Frank Schultz was a fresh recruit and a rising star in the accounting department of Nasdall Bank's West End branch. He had become accustomed to the star treatment even before he began working at Nasdall; Frank took pride in his multiple most valued player (MVP) awards in the intercollegiate basketball tournaments he played in, representing State College. He loved flaunting an image of being linked with pretty girls, fabulous cars and extravagant nightlife. However, when Frank was recruited straight from graduation as an assistant accountant for Nasdall Bank, he was not ready to let go of the illusions of his good times in college. For him, life should not be a bore, even in the financial world. "Let's create excitement," he told himself.
During his university days, Frank masterminded a gambling game that he introduced to his school buddies. The players bet online, using an Internet hosting facility, for the last winning digit of the scores of their favorite National Basketball Association (NBA) team, and whoever hit the correct score would get the pot money. The winner would receive his take through an online credit to his bank account. The losers had to pay their share through an interbranch deposit to the dealer's account. The dealer, Frank, enjoyed a 10 percent commission and deposited the remaining 90 percent to the winning bettor's account.
At first, it was just a game for fun. Almost every participant would regularly bet $5 per share of a winner's block; not enough to really hurt one's pocket. But it later became a lucrative business for Frank. He received his 10 percent commission weekly, which helped him create his high-flying lifestyle. Starting with a handful of about 20 bettors, the game quickly turned into a campus craze and captured a market of 70 participants, then 200 and eventually 300. Nobody knew exactly whom they were betting against. In reality, the players were dealing with an out-of-school punk, Curtis Harris, who acted as Frank's middleman. Frank was very clever about covering his tracks by avoiding direct contact with his "clients." The online betting game masterminded by Frank became so popular in the underground world that it branched out to several other schools in the region. Most bettors were college students who were also basketball fanatics. One good thing about such a client base — everyone was mum about the betting because they did not know with whom they were dealing. They would simply receive their winning shares or pay their shares when they lost. For them, it was more fun than off-track betting on horse racing because the basketball game provided a high chance of winning combined with certain excitement and challenge. And the score was fair and square — each player could watch the results live on TV or through the Internet.
After college, Frank Schultz went on to earn a name for himself in the banking world, starting out as an assistant accountant at Nasdall . He satisfactorily passed the six-month probationary period and earned the trust and confidence of his colleagues. He spent a great deal of time learning the ropes of his new career in the accounting department. He easily learned and became acquainted with the software packages used in his department. Schultz familiarized himself with the accounting processes of his branch and the head office and he absorbed the intricacies of the job. He envisioned himself working as a top-notch executive in the bank within the next five years.
However, the lure of the easy money he made during his college days did not leave his mind. Frank was still itching with the way he pulled away substantial sums of money through his online gambling without being detected. As a result, he decided to continue after graduation and while working with Nasdall. He soon became obsessed with the thought of bringing his online gambling scheme into the banking world. He started to build a network of friends in the bank, including Henry Flanagan, a bookkeeper at his branch. Henry, who was an avid basketball fan, became a frequent drinking buddy of Frank's.
One evening when the two were out to happy hour together, Frank took the opportunity to propose his Internet gambling scheme to Henry. At first, Henry was hesitant about the idea but later became convinced that the plan was "flawless." Soon after, Henry became Frank's middleman for the Nasdall Bank bettors and was able to capture a sizeable market; he recruited almost 100 banking personnel in 19 branches in the area and later expanded to almost 500 bettors from 60 branches. It wasn't clear that this online betting game using Nasdall's Internet banking procedures violated the rules of employee conduct. The employees who were patronizing the game looked at it as a fun game and a stress reliever. However, Frank had decided to set the minimum bet higher than his college levels — after all, he was dealing with working professionals now. He upped the entry bet to $40 per share and the pot sometimes reached $20,000 per week. Furthermore, the "fun game" got out of line when Frank — not content with his 10 percent commission — and Henry bet huge sums of money and incurred a heavy loss of around $20,000 in one week. Frank's losses reached $100,000 in that particular month, which forced him to get creative about ways to pay them off. His flawless modus operandi had quickly turned into an abyss of gambling debts for both Frank and Henry.
