OTS Examination Handbook Update Addresses INTERNAL Fraud Concerns and Controls

And once again, I thought it was the Deadbeat Homeowners that took down the entire global economy…

Internal Fraud is to blame for most breaches and financial losses. Identifying it early, or preventing fraud before it starts, must be a priority, the OTS says.

The FBI estimates that 80 percent of all mortgage fraud involves collaboration or collusion by industry insiders.

From the report…

Fraud and Insider Abuse

Difficult economic times often lead to an increase in fraud and insider abuse. During the market downturns of the late 1980s and early 1990s, fraud and insider abuse significantly contributed to thrift failures and caused substantial losses at many others. Since the recession began in 2007, there have been increases in white collar crime as well as changes  in the way fraud scams are carried out. Although certain crimes such as, investment fraud and Ponzi schemes are not new, they are increasing as a result of market deterioration.
See 4closurefraud.org for more info…
The difficult times of the past year have lead the federal government to commit considerable amounts of financial resources through the Troubled Asset Relief Program and other stimulus programs to spur the economy. Inevitably, the flow of massive amounts of federal assistance lends itself to various forms of fraud. In an effort to safeguard the use and expenditure of public dollars, Congress passed the Fraud Enforcement and Recovery Act of 2009 (FERA) on May 20, 2009. FERA’s amendments to the civil False Claims Act broadens the risk of liability in a manner that warrants the attention of not just fraudsters, but to anyone doing business with the federal government.
See 4closurefraud.org for more info…
The Department of Justice (DOJ) labels financial fraud “one of the most glaring threats” facing the US economy and has prioritized the fight against fraud  to a level that merits the close attention of American corporate leaders. Following a wave of major corporate scandals, Congress established the President’s Corporate Fraud Task Force to restore public and investor confidence in American businesses. In 2009, the President elevated the fight against mortgage fraud to a cabinet-level priority and expanded the taskforce to include OTS, OCC, the Federal Reserve, The Federal Housing Finance Agency, HUD, and the Special Inspector General  for the Troubled Asset Relief Program. The President’s task force joins the work that the Federal Trade Commission has already begun with their “Operation Stolen Hope” to crack down on mortgage foreclosure rescue and loan modification scams. The latest effort to expand the taskforce emphasizes the continued need to crack down on mortgage Fraud, particularly with regard to ongoing investigations into securitization fraud. In addition to the President’s taskforce, several other federal agencies work together to combat fraud and insider abuse at financial institutions.

FRAUD, INSIDER AB– USE, AND CRIMINAL MISCONDUCT

Many of the largest cases  of financial institution fraud involved insiders.

Fraud is the intentional misrepresentation of a material fact(s), or a deception, to secure unfair or unlawful gain at the expense of another. Either insiders or outsiders, or both acting in concert, can  perpetrate fraud on financial institutions.
See 4closurefraud.org for more info…
Every year, thrifts lose a significant amount of money due to insider abuse and criminal misconduct. Many of the largest cases of financial institution fraud involved insiders. The FBI estimates that insiders of financial institutions steal eight times more  money than is stolen through bank robberies and burglaries. If the insider is in a key position, the amount of loss can be significant enough to cause the institution to fail. The term insider abuse refers to a wide range of activities by officers, directors, employees, major shareholders, agents, and other controlling persons in financial institutions. The perpetrators intend to benefit themselves or their related interests.

Red Flags of Fraud and Insider Abuse

Experience has taught OTS staff that certain common elements are often present in cases of fraud and insider abuse. The following listings are warning signs of possible fraud and insider abuse.

