Think You're a Good Fraud Auditor? Try this Case!
The Last of the Good Ole Boys (a true story—names have been changed to protect the guilty!)
Located in an extinct volcano basin at 9,000 feet in the mountains of Oregon is a small town we'll call Gold Mine City. Since the gold rush days of the 1860s, the First City National Bank had served the needs of gold miners, businesses and other individuals. Quite large in its early years, the size of the bank had dwindled nearly to extinction; total assets were barely $1,300,000.
The bank was operated for its shareholders by two "good ole boys" and a small board of directors. Rob Enhud was the vice-president, John Little the cashier and Maude Merrian the secretary/teller. The bank received semi-annual visits from auditors with the Controller of the Currency and the FDIC. A CPA firm, Largess, Oughtiter & Associates, performed annual directors’ examinations for the last five years.
The director’s examination, an agreed-upon procedures engagement, included these procedures which were performed “by the book:”
• A trial balance of accounts was obtained and agreed to the general ledger.
• All cash in the teller’s cage and in the vault was counted without exception and agreed to the trial balance.
• All cash accounts reconciliations were proved and confirmed with the depository bank without exception.
• Commercial and installment loans subsidiary records were satisfactorily reconciled to the trial balance.
• 50% of the total balance of commercial and installment loans was confirmed positively and their loan files were examined in detail. All confirmation replies were received in less than three weeks and none contained exceptions. Loan files were perfect.
• Subsidiary records for demand and time deposit accounts were reconciled to the trial balance without exception.
• Approximately 25% of demand and time deposits accounts were confirmed positively. 90% of the confirmations were returned; none contained exceptions.
• Receipts and payments on serviced loans participated out to other banks were traced to serviced loans’ payment amortization schedules. A few exceptions were noted and are described below.
Shortly after the last director’s examination, the town was stunned when Rob and John were found dead on a hillside overlooking the city, their suicide note confessing nearly ten years of using bank assets to help needy farmers, widows and the poor in the community. As the story unfolded, one of the bank directors had arrived at the bank that day prior to the release of the time lock on the vault. As the vault was opened, the director discovered two complete sets of bank records! One set of fabricated records showed total assets of $1,300,000; the actual records reported less than $100,000 in assets. Not only were most of the assets missing, they had been missing for over 10 years! When Rob and John were confronted, they chose to end their lives rather than bear the shame and humiliation of being prosecuted.
Needless to say, the partners of Largess, Oughtiter and Associates and their legal counsel had cause for concern! After a "hindsight" review of working papers, only these unusual circumstances came to light:
• Payments on loans made and serviced by the bank, portions or all of which had been sold to other banks, were being made to the participating banks in amounts, and at times, different from the amounts and dates of the actual receipts from borrowers.
• A note from the vice-president's brother was found in the pending note file without a signature, although the funds had been disbursed. The vice-president told the auditor that his brother had been busy and overlooked signing the note. The auditor agreed to let the vice-president take the note to his brother for signing. It was determined later that the vice-president had signed his brother's name to the note.
• A handwriting expert was hired to examine the signatures on loans receivable and deposit confirmation replies. The expert found that the same hand, the vice-president’s, signed over 70% of the notes!
Post a comment below and describe the ways this fraud was perpetrated and covered up for 10 years. The first comment correctly listing all the fraud techniques will receive a complimentary copy of my book, Small Audits Made Easy and Profitable—An Overview. Look for my response to your comments to see if you are a winner.