I am pleased to provide this semiannual report on the activities and accomplishments of the Office of Inspector General (OIG) from April 1, 2006 to September 30, 2006. The audits, evaluations, investigations, and other activities highlighted in this report illustrate the FDIC OIG’s on-going commitment to promoting efficiency, effectiveness, and integrity and helping the Corporation successfully achieve its honorable mission of maintaining stability and public confidence in the nation’s banking system. Our Fiscal Year 2006 Performance Report is also included as part of this semiannual report to show our progress in meeting annual performance goals.

Over the past 6 months, our office issued 15 audit and evaluation reports. We closed 21 investigations, with over $27 million in total fines, restitution, and potential monetary recoveries. As discussed in more detail in this report, our audit and evaluation work, in particular, reviewed and made recommendations related to: the FDIC reserve ratio and assessment determinations, industrial loan companies, predatory lending, protection of personally identifiable information, consumer rights issues, FDIC contract administration, and corporate emergency response plans. We also issued a comprehensive report on the Corporation’s information security program in accordance with the Federal Information Security Management Act of 2002 and highlighted steps that the Corporation could take to enhance the security of its information resources.

Of special note on the investigations front, among other successful cases, we report that as a result of OIG investigative work in partnership with the U.S. Attorney’s Office for the Southern District of Florida, in July 2006, the former chairman of the board and chief executive officer of Hamilton Bank was sentenced to 30 years of incarceration and 36 months of supervised release. He had earlier been convicted on all 16 charges of making false filings to the Securities and Exchange Commission and to bank examiners, making false statements, wire fraud, bank fraud, securities fraud, obstruction of a bank examination, and conspiracy. Most recently, he, along with two other convicted Hamilton Bank officers, was ordered to pay $32 million in total restitution for bank and securities fraud, $16 million of which is payable to the FDIC.

We intend to continue to address issues of such significance to the Corporation, the Congress, the financial services industry, and the American people. We have just issued our Fiscal Year 2007 Business Plan, outlining a series of audits, evaluations, investigative activities, internal operational improvement projects, and other initiatives that we will undertake in the coming year. Included in that plan is a newly articulated vision statement that I firmly believe in and that will serve to inspire all OIG staff in their daily work: The OIG is a quality-focused FDIC team that promotes excellence and trust in service to the Corporation and the public interest.

I was sworn in as Inspector General of the FDIC on July 5, 2006. I have greatly appreciated the support of FDIC Chairman Sheila Bair and the FDIC Vice Chairman and Chair of the Audit Committee, Martin Gruenberg, during my first months on the job. As my office carries out its independent oversight role, I anticipate continuing a cooperative and productive working relationship with them and others at the FDIC.

In closing, I express my gratitude to Patricia M. Black, Deputy Inspector General, for her leadership as Acting Inspector General prior to my appointment. I also thank the OIG Executive team and staff for their helpful assistance as I began my tenure as Inspector General. I look forward to working with the Congress, the Corporation, and other members of the Inspector General community as we address the challenges ahead.

STRATEGIC GOAL 1

Achieving this goal is largely dependent on investigative success in combating financial institution fraud, and we made excellent progress in this area. As a result of cooperative efforts with Assistant U.S. Attorneys from around the country, numerous individuals were prosecuted for financial institution fraud during the reporting period. The former chairman of the board and chief executive officer of Hamilton Bank was sentenced to 30 years of incarceration and 36 months of supervised release. He had earlier been convicted on all 16 charges of making false filings to the Securities and Exchange Commission and to bank examiners, making false statements, wire fraud, bank fraud, securities fraud, obstruction of a bank examination, and conspiracy. The former Hamilton Bank president and the former chief financial officer also received stiff sentences for their roles in the fraud. In another case, the former president of the First National Bank of Blanchardville, Wisconsin, was sentenced to 108 months’ incarceration to be followed by 5 years of supervised release and was ordered to pay $13.4 million in restitution to the FDIC. We were also successful in obtaining three guilty pleas from businessmen involved in an $8 million real estate land flip scheme and another guilty plea from a mortgage broker for mortgage fraud. Multiple other guilty pleas, indictments, and sentencings of former bank officers, directors, and bank customers contributed to successful OIG results in this goal area.

STRATEGIC GOAL 2

Two major audit assignments focused on helping to maintain the viability of the insurance funds. We issued a report on the FDIC’s reserve ratio and assessments determination process, recommending that the Corporation periodically validate key assumptions, estimates, or other components that factor into the calculation of the reserve ratio. Importantly, in connection with corporate governance practices, we recommended improved communication of information relevant to assessment determinations and other corporate matters and activities to the FDIC Board of Directors. In another report on the industrial loan company insurance application process, we made six recommendations to strengthen that process and subsequent monitoring of conditions imposed on industrial loan companies and business processes.

STRATEGIC GOAL 3

Audits and investigations contributed to the FDIC’s protection of consumers in multiple ways. We issued a report on the challenges faced by the FDIC and the efforts taken to identify, assess, and address risks posed to FDIC institutions and consumers from predatory lending practices. We issued reports and made several recommendations to ensure better protection of sensitive customer information. One report related to the risks of financial institutions’ increased outsourcing of software development and maintenance, data processing, and other information technology services to technology service providers and the FDIC’s related examination coverage. Another audit examined the Division of Resolutions and Receiverships’ protection of bank employee and customer personally identifiable information. From a compliance standpoint, we assessed examiner use of Home Mortgage Disclosure Act data to identify and assess instances of potential discrimination in FDIC-supervised institutions and recommended strengthening examiner guidance. We also identified needed improvements in the FDIC’s process for addressing the violations and deficiencies reported in compliance examinations. To help protect consumers, our Electronic Crimes Unit responded to phishing schemes where the FDIC and OIG Web sites were misused to entice consumers to divulge personal information. We successfully shut down several Web sites used for such purposes during the period.

