Federal Financial Institutions Examination Council, Examiner Education

3501 Fairfax Drive • Room 3086 • Arlington, VA 22226-3550 • (703) 516-5588 • FAX (703) 516-5487 • http://www.ffiec.gov

The Detection, Investigation and Prevention of

Insider Loan Fraud: A White Paper

Produced by the October 20 – November 1, 2002

FFIEC Fraud Investigations Symposium

Participants:
Stan Shull, Patricia Handley, John Lombardo, Phil Houle, FDIC
Linda Word, FRB–Atlanta, Carol Gorton FRB–Chicago, (Lead Writer)
Meg McPartlin, Jeffrey Steele, Darlene Callis, (Moderator), NCUA
Christopher Sablich, Louis Pinder, Larry Burch, OCC
Edward Bodden, OTS

Development Group:
Karen Currie, Debra Novak, FDIC
Laurie Bender, Dale Vaughan, FRB
Lynn Markgraf, NCUA
Nikki Boxrucker, Matt Johnson, OCC
Don Cooper, David Freimuth, OTS

Dennis Dunleavy, FFIEC, (Senior Program Administrator)

(Any suggestions for future enhancements may be directed to your
development group rep or Dennis at: [email protected])

May, 2003

Board of Governors of the Federal Reserve System, Federal Deposit Insurance

Corporation, National Credit Union Administration, Office of the Comptroller of the
Currency, Office of Thrift Supervision.
 INSIDER LOAN FRAUD

TABLE OF CONTENTS

Introduction 1
Factors Conducive to Fraud 1
Examples of Insider Loan Fraud 2

Control Environment Assessment 3

Code of Conduct 4
Employment Practices 5
Independent Loan Review 6
Audit 7
Internal Controls 7

Insider Loan Fraud Detection 8

Analysis of Electronic Loan Data 9
Board of Directors Minutes and Reports 10
Discussions with Employees 10
Insider and Borrower Financial Statement Analysis 10
Loan File Review 11

Researching Suspicious Circumstances 11

Interviewing 12
Documentation 14

Conclusion 17

Appendices:
Appendix A Control Environment Assessment Quick Reference 18
Appendix B Detectable Warning Signs 19
Appendix C Research Procedures 32
Appendix D Loan Tracing Procedure Detail 36
Appendix E Summary Case Memo 37
Appendix F Flowchart Sample 38
Appendix G Public Websites 39

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 INSIDER LOAN FRAUD
Fraud poses substantial risks, both to individual
institutions and the financial system. This interagency guidance
focuses on insider1 loan fraud and ways that financial
institution examiners can identify, research, and document
suspected activities. Though intended to heighten examiners’
awareness and encourage flexible approaches to this problem,
direction provided herein is not meant to over-ride or replace
current examination policies and practices. Examiners should
only use these procedures contained in this document when warning
signs that warrant expanded procedures are present and in
consultation with their supervisors.

The initial narrative portion discusses various issues

related to prevention, detection, and documentation. In
addition, a series of appendices contain warnings signs,
procedures and other guidance designed to be separated for
examiner use. The first narrative section, Control Environment
Assessment, concentrates on infrastructure that reduces the risk
of insider loan fraud. The second portion, Insider Loan Fraud
Detection, identifies avenues of review that might reveal
anomalous items requiring additional research. The last section,
Researching Suspicious Circumstances, while discussing the
importance of additional procedures, also highlights the critical
nature of interviewing skills and appropriate documentation. The
associated Appendices include an inventory of warning-signs
specific to insider loan fraud and a group of procedures that can
be used to research suspected activities, as well as other
reference materials. Examiners should use these appendices in
conjunction with the applicable narrative sections and in
consultation with their supervisors.

Factors Conducive to Fraud

Fraud is often defined as: “[a] knowing misrepresentation

of the truth or concealment of a material fact to induce another
to act to his or her detriment.”2 There are several common
psychological and environmental conditions that foster the
occurrence of fraud. The fundamental element that must exist is
awareness of a control weakness that can be exploited for
financial gain. Further, whether committed individually or in
collusion, fraud frequently arises when an instigator(s) develops
a financial need that he or she cannot share with anyone.
Examples include addictive behaviors, family medical problems,
romantic entanglements, financial hardships, or similar

1
The term “insider” is intended to mean an institution-affiliated party, such as an
officer, director, employee, agent, consultant or any other person who participates in
the affairs of a financial institution.
2
Black’s Law Dictionary p. 670 (7th ed. 1999).

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situations. Finally, the instigator(s) develops a
rationalization that makes the act acceptable in his or her
personal ethical code.

Since the tone set by executive management tends to

permeate the entire organization, a strong ethical tenor at the
top of an organization will help establish a principled attitude
throughout. Absent that, it is not unusual for lower level
employees to follow the lead of any top managers who may be
engaging in fraud or perceived as such. Even without illegal
activity at the top, lax management and weak internal controls
can produce a similar effect.

Environmental aspects such as weak internal controls and an

inadequate audit program present the motivated insider with the
opportunity to engage in improper behavior. Active, strong
controls reduce the opportunities available to those who find
themselves in the circumstances referred to above. In the
absence of a satisfactory control environment, the following
elements can help to counter-balance structural deficiencies:

• Increased attention to an institution’s operations and

staff when examiners are on-site,
• A skeptical attitude on the part of examiners and auditors
geared toward early fraud detection, before the level of
damage imperils an institution, and
• Visible, credible adverse consequences, such as a high
probability of detection, administrative enforcement, and
criminal prosecution.

Examples of Insider Loan Fraud

The following list, while not all-inclusive, illustrates

various insider loan fraud situations typically found in
financial institutions:

• Nominee loans4 and similar transactions that are constructed

to circumvent laws, regulations, and institutions’ internal
limits or internal policies;
• Conflicts-of-interest that go beyond laws governing insider
interests;
• Bribes and kickbacks arising from lending activities;
• Loans tied to favors for friends and family, including non-
monetary consideration;
• Fictitious loans;

4
A “nominee loan” is one in which the borrower named in the loan documents is not the
real party in interest, i.e., the party that receives the use or benefit of the loan
proceeds.

2
 • Manipulation in the sale and purchase of loan pools,
• OREO sold through preferential contracts that include
favorable financing or are not at arms length,
• Inappropriate or fraudulent loan arrangements used to
purchase capital stock, which inflates the capital base.

When insider loan fraud does occur, the federal regulatory

agencies may be able to penalize the offender, protect the
financial system from the offender, and deter similar offences by
other insiders by pursuing civil enforcement action. The
agencies may have the authority to pursue certain enforcement
actions against an insider who has committed loan fraud,
regardless of whether the insider is criminally prosecuted.
These possible actions include assessing civil money penalties;
ordering insiders to reimburse, make restitution or indemnify
losses; or prohibiting insiders from participating in the affairs
of insured institutions.

CONTROL ENVIRONMENT ASSESSMENT

Insider loan fraud prevention, like other forms of fraud
prevention, is a frame of mind. An institution’s control
environment, including management’s attitude, may contribute
significantly to windows of opportunity for insiders to commit
loan fraud. Not only do control weaknesses provide the
opportunity for an insider to commit loan fraud; some insiders
may even seek out weaknesses to exploit. Examiners and
institution management should be alert to all possibilities.

The control environment should be examined with healthy

skepticism. Different facets of the institution’s structure and
culture should be examined using your agency’s risk assessment
approach to examinations. Certain tools can be used to determine
if windows of opportunity are open and to determine the need for
additional resources and time to be allocated to an on-site
examination to help close these windows.

Although it is not possible to avoid all instances of

insider loan fraud, financial institutions can better manage such
risk by creating a control environment that promotes honest and
open corporate behavior. It is far more cost effective to
prevent insider loan frauds than to investigate and prosecute
them. A strong control environment hinders an insider from
dominating the institution and circumventing restrictions.
Strong employment practices prevent people with questionable
reputations from entering the financial services industry.
Essential elements of a strong control environment include code
of conduct, employment practices, loan review system, independent
audit, and internal controls.

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 Code of Conduct

An essential preventive element against insider loan fraud

is a clear statement by the institution’s board of directors of
its ethical position, such as a code of business principles.5 A
code of conduct, which is expressed strongly and applied
vigorously, gives all employees a way to resolve ethical
conflicts and positions the institution as one that does business
fairly and honestly. Compliance must include the entire
institution: directors, management, employees, and institution-
affiliated parties. The code of conduct should be impartially
enforced and include sanctions.

