FINANCIAL INSTITUTION FRAUD

Question 1

Embezzlement Schemes False Accounting Entries

Answer 1

Employees debit the general ledger to credit their own accounts or cover up customer account thefts.

Question 2

Embezzlement Schemes Unauthorised Withdrawals

Answer 2

Employees make unauthorised withdrawals from customer accounts.

Question 3

Embezzlement Schemes Unauthorised Disbursement of Funds to Outsiders

Answer 3

Employees cash stolen/counterfeit items for outside accomplices.

Question 4

Embezzlement Schemes Paying Personal Expenses from Bank Funds

Answer 4

An officer or employee causes the bank to pay personal bills, then causes amounts to be
charged to bank expense accounts.

Question 5

Embezzlement Schemes Theft of Physical Property

Answer 5

Employees or contractors remove office equipment, building materials, and furnishings from bank premises

Question 6

Embezzlement Schemes Moving Money from Customers’ Dormant or Inactive Accounts

Answer 6

Persons with apparent authority create journal entries or transfer orders not initiated by
customers to move money among accounts.

Question 7

Embezzlement Schemes Unauthorised, Unrecorded Cash Payments

Answer 7

A director, officer, or employee causes cash to be disbursed directly to self or accomplices and does not record the disbursements

Question 8

Embezzlement Schemes Theft and Other Unauthorised Use of Collateral

Answer 8

Custodians steal, sell, or use collateral or repossessed property for themselves or
accomplices

Question 9

Dormant or inactive accounts are

Answer 9

those defined as “bank or brokerage accounts showing little or no activity, presumably with small and without increasing balances.”

Question 10

Embezzlement Schemes Detection Methods

Answer 10

if the dollar amount of the embezzlement scheme is small enough such that the financial statements will
not be materially affected, embezzlement fraud can be most effectively detected through the
review of source documents.
or large embezzlements, the most efficient method of detection is an analysis of the financial tatements (which is also a review of documents)

Question 11

Common Loan Fraud Schemes Loans to Nonexistent Borrowers

Answer 11

False applications, perhaps with inaccurate financial statements, are knowingly or
unknowingly accepted by loan officers as the basis for loans. These types of loan fraud can
be perpetrated by people either external to the lending institution (“external fraud”) or by
officers, directors, or employees of the victim institution (“internal fraud”).

Question 12

Common Loan Fraud Schemes Sham Loans with Kickbacks and Diversion

Answer 12

Loan officers will sometimes make loans to accomplices who then share all or part of the
proceeds with the lending officer. In some instances, the loans are charged off as bad debts;
in other instances, the bogus loans are paid off with the proceeds of new fraudulent loans.

Question 13

Common Loan Fraud Schemes Double-Pledging Collateral

Answer 13

Borrowers pledge the same collateral with different lenders before liens are recorded and
without telling the lenders.

Question 14

Common Loan Fraud Schemes Reciprocal Loan Arrangements

Answer 14

Insiders in different banks cause their banks to lend funds to the others, or sell loans to other banks with agreements to buy their loans—all for the purpose of concealing loans and sales.

Question 15

Common Loan Fraud Schemes Swapping Bad Loans—Daisy Chains

Answer 15

In a daisy chain, a bank buys, sells, and swaps its bad loans for the bad loans of another bank, creating new documentation in the process. Its purpose is to mask or hide bad loans by making them look like they are recent and good.

Question 16

Common Loan Fraud Schemes Linked Financing

Answer 16

Large deposits are offered to a bank (usually brokered deposits) on the condition that loans
are made to particular persons affiliated with the deposit broker. High returns are promised,
but the loans are longer term than the deposits (hot money). Sometimes kickbacks are paid
to the broker or banker.

Question 17

Common Loan Fraud Schemes False Applications with False Credit Information

Answer 17

Sometimes loan applicants provide false information about their credit situation, and/or overstate their assets.

Question 18

Common Loan Fraud Schemes Single-Family Housing Loan Fraud

Answer 18

In this scheme, unqualified borrowers misrepresent personal creditworthiness, overstate ability to pay, and misrepresent characteristics of the housing unit.

Question 19

Red Flags of Construction Loan Fraud

Answer 19

Nonperforming Loans
High Turnover in Developer’s Personnel
 High Turnover in Tenant Mix
Increased Change Orders
Missing Documentation 
Loan Increases or Extensions, Replacement Loans
Funds Transformation 
Cash Flow Deficiencies 
Change in Ownership Makeup 
Disguised Transactions

Question 20

Fraud schemes resulting in a nonperforming loan include:

Answer 20

• Fraudulent appraisals—The cash flow cannot support an inflated loan and resulting debt
amount.
• False statements—The loan was made on false or fraudulently presented assumptions.
• Equity skimming—There was never any intention to make the underlying loan payments.
• Construction over-budget items—The over-budget amount might be a concealment method for other schemes such as embezzlement, misappropriation, or false statements.
• Bribery—The loan was made because the lender received a bribe or a kickback from the borrower.
• Land flips—The purpose of the loan was to finance the seller out of a property that has an artificially inflated value.
• Disguised Transactions—Transactions that are sham transactions, without substance, made
to conceal other ills.