STRATEGIC GOAL 4

We continued to pursue concealment of assets investigations related to the more than $1.7 billion in criminal restitution that the FDIC is owed. We continued coordination with the Division of Resolutions and Receiverships, the Legal Division, and the Department of Justice on such cases. We also began to strategize approaches for OIG work related to potential large bank failures.

STRATEGIC GOAL 5

We issued a number of audit and evaluation reports resulting in positive benefits to the FDIC. Our Federal Information Security Management Act-related work reported that the FDIC had made significant progress over the last several years but continued attention was needed in such areas as enterprise architecture, configuration management, access controls, and audit and accountability controls. Other reports addressed strengthening the Corporation’s emergency response policy and the maintenance, communication, and content of emergency response plans; and enhancing controls over the disposal of sensitive FDIC information. We also made a series of recommendations to help ensure an efficient, effective, and accountable FDIC contract administration process and better position the Corporation to control costs, meet scheduled timeframes, and ensure contractor performance.

STRATEGIC GOAL 6

We continued to focus on strategically planning OIG work, resulting in formulating our Fiscal Year 2007 Business Plan, which combines our strategic plan and performance plan and includes our Audit and Evaluation Plan, infrastructure improvement projects, and other initiatives. These plans unify, guide, and integrate OIG activities in pursuit of our six strategic goals. We promoted effective stakeholder relationships and information-sharing by way of OIG Executive meetings with FDIC Executives; presentations at FDIC Audit Committee meetings; Congressional interaction; and coordination with financial regulatory OIGs, other members of the Inspector General community, and the Government Accountability Office. We reviewed and/or commented on six proposed corporate policies (e.g., protection of privacy information, the FDIC’s software configuration management program, and enterprise risk management) and two draft legislative documents and regulations. We focused on continuously enhancing the OIG’s business and management processes by strengthening the OIG’s human capital practices, taking steps to better ensure the quality of OIG activities and products, and investing in cost-effective and secure information technology to improve performance and productivity.

Bank supervision is at the core of the FDIC’s efforts to ensure stability and public confidence in the nation’s financial system. The FDIC is the primary federal regulator for 5,241 FDIC-insured, state-chartered institutions that are not members of the Federal Reserve System (generally referred to as “state non-member” institutions). The Department of the Treasury (the Office of the Comptroller of the Currency and the Office of Thrift Supervision) or the Federal Reserve Board supervise other banks or thrifts, depending on the institution’s charter.

Key to effective supervision is a strong examination program. The FDIC performs safety and soundness, information technology (IT), trust, and other types of specialty examinations of FDIC-supervised insured depository institutions. The majority of the states participate with the FDIC in an examination program under which certain examinations are performed on an alternating basis by the state regulators and the FDIC. The Corporation also has back-up examination authority for national banks, state-chartered banks that are members of the Federal Reserve System, and savings associations, all in the interest of protecting the deposit insurance fund. The examinations are conducted to assess an institution’s overall financial condition, management practices and policies, and compliance with applicable laws and regulations.

The banking industry has been marked by consolidation, the impact of globalization, and the development of increasingly complex investment strategies available to banks. This has led bank regulators, both domestically and internationally, to devise new standards for bank capital requirements commonly referred to as Basel IA and Basel II. The FDIC has been engaged with other bank regulators in developing new standards and assessing the potential impact on bank safety and soundness.

In addition, the FDIC is faced with developing and implementing programs to minimize the extent to which the institutions it supervises are involved in or victims of financial crimes and other abuse. Bank governance practices are important safeguards against fraud and other abuses, and the FDIC has issued guidance to banks about governance expectations, including adherence to requirements in the Sarbanes-Oxley Act for publicly traded financial institutions. In its role as supervisor, the FDIC also analyzes data security threats, occurrences of bank security breaches, and incidents of electronic crime that involve financial institutions. As part of safety and soundness examinations, the FDIC also ensures that the institutions comply with regulatory reporting requirements of the Bank Secrecy Act.

As more and more laws are passed, and new regulations are adopted to implement those laws, policy makers and regulators have worked to ensure that the intended benefits justify the considerable costs. Pursuant to the Economic Growth and Regulatory Reduction Act of 1996, the FDIC and other bank regulators have been reviewing regulations in order to identify outdated or otherwise unnecessary regulatory requirements imposed on insured depository institutions. Of note as we were going to press with this semiannual report, the President had signed S.2856, the Financial Services Regulatory Relief Act. Among other provisions, this act includes an increase from $250 million to $500 million on the asset size for eligibility for an 18-month examination cycle; permission for banks, thrifts, and credit unions to use new lending and investment authority; and other changes allowing financial institutions to improve the efficiency of their operations.

The OIG’s role under this strategic goal is conducting audits and evaluations that review the effectiveness of various FDIC programs aimed at providing continued stability to the nation’s banks. The OIG also conducts investigations of fraud at FDIC-supervised institutions; fraud by bank officers, directors, or other insiders; obstruction of bank examinations; fraud leading to the failure of an institution; fraud impacting multiple institutions; and fraud involving monetary losses that could significantly impact the institution.

To assist the FDIC to ensure the nation’s banks operate safely and soundly, the OIG’s 2006 performance goals were as follows:

	Evaluate the effectiveness of the FDIC’s supervision program, and
	Evaluate and assist FDIC efforts to detect and prevent bank secrecy violations, fraud, and financial crimes in FDIC-insured institutions.