People have a tendency to view fraud as a crime which is

committed by outsiders rather than intimates. As a result,
insider loan fraud is sometimes not fully considered in the
development and enforcement of codes of conduct and business
principles. It can be seen by management as a negative feature
in a code extolling positive corporate principles such as
teamwork, trust, and respect. Ignoring this potential risk is a
lost opportunity. Financial institutions, which successfully
promote high standards of ethical conduct in all situations, have
a lower incidence of fraud and find out about incidents earlier.

Consider the following questions when assessing the

adequacy of an institution’s code of conduct:

ƒ Does the code of conduct address conflicts of interest and

self-dealing that could lead to fraud?

ƒ Does the code of conduct define acceptable behavior, encourage

ethical conduct, and establish mechanisms to monitor and
enforce the policy?

ƒ Does the institution have a system to validate compliance with

its code of conduct?

ƒ Does the institution have an ongoing program to educate and

raise the awareness of the entire institution regarding its
code of conduct?

ƒ Does the institution provide an independent avenue, such as a

whistle blower policy, for reporting suspicious activity
directly to the board of directors?

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Refer to agency guidelines for specific guidance regarding appropriate code of conduct
and conflicts of interest policies.

4
ƒ Does the code of conduct or loan policy define the term
“related interests” and include provisions for proper
disclosure of all related interests?

Employment Practices

An essential defense against insider loan fraud is the use

of proactive hiring procedures. Employees engaging in frauds
often fit a profile. As stated earlier, they may be involved
with drugs, alcohol, gaming, or personal relationships creating
extraordinary financial needs, or may be experiencing personal
financial hardships that are otherwise unknown to their employer.

Ongoing monitoring and awareness of all employees’

immediate situational factors is essential. Many of the most
scandalous insider loan frauds have been generated by persons of
“impeccable” social background with no previous record of
dishonesty. In essence, this lack of a prior history of insider
abuse and self-dealing led to a false sense of security and
contributed to the ability of such insiders to participate in
large frauds.

Consider the following questions when determining whether

an institution’s employment practices are proactive deterrents
for insider loan fraud:

ƒ Are comprehensive background checks performed for all new

personnel, including directors? While such a program should
be tailored to the size and complexity of the institution, the
protocol could include evaluation of handwriting and
fingerprint samples by law enforcement authorities,
verification of educational transcripts, analysis of credit
reports, reference validation, and public records searches?
Institutions should ensure legal requirements for above items,
such as credit reports, are observed.

ƒ Are there procedures in place to check employment references

with other financial institutions with respect to prospective
employee’s suitability? For example, are references reviewed
to determine if there has been involvement in potentially
unlawful activities? (Section 355 of the USA Patriot Act).

ƒ Are there appropriate procedures to ensure that the

institution has an ongoing screening program to monitor and
detect changes in its employees’ and directors’ lifestyles,
behaviors, and actions? Do these procedures include periodic
credit reports and public records searches?

The extent to which employment practices are implemented

may differ due to the size and complexity of the institution;

5
however, compensating controls should be in place. Examples of
compensating controls could include some of the following:

• Periodically reviewing the financial statements and tax

returns of insiders with outstanding loans,

• Reviewing an annual questionnaire in which insiders identify

their related interests, and

• Reviewing insiders’ deposit and loan accounts on a routine

basis to determine the reasonableness of transactions.

Independent Loan Review

The complexity and scope of a loan review system will vary

based on an institution's size, type of operations, and
management practices. However, an effective loan review function
can expose insider loan fraud and self-dealings at an early
stage.

Consider the following questions when trying to determine

the effectiveness of an institution’s loan review system relative
to insider loan fraud:

ƒ Is the loan review function independent of the credit

administration and loan approval processes? Are loan review
findings reported directly to the board of directors or board
level committee?

ƒ Are procedures in place to review insider loans within a

reasonable time period after origination?

ƒ Is the loan review timely, thorough, and comprehensive? Does

it ensure that loan samples include loans originated by all
lending officers and is representative of all lending types?

ƒ Are procedures in place to ensure the prompt identification of

loans with well-defined weaknesses and relevant lending
patterns that may potentially be indicative of fictitious or
fraudulent activity?

ƒ Are procedures in place to identify multiple extensions,

renewals, or rewrites that are exceptions to policy?

ƒ Are procedures in place to assess the adequacy of and

adherence to established lending and conflict of interest
policies?

ƒ Does loan review substantiate appraisal values for real estate

properties and make adequate reviews of appraisals?

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ƒ Do loan review personnel have the knowledge and confidence to
challenge transactions that look suspicious, especially if the
transactions have been executed by an executive officer or
board member?

Audit

Deterring dishonest insider lending practices may be

achieved by increasing an insider’s perception of the risk of
credible adverse consequences – namely, detection and
prosecution. A comprehensive independent audit function provides
a significant deterrent on both accounts. The institution should
have a reliable accounting function and internal control system,
as well as an appropriately staffed audit function that has
sufficient authority and resources to perform its function. The
audit function should be independent and report findings directly
to the board of directors.

Consider the following questions when assessing the

adequacy of an institution’s audit function as a viable deterrent
against insider loan fraud:

ƒ Does the scope of the audit include review of compliance with

the code of conduct, employment practices, loan review
systems, and internal controls?

ƒ Are there specific audit procedures to target insider loan

fraud?

ƒ Are confirmations of loan balances performed frequently enough

with proper controls?

ƒ Does the audit include a review of general ledger suspense

accounts, such as loans in process; employee accounts and
other transactions, such as wires, performed by employees; and
charged-off loans for insider involvement?

ƒ Are auditors willing to challenge any transaction that looks

suspicious, especially those involving an executive officer or
board member?

Internal Controls

The potential for insider loan fraud is greatly increased

in an environment where internal controls are lax, arbitrary, or
non-existent; where management and others are exempt from policy
and procedures; where nepotism is allowed but not acknowledged;
and where the authority to act does not accompany responsibility
for results.

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 Consider the following issues when assessing the
effectiveness of an institution’s internal control system:

ƒ Does the institution perform a risk assessment relative to

insider loan fraud? Are anti-fraud policies and procedures in
effect?

ƒ Does the institution routinely assess the effectiveness of

controls with the ultimate test: would its system of checks
and balances identify actions of a dishonest insider
committing loan fraud?

ƒ Does the institution’s control environment and organizational

structure allow one employee or director to dominate or
undermine lending decisions, or dominate senior management and
the board?

ƒ Does the institution require rotation of duties and schedules

without notice?

ƒ Is there sufficient segregation of duties? It should not be

possible for a single individual to complete all aspects of a
transaction. Authorization for a transaction, custody of the
asset, and ability to effect accounting entries should not be
concentrated in one person.

ƒ Is the institution’s vacation policy strictly enforced for all

employees? What are the consequences of policy violations?

ƒ Does the board monitor and supervise the actions of the

institution’s loan officers to determine that they are
executing their duties and loan authority in accordance with
the loan policy and delegations of authority granted by the
board?

To summarize, as examiners assess the complete control

environment in relation to insider loan fraud, a “no” answer to
any of these questions indicates that the institution may have a
heightened exposure to insider loan fraud. Although not a
certainty, a negative response to a single issue is a window of
opportunity for insider self-dealing, abuse, or fraud. A one
page recap of the above tips is provided in Appendix A for
detachment and use in the field. In addition, many of these
concepts can be applied to the detection, not just the prevention
of insider loan fraud.

INSIDER LOAN FRAUD DETECTION

Experience and common sense are key elements in the
identification of potential insider loan fraud. If something

8
does not look right or does not seem to make sense, further
analysis is usually needed. In addition, communicating your
concerns to the examiner-in-charge early on is critical to
alerting other examiners to look for similar patterns or
circumstances.

This section identifies common sources of information that

may contain warning signs of possible insider loan fraud. In
reviewing documentation from these sources, examiners need to be
mindful of the ease with which fraudulent documents can be
created. Photocopies may not be representative of the original
documents. Inconsistencies between what should be identical
information contained in one document and another may indicate
that one, or both, of the documents may be forgeries. The
examiner should always request original documents in these
situations.

The following are examples of instances where examiners

discovered information that did not seem to make sense, and their
perseverance uncovered material insider loan frauds.

ƒ Over a three-year period, an institution’s quarter-end past

due loan ratio was consistently around one percent. Closer
review by examiners revealed that the chief executive officer
was refinancing loans and extending loan payments to maintain
a low past due loan ratio.

