Inspector General's Statement
At the time of our last semiannual report, the country was mourning in the aftermath of September 11, and our report was dedicated to the memory of those who had lost their lives in that tragedy. My office recommitted itself to the privilege of carrying out the mission of the Office of Inspector General (OIG) as public servants. We have done that in earnest during the reporting period and will continue to proudly serve the Federal Deposit Insurance Corporation (FDIC), the Congress, and the American people.
Our audit and evaluations staff successfully completed a comprehensive series of reviews related to the failure of Superior Bank, FSB, Hinsdale, Illinois, and I, along with the Inspector General from the Department of the Treasury and a representative from the U.S. General Accounting Office, testified before the Senate Committee on Banking, Housing, and Urban Affairs regarding the causes of that failure based on our work. Our investigative staff continued work related to the events of September 11 by participating on the New York Joint Terrorism Task Force and the Evidence Recovery Team at the Pentagon and by responding to a request from the Federal Bureau of Investigation's Financial Crimes Section for assistance in investigating the funding used to perpetrate the acts of terrorism and links to possible future acts.
As a mark of additional success this period, fines, restitution, and monetary recoveries resulting from investigative work totaled $536 million. Other OIG components have provided assistance to the Corporation in a spirit of partnership in such areas as advice on the Division of Supervision Process Redesign II effort, comments on the Corporation's draft Emergency Response Plan, and input to the Corporation's 2002 Performance Plan. Our office also co-sponsored a 2-day Emerging Issues symposium with Inspectors General of the Department of the Treasury and the Board of Governors of the Federal Reserve System. This symposium brought together senior officials, congressional staff, and other subject experts from our organizations who offered insights on the banking and financial services industries and the challenges facing all who are involved in those arenas.
However, much more needs to be done, and the future for everyone at the FDIC will be demanding. In February 2002 at an Executive Leadership Conference, FDIC Chairman Donald Powell announced a new and bold vision for the Corporation going forward. Through downsizing and reorganization, the workforce of the FDIC is expected to be streamlined but more agile and efficient. And though the workforce will be smaller in number, the Chairman further challenged his executive team to make the FDIC a leader in banking information, supervision, and policy. He envisions the FDIC providing more timely and better information than anyone else; recognizing and responding to emerging risks before they threaten safety and soundness or harm consumers; and becoming the authority and resource that the Congress, media, and others turn to for guidance.
The OIG fully supports that vision for the Corporation and will do all it can, in partnership with the Corporation, other financial regulatory agencies, and the Inspector General community, to help make it a reality. We are participating in the corporate downsizing program and have plans for resource realignments that we believe will enhance our overall effectiveness. We will also monitor the various executive task forces as they carry out the Chairman's proposals. We appreciate additional opportunities afforded us by the Chairman to help shape the Corporation's future-we are attending the Chairman's meetings and other forums with the Chairman, Director John Reich, and other senior FDIC Executives and Board Members where we can share the OIG's independent perspectives on new initiatives and issues facing the Corporation. We not only value the opportunity for expressing such views, we also appreciate the support we are receiving from the Chairman and Director Reich, especially, as we carry out the OIG mission.
In addition to the organizational changes that the Corporation is facing, the banking industry itself continues to face risks, given economic uncertainties; new and riskier financial services and products; and possible new security threats to information, human, and physical resources. As the Corporation downsizes and restructures, it must ensure that it is able to fully carry out its mission. Every FDIC employee must be fully engaged in protecting the safety and soundness of the financial institutions and preserving public confidence in the nation's banking system. The OIG understands that responsibility and is committed to continuing to prepare and improve itself so that it can add maximum value to the Corporation as it confronts these risks.
Against the backdrop of change and risk, the FDIC and a number of other policymakers continue to recommend the merging of the Bank Insurance Fund and the Savings Association Insurance Fund. On October 17, 2001, Chairman Powell testified on deposit insurance reform before the Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services, U.S. House of Representatives. During the period January 1, 2000 through March 28, 2002, 17 financial institutions failed. We note that recent losses to the insurance funds are pushing the FDIC ever closer to the 1.25 percent designated reserve ratio of the insurance fund balance to estimated insured deposits, whereby the FDIC must charge premiums to all insured depository institutions. Increases in estimated insured deposits and/or losses from additional bank failures could potentially cause insurance funds to fall below the statutorily mandated reservc ratio. The FDIC is concerned that automatic triggers limit the flexibility of the FDIC Board of Directors to respond appropriately to differing economic and industry conditions. Therefore, the FDIC has supported statutory changes related to risk-based insurance premiums and assessment credits for past contributions. This situation lends additional importance to timely consideration of deposit insurance reform provisions.
