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Enforcement Actions Against Individuals 2005: A Year in Review
This is the third and final article in a series addressing insider fraud and enforcement actions. The first article1 presented an overview of the enforcement action process; the second2 presented two enforcement action case studies. This article will present details on a calendar year of enforcement actions against individuals, focusing on the losses to institutions and the importance of oversight at all levels of a financial institution as a deterrence to insider fraud. Some representative fraud cases are included to illustrate how fraudulent activities have been carried out for a number of reasons, including personal gain, to conceal the deteriorating condition of a bank customer, or to protect an individual's position in the financial institution. Fraud has been a contributing factor in many bank failures, as financial institutions are not always able to recover from fraudulent activities.3 This article will look at the importance of board oversight of senior bank management,4 who were responsible for 80 percent of the fraud losses5 identified in these enforcement actions in 2005.
Overview of Enforcement Actions Issued in 2005
In 2005, the Federal Deposit Insurance Corporation (FDIC) issued 84 enforcement actions against individuals. The enforcement actions included Orders of Removal/Prohibition, Orders to Pay Civil Money Penalty, and Orders to Pay Restitution. Some respondents were issued an Order of Removal/Prohibition with a joint Order to Pay Civil Money Penalty or Order to Pay Restitution. Of the enforcement actions issued in 2005, 63 percent were stand-alone Orders of Removal/ Prohibition and 5 percent were stand-alone Orders to Pay Civil Money Penalty. A total of 32 percent of the Removal/ Prohibition cases involved either a joint Order to Pay Civil Money Penalty or a joint Order to Pay Restitution.
The individuals against whom the FDIC issued enforcement actions in 2005 caused 68 financial institutions to incur a combined total loss of $67 million.6 The following comments present the FDIC's 2005 removal/prohibition action cases with a focus on loss to financial institutions. The cases are divided into three categories to show the loss impact of fraudulent activities perpetrated by individuals subject to the enforcement actions.
2005 Removal/Prohibition Orders Classified by Loss
The enforcement actions issued in 2005 (with the exception of the stand-alone Orders to Pay Civil Money Penalty) are grouped into categories on the basis of the gross amount of loss to the financial institution:
The categories also contrast the various factors related to the enforcement action cases and highlight the impact of fraud perpetrated by senior bank management. Table 1 provides a breakdown of the categories and the resulting losses.
With total losses of approximately $54.5 million, the enforcement action cases in Category 1 represented the greatest loss to financial institutions. It is notable that most cases in Category 1 were perpetrated by senior bank management, including board chairmen, presidents, and internal directors. This category includes fraud schemes that were carried out by more than one insider and for which the FDIC issued Orders of Removal/Prohibition against each respondent. Some fraudulent activities involved both the chairman of the board and the president. The most significant loss in this category was approximately $34 million, which led to the bank's insolvency and eventual merger into another financial institution. Excluding this case, the total loss for Category 1 is approximately $20 million, and the average loss adjusts to $2.3 million. While the Category 1 median misconduct period is 5.3 years, two cases at the upper limit are a misconduct period of 14 years with a bank loss of $1.5 million, and a misconduct period of 20 years with a bank loss of $1.6 million. There are also cases in this category that occurred within a one-year period and still resulted in significant loss to the financial institution. The median age for Category 1 respondents was 56; no respondent in this category was less than 40 years of age. Approximately half the total losses in Category 1 were used by respondents for their personal benefit. The remaining losses were primarily loan losses suffered by the institutions as a result of the fraudulent insider activity.
Category 2 involves 20 cases and a total loss of approximately $8.6 million. While only two cases in this category involved senior bank management, the remaining cases included various other levels of bank management, including assistant vice presidents, vice presidents, assistant cashiers, branch managers, senior loan officers, and loan officers. As with Category 1, the fraudulent activities of individuals in management positions caused the greatest financial loss. The youngest respondent in this category was 30 years of age; the median age of the respondents was 47. The highest loss of the category, $800,000, occurred over a ten-year period, and the insider responsible for the loss was the bank's president. As with Category 1, funds used by respondents for their personal benefit represented approximately half of the total losses in Category 2.
This category includes 39 cases with a total loss of approximately $4.1 million. Category 3 also includes nine enforcement action cases in which there was no monetary loss to the financial institution. However, the no-loss cases resulted in personal gain or benefit to the respondents, and the institutions' depositors were or could have been prejudiced. Most of the no-loss cases involved senior bank management. The respondents in Category 3 ranged from a chairman of the board to a teller/proof operator. The youngest respondent was 23; the median age was 43.
Senior Bank Management The Primary Cause of Fraud-Related Losses
The total loss to financial institutions resulting from the conduct of individuals against whom the FDIC issued enforcement actions in 2005 was approximately $67 million. Senior bank management was responsible for 80 percent of those losses. Clearly, the significance of those losses emphasizes the need for strong board oversight of senior bank management, including fellow directors. Insiders in senior management positions have perpetrated fraudulent schemes for personal gain, to conceal the deteriorating financial condition of loan customers, and to protect their positions. The following examples illustrate some of the fraudulent activities conducted by senior bank management.
Oversight The Deterrence to Insider Fraud
Ultimate responsibility for preventing fraud rests with the board of directors, which must create, implement, and monitor a system of internal controls and reporting. The board also appoints executive officers, who share the responsibility for the financial institution's well-being. As demonstrated above, the most significant losses have been perpetrated by senior bank management; therefore, the board must ensure that appropriate controls are in place throughout the institution and must actively review the activities of senior management. Most of the cases described above reflect the lack of appropriate board disclosure, poor internal controls, or dominance of the board by a single individual. As stated in the first two articles of this series, bank employees in positions of trust can exploit internal control weaknesses to conduct improper activities. Strong management oversight and thorough audit and loan review programs are essential to identifying and deterring wrongdoing.
Although not all fraud can be prevented, procedures should be established whereby suspicious activity of any insider is reported to senior bank management and the board. Refer to the text box for key directorate responsibilities. In addition, the board should develop operational policies and require management to adhere to the policies. For example, deviations from the board's approved loan policy, which generally provides guidelines regarding officer lending authority and loan documentation requirements, should be approved by the board, or an individual or committee designated by the board. Most important, the board should question and investigate the actions of insiders that do not conform to the board's policies, or that are of a suspicious nature.
A board of directors' primary responsibilities are formulating sound policies and objectives for the bank and effectively supervising the bank's affairs and welfare. The circumstances surrounding each of the 2005 enforcement actions issued by the FDIC indicate that an estimated $67 million in losses might have been avoided or reduced by sound board oversight and supervision and strong audit programs.
1 Enforcement Actions Against Individuals in Fraud-Related Cases: An Overview, Supervisory Insights 2, Issue 1, Summer 2005.
2 Enforcement Actions Against Individuals: Case Studies, Supervisory Insights 2, Issue 2, Winter 2005.
6 The loss amounts discussed in this article represent only losses related to enforcement actions the FDIC issued in the 2005 calendar year, not industry-wide fraud-related losses to financial institutions.
7 Defined by Section 8(e) Removal and Prohibition Authority of the Federal Deposit Insurance Act.
9 FDIC's Director's Corner web site.
10 FIL-80-2005 , Fraud Hotline: Guidance on Implementing a Fraud Hotline.
11 FDIC's Director's Corner web site and other resources for bank directors.
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