Question 21

Fraudulent appraisals result from any number of situations, some of which are:

Answer 21

• Intentional use of an incompetent appraiser.
• “Stacking the deck” by giving the appraiser improper or false assumptions to use in arriving at the value such as:
− Assume zoning will be changed for a higher and better use when in fact zoning will not be changed.
− Assume unrealistically high vacancy and low expense rates.
− Assume unrealistically high income, selling prices, or absorption – the rate at which vacant space will become rented.
− Otherwise influencing the appraiser, e.g., paying above-market fee or promising
future business.
• Direct collusion with the appraiser to commit fraud.

Question 22

Uses for Fraudulent Appraisals

Answer 22

• To obtain approval on marginal or substandard loans to attain or exceed goals in order to be promoted or receive commission, bonus, or raises.
• To justify extending or renewing a “bad” loan to avoid recognition of a loss that might defer commission, promotion, bonus, or raises.
• To avoid adverse publicity and regulatory, management, and shareholder disapproval
because of excessive losses.
• To avoid recognition of a loss on real estate owned, and to permit additional capital
infusions.
• To criminally gain money.

Question 23

Red Flags of “Made-as-Instructed” Appraisals

Answer 23

• The appraiser used has never been used before, is not on an approved list, has no
professional credentials, or those offered are of questionable credibility.
• The appraisal fee is unusually high.
• Invalid comparables are used.
• Supporting information is missing, insufficient, or contradictory.
• Market data does not support the price and absorption figures used to arrive at value.

Question 24

Detecting Fraudulent Appraisals

Answer 24

(1) Read the appraisal. Does it match the documents in the file
(2) Is there sufficient demand for the project to ensure absorption of the property into the
marketplace?
(3) Are there unique characteristics of the project that will ensure a competitive advantage over other projects?
(4) Is the project sensitive to changes in local economic conditions?

Question 25

Equity Skimming

Answer 25

Equity skimming is a scheme whereby an individual, entity, or group of individuals purchase
one or several single-family homes. Typically, the financing is for a percentage of the purchase price (e.g., 80–90 percent) and the owner invests the balance of the purchase price as equity. The home(s) is/are then rented. The owners collect the rent from the tenants but fail to make the mortgage payment(s). When the owner has withheld mortgage payments that equal the amount of the invested equity, he can then either resume payments or allow the mortgage to be foreclosed.

Question 26

Property flipping is

Answer 26

the process by which an investor purchases a home and then resells it at a higher price shortly thereafter. property flipping becomes illegal and fraudulent when a home is purchased and
resold within a short period of time at an artificially inflated value.

Question 27

Nominee or Strawman Loans

Answer 27

Loans made in the name of a straw borrower or agent having no substance, while the identity of the real borrower is undisclosed to the lender.

Question 28

Mortgage Pulling

Answer 28

For the purpose of disguising loans exceeding a bank’s legal limits, loans are made to a
partnership’s members who by prearrangement then invest in a single risky venture in a total
amount exceeding the lending limit. In reality, the single borrower is the partnership, and the
collateral is the partnership’s property. Mortgage-pulling might involve fraudulent loan
applications and payoffs to the individual partners for participating.

Question 29

New Account Fraud Schemes

Answer 29

False Identification
Business Accounts Using Stolen Cheques
Personal Accounts Using Fraudulent Cheques

Question 30

Some of the more common red flags of potential new account schemes are:

Answer 30

• Customer residence outside the bank’s trade area;
• Dress and/or actions inconsistent or inappropriate for the customer’s stated age,occupation, or income level;
• New account requesting immediate cash withdrawal upon deposit;
• Request for large quantity of temporary cheques; and
• No order for printed cheques.

Question 31

Money Transfer (Wire) Fraud Schemes

Answer 31

Dishonest Bank Employees
Misrepresentation of Identity 
System Password Security Compromised 
Forged Authorisations 
Unauthorised Entry and Interception

Question 32

Following are other examples of wire transfer controls.

Answer 32

• Make sure the person authorising the wire transfer isn’t the individual who orders the wire transfer.
• Require those ordering transfers to have secure passwords.
• Maintain and keep a current list of those ordering wire transfers, and a log of all transfers.
• Require vacations of persons who handle wire transfers.
• Require that reconciliations of accounts affected by wire transfers be performed by persons not involved with the wire transfer process.
• Keep all confidential information about firms’ accounts and wire transfers in safe room
secured with locks. Give computer key cards to these rooms to authorised personnel only. Shred trash.

Question 33

Businesses frequently perform vendor audits, but often neglect to audit their bank’s wire transfer controls. A fraud examiner should evaluate these areas.

Answer 33

• Pick a sample of transactions and review the log of the calls made back to the banking points to verify their authenticity (You may listen to the tape recording of the actual authorisation to ensure compliance with call-back rules.)
• Review documentation of past wire transfer activity from bank statements or bank online transaction history for a daily debit and credit match of each transaction.
• Obtain written confirmations of transactions from the wire transfer provider to determine the timeliness of their receipt by your firm.
• Promptly reconcile problems caused by the usual custom of ending all wire transfers for a day in the mid-afternoon. (Some customers believe they should receive credit and interest on funds received at the end of a day. However, wire transfers made after the afternoon closing time aren’t credited until the next business day.)

