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Crimes of the vault.


BANK FRAUD IS A TERM USED to describe a large and varied list of offenses, ranging from simple check forgeries to complex wire transfer schemes. But all these frauds have the same objective - to steal money from a financial institution.

Four of the five crimes commonly committed against banks involve fraud. The major categories of criminally instigated monetary losses to banks are robbery, credit card fraud, insider abuse, loan fraud, and check fraud. Not surprisingly, robbery receives the most attention from bank security departments and law enforcement agencies because of the physical danger involved. However, in terms of financial harm, robberies are on the bottom rung on the loss ladder.

Loss categories rank as follows:

* robbery - $60 million to $70 million

* credit card fraud - $1.2 billion

* inside abuse (defalcation) - $2.1 billion

* loan fraud - $6 billion to $7 billion

* check fraud - $7 billion to $10 billion These figures are industry estimates based on official reported figures and annual bank charge-off categories prorated nationally by asset size of the institutions.

As with any statistics, some people might argue with these figures. Certain crimes are clear-cut, such as robbery or credit card counterfeiting, while some are subject to interpretation. For example, a pattern of check losses may be a simple case of nonsufficient funds, a result of poor or inept bookkeeping, or deliberate check fraud.

The Bank Protection Act of 1968 (revised in 1972) placed the responsibility of security with each bank's board of directors and required all banks to have a security officer. The intent was to establish guidelines on security matters to promote security procedures and ensure loss prevention standards.

The act permitted banks to develop security plans to meet their own needs and internal structures. In many cases, physical security responsibilities are distinct from fraud loss prevention and investigation. Also, internal defalcations are often the responsibility of the internal audit section, and commercial loan fraud is the concern of the commercial loan department.

Despite these initiatives, fraud losses have skyrocketed over the past decade. The public and the business community have become more aware of the high cost and pervasiveness of fraud. The effects of fraud in the failure of some savings and loan institutions have also made people painfully aware of the frequency, significance, and devastating effects of fraudulent activity. Public perception of the causes of these failures has dictated further safeguards.

Various frauds committed against banks reveal well-established schemes, new variations of older patterns, and novel forms of abuse.

Check fraud. One of the oldest types of bank fraud is check fraud, which includes theft, counterfeiting, and kiting.

Stolen checks, particularly payroll checks, continue to be a significant problem. Theft through burglary or internal pilferage can result in their use over a wide geographic area. Thieves often sell stolen checks to fences who quickly distribute them or hold a number for months or even years.

An increase in the use and the quality of counterfeit checks has occurred, too. One recent scheme involved the negotiation of phony checks drawn on a Florida bank against an insurance company in Texas. These checks, in amounts of thousands of dollars, were made with excellent paper and printing.

Check-kiting schemes often have unique variations. Sophisticated kiters now use computers, which inform the criminals where and when to deposit checks. This technique has permitted more complex patterns that involve more banks. Enterprising thieves have even concocted variations such as deposits of bogus charge card slips to float funds as part of the scheme. The Expedited Funds Availability Act (commonly referred to as Regulation CC), which limits the holding period financial institutions can place on deposits, has contributed to making check kiting a major cause of check fraud losses.

Automatic teller machine (ATM) fraud. ATMs have been a constant source of problems since their inception. Criminals can devise ways to manipulate ATMs as fast as banks install them. Although operating flaws that permit ATM abuse have been checked or overcome, schemers continue to abuse the machines.

Legitimate ATM cardholders' naivete often contributes to the problem. In many instances where cards were stolen, cardholders had their personal identification numbers (PINs) written on the ATM cards themselves; had the PINs clearly identified in their address books, which were stolen along with their cards; or had obvious codes as their PINs. These meager attempts at password security make a criminal's job far easier.

Some banks are now using systems that can encode or change PINs at branch locations. Of course, lax procedures create the opportunity for abuse by unscrupulous bank employees. Some banks have procedures to permit the customer to encode the PIN discreetly to reduce possible abuse. Other banks are considering voice identification systems at terminals.