ƒ While reviewing a loan trial balance, an examiner noticed

several real estate secured loans to different borrowers on
the same street with consecutive house numbers. The examiner
also noticed that the loan balances did not appear to be
amortizing. Research of public records disclosed that the
borrowers did not own the real estate pledged as collateral.

These are just a couple examples of examiners taking a step back

and looking at the big picture to see if things just make sense.

Analysis of Electronic Loan Data

It is common practice for financial institutions to provide

regulators with an electronic download of the institution’s loan
data, which is used primarily to determine the loan review scope
for an examination. Many of the data fields contain information
that, when properly analyzed, may be early indicators for
potential insider loan fraud. Often the data is in a spreadsheet
format, which enables examiners to perform calculations and data
sorts.

Although the guidelines in Appendix B are based on data

fields that are common to loan processing systems, not all
institutions will maintain each of the data fields discussed

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below. In those instances, and especially where insider loan
fraud is suspected, examiners should consider alternative
information sources such as reviewing system generated reports.

Board Minutes and Board Reports

The content and informative value of board of directors’

minutes and board level reports varies from institution to
institution. It is just as common for some institutions to
maintain detailed board minutes as it is for others to record
only basic information. Management may be able to successfully
conceal indications of fraud by generating voluminous board
packages rife with minute detail as easily as by omitting key
information. Board reports should be reviewed carefully to
determine the accuracy, adequacy, and appropriateness of
information reported to the directorate.

Discussions with Employees

Formal and casual discussions with employees may reveal

irregularities, anomalies, or suspicious behavior. Employees who
are very guarded in answering examiner questions may have
something to hide. They may have personal knowledge of
questionable loan transactions and are looking for an opportunity
to inform examiners. Some employees may seek out examiners with
known situations. Other employees may unknowingly reveal
information through casual discussion that should be pursued by
examiners. An additional discussion of interviewing is included
in the section - RESEARCHING SUSPICIOUS CIRCUMSTANCES.

Insider and Borrower Financial Statement Analysis

Analysis of insiders’ and borrowers’ financial statements

can reveal several points of interest. Statements that contain
accumulated assets or liabilities that are in excess of an
insider’s income generation capabilities can be a significant
indicator of suspicious activity. Additionally, review of a
borrower’s financial statements can reveal borrowing or business
relationships between an insider and other institution customers.

It is important that a institution’s internal analysis of

insider financial statements occur in the ordinary course of
business under the established credit granting regimen. This
would include verification of assets and liabilities,
particularly if the financials are unaudited. Lack of
verification of financial statement items can be a warning sign
that merits further examiner review.

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 Loan File Review

If warning signs are present, examiner loan file review

should include a review of the financial institution’s policies
and procedures, loan files, and committee minutes to determine
existence of anomalies. A synopsis of key policy parameters
prepared by a member of the examination team can aid file review
examiners by providing a ready reference for assessing policy
compliance. Inconsistencies with policies and procedures should
trigger more intense scrutiny.

In summary, suspicion of insider loan fraud may arise from

a variety of sources or from a just single source. The key is to
question inconsistencies or information that does not make sense
until the issues are resolved. Researching issues can be
accomplished through a number of avenues that are discussed in
the following section. A detailed list of warning signs is
provided in Appendix B.

RESEARCHING SUSPICIOUS CIRCUMSTANCES

Standard examination procedures are not designed to test
routinely for fraud, particularly in a risk-focused environment.
This section and related appendices provide possible procedures
to use when examiners suspect insider abuse or fraud, as well as
guidance for interviewing and documenting findings. Some of
these procedures include tracing loan payments and proceeds,
reviewing insiders’ deposit account activity, analyzing general
ledger reconcilements and suspense account activity, and
researching public records for relevant information.

• Tracing loan payments and proceeds can provide details on the

transaction originator(s) or identify additional participants,
as well as reveal the path of funding flows, and the final
destination of funds. This information can be used to
substantiate evidence of intentional misconduct.

• Reviewing insiders’ deposit account activity and official

checks can also help establish the flow of funds; identify
previously unknown, related parties to transactions; accounts
at other institutions; and other lending relationships,

• Review and tracing of reconciling items can reveal items that

are not cleared properly or are re-aged to hide
irregularities. Fraudulent lending activity is sometimes
hidden in reconciling items of general ledger accounts.

• Researching public records will supply a wide variety of

information related to lien filings, ownership of assets,

11
 relationship of different parties, previously unidentified
related interests, etc.

A more extensive list of potential procedures is provided

in Appendices C and D, which can be detached for field use.
These are not intended to be all-inclusive, but rather are
designed to stimulate the thought process about procedures that
can be applied depending on the circumstances. Furthermore, each
of these steps would not be appropriate in all instances. The
nature of the suspected fraud will dictate the avenue of inquiry.
Many of these items can also be used in detection of fraud.

If a special inquiry appears to be indicated, examiners

should consult with their supervisors, fraud specialists, subject
matter specialists, and legal staff in planning and executing
fraud detection or research procedures. The review should be
conducted in an objective manner and proceed in a way that does
not raise the defenses of the insider(s). It is important to
proceed in a way that does not reveal the examiner’s suspicions
too early, as the insider may destroy records to protect his or
her position. It is usually desirable to request a larger group
of records than the specific documents that may reveal the
precise fraud. This puts the evaluation in a broader context and
helps cover the anti-fraud purpose of the review. The examiner
should also carefully consider the timing as to when the anti-
fraud purpose of the review is revealed. Generally, the examiner
should wait until all applicable records have been obtained and
copied or until all leads have been exhausted with no further
avenues to pursue before discussions with personnel.

In addition, examiners may consider other actions to

follow-up on suspected insider loan fraud. For instance, in
accordance with the agency’s policies and procedures, the
examiner may recommend the issuance of an order of investigation.
The order of investigation empowers the agency to issue subpoenas
and take depositions. This provides a means of obtaining
evidence from sources that are outside of the institution.
Another option to consider is a recommendation that the
institution engage a third party to investigate the suspected
offenses, such as a financial institution consultant, forensic
accountant, or private investigator.

Interviewing

Information gathering through discussion or interview is a

standard examiner tool employed on every examination. While
interviews conducted when fraud is suspected contain some of the
same methods employed in standard examinations, additional
techniques are necessary for maximum effectiveness. The nature
of the interview is different and a more tactical approach is
necessary. An examiner should not conduct these types of

12
interviews alone, but should take another examiner as a witness
and to help with taking notes.

Since preparation is critical to success, it is important

for the interviewer to review existing documents and known
information. Initially, the examiner should determine the
information he or she needs to have from the interview. A
strategy needs to be developed that leads the interview from
general information toward the specific details that the examiner
needs to reveal. It is important not to script the interview
with specific questions, but rely on a list of key discussion
points. The interviewer needs to ensure that the interview
subject does not glean too much information from the nature of
the questions asked and discern the purpose of the interview too
early.

A good interviewer needs to be skilled at human interaction

and able to easily establish rapport in the interview. Efforts
should revolve around setting the interviewee at ease and making
him or her feel comfortable about volunteering information.
Helpful techniques include conducting the interview in an
informal manner without the use of accusatory language. It is
important that the interviewee not feel at risk at this stage.
Maintain eye contact with the subject as much as possible, but
avoid showing excitement in regard to specific answers. This can
reveal the direction of your research at an inopportune time.
Asking for his or her help frequently helps to create a non-
threatening atmosphere. The use of clear and concise open-ended
questions can expedite the gathering of information. It is also
important for the interviewer not to try to impress the subject
with an abundance of knowledge about the topic of the interview.
This may limit the flow of information. Above all, the
interviewer must adopt an unbiased approach with a demonstrated
commitment to fairness for all involved.

Although an interviewer needs to take notes, the examiner

should not try to write everything down during the interview, but
should note only the pertinent facts. It is important to avoid
impeding the pace of the interview just for note taking. As
stated above, there should always be two examiners in an
interview of this type. It is common for one to focus on note-
taking while the other takes the lead in the conversation. Each
interviewer’s notes should then be expanded into as much detail
as possible, immediately after the interview, and compared for
accuracy and completeness. Avoid making notes regarding your
overall opinions or impressions of a witness during the interview
as this can also prematurely signal the examiner’s concerns or
direction of the research.

