NCUA Report - February 2012

Region IV Report
A WATCHFUL EYE ON FRAUD

Fraud is an ever present possibility and an unfortunate reality within the credit union system. The fraud that takes place at financial cooperatives like credit unions can be particularly devastating not only because the money lost comes from all members, but credit unions have been put into conservatorship because of it. A watchful eye must be a constant in this battle against fraud. As such, the key to preventing fraud is putting in place a sound system of internal controls and keeping vigilance over what has been put in place.

A strong internal control system is a credit union’s best defense against fraudulent activity while weak internal controls provide a breeding ground for substantial losses or even failure. It may be only one person who commits the fraud, but lax management oversight along with a failure of the supervisory committee to perform its vital functions may allow this individual to embezzle for months, if not years.

There is a long list of internal control weaknesses that, in some combination, have been present in credit union fraud cases. In reviewing a series of fraud and embezzlement cases, NCUA produced Letter to Credit Unions 96-CU- 4 which lists common factors. When a management team is reviewing internal controls to spot deficiencies and plan for improvement, keep in mind these common traits:

; A weak and/or uninvolved Supervisory Committee;

; Limited staff;

; Recordkeeping problems or out of balance conditions;

; Overdue or poor annual audit and/or member account verification;

; Manipulated records; and

; Trusted staff.

NCUA Board Chairman Debbie Matz has often noted the vital importance that volunteers play in the “short-term perseverance and long-term success of our nation’s credit unions.” The Supervisory Committee is a critical link for the perseverance and success of a credit union that Chairman Matz alludes to. Among the duties of the Supervisor Committee members are to review internal controls, perform verifications, and complete audits.

These functions are required in regulation and set out in the Supervisory Committee Guide. This valuable guide not only lays out the responsibilities of committee members, but also provides instructions on how to complete various reviews. It may be found on the NCUA Website at http://www.ncua.gov/ Legal/GuidesEtc. An active supervisory committee is vital, especially in small credit unions with limited staff, who are faced with finding creative ways to incorporate the checks and balances provided by segregation of duties in larger credit unions.

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REGION IV

Recordkeeping problems, out of balance conditions, overdue audits or member account verifications, and manipulated records create a dangerous environment for fraud to take root and go undiscovered. Accurate and up-to-date records and audit trails are, in themselves, deterrents to fraud.

Listing “trusted staff” as a fraud trait may seem counter-intuitive, but in many fraud cases, the perpetrator is an employee working for the credit union for many years, garnering trust in the absence of controls. These employees are often familiar with operations and know where internal control weaknesses exist. As an individual’s personal situation changes, so do the incentives for enrichment and criminal behavior.

Experts often refer to the “Fraud Triangle” when discussing this topic. The three components of the fraud triangle are motive or pressure, opportunity, and rationalization. Pressure might start simply as a series of overdue bills or a personality turned over to greed. As we have alluded to in this article, opportunity is created by poor management, weak internal controls, and when trust is always assumed, but not properly tested. Rationalization is a key ingredient in this volatile mix because a person’s fraudulent behavior may be perceived by him or her as an acceptable norm.

The best way to prevent this triangle from being formed is by taking away opportunity. That entails all that we have discussed here in terms of staying on top of internal controls and a Supervisory Committee that is active and dedicated to consistently perform its important tasks. Internal controls are not static, they need to be evaluated and periodically updated and improved to keep up with the credit union’s growth or use of technology as just two factors to consider. Once the internal control environment is assessed, then weaknesses can be determined and policies can be put in place for improvement.

As we continue into the new year, our shared goal of safeguarding credit union assets needs to be forward thinking. As credit unions evaluate lending programs, interest rate risk, and liquidity contingency planning, they should also consider whether their internal control environment is sufficiently robust to offer protection from potential fraud. NCUA examiners will continue to review internal controls through the examination and supervision process.