In past semiannual reports I have pointed out that the FDIC Board position of Vice Chairman has been vacant since January 2001, a condition which I believe is to the Board's detriment and fails to ensure the independence of the FDIC. Although the FDIC Board is still not operating at full strength, a change to the FDIC's Board of Directors did take place during the reporting period. Mr. James Gilleran was confirmed as Director of the Office of Thrift Supervision, replacing Director Ellen Seidman, and thereby became one of the outside Directors on the FDIC Board. Director Gilleran also serves as a member of the Corporation's Audit Committee and brings to that forum valuable insights and background. I must also note that another member of the Audit Committee, Ms. Myrta "Chris" Sale, who has served as Chief Financial Officer at the Corporation since May 1999 and who has offered great support of the OIG, will soon be leaving the Corporation and therefore the Audit Committee. We will miss her participation and the contributions she made to Audit Committee discussion and debate. I wish her much continued success on behalf of the entire OIG.
I also wish to acknowledge that I named Patricia M. Black as the OIG's Deputy Inspector General on April 8, 2002. Pat has served for the past 5 years as my Counsel and brings to her new position substantial experience in the Inspector General community as well as outstanding leadership and management skills that will serve the OIG well in the upcoming months as we re-create our office.
Finally, and sadly, the OIG lost a highly esteemed former colleague and friend during the reporting period. James A. Renick, my former Deputy Inspector General, who served at the FDIC for more than 23 years, died on February 5, 2002. He will long be remembered for his many contributions to the OIG, the model life he led, and the positive human qualities that made him unique. We extend our sympathies to the members of Jim's family for their loss.
Gaston L. Gianni, Jr.
The Major Issues section of our report focuses on key challenges confronting the FDIC as it works to accomplish its mission. In the OIG's view, these major issues fall into two broad categories. First, the Corporation faces challenges related to its core mission of contributing to the stability and public confidence in the nation's financial system by insuring deposits, examining and supervising financial institutions, and managing receiverships. Such challenges sometimes involve significant policy decisions and are often influenced by external factors such as industry events, economic trends, activities of other federal banking regulators, consumer concerns, and congressional interest.
Second, a number of important operational matters require the Corporation's attention as its workforce actually carries out the corporate mission. These issues touch on, for example, information technology resources and security, contracting activities, human capital concerns, cost efficiencies, and performance measurement and accountability.
In our previous semiannual report, we identified an important emerging management challenge that warranted attention: Security. This area extends beyond information resources security concerns to issues of personal security and safety, largely in response to the terrorist activities of September 11, 2001. In this report we update efforts in this area.
We are also identifying a new emerging issue-that of the Quality of Bank Financial Reporting and Auditing. This emerging risk potentially affects the FDIC in its role as regulator, receiver, and insurer.
With respect to the major issues relating to the Corporation's core mission, the FDIC must address risks to the insurance funds in a complex global banking environment that continues to experience change and offer expanded services. At the same time, the Corporation is charged with effectively supervising financial institutions and carefully protecting consumers' rights. A Board of Directors operating at full strength is essential to lead the Corporation as it faces such challenges. Without a full Board, the Corporation's independence cannot be guaranteed. As the Corporation moves forward, deposit insurance reforms will continue to be debated and deliberated by the banking industry and the Congress. One aspect of such reform involves the possible merger of the Bank Insurance Fund and the Savings Association Insurance Fund, an action that the OIG supports.
Turning attention to the Corporation's more "operational" demands, the use of information technology (IT) at the FDIC is crosscutting and absolutely essential to the Corporation's accomplishment of its mission. In conducting its IT activities, the Corporation's priority must be the effective and efficient use of IT to achieve program results corporate-wide. It must continue to develop an enterprise architecture process to manage technology, applications, and technical infrastructure for the Corporation. It also needs to follow sound system development procedures, comply with IT principles espoused by legislation and regulation, and ensure that effective controls are in place and implemented to safeguard system security, mitigate risks, and protect IT resources. Given the extent of the FDIC's contracting activities, strong controls and vigilant contractor oversight are also critical to the Corporation's success. Contracting must be done in the most cost-effective manner. The Corporation's contract oversight mechanisms must protect the FDIC's financial interests and help ensure that the FDIC is actually getting the goods and services for which it is spending millions of dollars.
Major downsizing over the past years has already impacted the FDIC workplace and more is in store. As a result, the Corporation has lost leadership and, in some cases, expertise and historical knowledge. The Corporation is taking steps to compensate for these resource losses and must build on ongoing initiatives to develop a comprehensive, integrated approach to human capital issues. It has established a Human Resources Committee and must continue to focus attention on human capital concerns.