Focusing on inconsistencies between various statements and

documentary evidence is a useful tactic. These could be
differences between individual subjects’ statements on the same
13
topic or question, differences between subjects’ statements and
documented evidence, differences between statements made by a
subject and statements made by other staff about the same topic
or question, or a variety of other situations. The examiner
should continue to question institution employees and officers
about these inconsistencies until satisfactory answers are
obtained. If the answers do not make sense, keep asking
questions until they do. Once clear evidence of wrongdoing has
been documented, this information should be discussed with your
supervisor regarding the appropriate steps to take. In addition
and in consultation with your office, the information should be
provided to the highest level of authority at the institution
that is not suspected in the fraud for the institution’s own
follow-up investigation. In many cases, this would be the board
of directors. However, since directors are sometimes involved in
insider frauds, care must be taken to approach parties not
believed to be involved in the fraud scheme.

Documentation

Examiners must properly document insider loan fraud in

order for the regulatory bodies and law enforcement to pursue
appropriate civil or criminal enforcement action. While the
decision to criminally prosecute an insider suspected of fraud is
outside the control of the agencies, law enforcement officials
may be more inclined to pursue a well-documented case.
Regardless of whether a criminal prosecution is pursued, insider
loan fraud cases will likely involve activity that is subject to
civil enforcement action by the agencies, such as civil money
penalties (“CMP”); restitution, reimbursement, and
indemnification orders; and prohibition orders.6 The success of
a civil enforcement case is highly dependent on the quality of
the examiner’s documentation. Examiners should consult with
their supervisors, fraud specialists, and legal staff to ensure
insider loan fraud cases are properly documented. The following
paragraphs contain some basic guidelines on documentation that
examiners should keep in mind when looking into possible insider
loan fraud.

At a minimum, the examiner must document that the insider

engaged in an “actionable” offense, i.e., that he or she violated
a law or regulation, engaged in unsafe and unsound practice, or
breached a fiduciary duty. However, just documenting the
existence of an offense is not enough. The examiner must also
determine and document the effects of the insider’s offense

6
For U.S. banks and agencies of foreign banks, federal branches, and savings
associations, see 12 U.S.C. § 1818(i) (civil money penalty); 12 U.S.C. § 1818(b)(6)
(restitution, reimbursement, or indemnification order); and 12 U.S.C. § 1818(e)
(prohibition order). For federally insured credit unions, see 12 U.S.C. § 1786(k) (civil
money penalty); 12 U.S.C. § 1786(e)(3)(A) (restitution, reimbursement, or indemnification
order); and 12 U.S.C. § 1786(g) (prohibition order).

14
(e.g., whether there was gain to the insider, unjust enrichment
to the insider, or loss to the institution) and the culpability
of the insider (e.g., whether the insider acted knowingly,
willfully, or recklessly in engaging in the offense). These
elements are important in determining the type of enforcement
action that can be pursued.7

To help ensure complete documentation, prepare a written

description of the insider’s actionable offense, and then
determine whether you have documents or records to support each
statement of “fact” set forth in that description. A sample
memo is provided in Appendix E. This process will assist in
identifying gaps in documentation, as well as instances where the
examiner’s initial perception of the “facts” is not supported by
the documentation.

The following tips may aid the examiner in gathering

documents in a condition that will support an administrative,
civil, or criminal action:

ƒ Examiners should document whether and how the insider’s

activities strayed from established policies, procedures, and
practices that were in effect at the time of the insider’s
transactions. This comparison is important in demonstrating
the insider’s culpability. Accordingly, examiners should
retain, where appropriate, complete copies of the
institution’s loan policies, loan authorization limits, loan
approval procedures, ethics or conflicts of interest policy,
samples of routine loan presentation/approval packages, etc.

ƒ Sometimes it is important to document the absence of an

occurrence. For instance, the fact that a loan to an insider
was not presented to the board for approval may be relevant to
a case against the insider. Examiners should document the
lack of board approval by retaining complete copies of full
board and board committee minutes for all relevant time
periods.

ƒ If relevant information is contained in a certain document or

file, retain a copy of the entire document or file, not just
the pages that include the relevant information. This will

7
As an example, to support a tier II CMP for a recklessly engaged in unsafe and
unsound practice, the documentation must show that the insider acted or failed to act and
that:
1) Those acts or omissions were contrary to normal financial institution practices,
2) Those acts or omissions placed the institution, its depositors or its
shareholders/members at an abnormal risk of loss,
3) The insider knew or should have know of the associated risk, yet failed to heed
such risk, and the insider benefited or the institution incurred losses as a result
of those acts or omissions.

Consult with your agency’s enforcement area for specifics to your agency.

15
 protect against the insider adding or deleting information to
or from those documents at a later date.

ƒ Copy both sides of records such as checks, notes, and general

ledger tickets. The information on the reverse sides of these
records may be relevant to the case. Moreover, copying both
sides of these records will protect against subsequent
counterfeits by the insider or others. When on-line
processing systems are used to post debits and credits, screen
prints showing trace and batch numbers for both sides of these
records should be obtained.

ƒ Examiners should not write on or make marks on the face of any

of the documentation. Such writing or marks could jeopardize
the integrity, authenticity, and admissibility of those
documents as evidence.

ƒ At the time of receipt, examiners should document the date

they acquired a record and the name and title of the person
from whom they obtained the record.

ƒ Use flowcharts and other graphics in documenting the case.

Use of flowcharts and graphics will help others, including
agency attorneys, other examiners, opposing counsel, law
enforcement, and administrative law judges, visualize the
transactions and gain a better understanding of the case. A
sample flow chart is included as Appendix F.

ƒ Make sure copies of documents and records are readable.

ƒ Examiners should label, date, and index all documentation. The

organization of documents should mirror the flow of events
they support.

ƒ When in doubt, make and retain a copy of the record. This

will help minimize the time spent going back to the
institution to obtain necessary documentation. Furthermore,
it may protect against subsequent destruction of relevant
records.

ƒ When examiners suspect the possibility that institution

records could be destroyed or altered, consider sealing those
records or requesting the institution to place special
controls over those records. Consult with your supervisor and
legal counsel before taking steps to seal or control
institution records.

In summary, use these methods to research and document a

case once suspicious behavior has been identified. The
techniques included in this section and the appendices are just a
starting point to examine suspicious insider loan activity. The

16
assortment of possible procedures are as numerous and varied as
the array of events to be investigated.

CONCLUSION

This document is not intended to be an all-inclusive guide

to detecting and investigating fraud. It is intended to be
thought provoking and to provide the field examiner with tools to
utilize when fraud is suspected. Remember the primary
responsibility for preventing and detecting any type of fraud—not
just loan fraud--lies with the financial institution and the
system of internal controls they establish. There should be an
infrastructure in place that promotes a system of controls that
mitigates the risk of fraud. The role of the examiner is to
ensure that these controls are in place and working. However, if
this is not the case, the examiner should take additional steps
to investigate the potential for fraud, as well as researching
and documenting occurrences that point to fraud.

