Fraud Fuels Reputation Risk
It’s been about a year since two employees at the $1.6 million Enterprise Credit Union pleaded guilty to embezzling almost $1 million over a period of 10 years, but the topic still fuels the gossip mill in the small Kansas town. And, according to one prominent resident, the incident reduced residents’ trust in the credit union industry and regulators.
“Everyone in town wonders how that much money could go missing over so many years without someone noticing it sooner,” said Tom Decker, who for many years was mayor of the 855-resident town.
Decker, who belonged to the 478-member credit union when the fraud hit the fan last fall, said the problems prompted him and others to wonder whether credit union regulators are focusing enough attention on small institutions.
“I’m not sure how it got past the board of directors and it seems like the federal government wasn’t doing a very good job of keeping an eye on what was going on,” he said. “Since it’s a small credit union, maybe the people who are supposed to monitor credit unions just don’t pay much attention, but that just doesn’t seem right.”
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Although the credit union is still operating with about 450 members, Decker said he’s heard numerous former members and local residents express distrust.
“As a result of the mess, there are definitely some folks in town that don’t think it’s a good idea to put their money in any credit union,” he said. “Once you break that type of trust, there’s no turning back.”
The $1.6 million Enterprise Credit Union is among more than a dozen small credit unions hit hard by employee embezzlement, member fraud and mismanagement during the past two years. Small credit unions that failed because of fraud include the $3.1 million Border Lodge Credit Union of Derbyline, Vt., the $2.5 million Lawrence County School Employees FCU in New Castle, Pa., and the $5 million El Paso FCU in El Paso, Texas.
Across the Kansas border in Nebraska, the former manager, treasurer and sole employee of the H.B.E. Credit Union was sentenced to four years in prison in January 2013 for embezzling more than $635,000 from the failed institution, which represented nearly all of the credit union’s assets.
Additionally, the NCUA seized the $2 million Women’s Southwest Federal Credit Union of Dallas after its former manager pleaded guilty to stealing $3.4 million over a period of 11 years.
Despite the significant number of fraud and mismanagement cases at small credit unions, the NCUA has reduced the amount of time it spends examining institutions with assets less than $10 million and a CAMEL rating of three or better.
As part of the NCUA’s new Small Credit Union Examination Program, launched last year, the agency now allocates only 40 hours for each on-site exam, the agency said.
Some support the strategy.
By shifting resources away from smaller credit unions, the agency can focus on larger organizations that, by nature of their asset size, could create larger losses for the share insurance fund if they failed, said NCUA Board Chairman Debbie Matz.
Matz said during CUNA’s 2013 Governmental Affairs Conference that the agency is dedicated to preventing and detecting problems at credit unions, no matter what size.
Yet, experts question whether streamlining the exam process for smaller organizations has opened doors for increased incidents of credit union fraud, failure and reputational risk.
“It is the smaller credit unions that face a higher risk of fraud and embezzlement, due to their inherent weaker controls structure. As such, they are the ones that need greater scrutiny and oversight,” said Christopher Marquet, founder of Marquet International Ltd., a Wellesley, Mass., investigative, litigation support and due diligence firm that publishes an annual report on embezzlement.
Next Page: Credit Unions Hit Hard
According to Marquet’s most recent report released in May, nearly one in four major embezzlement schemes last year in financial institutions involved credit unions.
The failed El Paso FCU is one example of examiners not paying close enough attention to a small credit union, according to a recent report by NCUA Inspector General James Hagen wrote that NCUA examiners could have reduced losses to the share insurance fund by doing a better job of identifying and following up on fraud risk factors.
To prevent similar incidents in the future, the report recommended that the NCUA implement tighter controls, especially in situations when a lack of segregation of duties exists, which is often the case in small credit unions.
In response to the OIG recommendations, the NCUA recently told Credit Union Times it is currently working on examination procedures and approaches to improve identification of fraud risk indicators.
“We believe an enhanced examination procedure designed to focus in on high fraud risk areas combined with training on the new procedures is a key step to mitigate risk,” said John Fairbanks, public affairs specialist.
Procedures are under development and are expected to roll out in 2014, he said.
In addition, NCUA is also evaluating approaches toward establishing specialist teams for the most significant fraud risks, Fairbanks said.
“NCUA continuously evaluates current risk indicators against new losses included fraud cases to determine what if any additional measure so of risk we should incorporate into the ongoing surveillance process,” he added.
With each case of fraud or failure, the NCUA often discovers ways to improve the exam process, said NCUA Executive Director Mark Treichel this summer.
“When we do a conservatorship, with each one, you learn something new you haven’t encountered before and might add a step,” Treichel said. “The same thing happens when have a fraudulent situation. The inspector general will do a review and sometimes discover a step that doesn’t add a lot of incremental time to the process.”
“What we do is not a fraud audit, but if there are five or 10 steps we can add relative to the fraud side, then we need to look at possibility of doing those things,” Treichel said.
“While scaling back hours relative to small to large, we need to be more effective in the hours we’re using,” he continued. “Adding too many steps for small credit unions might be too time consuming and inefficient. It’s a delicate balance.”