Aware of their predicament, they devised a plan to siphon out funds from bank deposits to cover their debts. Frank spotted a weakness in the recording of accounting adjustments against deposit accounts. They posted fictitious entries using a "correction advice" against several deposit accounts and credited through the Internet banking facility the proceeds to a fictitious conduit account. Exploiting this weakness, Frank and Henry were able to amass an aggregate of $1.2 million in a period of three months.
Nasdall Bank had been engaged in commercial banking for more than 50 years and gained an excellent reputation for its efficient service and trustworthy employees in the Midwest. The company implemented a hands-on management style and invested sizeable sums of money into technological development. It had 900 branches and employed 12,000 employees nationwide. Never in their wildest dreams did Nasdall's management and executives expect that one of their well-screened employees would become a bad egg.
Frank Schultz came up with a clean record during the reference check by the personnel department at the time he was hired. His scholastic record showed decent grades and his popularity as a collegiate basketball star did not pass unnoticed by the hiring staff.
As the head of the special audit group at Nasdall Bank, I conducted regular investigations into the bank's fraud cases and red-flag issues. In my more-than-a-decade tenure with Nasdall, most of the cases involved petty and white-collar crimes with fairly small losses. However, the amount eventually uncovered in this case looked serious enough to call for a top-down reorganization in the West End branch.
This situation was brought to my attention during a visit I made to the branches in the West End area, including the one where Frank was employed. I was speaking to staff members about the reporting duties of the control and marketing officers, which apparently prompted an employee to confide in me. After the meeting, he approached me to say that he sensed something wrong in the recording of Internet-related transactions at his branch. He suspected some people in accounting were engaged in unsound financial practices.
When I returned to my office I mentioned the tip to my special audit staff. After a thorough trend analysis of the balance sheets of the branches in the area, my team uncovered many long-outstanding, unreconciled entries in the West End branch. There were entries from suspense accounts without corresponding transactions. Based on these suspicious patterns, I decided to send an investigation team to the branch to do a little more digging.
Frank Schultz turned out to be a quick study in the Internet and intranet facilities of his branch. He became skilled in Internet usage while in college and was able to spot the loopholes of his branch's system and software package. These loopholes allowed him to siphon funds without being detected . . . initially.
My investigation team conducted a discreet review of the statement of conditions (SOCs) of five branches in the West End area. We noticed an unusual increase in the amount and volume of interbranch credit adjustments conducted through Internet-banking controls in the past three months. This was unusual because the bank used interbranch credit adjustments to post entries during offline mode. For example, credit adjustments would be made for interbranch cash deposits that were not posted, interest expenses and service charges, and this accepted practice did not cause substantial accumulation. Such postings could only be done with the correction advice (CA) of the bookkeeper and had to be approved by a designated branch accountant, which required an override password. After passing these controls, the batch amount would be posted by the bookkeeper using the Internet process for interbranch transactions.
The team tried to verify the supporting details of the SOCs and uncovered various fictitious CAs issued for interbranch credit adjustments. The recipient branch used the CA as the basis for a memo authorizing credits to a bank employee's account and to another bank client. It turned out that these recipient accounts were winners and losers of Frank's online gambling game and the settlement was made through a fictitious deposit account.
Frank and Henry (both acting as bookkeepers) dispatched by fax several fictitious CAs to branches within the West End and advised the bookkeepers at each branch to post the corrections. The bookkeepers unwittingly complied without knowing that Frank had forged the signature of the accountant on the correction advice. He immediately perforated the original copy of the correction advice to reduce the audit trail. The submitting branch's audit team recovered only faxed copies of the CAs Frank sent and was unable to vouch for their authenticity. The accounting department of Nasdall had not maintained a logbook of correction advices and failed to assign particular sets of CA forms to individual branches for accountability. My team further discovered that there were no cash deposit slips to support the CAs marked as "unposted cash deposits."