17
 Appendix A
CONTROL ENVIRONMENT ASSESSMENT
Employment QUICK REFERENCE GUIDE Loan Review
Practices ƒ IS THERE A STRONG CODE OF CONDUCT THAT
System
‰ Are comprehensive ‰ Are procedures in
IS STRICTLY ENFORCED?
background checks place to review
performed for all ƒ ARE EMPLOYMENT PRACTICES PROACTIVE? insider loans
new personnel, ƒ IS THE LOAN REVIEW SYSTEM EFFECTIVE? within a
including ƒ IS THERE A COMPREHENSIVE AUDIT? reasonable time
directors? Do ƒ ARE INTERNAL CONTROLS EFFECTIVE? period after
hiring protocols origination?
include A “NO” TO ANY OF THESE QUESTIONS
handwriting and COULD MEAN AN OPEN WINDOW FOR ‰ Is the loan review
fingerprint timely, thorough,
samples, INSIDER LOAN FRAUD. and comprehensive?
verification of Does it ensure
educational Audit that samples
transcripts, ¾ Does the scope of the audit include review of compliance with include all
credit reports, the code of conduct, employment practices, loan review lending officers
reference systems, and internal controls? and is
validation, and representative of
public records ¾ Are there specific audit procedures to target insider loan all lending areas?
searches of all fraud?
new hires? ‰ Are procedures in
¾ Are verifications of loan balances performed frequently and
properly controlled? place to ensure
‰ Are there the prompt
procedures in ¾ Does the audit include a review of general ledger suspense identification of
place to attempt accounts, such as loan in process; employee accounts and other loans with
to check transactions (wires) conducted by employees; and charged-off well-defined
employment loans for insider involvement? weaknesses and
references with relevant lending
other financial ¾ Are auditors willing to challenge any transaction that looks
suspicious, especially those involving an executive officer or
patterns that may
institutions with potentially be
board member?
respect to indicative of
prospective Code of Conduct fictitious or
employee’s fraudulent
¾ Does the code address fraud, define acceptable behavior,
suitability? For activity?
encourage ethical conduct, and establish mechanisms to monitor
example, and enforce the code?
involvement in ‰ Are procedures in
potentially ¾ Does the institution have a system to validate compliance with place to assess
unlawful its code? the adequacy of
activities and adherence to
committed ¾ Has the institution established an ongoing program to educate established
(Section 355 of and raise the awareness of entire institution regarding its
code of conduct?
lending and
the USA Patriot conflict of
Act). interest policies?
Internal Controls
‰ Are there ¾ Does the institution perform a risk assessment relative to
‰ Does loan review
appropriate insider loan fraud? Are anti-fraud policies and procedures in
substantiate
procedures to effect?
appraisal values
ensure that the for real estate
¾ Does the institution routinely assess the effectiveness of
institution has controls with the ultimate test: would its system of checks properties and
an ongoing and balances identify actions of a dishonest insider make adequate
screening program committing loan fraud? reviews of
to monitor and appraisals?
detect changes in ¾ Does the institution’s control environment and organizational
its employees’ structure allow one employee or director to dominate or
‰ Is loan review
lifestyles, undermine lending decisions, or dominate senior management and
the board?
afraid to
behaviors, and challenge
actions? Do ¾ Does the institution require rotation of duties and schedules transactions that
these procedures without notice and ensure that two or more persons or look suspicious,
include periodic departments are involved in any loan transaction? especially by an
credit reports executive officer
and public record ¾ Is the institution’s vacation policy strictly enforced for all or board
searches? employees? What are the consequences for policy violations?
¾ Does the board monitor and supervise the actions of the
institution’s loan officer to determine that they are
executing their duties and loan authority in accordance with
the loan policy and delegations of authority granted by the
board?

18
Appendix B – Detectable Warning Signs

The following table, while not all inclusive, contains a

wide range of items that would prompt additional review. Please
note that the same type of indicator can be found in assorted
reports, but in different forms. For example, if an insider is
advancing due dates on loans, it may be discovered through
various source points. Use this list in conjunction with the
narrative section on detection beginning on page 9.

ANALYSIS OF ELECTRONIC LOAN DATA

Data Analysis Warning Signs Potential Problems

Reconcile download data A large discrepancy There may be an attempt

to board reports, call between the number and to conceal problem or
report data, and dollar amount of past fraudulent loans from
institution’s systems due and nonaccrual loans board of directors.
generated reports. from the loan data
download and information
reported to the board of
directors.

Analyze fields Loans with chronic past An insider may be hiding

containing past due loan due loan histories are problem or fraudulent
counters by using search reported as current and loans by manually
criteria to identify do not appear on the adjusting due dates or
loans with chronic past institution’s problem using proceeds from
due loan histories. loan list. nominee loans to keep
loans current and off
management monitoring
reports.

Establish criteria to Loans with excessive A repayment source does

identify loans with number of payment not exist because the
multiple payment extensions. loan is to a nominee or
extensions. is fraudulent

Establish criteria to Loans with excessive An insider may have

identify loans with number of renewals and created a fraudulent
multiple renewals and an increasing loan loan or may be receiving
outstanding loan balance balances. bribes or kickbacks from
that exceeds the a borrower who cannot
original loan amount. repay the loan. Accrued
interest may be
capitalized.

19
 ANALYSIS OF ELECTRONIC LOAN DATA

Data Analysis Warning Signs Potential Problems

Identify loans with Loans with partial These could be nominee

partial charge-offs. charge-offs that do not or fraudulent loans
appear on the where part of the
institution’s problem balance was charged off
loan list. to keep the loan balance
below the minimum loan
amount subject to
routine review.

Determine reasonableness Accrued interest is too There may be an attempt

of accrued interest in high in relation to to conceal problem or
relation to loan type, delinquency status. fraudulent loans by
repayment terms and manually changing
payment status. payment due dates.

Establish criteria to Paid ahead status is There may be an attempt

identify loans inconsistent with loan to conceal problem or
significantly paid type and terms. fraudulent loans by
ahead. manually changing paid-
to-date fields.

Identify loans to Multiple borrowers with There could be loans to

different borrowers with the same mailing address a straw borrowers or
the same mailing address and different customer fraudulent loan.
but different customer identification numbers.
identification numbers.

Identify loans to Different borrowers with This could indicate a

different borrowers with identical social fictitious borrower.
the same social security security or taxpayer
number or taxpayer identification numbers.
identification number
and different customer
identification numbers.

Identify loans with Relationships exist that This could indicate

similar names or forms are not identified by fictitious borrowers and
of the same name. Also social security numbers or undisclosed related
identify addresses that and/or addresses. borrowers.
are similar or the same.

Generate a list of The financial The borrower does not

loans, by loan officer, institution is unable to exist or borrower has no
with a post office box contact or notify knowledge of loan.
mailing address or hold customer by mail. There could be a nominee
mail notation. or fictitious loan.

Identify loans by loan These accounts may not Possible kiting of

officers who may have be grouped by loan payments from one
been terminated or left officer and monitored account to another.
the institution. for activity. Borrowers may not exist.

20
 ANALYSIS OF ELECTRONIC LOAN DATA

Data Analysis Warning Signs Potential Problems

Identify loans that are Senior management and Loans could be

associated with a loan subordinates may not fictitious.
officer who has a question the loan
substantial portfolio or officer due to high
whose portfolio has production or
experienced rapid profitability of the
growth. portfolio.

If the institution A significant increase These could be insider

recently raised in loan originations or shareholder loans
additional capital, occurring on or about granted to fund stock
determine if insider the date the institution purchases.
loans or total loans received capital
increased substantially funding.
around the same time.

Identify loans with Preferential interest There could be low

comparably low interest rates. interest rate used to
rates. minimize cash flow
required to service a
fraudulent loan.

BOARD MINUTES AND BOARD REPORTS

Warning Signs Potential Problems Ways to Detect

An institution changes Frequent changes in loan Review board, audit

loan review personnel or review personnel may committee or loan
firm without apparent prevent them from committee minutes.
valid reasons. becoming familiar with Engage in discussions
the institution’s with management and
lending practices to employees.
identify insider
schemes. Also, they may
be close to uncovering
an insider loan fraud
and have been dismissed
for this reason.

An insider Collusion between the Review board minutes.

inappropriately suggests insider and the Engage in discussions
or resists changes in appraiser to falsify with management and
appraisers. appraisals. employees.

21
 BOARD MINUTES AND BOARD REPORTS

Warning Signs Potential Problems Ways to Detect

Insider receives To maximize Review board minutes and

compensation incentives compensation, insider compensation plans.
or bonuses based on new may camouflage poor Engage in discussions
loan volumes without quality loans with with management.
compensating controls. forged, altered, or
fraudulent documents, or
originate loans to
fictitious borrowers.

The insider is a A particular insider may Review board minutes and

defendant in a lawsuit be prone to engage in litigation summaries.
alleging improper dishonest or unethical
handling of a behavior.
transaction.

A past due loan report An attempt to conceal Compare board reports to

does not include an identity of delinquent system generated and
itemized list of past borrowers to avoid board departmental reports.
due loans. scrutiny.

Insider’s loans appear An insider’s financial Review board and system

on past due loan condition may be generated reports.
reports. strained and provide a
motive to engage in loan
fraud.

Delinquent loans to Loans may be omitted to Compare board reports to

insiders are omitted conceal insiders’ system generated and
from a past due loan strained financial departmental reports.
report. positions and avoid
board scrutiny.

The board does not Insider attempting to Review board reports and
receive an itemized list conceal charged-off request supporting
of charged-off loans. fraudulent loans. detail or internal
institution workpapers.
New loan report provided All new loans are not Review board and system
to the Board does not being reported to the generated reports for
reconcile to that Board. differences.
generated from the loan
system.

Report providing a list Inadequate monitoring of Review board reports and

of loans made as policy exceptions. discuss the existence of
exceptions to policy is policy exceptions with
not provided. examiners reviewing loan
files.

22
 DISCUSSIONS WITH EMPLOYEES

Warning Signs Potential Problems Ways to Detect

An insider appears to An insider may be Engage in discussions

receive special favors involved in a kickback with employees. Observe
from borrowers or shows scheme where loans are employee and officer
unusual favoritism granted in exchange for behavior.
toward certain personal benefits or
customers. cash.