Credit card fraud. Most bank credit card loss is due to account holders who are bad credit risks rather than criminals. However, some losses are the result of clear-cut fraud artists and rings.

Counterfeit credit cards have been around since the invention of plastic money, as have alterations of legitimate cards and the fraudulent use of stolen cards or card numbers. The practice of disposing of carbons and the introduction of carbonless charge slips have helped reduce this abuse. However, dishonest employees and vendors still have easy access to good account numbers.

There has been a growing awareness of schemes in which criminals use a legitimate, creditworthy individual's name and social security number to apply for and obtain credit cards. Often this crime goes undetected until the legitimate cardholder learns of the charges to his or her card or is denied credit because of a delinquent account. The frustrating process of clearing his or her name and reinstating a good credit record then must begin. Unfortunately, by that time the fraudulent trail is cold.

Holograms and smart cards have helped curb some counterfeiting. While some criminals have been successful in duplicating holograms, smart cards are gaining attention and acceptance and will probably become a banking industry standard in the near future.

Loan fraud. Considerable attention has been paid to fraudulent loans - both fraudulently obtained and fraudulently provided - particularly in the savings and loan industry.

Loan frauds, especially in commercial loans, are often sophisticated in conception and implementation. The perpetrators, familiar with banking operations and procedures, skillfully avoid detection and skirt procedures that would result in denial of the loans.

Under usual circumstances bank procedures reveal significant facts about the viability of a business and the standing of its principals. However, adept manipulators can skillfully fabricate business backgrounds and principals' histories to deceive lending officers. Bogus identities, assets, contracts, and customers can be constructed and successfully used in the verification process.

For example, in 1988 John Sanders, owner of a New Jersey printing firm, pleaded guilty to charges stemming from a commercial loan fraud of more than $1 million. The indictment alleged that Sanders used phony companies as collateral. He used mail drops and telephone answering services to deceive the bank and to further the plan.(1)

Many professional scam artists are adept at hiding assets, thus thwarting a bank's attempts to recover the funds. A dishonest or manipulated lending officer or other bank employee can be an essential element in devising significant loan frauds. Organized crime, often at the leading edge of frauds, has also used loan fraud as a means of conducting its business.

In 1980, a major scheme involving individuals linked to the Bufalino La Cosa Nostra family of Scranton, PA, was uncovered. Investigations revealed that First Federal Savings and Loan of Pittston, PA, through its president - Joseph Roman - had made unsecured loans totaling $139,500 to a supper club connected to the family. Further investigation resulted in Roman's 1983 indictment by a federal grand jury, which charged that in a two-year period he had misapplied $721,000 in savings and loan funds and falsified loan documents.

As a result of his manipulation and falsification, the savings and loan lost more than $7.3 million in 15 years, resulting in the financial collapse of the institution in 1982. In 1984, Roman pleaded guilty to several counts of manipulation and falsification of savings and loan records.(2)

Internal defalcation. Banks are seriously vulnerable to insider abuse and theft at all levels of personnel. Recognizing this, the federal government has reinforced regulations that deal with reporting internal losses. In 1986, the federal Office of the Comptroller of the Currency issued a replacement regulation requiring banks to submit referrals in all instances of crimes or suspected crimes by officers or employees and to report certain instances of unexplained disappearances of cash.(3)

Because of the responsibility and sensitivity of many employee positions in a bank, numerous opportunities exist for fraud and abuse. The advent of electronic data transfers and wire transfers has only added additional points of vulnerability. Even with safeguards in place, schemers scheme and defrauders find opportunities to defraud.

A major contributor to the problem is the high turnover rate in the ranks of certain bank employees, especially tellers. Obviously, these cash-sensitive positions provide a convenient opportunity for criminals and unethical employees. In many cities, teller turnover rates and approaching 70 percent per year with an average suburban turnover rate of approximately 30 percent per year. The inability to use polygraph in preemployment screening and possible restrictions in the use of other screening methods such as paper-and-pencil honesty tests are limiting the avenues that banks have to weed out undesirables. Banks are forced to hire individuals about whom they know little.