General

• Dominant officer with control over the institution or a critical operational area.
• Internal audit restrictions or unusual reporting relationships (the internal auditor not reporting directly to the board or audit committee).
• Lack of written or inadequately written policies.
• Lack of adherence to written policies.
• Unusual or lavish fixed assets (for example, aircraft or art work).
• Management attempts to unduly influence examination or audit findings.
• Material internal control deficiencies.
• Frequent changes of auditors.
• High turnover in the internal audit department.
• Delay tactics, alteration or withholding of records.
• Large transactions with small out-of-town banks.
• Ownership or control vested in a small group.
• Difficulty in determining who is in control.
• Overly complex organizational structure, managerial lines of authority, or contractual arrangements without apparent business purpose.
• Inaccurate, inadequate, or incomplete board reports.
• Discontinuation of key internal reports.
• No vacation taken by employee or officer.
  See 4closurefraud.org for more info…

Management Level

• Routinely contests exam findings by filing appeals, complaining to congresspersons, or directly or indirectly contacting agency officials.
• Routinely accuses you of being unfair, acting overzealously, or making errors.
• Fails to provide original documents – only provides copies.
• Hires ex-agency officials when faced with enforcement actions.
• High turnover or loss of substantial number of officers and directors.
• Motivation to engage in fraudulent financial  reporting – significant portion of management’s compensation is contingent upon aggressive targeted financial achievements, stock prices, or earnings.
• Use of aggressive accounting practices or tax-motivated behavior.
• High degree of competition in the community accompanied by declining margins of profit or customer demand.
• Management lacks expertise needed to fully understand ramifications of proposals made by third parties or they perceive unrealistic opportunity to enhance income.
  See 4closurefraud.org for more info…

Exam Level

• Inability to generate cash flows from operations.
• Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties.
• Unusually rapid growth in comparison to other institutions.
• High vulnerability to interest rate changes.
• Inadequate monitoring of significant controls.
• Lack of timely or appropriate documentation for transactions.
• Significant unexplained items on reconciliations.
• Falsified bank documents.
• Weak loan administration and out of balance loan accounts.
• Repeated regulatory violations including significant Thrift Financial Report violations.
• Significant related party transactions not in the ordinary course of business.
• Significant numbers of bank accounts located in tax haven jurisdictions.
• Weak internal controls and risk management such as:
  – Inadequate overall internal control design.
  – Inadequate procedures to assess and apply accounting principles.
  – Absence of controls for certain transactions.
  – Evidence that a system fails to provide accurate output, or evidence of design flaws, among others.
• Known SARs.
  See 4closurefraud.org for more info…

Lending Abuse Red Flags

• Poorly documented loans and appraisals.
• Lack of an acceptable past due or watch list.
• Lack of, or unsigned, borrower financial statements.
• Questionable loan disbursements.
• Loan funds disbursed to a third party.
• Corporate loans with no endorsements or guarantors.
• Large pay-down of problem loans prior to an audit or examination.
• Large overdrafts.
• Refinancing of debt in a different department.
• Loans secured by flipped collateral.
• Nominee loans.
• Loans of unusual size or with unusual interest rates or terms.
• Loans with unusual, questionable, or no collateral.
• Loan review restrictions.
• Questionable, out-of-territory loans.
• Evergreen loans (loans continuously extended or modified).
• A considerable amount of insider loans.
• Construction draws with nonexistent or inadequate inspection reports.
• Construction inspections conducted by unauthorized or inappropriate persons.
• Market study on proposed project not on file.
• Loan approvals granted to uncreditworthy employees.
• Lack of independence between the approval and disbursement functions.
• Frequent sales of collateral (land flips) indicating related party transactions.
• Predatory lending practices.
  See 4closurefraud.org for more info…

Appraisal Abuse Red Flags

• No appraisal or property evaluation in file.
• Mortgage broker or borrowers that always use the same appraiser.
• Appraiser bills association for more than one appraisal when there is only one in the file.
• Unusual appraisal fees (high or low).
• No history of property or prior sales records.
• Market data located away from subject property.
• Unsupported or unrealistic assumptions relating  to capitalization rates, zoning change, utility availability, absorption, or rent level.
• Valued for highest and best use, which is different from current use.
• Appraisal method using retail value of one unit in condo complex multiplied by the number of units equals collateral value.
• Use of superlatives in appraisals.
• Appraisal made for borrower.
• Appraisals performed or dated after loan.
• Close relationship between builder, broker, appraiser, lender and/or borrower.
• Overvalued (inflated) or high property value.
  See 4closurefraud.org for more info…

Full Report below…

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4closureFraud

OTS Examination Handbook Update Section 360