To make the scheme work, the branch's bookkeeper (Frank or Henry) posted the fictitious adjustment by crediting a savings account using various transaction codes that were standard at Nasdall, such as "credit memo — others (CMOT)" instead of "cash — savings account" to avoid using a self-responding ticket (SRT). If they did use an SRT, they would need proof of cash and it would be reflected in the book balance of branches and establish an audit trail. The use of the CMOT transaction code did not require interbranch accountability. Under this operating practice, the bank's computer system automatically generated an accounting entry for transactions still in process against savings accounts. To conceal their transactions, Frank and Henry manually reversed the fictitious entries in the branch's general ledger by debiting the amounts as service charges or interest expenses on deposits. This step would credit (reverse) the in-process account. To avoid detection, either Frank or Henry forced the balances reflected in the reconciliation statement of the deposit accounts so they would match the books.
The following two cases illustrate their methods for posting accounting entries. In the first case, they forced a fraudulent credit to the gambling conduit account and covered it up as an interest charge. In the second case, they charged a returned-check fee on a fraudulent check transaction:
Case 1: Internet entry using CMOT code to post a credit adjustment
Debit: In process — transaction systems (IP-TS) $ 9,750
Credit: Savings account $ 9,750
Manual reversed entry (posted by Frank or Henry) by charging fictitious interest
Debit: Interest expense — demand deposit $12,187.50
Credit: In process — transaction systems (IP-TS) $ 9,750.00
Withholding tax payable $ 2,437.50
Case 2: Excess amount posted as a reversal of income intended for other branches on outward return checks (system entry using the Internet banking code for Cash — Service Charges (CASV) used to post a $500 credit adjustment)
No system entry made
System entry on fictitious charges on return check and services charges
Debit: Due from clearing outward $5,000
Credit: Demand deposit $5,000
Debit: Demand deposit $1,100
Credit: Service charge fees — others $1,100
Reversal of income using manual entry (by bookkeepers)
Debit: Due from head office (for one returned check) $4,500
Debit: Service charge — others $1,000
Credit: Due from clearing outward $5,000
Credit: Savings account $ 500
Should be:
Debit: Due from head office $4,500
Debit: Service charge — others $ 500
Credit: Due from clearing outward $5,000
The fraud perpetrated by Frank and Henry indicated weaknesses in Nas-dall's internal controls of the interbranch transaction process, which was compounded by the negligence of the branch officers. My audit team discovered that the branch accountant approved correction advices without verifying the nature of the transaction and did not require supporting documents. Also, the branch head approved correction advices with credit memos —without verifying the memos.
Furthermore, the team learned that Frank connived with Alexander Horn, the information technology engineer at the West End branch, to acquire unlimited access to the bank's Internet-transaction processes. Alexander, who was actively engaged in Frank's online gambling scheme, provided the password and the conduit account for the gambling settlements. He was a necessary player in the successful execution of the fraud.
Frank and his associates were able to post fictitious credit adjustments using the Internet banking procedures of three branches of Nasdall in the area for their personal gain. They accumulated $1.2 million through 165 transactions in amounts ranging from $500 to $10,000. Their scam lasted three months. Our audit team analyzed the movement of cash deposits and withdrawals in the conduit account that Alexander established, and our report showed various Internet-banking fund transfers among employees of Nasdall Bank and the bank's customers. We traced numerous inter-branch fund transfers involving 35 deposit accounts under the names of Nasdall employees, including tellers, loans clerk, IT personnel, branch cashiers and accountants in 47 branches. It showed how rampant Frank's online gambling was among Nasdall's staff.
In summary, Frank and his cohorts siphoned money from the bank using accounting-initiated unposted entries and manipulating the income and expense accounts through Internet banking. They exploited the company's lax controls on Internet transactions to perpetrate a fraud that remained undetected for a considerable period of time. The bank was able to recover its loss of $1.2 million only after litigation.