OIG Work in Support of Goal 1

The OIG’s Office of Investigations is a driving force in combating fraud that occurs at or impacts financial institutions. The perpetrators of such crimes can be those very individuals entrusted with governance responsibilities at the institutions–directors and bank officers. In other cases, individuals providing professional services to the banks, others working inside the bank, and customers themselves are principals in fraudulent schemes. The intentional denial of accurate information to bank examiners undermines the integrity of the examination process. The OIG defends the vitality of the examination process by investigating allegations of criminal obstruction of bank examinations, often associated with fraudulent activities, and by working with U.S. Attorneys’ Offices to bring these cases to justice.

The following cases from the reporting period are illustrative of the OIG’s success in pursuing Strategic Goal 1 during the reporting period.

Sentencing of Former Hamilton Bank Officers for $20 Million Bank Fraud

On July 26, 2006, the former chairman of the board and chief executive officer, Hamilton Bank (Hamilton), and Hamilton Bancorp, Hamilton’s bank holding company, Miami, Florida, was sentenced in the U.S. District Court for the Southern District of Florida to 30 years’ incarceration and 36 months of supervised release. The defendant was immediately remanded to the custody of the Attorney General.

After a month-long trial, the former chairman of the board was convicted on all 16 charges of making false filings to the Securities and Exchange Commission (SEC) and to bank examiners, making false statements, wire fraud, bank fraud, securities fraud, obstruction of a bank examination, and conspiracy.

On July 27, 2006, sentencing hearings were held for the former Hamilton president, and the former Hamilton chief financial officer, both of whom pleaded guilty before trial and cooperated with the government during the investigation.

The former president was sentenced to 28 months’ incarceration, 24 months of supervised release, and was fined $10,000. He previously pleaded guilty to two counts of securities fraud. The former chief financial officer was sentenced to 28 months’ incarceration to be followed by 24 months of supervised release as a result of his earlier guilty plea to one count of securities fraud and one count of obstruction of a formal agency proceeding. Both men were ordered to surrender to the United States Marshal’s Service on October 27, 2006.

The defendants participated in a fraudulent scheme whereby they falsely inflated the results of operations, earnings, and financial condition of Hamilton Bancorp in the Securities and Exchange Commission filings; obstructed the Office of the Comptroller of the Currency’s (OCC) examination of Hamilton Bank; and lied to the investing public, the bank and securities regulators, and their accountants regarding the true financial health of Hamilton Bancorp and Hamilton Bank. In 1998 and 1999, the three defendants engaged in swap transactions (or “adjusted price trades”) to hide Hamilton Bank’s losses on certain loans, including more than $22 million in losses in 1998, and falsely accounted for the transactions to make it appear that no losses had been incurred. While the defendants falsely reported the nature of the swap transactions to the investing public and the regulators, the indictment cited recorded conversations in which the defendants openly discussed the transactions as swaps. During 1998, Hamilton Bancorp had a market capitalization of more than $300 million.

Hamilton Bank was South Florida’s highest profile trade finance bank before it ran into trouble with its regulator, the OCC, over the questionable loan swaps that allowed the bank to hide $22 million in losses in 1998. The OCC closed the bank in January 2002 and the FDIC took on liquidation responsibilities as receiver.

Investigation conducted by the FDIC OIG; prosecuted by the U.S. Attorney’s Office for the Southern District of Florida.

Former President of the First National Bank of Blanchardville Sentenced to 9 Years’ Incarceration and Ordered to Pay $13 Million in Restitution to the FDIC

On July 21, 2006, the former president of the First National Bank of Blanchardville (FNBB), Blanchardville, Wisconsin, was sentenced in U.S. District Court for the Western District of Wisconsin. The defendant was sentenced to 108 months’ incarceration, to be followed by 5 years of supervised release. In addition, the defendant was ordered to pay $13.4 million in restitution to the FDIC. The defendant earlier pleaded guilty to one count of bank fraud. On May 9, 2003, FNBB was declared insolvent by the OCC and the FDIC was appointed receiver for the failed institution.

As part of his earlier plea statement to the court, the defendant admitted that he devised a scheme to defraud FNBB of his honest services that caused the bank to fail. Specifically, the scheme to defraud involved:

	providing false information to the board of directors;
	substantially exceeding the bank’s lending limits;
	issuing unauthorized loans;
	filing false reports with regulators and causing bank records to be altered to mislead federal auditors;
	soliciting $17 million worth of worthless checks that were deposited into a customer’s account to reduce the overdraft status on the account and reduce delinquent loan accounts;
	falsifying minutes of the board of directors meetings;
	placing false loan notes in loan files; and
	failing to follow banking regulations regarding the classifications of loans.

Joint investigation by the FDIC OIG, the Federal Bureau of Investigation (FBI), and the Internal Revenue Service Criminal Investigation Division, based on a referral from the Division of Resolutions and Receiverships; prosecuted by the U.S. Attorney’s Office for the Western District of Wisconsin.

Former President of Canton State Bank and His Wife Indicted on 26 Counts of Bank Fraud

On June 8, 2006, in the Eastern District of Missouri, the former president of Canton State Bank and his wife were indicted by a federal grand jury on 26 felony counts of conspiracy to make false statements to FDIC-insured institutions and the U.S. Department of Agriculture Farm Service Agency (FSA), false statements, money laundering, and bank fraud.

