Spotting 2 + 2 = 5 Is Easier Said Than Done
Fraud is easy to hate but hard to detect.
While the vast majority of credit unions are run honestly, it is difficult sniff out malfeasance and fraud at those that aren't.
That's the consensus from interviews from the NCUA's examination director and from leading experts on financial fraud detection.
"Doing fraud audits on a routine basis are cost prohibitive and so labor intensive that we would have to quadruple our staff. You would have to look at a large number of transactions to prove a negative," NCUA Office of Examination and Insurance Director Melinda Love said in an interview. "But there are a lot of red flags we have our examiners look for."
Examiners that have specific training in detecting fraud perform detailed exams that entail "looking under the hood in a way that's not common during routine examinations," said Allan Bachman, education manager of the Association of Certified Fraud Examiners, an Austin, Texas-based education and advocacy group.
Love said there hasn't been an increase in fraud at credit unions in recent years, even though difficult economic conditions can sometimes tempt credit union employees to massage the numbers to make things look better.
Bachman said that "fraud is by its nature hidden, so there is a delay in detecting it. Any frauds driven by the economy are probably not being detected now but will be."
Two recent well-publicized incidents of credit union fraud took place at the New London Security FCU in Connecticut, which cost the NCUSIF $12.1 million, and at Center Valley Federal Central Union in West Virginia, which cost the fund $16.4 million.
CUNA Mutual Insurance Group reported that claims related to employee or director dishonesty represent about 10% of claim volume but more than 35% of losses in terms of dollars for credit unions of all sizes.
The NCUA Inspector General's report on New London Security FCU concluded
that NCUA examiner work-paper documentation contradicted the information found in the external auditor's work papers. "As a result, NCUA missed opportunities to mitigate the loss to the NCUSIF caused by New London's failure," the OIG said.
The NCUA Inspector General's report on Center Valley-which involved a CEO who eventually pleaded guilty to embezzlement and money laundering after federal prosecutors traced $5 million of $9 million that was missing from the credit union to her- said there was "no evidence" that NCUA examiners verified the procedures of the supervisory committee and outside auditors and "failed to adequately question the CEO when she blamed computer problems as a reason for some of the credit union's financial reporting irregularities.".
Love said the agency uses reports such as these when training examiners to make them aware of practices that they should try to detect, although she cautioned it is often difficult to detect incidents of outright deception, such as keeping two sets of books.
"Once we know or suspect fraud, lots of red flags become apparent," she noted. "But people are very creative in hiding things."
She added that ideally the credit union has safeguards, such as its board of directors' supervisory committee, which will catch potential problems early on. Those committees are charged with the validation of member accounts, and if there are discrepancies, it can be an indication of fraud.
If the agency suspects fraud, it will ask the credit union to hire an outside firm to perform a fraud audit, or if the situation is deemed beyond repair, it will conserve the credit union.
Love said examiners are trained to check potential problem areas, such as reconciling natural person credit unions' corporate credit union accounts so they can trace the check-clearing process; determining if interest collected doesn't correspond to the number of outstanding loans; and checking certain equity ratios "if they appear to be too good to be true."
Bachman, whose organization administers the examination that people must take to become certified fraud examiners, said sometimes fraud isn't detected because both the examiners and the financial institution have an incentive to expedite the examination process. He contends that the process can be improved if the examiner digs beneath the surface more often and that examiners without advanced training in fraud detection can still take significant steps to detect fraud.
"The credit union's goal is sometimes to deflect intrusive questions and provide simple answers. That's why the examiners have to know when to ask the institution to pull the loan files. Once you look under the hood you are putting more pressure on the person at the credit union." he said.