October 22, 2012
Faking an Audit Report
A financial firm's controller is indicted for forging an audit report.
A fake audit at the New Mexico Finance Authority (NFMA) went undetected for months and was distributed to investors because of a complete breakdown of the agency's management and oversight, reports The Santa Fe New Mexican. NMFA's ex-controller — who has been indicted for securities fraud and forgery — told securities investigators he had forged the audit, but there's no evidence that money is missing. New Mexico's securities division director said that while the ex-controller's motives remain unclear, the audit was needed as part of financial and legal materials for a US$24 million bond issue in March. An outside accounting firm has been hired to prepare the authority's audit.
Two fundamental ingredients can contribute to this type of massive fraud in U.S. financial institutions: fraudsters who take advantage of their position within the financial institutions and key systemic deficiencies in the design, oversight, and controls over these mortgage incentive programs.
In this case, a 2005 internal audit revealed that 83 percent of loans approved by now-defunct Washington Mutual's Montebello, Calif., office were fraudulent. While it may seem shocking that audit results were neither detected earlier nor addressed promptly enough to prevent the bank's collapse, auditors can learn several lessons from this case to help reduce the risk of these types of fraud.
A fraud risk assessment, conducted by audit staff, can bring forward issues that — if addressed — may prevent this type of mortgage fraud, including:
Clear differentiation between the bank's role of promoting versus reviewing and approving subprime mortgages.
More rigorous application of the criteria for approving loans.
Regular, independent reviews and audits of the loan approval process.
Stronger performance incentives that emphasize executive bonuses based on the validity and viability of the approved loans rather than the number of approved loans.
Although intentions around the various subprime mortgage programs were valid, banking, financial, investment, and government oversight/regulatory bodies, as well as investors, involved with subprime lending programs might have fared better by asking for and listening to the advice of their auditors regarding the soundness of the controls and risk mitigations in place.