The indictment charged that between October 2001 and August 2004, the defendants understated their liabilities on loan applications with Canton State Bank, The Paris National Bank, Perry State Bank, Bank of Monticello, and the FSA. In addition, the defendants represented to Perry State Bank and the FSA that the livestock and farm equipment that they pledged as collateral security for loans was free and clear of all other liens and encumbrances, when they had previously pledged the same collateral for other loans.

The indictment also charged that between August 2002 and May 2003, the former president allegedly made numerous loans to a bank customer, who then wrote checks to return a substantial portion of the loan proceeds to the former president. The indictment further alleged that, in some cases, the payee on those checks was listed as the bank president’s wife’s minor child in order to conceal the payments to him.

Former COO of Universal Federal Savings Bank Sentenced

On September 19, 2006, in the U.S. District Court for the Northern District of Illinois, Universal Federal Savings Bank’s (Universal) former chief operations officer (COO) was sentenced to 38 months of incarceration, to be followed by 3 years of supervised release and 600 hours of community service. She was also ordered to pay restitution in the amount of $1,313,082 to the FDIC. A Universal customer earlier pleaded guilty to one count of wire fraud affecting a financial institution and the former COO’s brother was sentenced to 2 years of supervised release and 200 hours of community service. All of Universal’s losses occurred prior to his activity; consequently, no restitution was ordered. The former COO’s sentence, the bank customer’s guilty plea, and the COO’s brother’s sentence were the result of an indictment filed in January 2005 concerning the activities surrounding the failure of Universal on June 27, 2002.

As previously reported, the indictment alleged that a Universal customer conspired with Universal’s COO to misapply the financial institution’s funds and to make a false entry in a book, report, or statement of or to Universal.

The bank customer wrote insufficient funds checks and deposited those checks in Universal’s correspondent account at American National Bank (ANB). After receiving immediate credit and availability of those funds, he withdrew some or all of the funds, and then covered the previous insufficient funds checks plus the withdrawn funds by depositing even larger amounts of insufficient funds checks. This cycle continued almost daily for more than 6 months. During the conspiracy, the bank customer made approximately 138 deposits at ANB that included insufficient funds checks totaling more than $200 million.

Universal’s chairman of the board of directors requested a review of the bank customer’s account activity and directed the former COO to provide copies of the fronts and backs of checks. In order to conceal the check-kiting scheme, the former COO and the bank customer agreed that the bank customer would alter the checks. The bank customer and the former COO’s brother, a certified public accountant and authorized signer on the account with the customer, falsified the backs of the account checks to conceal that they were deposited into Universal’s correspondent account at ANB. On or about June 20, 2002, the former COO knowingly provided the falsified check copies to the chairman in furtherance of the conspiracy. About 1 week later, the check-kiting scheme was discovered and stopped. The scheme and conspiracy caused a loss in excess of $10 million, and Universal was forced to cease operations.

Joint investigation by the FDIC OIG and the FBI; prosecuted by the U.S. Attorney’s Office, Northern District of Illinois.

Former Bank Director of Central Bank Convicted
of Misapplication of Bank Funds

On May 8, 2006, the former executive vice president and chief lending officer of Central Bank, Houston, Texas, pleaded guilty in the U.S. District Court for the Southern District of Texas, to 11 counts of misapplication of bank funds by a bank officer. The defendant’s guilty plea is the result of an information filed on April 14, 2006.

The defendant admitted that between May 2001 and September 2003, while employed as an officer and director of Central Bank, an FDIC-insured institution, he misapplied and converted to his own use proceeds of loans from Central Bank to various borrowers. The evidence proved, and the defendant conceded, that he had created an assumed business name for himself, CBMB & Associates. He placed false invoices for “fees” in Central Bank’s loan files, authorized the disbursement of loan proceeds to CBMB & Associates, and negotiated and deposited into bank accounts on which he was the sole signatory the checks representing these “fees,” thereby misapplying and converting the bank’s funds to his personal benefit. Each of the 11 counts of the criminal information accused the defendant of embezzling loan proceeds in sums ranging from as little as $3,390 to as much as $72,000.

As part of the defendant’s plea agreement, he entered into and executed stipulation to an action under 8(e) of the Federal Deposit Insurance Act, which provides for a lifetime ban from banking.

Joint investigation by the FDIC OIG and the FBI, based on a referral from the FDIC Legal Division; prosecuted by the U.S. Attorney’s Office for the Southern District of Texas.

Bank Vice President Sentenced to 41 Months’ Incarceration

On July 18, 2006, the former vice president of First Century Bank was sentenced in the Eastern District of Tennessee to 41 months’ incarceration, followed by 60 months of supervised release. She was also ordered to pay $600,000 in restitution to First Century Bank. The defendant earlier pleaded guilty to a one-count information charging her with bank fraud.

The defendant originated over 100 fraudulent loans during her tenure with First Century Bank, resulting in bank losses in excess of $600,000. She began falsifying loan records to enable customers to obtain loans. As these loans became delinquent, the defendant made unauthorized withdrawals from inactive customer accounts and originated new loans in the name of customers without their knowledge. The proceeds of these unauthorized withdrawals and fraudulent loans were then used to cover loan payments and to pay off existing fraudulent loans.

Joint investigation by the FDIC OIG and FBI, based on a referral from DSC; prosecuted by the U.S. Attorney’s Office for the Eastern District of Tennessee.

Bank Customer Pleads Guilty to $18 Million Bank Fraud

On July 12, 2006, in the U.S. District Court for the Northern District of Illinois, a bank customer pleaded guilty to a criminal information charging him with one count of bank fraud. The defendant admitted to devising a scheme to divert $18 million of loan proceeds from creditors.