Security and loss prevention personnel, knowing the value of prevention, often argue for preemployment screening programs. However, human resources managers must balance the potential benefit of such measures against their cost. Yet even the customary and time-consuming procedures of calling previous employers, processing fingerprints, and verifying other pertinent application data may not be enough to safeguard bank assets in the long run.

Internal losses are not just perpetrated by front-line employees. The recent savings and loan situation has revealed some high-level schemes and abusers. A US House of Representatives report on inside abuse highlighted the case of American Heritage Savings and Loan of Chicago, where bank executives made $15 million in fraudulent loans, resulting in a $45 million price tag to resolve the bank's financial mess.(4)

Money laundering. Although it does not often result in a financial loss to the bank, the indirect effects of money laundering can be as devastating to banks as they are to other institutions. Federal criminal and civil charges, alleged administrative and regulatory violations, and media notoriety can have derogatory effects on any institution.

Money laundering frauds have various forms. In one case, teams of individuals exchanged small bids for larger ones and purchased cashier's checks in amounts under $10,000. This and other schemes are attempts to avoid federal currency transaction reports. Tighter restrictions in the Anti-Money Laundering Act of 1988 should make it more difficult for criminals to use banks in exchanging cash.

The influence of the drug culture is becoming more and more prevalent in fraudulent activity. Although drugs may not be the only motivation, many veteran bank fraud investigators place drugs as a factor in 40 to 60 percent of all fraud cases.

Organized rings are not new to bank frauds, but some groups are relatively recent arrivals. Since the early 1980s, fraud rings composed of Nigerian nationals have been committing a wide variety of frauds involving student loans, credit cards, and checks.

Because of their alien status and often deceptive or fraudulently obtained IDs, these individuals are relatively unknown and change their identities regularly. Numerous federal, state, and local law enforcement agencies are investigating these fraud rings as possibly being part of a larger, diversified organized crime network.

Several other ethnic gangs are currently committing fraudulent activities. Some of the better-known gangs are gypsy groups. These gangs are very mobile and move in five-year cycles through various regions of the country, committing numerous financial frauds, including check fraud.

Law enforcement agencies and the criminal justice community are overwhelmed by the scope and volume of these fraudulent acts. In many instances they must place dollar thresholds on the cases they will investigate and prosecute.

The US House of Representatives committee that investigated the savings and loan crisis reported that the FBI and Justice Department lack the personnel needed to prosecute bank criminals. It also cited the lack of experienced bank examiners to handle such cases.

To alleviate these problems, federal authorities have instituted a fast-track process for prosecution. However, the program has yet to be fully implemented and streamlined. Even if successful, the program will not eliminate the already huge and rapidly growing quantity of cases reported to law enforcement agencies each year.

In his report The Future of Law Enforcement, Dr. William Tafoya of the FBI predicated that as a result of increasing demands for enforcement in street and property crimes, businesses will be required themselves to respond to acts committed against them.

According to Ron Hale in Bank Fraud, "Sophisticated crimes will overwhelm the criminal justice community by the year 2000. Again, law enforcement agencies will not be able to cope with this problem, and private sector businesses will have to develop their own resources for protection as well as the ability to investigate these crimes. Banks, because of their visibility, are likely to be more vulnerable than other businesses."(5)

In a criminal case the role of law enforcement is arrest, prosecution, and conviction. Yet, banks themselves have the responsibility to recover their financial losses. Even if restitution is ordered by the courts, banks must bear most of the burden of collecting restitution or recovering funds. In other words, each bank must protect its own financial interests.

Bankers are aware that with a rapidly changing society and increasing technological developments their safety nets have not kept up with their problems. As electronic data interchange and new regulations liberalize fund availability policies, many bank security and fraud prevention officers are concerned about the increased opportunities for abuse.

