Internal Fraud from the Board PerspectiveMay 03, 2016 · Fraud Type . Amount : Alleged Perpetrator...

© 2016 Fox Rothschild

Internal Fraud from the

Board Perspective Presented By:

Christopher J. Pippett, Esquire

National Association of Federal Credit Unions Webcast May 3, 2016

Credit Union Organizational Reporting/Supervision Chart

Internal Auditor

Supervisory Committee

Board Committees

Rank and File Employees

Department/Branch Managers

Senior Management

CEO/Manager

Board of Directors

Members

General Powers & Duties

•DUTY OF CARE •DUTY OF LOYALTY •DUTY OF OBEDIENCE TO THE LAW All of these traditional legal duties apply to non-profit directors and committee members, particularly credit unions.


• Duty of Care – A director must stay informed and must exercise independent judgment.

– Regular attendance at and participation in board

and committee meetings; – Performance of specific duties and

responsibilities set forth in bylaws, board policies and law;

– Obtaining information so that he/she is reasonably informed with regard to the affairs of the credit union.


– Information must be obtained/provided in time for meaningful discussion and response.

– The extent of the inquiry depends on the circumstances as well as the information available.

– May rely on information provided by officers, employees, committees, etc., provided reliance is reasonable.


• Duty of Loyalty – “Best interests of the credit union”.

– Independent Judgment -without regard for alliances

or constituencies; – Conflicts of Interest - must be identified and

discussed, addressed and documented; – Confidentiality - all nonpublic information.

Polling Question 1

• True or false: You can have term limits for your Board of Directors.

• A) True • B) False

Credit Union Board Challenges

• The Bad Board

– Rubber Stamp – Micro Managers – Outdated/Stale – Distracted

• All of these can lead to serious problems and threaten the viability of the credit union.

Credit Union Board Challenges

• Avoiding the Bad Board

– Active Recruiting Program – Updated Nominating Committee and Policies – Thorough Orientation – Continuing Education – Regular Evaluation – Succession Planning/Term Limits

Building the Good Board

• Specific Board Duties – Policies – are they current and relevant. – Job Description – what do you expect from a board

member.

• Composition of Board – Skills – Financial, accounting, legal, HR, security, etc. – Background – SEG member, business owner,

community volunteer, executive experience, other board experience, diversity, etc.

Building the Good Board

• Personal Characteristics:

– Integrity – this is key since this is truly a top down element of the credit union’s business approach.

– Fairness – is he/she objective in their approach to matters?

– Work Ethic – being a credit union director is hard work! Is he/she up to it and do you need another person who will do no more than show up?

Sources/Types of Fraud

• Theft of cash from vault and teller drawers • Manipulation of employee and family member

accounts • Abuse of expense accounts • Loan approvals and disbursements • Theft from inactive accounts (escheat, elderly,

etc.) • Theft of credit union investment accounts

Tools for Prevention

• The board should make sure there are policies in place for: – Random/surprise verification of cash in vaults and

teller drawers – Audit and verification of elderly, deceased and

escheat accounts – Random/surprise review of employee and family

member accounts – Verification of loans

Tools for Prevention (cont’d.)

• Policies should be in place for: – Mandatory employee vacation – Assignment of risk factors to employees and for

policies of reviewing and updating same – Random/surprise review of employee and family

member accounts – Verification of loans – Verification of purchasing and vendor relations – Internal controls and separation of duties

Tools for Prevention (cont’d.)

• Policies should be in place for: – Rotation of tellers branch managers and loan officers – Rotation of auditors – Review of loan losses for patterns (i.e., loan officers,

appraisers, brokers, etc.) – Periodic background and credit checks for certain

employees and executive management • All such policies should be reviewed and

updated annually

Types of Conduct

• Malfeasance – They’re just doing it wrong. • Misfeasance – They’re doing it wrong and

they don’t care. • Criminal Activity/Fraud – Theft,

embezzlement, diversion of assets.

Polling Question 2

• Loss Prevention is a role for a very specific part of the Credit Union.

• A) True • B) False

Red Flags Indicating Potential Bad Conduct

• Changes in behavior • Changes in life style • Changes in performance • Problems at home or outside of workplace • Changes in performance reviews. • Unusual control needs/refusal to let others help

Red Flags Indicating Potential Bad Conduct (cont’d.)

• No vacation • Repeated failure to provide requested

information • Unusual access in terms of frequency or time

periods to premises, systems, accounts or equipment

• Financial problems – garnishments, loans, etc.

Duty of Directors Upon Notice of Fraud

• Must investigate claims • Must consider relevant information and

assess the truth of the allegations • Must act promptly to end and/or prevent

wrongdoing • Most D&O coverage will cover costs

Sources of Notice

• Criminal Inquiries • Regulatory Inquiries • Auditor Questions • Whistle Blower Complaints

Reporting Process/Chain

• Supervisor • Security Officer • Supervisory Committee

– Then to Board and CEO (unless that’s where the problem is)

• NCUA

Response to Initial Report

• Depending on severity of claim first call should be to counsel with experience in guiding an organization through such claims. – Protects privilege – Experience in conducting an investigation – Experience in communicating with authorities and

regulators and handling HR issues. • First call should not be to NCUA Examiner!

– But not the last call either!

Response to Initial Report (cont’d.)

• Involve HR early – perpetrator may need to be removed from the premises and either terminated or put on leave with or without pay

• Involve IT and/or security early in order to preserve information or restrict access to systems or premises

• Review bond coverage

Preparing for the Investigation

• Determine if an investigation is required – What rules/laws are at issue?