An insider will not Employees may have Insist on sufficient

allow employees to talk knowledge of irregular verifiable objective
to examiners about loan transactions. information to resolve
loans. discrepancies. Engage
in informal discussions
with employees, if
possible.

A dominant insider An insider with this Engage in informal

exerts influence or level of control can discussions with
intimidates without force alteration of employees to the extent
restraint. institution records to possible. Review board
his or her benefit and committee minutes
and comparative
departmental records for
inconsistencies.
High turnover of lending Might signify working Engage in discussions
personnel. conditions or ethical with employees. Review
compromises that personnel records.
employees are unwilling
to accept.

An insider’s life style Insider may be booking Engage in discussions

is inconsistent with fictitious loans or with employees. Review
income. involved in a kickback insider’s financial
scheme. statements, income tax
returns, and credit
reports.

Disregard for or Insider may be trying to Review prior exam

significant disagreement discourage or impede in reports. Arrange
with regulatory depth review of discussions with
authorities. institution records. management and
examiners. Insist on
corroborating
information for
management’s views.

23
 DISCUSSIONS WITH EMPLOYEES

Warning Signs Potential Problems Ways to Detect

An insider dictates that An insider attempting to Engage in discussions

different loan control access to with internal audit
departments are audited records, which gives him staff. Review internal
at different times. the ability to shift and audit schedule. Review
manipulate data to cover records of loan
loan fraud. transfers or sales near
the time an audit is
scheduled to start.

Insider frequently takes Indicates possible Engage in discussions

loan papers out of the existence of fictitious with employees. Conduct
institution for customer loans and insider an internal control
signature, personally manipulation of loan review.
handles disbursement of status to hide
loan proceeds, routinely irregularities.
cashes loan proceeds
checks for borrower, and
insists on personally
handling certain past
due accounts.

An insider involved in Loan purpose or Engage in discussions

undisclosed silent insider’s involvement is with employees. Search
trusts, partnerships, or concealed to circumvent for undisclosed related
shell corporations that institution’s legal interests in state
borrow from the lending limits. incorporation records
institution. and investments listed
on the insider’s
financial statement.
Review the insider’s
financial statements and
those of any undisclosed
related interest’s for
intercompany borrowings.
Conduct a loan file
review.

An insider lending An insider may have Engage in discussions

personal funds to or violated a fiduciary with employees. Review
borrowing from duty by placing his or customers’ financial
customers, which may or her own interest above statements.
may not be disclosed on that of the financial
insider’s or borrower’s institution. An insider
financial statements. may be applying borrowed
funds to conceal
fraudulent loans.

24
 DISCUSSIONS WITH EMPLOYEES

Warning Signs Potential Problems Ways to Detect

An insider purchases An insider may extend Engage in discussions

assets from customers. preferential treatment with employees. Review
to a customer in insider’s financial
exchange for kickbacks statements and loan
or a reciprocal files.
arrangement.

An insider refuses to An insider could be Conduct discussions with

fully answer questions concealing information insider and examiners.
or provide relevant relevant to uncovering
records. lending irregularities.

An insider making Nominee, straw borrower, Engage in discussions

payments on a customer’s or fictitious borrower. with employees. Trace
loan. loan payments and
original loan proceeds.

An insider is An insider can conceal Engage in discussions

responsible for exceptions and with employees. Consider
resolving loan fraudulent loans. conducting loan
confirmation exceptions. confirmation as part of
the examination

Insider has access to Insider can divert loan Determine whether there
both the loan system and payments/proceeds or is proper segregation of
the general ledger post/alter institution duties. Review user
system. Insider has records. profiles for the various
control over both loan information systems to
receipts and determine if insiders
disbursements and the have access to system
recording of these not needed to perform
transactions. their daily function.

INSIDER AND BORROWER FINANCIAL STATEMENT ANALYSIS

Warning Signs Potential Problems Ways to Detect

An insider’s financial An insider may have a Review the insider’s

statement discloses motive to commit loan financial statements,
significant indebtedness fraud. credit reports, income
in relation to disclosed tax returns. Obtain
income sources. There compensation information
may also be a poor for human resources.
credit score.

25
 INSIDER AND BORROWER FINANCIAL STATEMENT ANALYSIS

Warning Signs Potential Problems Ways to Detect

An insider’s financial An insider may have Review the insider’s

statements show large or financial difficulties financial statements.
unusual fluctuations. and be motivated to
Net worth cannot be engage in fraudulent
reconciled with lending activities.
disclosed sources.

Rapidly appreciating An insider knowingly Review financial

assets not supported accepting unreliable statements.
with independent financial information in
valuations. order to grant loan
approval. There may be
financial incentive or
reciprocal favors.

Commingling of business An insider knowingly Review financial

assets on personal accepting unreliable statements.
financial statement financial information in
without disclosure of order to grant loan
business liabilities. approval. Financial
incentives or reciprocal
favors may be involved.

A financial statement An insider knowingly Review financial

fails to disclose debts accepting unreliable statements and compare
reported on credit financial information in to the credit report.
bureau report. order to grant loan
approval. Financial
incentives or reciprocal
favors may be involved.

Undisclosed contingent Insider may be unable to Review financial

liabilities such as service debt to the statements.
personal guaranty of institution if required
debt to a related to repay related
interest. interest’s debt.

An insider’s related Circumvention of an Review financial

interest is not institution’s legal statements.
disclosed or reported. lending limits. Masking
of true financial
condition.

26
 LOAN FILE REVIEW

Warning Signs Potential Problems Ways to Detect

Loan files are missing. Borrowers do not exist; Employees are unable to
loans are to fictitious provide loan file
borrowers or nominees. requested by examiners.

An insider conceals An insider is involved Loan file review.

noncompliance with in kickback or a
lending policies, fraudulent loan scheme.
guidelines from Blackmail may be
management and the involved.
board, regulatory
policies, or violations
of laws.

The loan amount exceeds An insider attempting to Review loan file, loan
loan officer’s lending conceal a questionable approval form, and
authority. or fraudulent loan, lending authorities.
policy exceptions, or
legal lending limit
violation.

Loan terms are different Fraudulent transaction. Loan file review.

from terms approved by Compare loan documents
loan committee or board to loan approval form or
of directors. board/loan committee
minutes.

Collateral inspections Collateral is inadequate Employees unable to

or valuations are or does not exist. provide the required
missing. information at the
examiner’s request.
Conduct a loan file
review.

Documents used to verify Loan is to a nominee or Employees unable to

borrower’s straw borrower. provide the required
identification are information at the
missing. examiner’s request.
Conduct a loan file
review.

An insider keeps An insider attempting to Conduct a loan file

“shadow” files or omits conceal documentation, review. Engage in
certain documents from underwriting, or discussions with
loan files reviewed by collateral problems. employees.
examiners. Loan transaction may be
fraudulent.

Insider maintains Documents may be used Conduct a loan file

signed, blank notes in for fictitious loans. review. Engage in
personal or customer discussions with
loan files. employees.

27
 LOAN FILE REVIEW

Warning Signs Potential Problems Ways to Detect

Insider loans do not Insider circumvents Review loan file, loan

comply with lending controls to receive approval form, and board
policies and exceptions preferential treatment and loan committee
are not authorized. or prohibited minutes.
transaction.

Insider loans with Insider collusion Review loan file, loan

unusual or preferential involving possible approval form, and board
terms, interest rates, kickbacks, bribes, or and loan committee
or collateral. other fraudulent minutes.
schemes.

Appraisals for insiders’ An insider influencing Review appraisal report

loans contain an appraiser to conceal and appraisal
deficiencies or values inadequate collateral regulations.
appear overstated and position. This may
are not adequately involve a kickback
supported. scheme.

Purpose of loan is not Purpose does not comply Review loan file,
recorded or proceeds are with lending policies or payment history, and
not used for stated violates the law. True paid loan disbursement
purpose. purpose may be to pay checks. Trace loan
accrued interest other proceeds.
loans to borrower.

Insider makes or Self-dealing. Review loan file and

approves loans to Concealment of loans loan approval form.
himself or herself, that do not meet policy
family members, or guidelines. Violation
related interests. of code of conduct.

Insider loans not Self-dealing. Review loan file and

approved by the board or Fraudulent loan loan approval form.
board committee. transaction.