Barbara Hurst is president of Hurst Associates of Brookhaven, PA, which provides legally mandated training to bank personnel nationally on compliance, regulation, operation, and loss avoidance. She has testified before Congress on issues regarding banking legislation and regulation.

Hurst has predicted that check fraud will skyrocket with further liberalization of availability of funds under Regulation CC and criminals' growing awareness of these policies. She believes that this fraud increase could cause substantial financial losses to banks to the point of becoming a significant factor in some bank failures.

Banks can and do take measures to reduce fraud and abuse. Some of these measures are not only basic but also critical in fraud loss prevention. These safety nets include the following:

Education and training. Banks that have regular in-house and out-of-house training programs have a substantially reduced incidence of fraud loss.

Policies and procedures. The majority of defalcation policies and procedures, though written and established, are not followed. Strict adherence to them is a key factor in reducing fraud.

Communication. Banks often separate fraud loss operations in different departments. However, frauds and fraudulent criminals often involve several segments of bank operations.

In one instance, an investigator working on an endorsement forgery contacted a bank he suspected may have incurred a loss. Fortunately, an intended check fraud was avoided. As a preventive measure, the investigator suggested the bank also search for any other accounts, including loans, in the criminal's name. The loan records revealed a commercial loan application for several hundred thousand dollars that was within days of approval. The loan application was based on fraudulent information.

If responsibilities are segmented, good communication must be established and maintained. This need involves not only security and fraud loss departments but also human resources, audit, operations, and loan departments.

Many banks' fraud loss programs are reactive - responding to the fraud after the occurrence. But banks are now becoming more aware of the necessity of preventing frauds in the first place. Programs such as preemployment screening, background checks, and drug testing services are becoming more common in human resources departments. In the long run, these programs are proving their worth in fraud prevention.

In commercial loans, banks are no longer content merely to accept information supplied to them by a loan applicant. In many cases, particularly when dealing with new customers or large loan amounts, they also demand independently obtained profiles on the business and its principals. Banks are also less willing to write off loans as bad or uncollectable. They are using search firms to verify the location and size of a company's assets.

Sharing information between banks is also critical in limiting the scope of frauds. Notification of current problems, such as stolen checks, counterfeit checks, kiting schemes, fraud rings, etc., is essential to preventing the problems from continuing.

Some banks sponsor regular meetings that enable their security professionals from different regions to discuss common problems. Some banks have instituted notification networks. Both of these are steps in the right direction.

Another step to fight bank frauds is to hire a professional firm to provide fraud detection, prevention, and investigation services. These firms can also provide other services, such as forensic accounting, law, computer security, compliance, and regulations.

Bank officials and employees must be aware of the frauds occurring, how they are perpetrated, and how they can be prevented. Good training, established and enforced procedures and controls, communication, information, and expert advice are the key elements in limiting and reducing fraud losses, now and in the future.

(1) "Maryland Exec. Admits Bank, Wire Fraud Guilt," Newark Star Ledger, November 15, 1988. (2) Pennsylvania Crime Commission, 1983 Report (Harrisburg, PA: Commonwealth of Pennsylvania, 1983), p. 40. Also, Pennsylvania Crime Commission, 1984 Report (Harrisburg, PA: Commonwealth of Pennsylvania, 1984), pp. 17, 29, and 39. (3) 12 CFR 21.11 (1987): superseded by an interim rule effective April 11, 1988. (4) The report further states that criminal activity at savings and loans will cost the FSLIC "an absolute minimum of $12 billion." Philadelphia Inquirer, October 29, 1988, p. 11-D. (5) Ron Hale, "Bank Security Today and into the Future," Bank Fraud, (Rolling Meadows, IL: Bank Administration Institute, 1989), pp. 4-7.

About the Author . . . Carl P. Brown is vice president of the National Fraud Investigation Center Inc. in Philadelphia, PA. He is a member of ASIS.
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Title Annotation:preventing bank fraud
Author:Brown, Carl P.
Publication:Security Management
Date:Jan 1, 1990
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