Fraud Friday — The Three Warning Signs of Bank Fraud

July 31, 2015

By Bob Coleman
Editor, Fraud Friday

Christmas has come early for you fraud junkies.

SIGTARP has issued her 584 page quarterly status report to Congress. Some like to binge Netflix’s releases — some, like me, love to binge read this fraud stuff.

I have been very critical of the feds focusing on community bankers and their borrowers, and avoiding the “too big too jail” bankers.

I never got the memo of the moral equivalency of choosing between extracting billions of dollars from “too big to fail” bank shareholders, or jailing community bankers and borrowers in flyover country for the criminal acts from the financial crisis.

Look, if a community banker has committed a true fraud — nail him or her. But, it is inconceivable to me that all bank fraudsters jailed from crimes during the recession are from the sole class of community bankers and borrowers that received TARP funds.

I digress.

In her report, SIGTARP has skillfully outlined talking points of common fraud schemes.

SIGTARP says common fraud schemes at TARP recipient banks — and I would expand the list to all banks — are:

1) Excessive risk-taking and lack of accountability for consequences of that risk-taking

Sometimes the crime is committed during the aggressive growth strategy such as bankers that commit illegal accounting short cuts, elude internal controls, and violate underwriting laws such as legal lending limits designed to keep a bank’s risk related to any one borrower in check. Other times a bank may have taken excessive risk without violating the laws, but bank officers use fraudulent accounting tricks to conceal the bank’s true financial condition, and to delay and avoid reporting the bank’s impaired loans and true loan losses to the public.

2) Heavy concentration of lending in favorite customers

Eric Hranowskyj and George Menden were favored customers of Bank of the Commonwealth. Hranowskyj and Menden leveraged such control that Bank of the Commonwealth employees called it the ‘Bank of Eric and George.” Hranowskyj acted like he owned the bank, calling himself “Big Daddy” to bank employees, overdrawing his accounts by $600,000, and demanding that the bank “lower his rates ASAP” and cash his employees’ paychecks even though his
account was delinquent. If the bank did not do what he wanted, he threatened to stop participating in the bank insiders’ criminal scheme. Eric and George owed their bank nearly $41 million, contributing to its ultimate failure. SIGTARP’s investigation revealed that in exchange for favorable bank loans, they helped the bank make past-due loans appear current, bid up bank-owned repossessed property at auction using the bank’s own money, and made fraudulent construction draws, among other crimes. These co-conspirators were sentenced to prison for 14 and 11½ years.

3) CEO Maintains Control Including Over the Board of Directors

SIGTARP has uncovered cultures where crime has seeped in and continued unchecked where the CEO has power and control of the bank including over the board of directors. The CEO may also be chairman of the board and/or the board of directors may be overly deferential to the CEO without conducting sufficient inquiry or due diligence. This culture lacks checks and balances that could protect the bank by deterring or catching crime.

Banks with CEOs who built the bank or have held the position for a long time may be particularly vulnerable. Where the board members lack the CEO’s skills or knowledge, do not understand banking’s complex laws and rules, or do not ask the hard questions or challenge the CEOs about risky decisions, crime can seep in or continue unchecked. At community banks, board members often work outside the banking industry, but that should not mean that they defer all decisions to their CEOs.