According to the information, the defendant defrauded two financial institutions of loan payments owed by third-party borrowers. The defendant submitted falsified loan payment documents and financial reports to Lincoln State Bank, an FDIC-supervised institution, and Ottawa Savings Bank, an Office of Thrift Supervision-supervised institution. Both financial institutions were FDIC insured.

These diverted funds represented proceeds and payments against participation loan agreements between third-party borrowers and 15 financial institutions. Commercial Loan Corporation, Inc., Oak Brook, Illinois, a company controlled by the defendant, brokered commercial loans between the affected borrowers and lenders. As part of this service, Commercial Loan Corporation, Inc., provided collection and payment services for the borrowers. The defendant’s scheme involved collecting and diverting loan payments owed to creditors, and overselling the loan participation agreements to other financial institutions to obtain funds in excess of the borrowers’ approved loans. These loan payments and excess funds were then diverted, for the defendant’s personal benefit, into a manufacturing plant as capitalization loans. The defendant’s diverted funds were lost when the plant closed and these “loans” went into default.

Joint investigation by the FDIC OIG and the FBI, based on a referral from DSC; prosecuted by the U.S. Attorney’s Office for the Northern District of Illinois, Eastern Division.

Real Estate Frauds

The increased reliance by both financial institution and non-financial institution lenders on third-party brokers has created opportunities for fraud. Some of the emerging mortgage fraud schemes include “property flipping.” Property flipping is best described as purchasing properties and artificially inflating their value through false appraisals. The artificially valued properties are then repurchased several times for a higher price by associates of the “flipper.”

THREE MEN PLEAD GUILTY IN $8 MILLION REAL ESTATE “LAND FLIP” SCHEME

During April 2006, three businessmen pleaded guilty in the U.S. District Court for the Central District of Illinois to all charges in an August 5, 2005, 11-count superseding indictment that charged them with bank fraud, mail fraud, money laundering, and wire fraud.

The defendants admitted to engaging in a real estate “land flipping” scheme from 1999-2005 to defraud real estate lenders, including Central Illinois Bank, Champaign, Illinois, an FDIC-insured institution, buyers, and sellers. The scheme involved more than 150 fraudulent real estate sales and financing transactions totaling more than $8 million in fraud against financial institutions.

The superseding indictment alleged that the defendants used fraudulent appraisals to buy, sell, and finance properties at prices fraudulently inflated. Two of the defendants represented themselves as property managers who were in the business of buying, selling, and managing real estate, though neither were licensed real estate brokers or salespersons. The third defendant was a licensed real estate appraiser who allegedly performed numerous appraisals for the two defendants in which he falsely inflated the value of the real estate.

To carry out the scheme, two of the defendants recruited buyers, typically of modest means with little or no experience in rental real estate investment. To entice the buyers, the two defendants allegedly made one or more false representations to them regarding prospective properties.

The two businessmen allegedly made more than $3 million for their personal use and to promote the scheme, while the real estate appraiser received fees of $350 to $450 per appraisal.

Joint investigation by the FDIC OIG, the U.S. Postal Inspection Service and the FBI; prosecuted by the U.S. Attorney’s Office for the Central District of Illinois.

MORTGAGE BROKER PLEADS GUILTY TO A MORTGAGE FRAUD SCHEME

On September 25, 2006, a mortgage broker from Dallas, Texas, pleaded guilty in the U.S. District Court for the Northern District of Texas to an indictment charging him with one count of wire fraud and aiding and abetting. The defendant is scheduled to be sentenced on January 2, 2007.

As previously reported, the defendant and two other business associates were charged in a 14-count indictment in March 2006. The grand jury charged one of the defendants with one count of bank fraud, seven counts of wire fraud, and six counts of engaging in monetary transactions derived from specified unlawful activity. A second defendant was charged with one count of bank fraud and six counts of wire fraud. The third was charged with one count of wire fraud. Each of the counts in the indictment also included the associated charge of aiding and abetting. Following the indictment, arrest warrants were issued, and agents from the FDIC OIG and the FBI arrested two of the defendants on March 9, 2006. The third defendant self-surrendered on March 10, 2006.

The indictment alleged that the three associates devised a scheme to fraudulently obtain 21 mortgage loans totaling $3,220,550. The defendants used schemes commonly referred to in the mortgage industry as property flips, markups and kickbacks, and HUD swaps to facilitate the mortgage fraud. One of the mortgage companies impacted by this fraud scheme was Fremont Investment & Loan, an FDIC-supervised institution in Brea, California.

In each instance, one of the defendants convinced inexperienced real estate investors to stand in as straw borrowers and purchase the properties for fraudulently inflated sales prices. A second defendant, a loan officer, and the third, a mortgage broker, knowingly submitted false documentation to the lenders to enable the straw borrowers to qualify for the mortgage loans. Each of the straw borrowers received a financial inducement for participating in the fraud scheme. Fraudulent real estate appraisals were also submitted to the lenders to support the inflated sales prices of the properties.

Joint investigation by the FDIC OIG and the FBI; prosecuted by the U.S. Attorney’s Office for the Northern District of Texas.

Other Successful Investigative Outcomes

FORMER STATE BANK OF COKATO EXECUTIVES PLEAD GUILTY

In August 2006, two former bank executives from the State Bank of Cokato pleaded guilty in the U.S. District Court for the District of Minnesota in connection with various loan fraud schemes. The former president and director pleaded guilty to a criminal information charging him with one count of bank fraud and one count of making false entries in a Quarterly Bank Report to the FDIC. The bank’s former executive vice president pleaded guilty to one count of lying to a federal agent in connection with a Small Business Administration loan for a bank customer.