Loan funded prior to Fraudulent loan Review loan file.

approval. transaction. Compare date of loan
proceeds check to date
loan was booked and loan
approval date. Debit to
loans in process or
suspense account for
amount of loan proceeds.

Loan documents appear An insider knowingly Compare loan documents

altered or forged. accepting or preparing to minutes
forged or falsified
documents.

28
 LOAN FILE REVIEW

Warning Signs Potential Problems Ways to Detect

Credit reports with no Fraudulent transaction. Credit history is

or very limited credit Borrower’s true credit inconsistent with
history and absence of history may be concealed borrower’s financial
letters from landlords, by using fictitious information. Various
utility companies, etc. social security number loan files contain
stating satisfactory to generate credit similar documents.
payment record. report. Forged letters
Earnings statements and forged earnings
appeared altered. statements.

Files without True beneficiary of Trace loan funds as

documentation to funds may be hidden. described in Appendix D.
identify how loans were
funded, such as official
checks, deposit tickets,
funding sheet, etc.

Borrower's financial False information used Verify with information

statements are prepared as basis for loan provided by borrower/
by an insider. decision. compare to credit
reports.

INTERNAL REPORTS AND ACCOUNTING RECORDS

Warning Signs Potential Problems Ways to Detect

Loan disbursement checks Insider using loan Review loan disbursement

are presented for proceeds for personal account reconcilements.
payment before loan is benefit, hiding problem Compare new loan report
booked. loans, or lending limit with loan check
violation. register.

Insiders or related Insider having financial Review overdraft

interests have frequent difficulties and motive reports, suspense items,
overdrafts or appear in to commit fraud. and suspense account
suspense account item reconcilements.
listings.

Adversely classified Insider attempting to Compare previously

loan paid off or paid conceal fraudulent classified or problem
down just prior to or loans. balance to current
during the examination. balance.

29
 INTERNAL REPORTS AND ACCOUNTING RECORDS

Warning Signs Potential Problems Ways to Detect

An insider loan is paid Insider attempts to Review recently paid off

off prior to or during conceal lending limit insider loans
the examination. violations, delinquency
or fraudulent loans.

Customer loan proceeds Loan proceeds not used Review wire transfer
disbursed by wire to stated purpose. activity.
transfers to institution Fraudulent transaction.
secrecy haven countries.

High level of loan Charge-off of fraudulent Review charged off loan

losses. loans. A loan officer files and payment
directed by senior histories. Be alert to
officer or director to an unusual level of
grant loans that charge-offs resulting
normally would be from loans originated by
declined. There could a particular loan
be financial incentives officer.
or reciprocal benefits
involved.

No review of inactive or Insider using dormant or Review dormant and

dormant accounts. inactive accounts for inactive account
fraudulent lending reports. Cross check
activities. Possible with loan trials to
use of customer determine if a large
information to generate number of dormant
fictitious loans could account holders also
be involved. have loans.

Cash disbursement of Insider receiving Internal control review.

loan proceeds. kickbacks or bribes. Copies of transaction
tickets in loan file
should trigger further
research. Trace loan
proceeds, if
appropriate.

Insider changes loan Conceal delinquent or Loan file system

payment due dates, fraudulent loans. maintenance reports.
renews loans, or grants
loan extensions.

Internal debits/credits Fraudulent transactions. Review deposit and loan

(noncash transactions) Insider receiving account histories for
posted to insider or kickbacks from loan noncash transaction
customer’s loan/deposit customer or embezzling codes. Trace
accounts. loan proceeds or funds transactions.
from deposit accounts.

30
 INTERNAL REPORTS AND ACCOUNTING RECORDS

Warning Signs Potential Problems Ways to Detect

Rapid loan growth. May be partially Comparative analysis of

attributable to balance sheet accounts.
fraudulent lending
transactions.

No reconciliation of Fraudulent loan activity Perform reconciliations

loans-in-process and may be processed within of these accounts.
disbursement accounts. these accounts.

31
Appendix C – Research Procedures

The following is a list of procedures that may aid in

researching suspicious circumstances. To maximize the
effectiveness of such a review, the examiner should read the
sections on interviewing and documentation starting on pages 13
and 14 prior to using these procedures.

Procedure Uses

Trace the flow of funds – e.g., use Tracing loan proceeds and payments and
of loan proceeds, source of loan other funding flows can help in
payments, source of funds used to identifying fictitious or nominee loans,
purchase cashiers checks or money or insiders’ undisclosed interests in
orders, debits or credits to borrowing entities.
dormant accounts, debits or credits
to accounts for which the
institution holds the monthly
statements, etc. Appendix D
provides detailed procedures for
tracing loan transactions.

Review demand deposit account By reviewing the activity in insiders’

statements of insiders. Obtain and demand deposit accounts, examiners may be
analyze copies of significant or able to identify insiders’ undisclosed
unusual debits or credits. financial interests, undisclosed
borrowings, or other similar
irregularities, or accounts at other
institutions.

Review paid official checks A review of paid official checks might

(official checks can include money reveal unauthorized diversion of
orders, cashiers checks, loan institution funds to insiders or their
disbursement checks, etc.) related interests. Be alert to payees
that seem inappropriate or unusual.

Reconcile general ledger accounts Account reconcilements can uncover debit

or review institution’s internal or credit entries used to offset
reconcilement. Review fraudulent transactions.
reconcilements over a period of
time to observe fund flows in and
out. Trace suspicious items
between accounts.

Review reconciling items. Reconciling items may represent debit or

credit entries used to offset fraudulent
loan transactions.

Review safe deposit box access Insiders might store fraudulently

records. obtained cash in safe deposit box.

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 Procedure Uses

Review wire transfer activity. A review of wire transfer activity might

reveal unauthorized diversion of
institution funds to insiders or their
related interests.

Review insiders’ lists of related These lists provide names of insiders’

interests. businesses that may have loans or
deposits accounts at the institution, or
have received proceeds of official
checks.

Review suspense accounts for Suspense accounts may include debit or

several consecutive days or periods credit entries used to offset fraudulent
loan transactions.

Review loan trial balance reports Accrued interest that is more than the
for anomalies or unusual activity, delinquency status indicates could be a
e.g., loans paid in advance, sign of manipulation of the borrower’s
negative amortization, etc. performance status or misapplication of
funds. This can also help in identifying
fictitious loans.

Review credit reports on file at Low credit scores for insiders with large
the institution. loan balances at the institution should
trigger additional investigation.

Review deposit and loan account Fictitious deposit and loan accounts are
statements that the institution sometimes used to receive and hold funds
holds for customers for several misappropriated by insiders. Holding the
consecutive months. deposit statements for customer pickup
allows the insider to control that
statement. Statements mailed to post
office boxes can also be used in a
similar fashion. Tracing of loan
proceeds could lead to these accounts.

Review dormant accounts activity. Inadequately controlled dormant accounts

are a natural place to hide fraudulent
activity.

Review accounting for charged-off Payments received on charged-off loans

loans. can be diverted to insider’s accounts.

Send or request institution’s Confirmations are useful in identifying

auditors to send positive loan or fictitious borrowers or depositors, or
deposit confirmations. Review unexplained differences in account
accounts of customers who do not balances or payment histories.
respond. This may identify loans
for which proceeds should be
traced.

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 Procedure Uses

Visit real estate collateralizing Visits can reveal whether real estate
loans. collateral truly exists, or exists in the
condition described in the loan
documentation.

Obtain Dun & Bradstreet (“D&B”) or D&B reports can reveal insiders’
similar service reports on undisclosed financial interests in
borrowers and insiders’ related borrowers or other entities. Further,
interests lien filings included in the D&B reports
can reveal the existence of undisclosed
business relationships between borrowers
and insiders’ related interests.

Search internet and public records Public records can contain significant
on insiders, insiders’ related relevant information about insiders and
interests, and other borrowers, as borrowers, related or affiliated business
warranted. These could be recorded entities, the lien and title status of
deeds; lien searches; corporation, collateral, etc. Consult with your
limited liability company and supervisor and legal counsel before
partnership filings; news articles; conducting subscription-based searches of
lawsuits, etc. public records.

Search SAR and CTR databases. SAR and CTR data may indicate that
insiders, their related interests, or
other suspect borrowers were the subjects
of SAR or CTR filings at other
institutions.

Consult with agency subject matter Fraud or other subject matter specialists
specialists. can provide suggestions on types of
records to be examined.

