United States

Deterring internal and external fraud for specialty lenders

Improved policies, controls and education are the keys


RSM recently conducted research among specialty finance firms regarding fraud. Overall, we found that roughly half of all firms we contacted had experienced fraud. While fraud losses tended to be relatively low, they are almost never recovered. Following are some general observations and suggestions for improving controls and deterring future fraud losses.

We looked at both internal and external fraud. Interestingly, half of the companies that experienced one form of fraud also experienced the other, which seems to indicate a relatively lax internal control environment at those companies and underscores the importance of effective controls.

When it comes to external fraud, companies report that:

  • Fraud is discovered by internal controls or management roughly two-thirds of the time and by internal audit on most other occasions
  • Frauds are usually discovered within six months
  • In the majority of cases, fraud is not reported to an insurer, and there is no recovery
  • Losses were generally less than $25,000
  • Fraudulent loans and check fraud were the most common types of external fraud
  • Perpetrators were almost always male
  • About half of the companies revised their policies and procedures or improved their internal controls as a result of the external fraud

For internal fraud, companies report:

  • Losses were generally less than $10,000, though companies reported an increase in losses between $10,000 and $25,000 as compared to the prior year
  • Theft of cash cases decreased compared to the prior year, but fraudulent loans and vendor or billing schemes increased. This likely accounts for the increase in loss amounts in the $10,000-$25,000 range, as vendor and billing schemes tend to involve more significant amounts than theft of cash frauds, due to limited amounts of cash on hand
  • Perpetrators were predominately female, likely due to the employment demographics in the industry

Four ways to deter and detect fraud

Overall, the types of internal and external frauds most commonly experienced demonstrate a lack of controls and insufficient segregation of duties at branch locations. The types of fraud most commonly committed help underscore this point. For example, fraudulent loan schemes often involve someone at the branch office recording a fraudulent loan on the books, using misrepresentations by a third party or collusion between internal and external perpetrators and then writing the loan off. By ensuring those duties are performed by separate parties and verifying the information provided during underwriting and funding, this type of fraud could be largely avoided.

Second, specialty lenders should ensure that branch locations have strong internal controls on-site and not rely exclusively on controls at the home office. While the reported fraud losses were relatively small and generally caught quickly, stronger controls at the branch locations could help prevent or deter many of these instances from occurring in the first place. Improved systems that would allow real-time reporting between branches and the home office could play a key role in improving controls and providing real-time oversight of operations. Even if real-time reporting is not possible, more comprehensive and timely reporting will help deter and detect fraud.

Third, weak or poorly documented operating policies and procedures, including formal fraud policies, also play a role in increasing the likelihood of fraud. By making it clear to all employees exactly what your operating procedures are, deviations from those procedures are more immediately obvious to everyone.

Fourth, specialty lenders should also consider educating their employees on common types of fraud. This would help honest employees spot malfeasance by co-workers. In addition, it would also underscore to employees who might be considering fraudulent behavior how small the gains from those frauds generally are, how quickly they are usually discovered, the company’s zero tolerance policy and the consequences they could face.

Many specialty lenders are relatively small compared to more traditional lenders, especially at the branch level. They often have less formal policies and, in some instances, closer personal ties to their employees. But it is a mistake to rely on this more familial atmosphere as an effective control. Improved segregation of duties, real-time oversight, stronger, more formal operating and fraud policies and effective employee education can go a long way to deterring fraud at your organization.


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Morris Marshburn
National Practice Leader