If convicted, the former president and director of the bank faces a maximum potential penalty of 30 years in federal prison and a $1 million fine on each of those two charges. The former executive vice president faces a maximum potential penalty of 5 years in prison and a $250,000 fine.

Joint investigation by the FDIC OIG, the FBI, IRS - Criminal Investigation Division, based on a referral from the Kansas City FDIC Legal Division and DSC Regional Office; prosecuted by the U.S. Attorney’s Office for the District of Minnesota.

FORMER BANK OFFICER SENTENCED FOR BANK FRAUD

On April 27, 2006, the former assistant vice president of Falcon International Bank, Laredo, Texas, was sentenced in the U.S. District Court for the Southern District of Texas, to 14 months of incarceration, to be followed by 60 months of supervised release. She was also ordered to pay $106,768 in restitution; $50,000 of the restitution order is to be paid to the bonding company with the remaining balance to be paid to the bank.

The defendant’s sentence resulted from her earlier guilty plea to a one-count information charging her with embezzlement by a bank officer. The defendant’s scheme resulted in approximately $106,768 in losses to the bank.

Joint investigation by the FDIC OIG and FBI, with assistance from the FDIC Legal Division; prosecuted by the U.S. Attorney’s Office for the Southern District of Texas.

FORMER EXECUTIVE VICE PRESIDENT OF IOWA-NEBRASKA STATE BANK SENTENCED

On August 1, 2006, the former executive vice president of Iowa-Nebraska State Bank, an FDIC-supervised bank, South Sioux City, Nebraska, was sentenced in the U.S. District Court for the Northern District of Iowa, to 5 months of incarceration, to be followed by 5 months of house arrest, and fined $2,500. In March 2006, the defendant was found guilty of making false entries in the bank’s records.

Joint investigation by the FDIC OIG and the FBI; prosecuted by the U.S. Attorney’s Office for the Northern District of Iowa.

FORMER VICE PRESIDENT OF ALLIANCE BANK PLEADS GUILTY TO EMBEZZLEMENT

On August 23, 2006, in the U.S. District Court for the District of Minnesota, the former vice president in Commercial Lending, Alliance Bank, New Ulm, Minnesota, pleaded guilty to one count of theft, embezzlement, and misapplication by a bank officer.

During a routine examination of Alliance Bank in August 2005, bank examiners discovered irregularities involving dozens of cashier’s checks. They found evidence that the former vice president and other officers of Alliance Bank converted fees earned by the bank into cashier’s checks, diverted those funds to their individual bank accounts, and made false entries in the books and records of the bank.

In accordance with her plea agreement, the former vice president agreed to assist the DOJ in its investigation of the other senior Alliance Bank officers, paid $37,900 in restitution to the bank, and stipulated to an action under 8(e) of the Federal Deposit Insurance Act, which provides for a lifetime ban from banking.

Joint investigation by the FDIC OIG and the FBI, based upon a referral from the DSC Kansas City Regional Office; prosecuted by the U.S. Attorney’s Office for the District of Minnesota.

FORMER BRANCH MANAGER OF HUDSON SAVINGS BANK CHARGED WITH EMBEZZLEMENT

On June 8, 2006, in the U.S. District Court for the District of Massachusetts, the former branch manager of Hudson Savings Bank, Hudson, Massachusetts, was charged in an information with two counts of misapplication and embezzlement of funds from Hudson Savings Bank.

According to the information, over a 5-year period, the defendant allegedly tampered with more than 60 customers’ accounts at the bank, performing or authorizing hundreds of credits and debits, and causing a loss to the bank of more than $650,000.

The information alleged that the defendant withdrew funds from existing customers’ deposit accounts and from active or inactive home equity lines of credit. He also created false accounts from which he withdrew funds. The defendant allegedly avoided detection of his actions by repaying credit lines from other customers’ accounts, taking steps to prevent customers from receiving account statements for periods of time, creating false loan statements that were sent to customers, and changing the mailing addresses on loan accounts to addresses controlled by the defendant. According to the information, when customers became aware of unauthorized activity in their accounts, the defendant corrected the account by depositing funds from other customers’ accounts, sent a letter to the customer reporting that there had been an “error” in the account, and made a notation in the bank’s internal data system that the account had been fixed and the customer notified.

Joint investigation by the FDIC OIG, the FBI, and the Hudson Police Department, based on a referral from DSC; prosecuted by the Economic Crimes Unit for the U.S. Attorney’s Office for the District of Massachusetts.

BANK CUSTOMER SENTENCED FOR CONSPIRACY TO COMMIT BANK FRAUD

On April 24, 2006, a bank customer of the Bank of the Panhandle, Guymon, Oklahoma, and Production Credit Association of Woodward, Oklahoma, now Farm Credit Western, was sentenced in the U.S. District Court for the Western District of Oklahoma, to 60 months of incarceration, 104 hours of community service, and ordered to pay $2,608,137 in restitution ($2,361,245 payable to Production Credit Association and $246,891 to the Bank of the Panhandle). The defendant’s sentence was the result of his earlier guilty plea to an information charging him with one count of conspiracy to commit bank fraud.

Joint investigation by the FDIC OIG, U.S. Department of Agriculture OIG, and the FBI; prosecuted by the U.S. Attorney’s Office for the Western District of Oklahoma.

Ongoing Audit Work

An ongoing audit in the supervision area is determining whether the FDIC has established and implemented adequate procedures for addressing IT security risks at FDIC-supervised financial institutions that offer electronic banking products and services.

Another assignment is determining whether examiners assess the reliability of appraisals and sufficiency of insurance coverage as part of the evaluation of an institution’s lending practices and policies.