My team was able to trace and document Frank's fraud, committed in cahoots with other employees of the bank. The team used the following audit procedures to detect fraudulent interbank and interbranch credits. To follow the audit trail, we checked and verified:
Unposted items made with correction advices, especially for interbranch and on-branch credit adjustments
Source documents (e.g., deposit slips and credit memos) to support unposted credit transactions using correction advices
Manually posted entries and reversals of entries made by the bookkeeper in the transaction journal for unposted transactions
Credit memo adjustments made by the counterparty branches to support entries made by bookkeepers
Original and duplicate copies of correction advices to detect tampering
Overridden entries made by the bookkeepers for any unposted transactions
Deposit accounts of the recipients of illegally acquired funds to identify the individuals involved in the fraud
We interviewed Frank Schultz, Henry Flanagan, Alexander Horn and other employees involved in the online gambling scheme. Frank admitted that he masterminded the online gambling as a fun game but that it turned out to be addicting and got out of control.
Alexander Horn confessed that he provided the supervisor override codes for posting online entries and created fictitious accounts as a conduits for gambling, specifically betting on winners of basketball games. He further admitted that his account was used to receive bets (deposits) from various Nasdall employees and to make payments to winners (withdrawals). He revealed that he used his account as a conduit for the fraudulent activity of Frank and Henry by depositing part of the fictitious credits made by them to winning bettors and then transferring a portion to the account Frank maintained at a Nasdall branch outside the West End area. Alexander was also involved in recruiting several IT personnel from other Nasdall branches to help facilitate gambling settlements online.
This was further collaborated by bookkeeper Henry's admission that he worked with Frank and Alexander to forge documents, create fictitious unposted entries and infiltrate the bank's Internet processes using override codes. Henry also admitted their illegal gambling activities using Alexander's account to temporarily park settlements.
The fraudsters also revealed the involvement of Curtis Harris — a personal friend of Frank's and former partner in his college gambling organization — in brokering the gambling bets of bank employees and some clients.
Several Nasdall employees admitted that they placed bets for the online game but denied they knew about the fraudulent activities of Frank, Henry and Alexander. They expressed regret at having been involved with this activity, which we pointed out was in violation of Nasdall's employee code of conduct.
My team submitted a painstakingly prepared audit report to the chief legal counsel at Nasdall and circumspectly coordinated with the police and legal authorities. The following individuals were identified as the perpetrators:
Frank Schultz, Assistant Accountant — committed forgery, misrepresentation and falsification of commercial documents using the Internet and e-commerce.
Alexander Horn, IT Engineer — created a fictitious deposit account to serve as the conduit for illegally acquired funds and used this account for the settlement of gambling receivables and payables.
Henry Flanagan, Bookkeeper — committed forgery and falsification of commercial documents using the Internet and e-commerce.
Curtis Harris, third party and close associate of Frank Schultz — served as middleman for the gambling operations that included the use of illegally acquired money from Nasdall Bank.
The bank terminated Frank Schultz, Henry Flanagan and Alexander Horn for cause.
By the time formal criminal charges were filed against them, the foursome had disappeared. As a result, warrants for the arrests of Frank Schultz, Alexander Horn, Henry Flanagan and Curtis Harris were issued. Only Frank was arrested immediately; he was ultimately sentenced to 10 years of incarceration. The others went into hiding. After almost a year-long manhunt, Henry, Alexander and Curtis surrendered and were each sentenced to five years in jail. The Nasdall Bank employees involved in the online gambling activities were sanctioned by Nasdall as provided for in the employee code of conduct.
Antonio Ivan S. Aguirre, MBA, CFE, CPA, CSI, is a chief resident auditor under the Office of Internal Oversight Services (OIOS), United Nations. He previously worked with the largest bank in the Philippines as the head of special audit and acted on several occasions as an expert witness against numerous white-collar and organized crimes.