• Identify the potential objectives/goals of the investigation

• Select the investigative team, if there is going to be a team

• Determine who should contact interviewees

• Establish a timeline/deadline

Advantages for In-house Counsel

• Less costly • Familiarity with operations and personnel • May be perceived as less threatening • Better where complaint involves lower

level employee

Problems for In - House Counsel

• Privilege – Are you following business policies or legal

policies • Conflicts

– Legal - separating your duty as to officers and directors from that of the credit union.

– Professional – you could find yourself at odds with a direct report.

• Credibility – Outside counsel is generally viewed (rightly or

wrongly) as being more independent.

Preparing for the Investigation (cont’d.)

Selecting Witnesses/Potential Interviewees • Person(s) who raised the issue(s) • Person(s) identified in any claim • Supervisors of persons involved • Witness(es) to the alleged action(s) • Others with relevant information • Authors of relevant documents • Co-workers of persons involved

Preparing for the Investigation (cont’d.)

Order of Interviews • Is there any reason not to interview the

complainant(s) first? (Typically, the answer is NO!)

• Should the alleged wrongdoer(s) be interviewed second, last or in some other order?

Investigating the Complaint

• Let the investigation lead you don’t lead it • E-mails – Limit them immediately, they’re

discoverable • Develop a preservation program if

appropriate

Investigating the Complaint (cont’d.)

• Retention of professionals – Must have resources and expertise to get the

job done quickly – Don’t use existing auditor – No time to go cheap – Retention of audit and forensic professions is

preferably done by counsel. • protects privilege and controls chain of reporting


• Interviews – Conduct them in person, on site, with witness – Minimize interference with business operations – Be clear with employees regarding the purpose of

the interview – Employees have right to have counsel present


• Interviews (cont’d.) – Explain the importance of accurate

information and the obligation to provide truthful information

– Caution that disclosure of confidential information can thwart the investigation

– Think twice about recording but get signed statements

– Don’ let a witness lead the interview. – Follow up all leads

Duty to Report

• Supervisory Committee • Board/ Executive Management • Bond Carrier • NCUA/State Regulator

– Communicate but don’t necessarily report – protect the privilege

• State/Federal Criminal Authorities – File SAR

Polling Question 3

• Fraud has NEVER caused a Credit Union to fail. • A) True • B) False

Other Issues

• Bond Claim • Civil Action • Freezing Assets • Other Action (dismissal, etc.)

Credit Union Fraud Since 2013 Asset Size Credit Union Fraud Type Amount Alleged Perpetrator

$7M Borinquen FCU Loans/Theft of Funds $2.3M CEO

$2M Women’s Southwest FCU

Loans/Theft of Funds $3.4M Manager

$303K United Catholic FCU Aliases/Forged Checks $2.1M Manager

$270K Associated Blind of Oklahoma/Texas

Theft of Funds $200K Manager

$3.1M Border Lodge CU Theft of Funds $300K CEO

$2.5M Lawrence County School EE’s FCU

Theft of Funds $285K Employee

$630K H.B.E. CU Unauthorized Checks $636K Manager

$1.6M Enterprise CU Theft of Funds $800K Manager

$16M GIC FCU Theft of Funds/False CDs

$2M Manger

$24M Taupa Lithuanian Cu Loans/Theft of Funds $15M CEO, Teller, 5 Others


$60M WesTex FCU Theft of Funds $500K Assistant Accountant

$1.9M Aurora Firefighters CU Theft of Funds $36K CEO

$13.8M Lynrocten FCU Loan Participation Fraud

$1M Manager, 2 Employees

$42M Toledo Metro FCU Corporate Expenses $234K CEO

$186M St. Paul Croatian FCU Loans $70M CEO, 30 Others

$38M Wilkes Barre City EE’s FCU

Loans $16M Mgr, Asset Mgr, Members

$16.3M Shoreline FCU Cash Theft from Vault $1.9M Manager

$10.4M Centra Health CU Theft From Corp. Account

$1.7M CEO, 2 Others

$13B $924M $1.1B

Boeing EE’s CU Twinstar CU Sound CU

Stolen Check $987K Members


$639M $17B $20M $246M

Great Lakes CU Pentagon FCU Sherwin Williams CU CU 1

Car Loans $853K Members

$24.5M Georgia Power Valdosta FCU

Accounting Fraud $500K Operations Manager

$13.5M Parsons Pittsburg CU Embezzlement/Transfer of Funds

$10M Manager

$1B Scott Credit Union Loan Falsification $12M Business Relationship Manager

$68M Clarkson Brandon Community CU

Accounting Fraud $20M CFO

$603M Houston Police FCU Stale Checks $1.2M VP

$223M Pantex FCU Check Fraud/Theft From Teller Drawer

$826K AVP

Credit Union Fraud Not – so – fun Facts!

• 192 CU’s failed in the last 10 years. • 78 of the failures were caused by fraud. • 46% of Claim Dollars Paid by CUNA Mutual from

2009 to 2013 involved employee dishonesty. • 94% of losses to NCUSIF were related to

internal fraud. • Moral – Trust but verify!

Christopher J. Pippett, Esquire

610-458-6703 [email protected]

Internal Fraud from the Board PerspectiveMay 03, 2016 · Fraud Type . Amount : Alleged Perpetrator...

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Transcript of Internal Fraud from the Board PerspectiveMay 03, 2016 · Fraud Type . Amount : Alleged Perpetrator...