FDIC deposit insurance remains a central component of the federal government’s assurance to the public that it can be confident in the stability of the Nation’s banks and savings associations. Since its establishment in 1933, the FDIC has insured deposits up to the legally authorized threshold, which presently stands at $100,000 for individual accounts and $250,000 for certain retirement accounts. For almost two decades following bank crises in the late-1980s and early 1990s, the FDIC managed two deposit insurance funds–one for banks and one for savings and loans.

Legislation passed by the Congress on February 1, 2006, merged separate insurance funds for banks and thrifts into a single Deposit Insurance Fund with about $49.6 billion in reserve. This legislation also imposed some reforms on how the FDIC is to manage the fund in the future, including indexing for inflation, permitting the fund reserves to fluctuate inside a percentage range of estimated insured deposits, and administering credits, dividends, and risk-based assessments. The Corporation is working to implement these reforms.

As insurer, the FDIC must evaluate and effectively manage how changes in the economy, the financial markets, and the banking system affect the adequacy and the viability of the deposit insurance fund. Financial instruments and transactions continue to become more complex, and the process of financial intermediation, even in smaller institutions, increasingly sophisticated. Further, the ongoing consolidation of the banking industry means that there are a few very large institutions that represent an increasingly significant share of the FDIC’s exposure. According to the Corporation, as of June 30, 2006, the ten largest FDIC-insured institutions accounted for 42 percent of deposits and 44 percent of the assets of all FDIC-insured institutions.

The OIG has a responsibility to evaluate the FDIC’s programs and operations to ensure that the agency has adequate information to gauge the risks inherent as financial institutions consolidate, enter into new business areas, and become more global.

To help the FDIC maintain the viability of the insurance fund, the OIG’s 2006 performance goals were as follows:

	Evaluate corporate programs to identify and manage risks in the banking industry that can cause losses to the fund, and
	Assess the management of the deposit insurance fund.

OIG Work in Support of Goal 2

The OIG’s Office of Audits issued two reports in the insurance area during the reporting period, as discussed below:

Reserve Ratio and Assessment Determinations

We conducted an audit of the FDIC’s reserve ratio and assessment determinations processes to determine whether: (1) the Division of Insurance and Research accurately determines the funds’(the Bank Insurance Fund and the Savings Association Insurance Fund–now the DIF) reserve ratios and (2) the Division of Finance has adequate controls in place to ensure that the FDIC accurately calculates, collects, and processes assessments of financial institutions. We concluded that the FDIC could improve internal controls over the reserve ratio and assessment determination processes. Although the FDIC accurately calculated fund reserve ratios and assessments due from financial institutions, a key underlying assumption supporting the reserve ratio calculations became outdated and was not representative of actual transactions. We also concluded that FDIC could improve communication of information relevant to assessment determinations and other corporate matters and activities to the FDIC Board of Directors.

We recommended that the FDIC periodically validate key assumptions, estimates, or other components that factor into the calculation of the reserve ratio; review and clarify Board delegations of authority related to the assessments determination process; and evaluate procedures and practices for keeping Board members fully informed of Corporation matters and activities.

FDIC management concurred with our findings and recommendations and is taking responsive action. The FDIC planned to submit to the Board proposed revisions to policies, procedures, and delegations of authority by September 30, 2006.

FDIC’s Industrial Loan Company Deposit Insurance Application Process

Industrial Loan Companies (ILC) are FDIC-supervised, limited-charter depository institutions. ILCs may be owned by commercial firms, and these parent companies may not be subject to consolidated supervision by a federal regulator. As of March 2006, there were 61 ILCs with total assets of $155 billion.

The FDIC solely grants deposit insurance and evaluates whether an ILC application for deposit insurance meets statutory factors. After approving the application, the FDIC issues an Order for insurance that includes standard conditions and, if warranted, nonstandard conditions.

The FDIC uses conditions to impose restrictions and establish operating parameters and controls on ILCs, including business plan limitations. The FDIC may also impose certain types of nonstandard conditions on ILCs, known as prudential conditions, which are related to separating and insulating an ILC from its parent company.

We conducted a review during the reporting period to evaluate the FDIC’s process for (1) reviewing, investigating, and approving ILC applications for deposit insurance and (2) monitoring business operations to ensure adherence to conditions imposed on ILCs. We placed particular emphasis on the FDIC’s monitoring of conditions associated with ILC business plans.

We made six recommendations to strengthen the ILC deposit insurance application process and subsequent monitoring of ILC conditions and business operations. The recommendations address our observations associated with:

	documenting pre-filing meetings;
	imposing conditions associated with deposit insurance applications;
	obtaining the applicant’s agreement in writing to nonstandard conditions, and confirming the applicant’s compliance with conditions;
	clarifying corporate guidance for investigating the possible impact of an applicant’s proposed line of business on existing financial institutions and the Deposit Insurance Fund; and
	addressing the status of conditions in visitation reports and reports of examination.

The FDIC concurred with each of our recommendations and agreed to take action to address four of the recommendations by December 31, 2006 and the two remaining recommendations by June 30, 2007.

Planned Work

Planned work in this goal area in fiscal year 2007 will include an audit of the FDIC’s Dedicated Examiner Program, a program that the FDIC uses in the six largest banks, in cooperation with other primary federal regulators and bank personnel to obtain real-time access to information about risks and trends in those institutions. We also plan to review the FDIC’s overall approach to identifying and managing risks to the Deposit Insurance Fund.