Question 34

Financial institutions should ensure the following safeguards when transferring funds:

Answer 34

• Provide customers with unique codes that are required to authorise or order wire transfers.
• Maintain and update lists of employees authorised to perform wire transfer transactions.
• Compile audit trails of incoming and outgoing wire transactions, as well as the employee responsible for each portion of the transaction.
• Review all wire transfer transactions at the end of each day to ensure that the original transfer instructions were executed correctly.
• Make sure the businesses to which the funds are transferred are contacted to ensure authenticity of fund transfer requests. If the businesses are contacted by phone, the phone numbers used should be the original numbers given by the customers when the accounts were opened and not the phone numbers provided by the callers who
requested the transfers.
• Don’t execute wire transfers solely from faxed instructions. Again, verify authenticity by
phoning the original numbers given by the customers when the accounts were opened
and not the numbers provided by the callers who requested the transfers.
• Require that all accounts affected by wire transfers be reconciled by bank employees not
involved with the wire process.
• Ensure the in-house wire operations manual is available only to authorised personnel
and secured when not in use—especially after hours. Cleaning crew employees could
help themselves to client pass codes and other confidential information.
• Record all incoming and outgoing calls for wire transfer instructions.
• Carefully screen wire transfer personnel applicants.
• Reassign to other departments wire transfer employees who have given notice that they
are resigning but still have some time left with the company.
• Require all employees involved in the transfer of funds to take at least five consecutive
days of vacation each year; assign their duties only to other transfer department staff
members during their absence.
• Make sure bank employees never disclose sensitive information over the telephone until
the caller’s identity and authorisation have been verified to the customer information file.
• Separate duties among wire employees who transmit or receive requests for funds. These
employees shouldn’t also verify the accuracy of the transactions.
• Train employees on proper internal controls, fraud awareness, and the importance of
protecting information. Share alerts issued by government agencies and professional
groups.

Question 35

Fraud schemes have been perpetrated involving the unauthorised use of ATM facilities. Schemes include:

Answer 35

• Theft of card and/or unauthorised access to PIN numbers and account codes for ATM transactions by unauthorised persons;
• Employee manipulation;
• Counterfeit ATM cards; and
• Counterfeit ATM machines.

Question 36

Advanced Fee Fraud

Answer 36

Banks find deals that seem “too good to be true” to gain access to large amounts of money
(deposits) at below-market interest rates. The catch is that the bank must pay an up-front
finder’s fee to a person claiming to have access to the money.

Question 37

Advanced Fee Fraud Red Flags

Answer 37

• The agent requests documents on bank stationery or signatures of officers.
• The bank is asked to give nondisclosure agreements to protect agents or other parties.
• There are several complex layers of agents, brokers, and other middlemen.

Question 38

Brokered Loans

Answer 38

A variation of the advanced fee scheme is the brokered loan. Loan brokering applies to either
packages of individual residential (consumer) loans or single commercial loans. A variation
of a brokered loan is the loan participation, where the purchaser participates in the loan but
does not purchase the entire loan. The fraud schemes associated with brokered or
participated loans generally involve selling phoney loans (packages) or selling participations
in loans that have not been properly underwritten. Generally, a large fee is charged for these
brokered loans.

With residential loan packages, the broker sells the package, takes the money, and disappears.
Brokered loans are generally not sold with any recourse to the broker. Therefore, the
purchaser must look to the borrower and the underlying collateral for debt satisfaction. With
loan participations, the lead bank generally performs the underwriting. However, this does
not relieve the participating bank from its obligation to perform its own due diligence. If the
participating bank does not independently examine the documentation and perform its own
due diligence, then fraud schemes on the part of the selling institution are possible.

Question 39

Letter-of-credit fraud can be perpetrated by

Answer 39

beneficiaries using forged or fraudulent documents presented to the
issuing bank with a demand for payment.

Question 40

Prevention

Answer 40

Loan Origination, Underwriting, Closing, Disbursement, and Servicing Segregation
Committee Approval of all Large or Unusual Transactions
Transfer Journal Entries and Orders Review
Independent Review of Loans
Management Review of Write-Offs
Routine Examination of Officers’ Accounts
Proper Lending Policies
Document Requirements for Standard Transactions
Information Verification (for example, Loan Applications)
Employee Training
Standardised Procedures

Question 41

he Basel Core Principles define 25 principles that are needed for a supervisory system to be
effective. Those principles are broadly categorised into seven groups:

Answer 41

• Objectives, independence, powers, transparency, and cooperation (principle 1);
• Licensing and structure (principles 2 to 5);
• Prudential regulation and requirements (principles 6 to 18);
• Methods of ongoing banking supervision (principles 19 to 21);
• Accounting and disclosure (principle 22);
• Corrective and remedial powers of supervisors (principle 23);
• Consolidated and cross-border banking supervision (principles 24 and 25).