersen executives

© Paul Lower 2010

 Management Level Fraud

LAMIDO SANUSI, the wry and diminutive governor of Nigeria’s

central bank, has a simple enough goal: to use the country’s
banks to make its economy bigger and better. This month he
completed the first leg of what promises to be a long journey.
On taking office in June, Mr Sanusi pledged to clean up an
industry in which a round of consolidation earlier this decade
and subsequent euphoric expansion had given way, in many
cases, to mountains of bad debt, mistrust and malpractice. So
far he has stuck to his guns, as did the armed police who
briefly surrounded some banks’ headquarters in Lagos one
dramatic Friday afternoon in August, just after the results of
the first wave of Mr Sanusi’s emergency audits were released.

© Paul Lower 2010

 Management Level Fraud

Those audits revealed that five banks holding 30% of Nigeria’s

deposits—Afribank, Finbank, Intercontinental Bank, Oceanic
Bank and Union Bank—were on the brink of collapse thanks to
reckless lending. This month a second and final round of
audits deemed that four more, among them Bank PHB, whose
directors include President Umaru Yar’Adua’s nephew, were in
“a grave situation”. Yet another was short of capital. The
remaining 14 banks to be audited, including foreign-owned
Standard Bank, Standard Chartered and Citigroup, were
unscathed. The central bank has so far injected $3.9 billion
into the nine troubled groups. Opinions are split on whether to
expect top-ups.

© Paul Lower 2010

 Management Level Fraud
1st September 2009

Nigeria: Bank Chiefs Arraigned, Face 131 Charges

Lagos — At last, four of the five bank chiefs sacked three weeks ago by
Central Bank of Nigeria (CBN) Governor Sanusi Lamido Sanusi over the huge
non-performing loans of their banks have had their day in court.
They were arraigned by the Economic and Financial Crimes Commission
(EFCC) yesterday before a Federal High Court sitting in Lagos.
The four ex-bank chiefs arraigned on five separate charges of 131 counts
bordering on fraud, concealment and grant of loans without adequate collateral
running into about N625.95 billion were former Chief Executive Officers of
Oceanic International Bank, Mrs. Cecilia Ibru; FinBank Nigeria Plc, Mr. Okey
Nwosu; Afribank Plc, Mr. Sebastian Adigwe and Union Bank of Nigeria,
Bartholomew Ebong.

© Paul Lower 2010

 Management Level Fraud
1st September 2009

Nigeria: Bank Chiefs Arraigned, Face 131 Charges

[Also] in the dock were Sebastian Adigwe; former MD of Africabank Plc, Mr

Peter Ololo; and his company, Falcon Securities Ltd.

Adigwe was accused of granting loans of about N91 billion to Falcon

Securities Ltd, Rehobet Assets Ltd, Kolvey Company Ltd and many others
without adequate collateral contrary to the provisions of Failed Bank (Recovery
of Debts) and Financial Malpractices in Bank Act, Cap F2 Laws of the
Federation of Nigeria, 2004 and other offences punishable under the same
law.

Other charges leveled against Adigwe were that he failed to keep proper
books of accounts and classification of commercial papers as contingent
liabilities of his bank.

© Paul Lower 2010

 Management Level Fraud
1st September 2009

Nigeria: Bank Chiefs Arraigned, Face 131 Charges

The seven non-executive directors and members of Board of Directors of

Intercontinental Bank, who were the third set to be arraigned on 18 count
charges, were accused of colluding with the former managing director,
Akingbola (now at large), to grant various credit running into over N36 billion to
companies, in which they are also directors without security.

© Paul Lower 2010

 Management Level Fraud

• Red flags of management fraud

– Managers have lied to auditors

– Any of the red flags of employee frauds

– Manager personally delivers loan proceeds

– Incomplete loan application / collateral documents

– Intimidation or harassment of subordinates

– Contracts awarded without competitive bidding

© Paul Lower 2010

 Management Level Fraud

• Red flags of management fraud

– Unusual offshore bank accounts set up

– Signs that family or friends are receiving loans

– Managers own shares or have directorships in third

party companies outside of the bank

© Paul Lower 2010

 Management Level Fraud

• Preventing management level fraud

– Do not allow cheque signatories to prepare cheques

– Enforce segregation of duties at all levels

– Ensure ALL loan applications subject to review

• Investigate “preferential” interest rates

• Investigate “thin” or inappropriate collateral

© Paul Lower 2010

 Management Level Fraud

• Preventing management level fraud

– Do not allow cheque signatories to prepare cheques

– Enforce segregation of duties at all levels

– Ensure ALL loan applications subject to review

– Implement and monitor crystal clear policy on

• Bribery and kickbacks

• Outside shareholdings and directorships

© Paul Lower 2010

 Will there be another scandal?

• Yes
– Recent years have seen an increase in the number of
financial statement frauds

• 1977-87 (300); 1987-1997 (300); 1997-2002 (over

300)
– Incentives still there (Stock Options, etc.)

– If we do nothing

© Paul Lower 2010

 Will there be another scandal?

• No not if we have
– Executive “sign off”

– A legal requirement to have internal controls

– Rules for accountants and auditors (mandatory audit

partner rotation; Oversight Board, limitations on services,
etc.)

– Rules for lawyers (mandatory audit partner rotation)

– Rules for bonuses (the FSA says that bonuses should not
be guaranteed for more than a year, and that senior
employees should have their bonuses spread over three
years).

© Paul Lower 2010

 Will there be another scandal?

• No not if we have
– More focus on accounting policy rather than rules

– Greater public awareness

© Paul Lower 2010

 FRAUD DETECTION & CONTROL

MANAGEMENT LEVEL FRAUD

© Paul Lower 2010