The U.S. Congress has long advocated particular protections for consumers in relationships with banks. Federal fair lending and consumer protection laws, such as the Fair Housing Act, the Equal Credit Opportunity Act, Gramm-Leach-Bliley Act, the Fair and Accurate Credit Transaction Act of 2003, the Truth in Lending Act as amended by the Home Ownership and Equity Protection Act, and the Real Estate Settlement Procedures Act provide substantive protection to borrowers. These laws provide disclosure requirements, define high-cost loans, and contain anti-discrimination provisions.

To help monitor the home lending market, the Federal Reserve and other bank regulators, such as the FDIC, collect and monitor loan pricing data in accordance with the Home Mortgage Disclosure Act. Obtaining the data enables bank regulators, including the FDIC to conduct efficient fair lending reviews and to make sure banks are providing equal access and pricing for loans regardless of a borrower’s racial or ethnic background or gender. The Congress has also enacted the Community Reinvestment Act (CRA) of 1977 to encourage federally insured banks and thrifts to help meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound operations. The CRA requires federal bank regulators to assess each insured institution’s record of meeting these needs. Amendments to CRA regulations became effective in September 2005.

The FDIC oversees statutory and regulatory requirements aimed at protecting consumers from unfair and unscrupulous banking practices. Data security and financial privacy are important values to consumers. Financial institutions are obligated under various laws and regulations to protect consumer privacy and sensitive consumer information. The FDIC carries out its role by (1) providing consumers with access to information about their rights and disclosures that are required by federal laws and regulations and (2) examining the banks where the FDIC is the primary federal regulator to determine their compliance with laws and regulations governing consumer protection, fair lending, and community investment. A principal effort at consumer education has been the FDIC’s Money Smart program that aims to provide basic financial education skills to current and potential bank customers, often through alliances with government, charitable, and community development organizations.

The FDIC’s bank examiners conduct examinations in FDIC-supervised banks on a scheduled basis to determine the institutions’ compliance with laws and regulations governing consumer protection, fair lending, and community investment. When problem institutions are identified, primarily through the examination process, the FDIC seeks to bring about corrective actions and possesses broad enforcement powers to correct situations that threaten an institution’s compliance with applicable laws.

The OIG’s role under this strategic goal is to review the effectiveness of various FDIC programs aimed at protecting consumers, fair lending, and community investment. Additionally, the OIG’s investigative authorities are used to identify, target, disrupt, and dismantle criminal organizations and individual operations engaged in fraud schemes that target financial institutions or that prey on the banking public.

To assist the FDIC to protect consumer rights and ensure community reinvestment, the OIG’s 2006 performance goals were as follows:

	Evaluate the effectiveness of FDIC programs for protecting consumer privacy,
	Review FDIC’s fair lending and community reinvestment examination programs, and
	Strengthen enforcement against misrepresentations of deposit insurance coverage.

OIG Work in Support of Goal 3

A number of audits completed during the reporting period addressed important consumer protection matters: privacy, predatory lending, examiner use of Home Mortgage Disclosure Act data, and supervisory actions taken for compliance violations in FDIC-supervised institutions. Investigative work related to protection of personal information and misrepresentation of deposit insurance complemented audit efforts in this strategic goal area, as described below.

FDIC’s Oversight of TSPs

An increasing number of financial institutions are outsourcing software development and maintenance, data processing, and other IT services to technology service providers (TSPs). Under the Bank Service Company Act, the FDIC and other federal financial regulators have statutory authority to regulate and examine the services a TSP performs for FDIC-insured financial institutions.

According to the Federal Financial Institutions Examination Council (FFIEC), TSP relationships should be subject to the same risk management, security, privacy, and other internal controls and policies that would be expected if the financial institution were conducting the activities directly.

Given the potential risks associated with use of TSPs, we are conducting a series of audits to assess the FDIC’s examination coverage of TSPs and related efforts to protect sensitive customer information. During the reporting period, as a first step, we assessed the FDIC’s oversight process for identifying and monitoring TSPs used by FDIC-supervised institutions and for prioritizing examination coverage of TSPs. We also reviewed the extent to which TSP information was being captured in the FDIC’s Virtual Supervisory Information On the Net system (ViSION).

The FDIC actively supported the FFIEC through examinations of numerous high-priority TSPs and has acted to strengthen its IT Risk Management Program and corresponding coverage of TSPs. However, the FDIC’s oversight process for identifying, monitoring, and prioritizing TSPs for examination coverage needed improvement. Further, our evaluation of TSP data in ViSION indicated that adequate controls had not been implemented to obtain and maintain TSP data. Additionally, we determined that the FDIC could improve its participation in the TSP risk-based supervisory process used by the federal banking agencies.

To address these concerns, we made six recommendations to help the FDIC: (1) better identify and monitor TSPs with access to sensitive customer information and (2) improve the process the FDIC uses (in conjunction with the other FFIEC agencies) for assessing the risks posed by, and prioritizing for examination, those TSPs with access to sensitive customer information.

FDIC management generally agreed with our recommendations. The FDIC will take steps to improve its TSP inventory and sharing of TSP information with the other federal banking agencies, enhance controls over Bank Service Company Act notifications, increase data reliability, and work with the FFIEC IT Subcommittee regarding including in the new risk-based examination priority ranking program those TSPs processing sensitive customer information.

DRR’s Protection of Bank Employee and Customer
Personally Identifiable Information

The FDIC’s Division of Resolutions and Receiverships (DRR) has primary responsibility for resolving failed FDIC-insured depository institutions promptly, efficiently, and responsively in order to maintain public confidence in the nation’s financial system. In performing their duties, DRR personnel have access to a wide variety of records containing personally identifiable information of a bank’s employees and customers.

During the reporting period we conducted an audit to determine whethe