Theft By Collusion: Five Times More Loss

Reprinted with permission from Fraud Matters Newsletter of CPA America.

Collusion accounts for as much as 40 percent of fraud, with median loss of approximately $485,000 – nearly five times that of crimes perpetrated by an individual alone.

That is the finding of the 2006 Report to the Nation on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners.

Frauds committed by a single individual average approximately $100,000 per occurrence.

Collusion is defined as secret cooperation between people to do something illegal or underhanded.

A strong system of internal controls (an organization’s system of checks and balances) usually helps to prevent and deter fraud. In the case of collusion, individuals are usually working together to circumvent these controls. Not only is this type of exploitation difficult to prevent, it is very difficult to investigate.

A massive mortgage fraud case in the Northeast exemplifies why detecting collusion is so challenging and costly. In this particular case, a number of mortgage lenders were defrauded out of nearly $60 million. Collusion allowed it to prosper.

A prominent home builder and his sons sold their homes through a real estate agent. This particular agent forged relationships with several mortgage brokers who became “heavily incentivized” to start selling a backlog of inventory of homes for the builder.

The mortgage brokers began qualifying inappropriate candidates by falsifying their income and financial position. They retained the services of appraisers who artificially inflated the value of the homes being sold.

Once the lenders received the paperwork, they processed the loans and released the funds to the builder.

The brokers were paid a commission from the lenders, and the builder and his sons shared the proceeds with their conspirators. The buyers found themselves owning property they couldn’t afford. Numerous individuals were working in collusion to dupe the lenders out of millions.

When the mortgage brokers had difficulty finding new candidates to purchase homes, they began to offer additional properties to existing owners.

As an incentive, the builder and brokers assisted by paying some of their mortgage payments to keep them current. The brokers again falsified mortgage applications and found an accountant who falsified the buyers’ tax returns.

The applications failed to mention that these homes were not going to be owner occupied and that the buyers had mortgages pending with other financial institutions.

The effects of collusion

The lending institutions were like sitting prey. They were taken in by a massive act of collusion and fraud. All controls that existed had been compromised.

The first line of defense, the brokers, lied about everything. All the appraisals and the income verifications were false. Forced to foreclose, the collateral wasn’t worth nearly the amount of money that was passed along.

The real estate taxes on the properties and legal fees added to the banks’ losses.

Investigating collusion

By cooperating with others, perpetrators are often able to thwart exposure. The separation of duties and controls becomes compromised and ineffective against these acts of collusion.

The initial investigation of a collusion scheme is difficult. At the onset, you’re not sure who is involved and how widespread the problem is. It’s best to engage an independent third party, such as a fraud examiner, to commence an investigation. This is especially effective when the board of an organization suspects malfeasance by the management team.

Avoiding being victimized

Recent events have prompted many organizations to re-examine their controls and engage trained fraud professionals to provide risk assessment examinations for them.

A company receives a complete and thorough review of its internal controls and segregation of duties. Critical operating areas of the organization are identified and examined.
Some examples may include:

  • Accounts receivable, cash receipts and revenues
  • Fixed assets
  • Inventory
  • Payroll, personnel and expense reimbursement
  • Purchasing, accounts payable and cash payments

This type of investment is minor compared to the potential costs of falling victim to a fraud. It’s tough enough to protect your organization from the acts of a skilled perpetrator preying on your vulnerabilities.

James I. Marasco, CPA/CFF, CFE, CIA
Jim is a partner at EFP Rotenberg. He brings more than 18 years of public accounting and auditing experience. He is a full-time management consultant and travels extensively throughout the country while leading StoneBridge Business Partners (an EFP Rotenberg affiliate company). Read more about Jim. Article republished with the permission of CPAmerica.