Be alert to situations where the In these situations the “true” loan

loan officer of record does not officer may have benefited from the loan,
appear to be the officer who and the loan may have been assigned to
actually handles the loan. another loan officer to avoid suspicion.
In addition, it could indicate a loan
placed in the institution by the CEO,
control owners, or board members

Be alert to loan terms or Changes in rates, abnormal rates, and

conditions that are inconsistent repayment terms that are inconsistent
with the loan purpose or normal with use of loan proceeds may represent
institution practice. transactions warranting closer scrutiny.

Be alert to unusual events or Casual discussions with institution staff

activity anywhere within the can both yield clues of insider abuse and
institution. enable staff to approach examiners with
information. An insider’s public
lifestyle (e.g., expensive cars,
clothing, etc.) beyond apparent means
might indicate insider fraud. Document
conversations with staff.

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 Procedure Uses

Communicate with examiners working Aspects of loan fraud may involve other
on other areas of the financial non-lending areas of the institution.
institution. Examiners working on those other areas of
the institution should be alert for
transactions or activity that may be
involved in the suspected fraud.

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Appendix D – Loan Tracing Procedure Detail

The following steps can be used to trace loan proceeds or

payments.

Procedure Use

For the sample loan identified, The transaction history will show
obtain a payment history on the all advances, payments, and charges
loan selected. Maintain a copy of to the loan.
the loan history for examination
workpapers.

Select either the advance or An advance on the loan will reveal

payment to be traced. where funds went and a payment will
reveal the source of the funds.

Find the general ledger debit This provides the source document
(advance) or credit (payment) for data entry onto the accounting
ticket for the selected system.
transaction. Look for the proof
transaction number located on the
back of the ticket and retain a
copy of the ticket (front and back)
for the examination workpapers.

Go to the proof tape for the day of This shows the entry of the data
the transaction and find the onto the accounts of the
transaction number for the institution.
debit/credit ticket. Identify the
corresponding entry. (TIP: Credits
are usually listed before debits on
the proof tape. Also, some
institutions can use their optical
system to identify transactions
rather than physical general ledger
and proof tapes.)

Use microfilm, microfiche, or The credit should show the

optical equipment to find a picture disposition of the loan proceeds
of the items(s). Retain a copy of and the debit the source of funds
the items, front and back, for the for payment.
examination workpapers.

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Appendix E

The following excerpts are from a sample insider fraud write-up

referencing supporting documentation and a documentation index.

The evidence presented here suggests that $75,000 of the proceeds of the Institution’s loan
to Smith was used for the economic benefit of Vice President Jones in the form of a one-
third interest in the underlying investment.

Mr. Smith is the principal shareholder and officer of XYZ Inc., a local manufacturer. On
October 12, 20X0 the institution made a $225,000 unsecured loan to Mr. Smith, due May
11, 20X1 (Exhibit A-2). Vice President Jones was the lending officer (Exhibit A-2). The
loan file memorandum, prepared by Vice President Jones, states that the proceeds were
used to purchase real estate for investment purposes in AnyState (Exhibit A-3). The full
proceeds were wire transferred to the ABC Bank (Exhibit A-4). On May 31, 20X1 the
$225,000 loan was renewed, due April 10, 20X2 (Exhibit A-5). On May 31, 20X2, interest
accrued through the April 11, 20X2 maturity of the $225,000 note totaling $33,971.93 was
paid by check # 3056 in the amount of $33,971.93 drawn on Smith’s demand deposit
account #999-888-7777 (Exhibit A-6). However, on this same day Vice President Jones
drew two checks on his demand deposit account at the Institution # 111-222-3333 in the
total amount of $11,323.97 (one third of the amount of interest on the Smith loan) payable
to John Robert (Exhibit A-9). These checks were deposited in Mr. Robert’s account # 444-
555-6666 on June 8, 20X2 (Exhibit A-10 and A-11). On the same day, Mr. Robert drew
check # 5500 on his account # 444-555-6666 in the amount of $11,323.97 payable to Mr.
Smith (Exhibit A-12). On June 10, 20X2 check # 5500 on Robert’s account was deposited
to Smith’s account #999-888-7777 (Exhibit A-13).

Mr. Smith’s personal financial statement dated March 31, 20X2 reflect a $150,000
investment in AnyState real estate rather than a $225,000 investment. (Exhibit A-14).
Vice President Jones’ signed personal statements dated December 31, 20X1 and March 31,
20X2 list an “AnyState investment property partnership,” acquired in 20X0 at a cost of
$75,000 (Exhibit A-15 and A-16). A corresponding debt to finance this acquisition does
not appear on Mr. Jones’ financial statement or Regulation O form dated June 24, 20X2.
Furthermore, AnyState Secretary of State partnership records show Vice President Jones
and Mr. Smith are both general partners in Green Acres Partnership (“GAP”) (Exhibit A-
17). According to the AnyCounty real estate title records, GAP is the owner of 60 acres of
real estate in Any County, AnyState (Exhibit A-18).

****

Index

Exhibit A-1 - Flowchart of transactions

Exhibit A-2 - Copy of $225,000 note to Mr. Smith dated October 12, 20X0
Exhibit A-3 - Copy of Smith loan file memorandum dated October 3, 20X0
Exhibit A-4 - Copy of wire transfer instruction dated October 12, 20X0
Exhibit A-5 - Copy of $225,000 renewal note to Smith dated May 31, 20X1
Exhibit A-6 - Copy of cancelled check #3056 drawn on Smith account # 999-888-
7777 (front and back)

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Appendix F

Flowcharts

Flowcharts can be used to simplify complex movement of money and highlight the
involvement of key insiders or loan officers. A brief example is shown below.

Financial Institution XYZ

Anytown, USA

Loan #9999 in the name of B. Rich

Amount: $50,000
Collateral: Unsecured
Loan Purpose: Investments
Dated: June 20, 2002
Originating Officer: T. Brooks
Disbursement Item: Cashiers Check #7777

Cashiers Check #7777

Amount: $50,000
Remitter: "Loan Proceeds"
Payable to: ABC Investments
Deposited to Account #2222 in the name of ABC
Investments at Financial Institution B
Date of Deposit: June 20, 2002
Endorsement: "ABC Investments"

Check #3333 in the amount of $40,000

Dated: June 21, 2002
Signed by: T. Brooks
Drawn on: ABC Investments Checking Account
#2222 at Financial Institution B
Payable to: Mastercard
For payment on Account #XXXX-XXXX-XXXX-2345
in the name of T. Brooks

Note: In this situation, loan officer T. Brooks made a $50,000 ficticious loan in the name of B. Rich,
deposited the proceeds in an account he contro lled and then used $40,000 to pay his Mastercard
bill which had become excessive due to habitual online gambling. The full $50,000 is deemed to
benefit Mr. Brooks due to the fact that all the money was deposited to an account he controlled.

38
Appendix G

The following list of websites is included for your reference

SEARCH ENGINES
www.alltheweb.com
www.nbci.msnbc.com
www.ixquick.com
www.allonesearch.com
www.excite.com
http://webfile.com
www.google.com

FRAUD SITES
www.fraud-report.org
www.fraud.org/info/contactnfic.htm
National Fraud Information Center

PUBLIC RECORDS
www.searchsystems.net
Public Records in US
www.archives.gov
National Archives & Records Admin

GOVERNMENT SITES
www.fdic.gov
www.federalreserve.gov
www.fedworld.gov
Locate government information
www.fincen.gov
www.irs.ustreas.gov
www.gao.gov/special.pubs/soi.htm
Investigators Guide to Sources of Information
www.usps.gov/websites/depart/inspect
Postal Inspection
www.ncua.gov
www.occ.treas.gov
www.ots.treas.gov
www.state.gov

LAW ENFORCEMENT
www.usdoj.gov
Click on Organization Chart under “About DOJ”
www.fbi.gov
www.dea.gov
www.irs.treas.gov

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 Click on sitemap; click on Criminal Investigation under “About
IRS”
www.ustreas.gov
Click on Law Enforcement under “Key Topics”
www.leolinks.com
www.officer.com
Police information
www.usss.treas.gov
www.usmarshals.gov
www.customs.treas.gov

LEGAL INFORMATION SITES

http://uscode.house.gov/usc.htm
Researching US Code
www.findlaw.com

MISCELLANEOUS
www.cfenet.com
www.bankersonline.com
www.asc.gov
Check appraiser license or for disciplinary action
www.classified3.com/
Dig up dirt on anybody doing anything
www.cybercrime.org/
National White Collar Crime Center (large listing of
investigative resources)
www.whowhere.lycos.com

40