The third time is a charm

Internal Auditor, Feb, 1997 by Charles A. Krueger

This small, close knit staff consisted primarily of upper level loan officers with broad responsibility and authority. The management group, which included two former internal auditors, all had strong financial backgrounds. Staff members were personal friends as well as professional colleagues.

Given the relatively small size of the operation, the traditional separation of duties usually found in larger loan offices did not exist. The origination of a loan, the underwriting, and the subsequent servicing of the account were all handled by the same loan officer.

Management pointed out that assigning one loan officer to handle all questions, service issues, and communication on the book of loans written by one agent provided a clear customer service advantage. Also, requiring the same individual to address a customer's issues and questions helped build somewhat of a personal relationship between the customer and the loan officer. Management did, however, have a high awareness of internal control principles and, therefore, segregated cash handling duties. In addition, all loans were reviewed by the president of the subsidiary.

* A Red Flag

One day, the president of the organization happened to take a routine inquiry call from a customer regarding a new loan. The regular loan officer assigned to that customer's region was out of the office.

In the course of conversation, the president mentioned another loan made to the client; but the client knew nothing about it. The signature on the application for the loan in question was different from that on previous applications completed by the client. The address on the application was correct, but all mailings were flagged to be sent to a post office box. The suspect loan application was assigned to a territory that did not have an agent so that no commission payment was allocated. In addition, the loan payments were current. Alarmed, the president called internal audit for help.

The internal audit investigation quickly found several loans with the same post office box address and similar applications and signatures. They were all assigned to vacant territories so that commission reports were not generated, and all were current in their payments. Each loan was well documented and would typically attract little or no attention on its own. The inventory of questionable loans totaled approximately $45,000, and they were all serviced by the absent loan officer.

The legal department was consulted, along with the authorities and the bonding company. When confronted, the loan officer quickly admitted to the fraud. He had used the initial money to finance his auto collecting hobby and had continued the fraud by making periodic new loans to service the older loans. The loan officer indicated that the list of questionable loans was accurate and complete, and the district attorney and company attorneys began coordinating prosecution and restitution.

* Another Red Flag

Afterwards, internal audit began a full scale review of the financial services subsidiary, including a review of all loans. During the review, several loans became past due. Follow-up with the clients revealed that these loans were also fictitious. These loans were in other loan officers' books of business, and another pattern of vacant agents' codes and post office box addresses emerged.

Internal audit, working with the loan officers, was able to develop an inventory of additional bogus loans totaling approximately $70,000. The same loan officer who perpetrated the previous fraud had been able to issue loans in other officers' books of business, and as long as the loans were current they had not drawn attention. Once the loan officer was accused, he stopped servicing all his fictitious loans, and the fraud surfaced.

When confronted with the additional bad loans, the accused loan officer admitted making these fictitious loans in addition to the first group. He also stated that these two lists contained all the fraudulent loans he had made.

Put in the uncomfortable position of informing the legal department, the company president, and the legal authorities of the increase in the amount of the fraud, internal audit was more than a little embarrassed. The professional image of audit suffered in the perceived fumbling of the investigation.

* Red Flag Number Three

The criminal charges and civil negotiations for restitution were near conclusion when a third method of fraud was discovered. This time the loan officer's fraud involved closed loan files. A review of closed files had been performed as part of the earlier audit and had included searches for common addresses, for files with unusual commission arrangements, and for all files within the former officer's book of business. The checking account the former loan officer used to make loan payments had been reconciled to the various loans on file.

However, an undiscovered method had been used to transfer monies between active and closed files. An inventory of $45,000 of additional lost monies was compiled. The former loan officer admitted to the additional fraud, assuring the auditors and authorities that their most recent discovery did indeed represent the totality of the fraud. Somehow, those involved were less than confident they had really found everything. The charges were not revised again, but read into the record. Internal audit's credibility was badly bruised by that point.