In light of changes in the banking industry, advances in technology, and such dramatic shifts in staffing and skill levels, the Corporation has begun to closely scrutinize its business processes and their associated costs in the interest of identifying operational efficiencies. Among other activities, its Division of Supervision Process Redesign II project, New Financial Environment, and plans to relocate many D.C.-based staff to Virginia Square in the future have generated ideas for such efficiencies and are positive steps.
Finally, under the provisions of the Government Performance and Results Act with its emphasis on accountability, the Corporation establishes goals, measures performance, and reports on its accomplishments for all of these major issues and their corresponding challenges.
Our Major Issues section also discusses the OIG's completed and ongoing/planned work to help the Corporation successfully confront these major issues and their associated challenges. We discuss areas where we identified opportunities for improvements and the recommendations we made in those areas. We identified potential monetary benefits of $1.6 million and made 68 nonmonetary recommendations during the reporting period. Our work targets all aspects of corporate operations and includes a number of proactive approaches and cooperative efforts with management to add value to the FDIC (see pages 11-26).
The operations and activities of the OIG's Office of Investigations are described beginning on page 27 of this report. As detailed in the Investigations section, the Office of Investigations is reporting fines, restitution, and recoveries totaling approximately $536 million. Cases leading to those results include investigations of bank embezzlement, wire fraud, bank fraud, misrepresentations regarding FDIC insurance, money laundering, and concealment of assets. Our report also highlights efforts of OIG agents working on September 11-related investigative assignments and discusses our new Electronic Crimes Team. Some of the investigations described reflect work we have undertaken in partnership with other law enforcement agencies and with the cooperation and assistance of a number of FDIC divisions and offices. To ensure continued success, the OIG will continue to work collaboratively with FDIC management, U.S. Attorneys' Offices, the Federal Bureau of Investigation, and a number of other law enforcement agencies (see pages 27-35).
The OIG Organization section of our report highlights several key internal initiatives that we have actively pursued during the reporting period. The OIG's internal focus has been on realigning resources, building effective working relationships, and achieving high performance. This section of our report also references some of the cooperative efforts we have engaged in with management during the reporting period, including making presentations at corporate conferences and meetings. We note the proposed or existing laws and regulations reviewed during the past 6 months, refer to litigation and other efforts of OIG Counsel, and also capture some of our other internal initiatives this reporting period. In keeping with our goal of measuring and monitoring our progress, we visually depict significant results over the past five reporting periods (see pages 36-47).
We are including the OIG's 2001 Performance Report as a separate but integral component of our Semiannual Report to the Congress. Our performance report summarizes our progress against our annual plan, which contained 34 specific goals under the following three areas: Audits, Evaluations, and Investigations Add Value; Professional Advice Assists the Corporation; and OIG Communicates Effectively with Clients/Stakeholders. It is our hope that by presenting this report along with our semiannual report, the Congress and other readers will have a more complete picture of the FDIC OIG's overall performance and accountability (see pages 49-68).
We list the Inspector General Act reporting requirements and define some key terms in this section. The appendixes also contain much of the statistical data required under the Act and other information related to our work this period (see pages 69-75).
OIG staff responsible for work related to the failure of Superior Bank, FSB
The FDIC and the banking industry are experiencing significant and rapid change. We believe a number of issues associated with these challenges are deserving of special attention at this time. These broad major issues are identifying areas where the OIG focuses its resources.
Strong leadership has always been vital to the success of the banking and financial services industry. The FDIC Board is comprised of five directors, including the FDIC Chairman, two other external directors, the Comptroller of the Currency, and the Director of the Office of Thrift Supervision (OTS). All are presidential appointees. At the FDIC, during the 1990s, one or more presidentially appointed positions on the Board of Directors frequently were vacant. Perhaps now more than ever, the Corporation needs a full complement of Board members to carry out the FDIC mission.
Of special note during the reporting period was that James Gilleran was sworn in on December 7, 2001 as Director of OTS and, as such, joined the FDIC Board. Notwithstanding Director Gilleran's membership on the FDIC Board, the Board continues to operate with one vacancy. The Board position of Vice Chairman has been vacant since January 2001. The FDIC is both the independent regulator of a significant portion of the nation's banking system as well as the only federal insurer of deposits wherever they are placed in our nation's banks. As a corporation governed by its Board of Directors, the vital balance between various interests implicit in the Board's structure is preserved only when all vacancies are filled. Accordingly, we have strongly urged that vacancies on the FDIC's Board be filled as promptly as practicable in order to afford the FDIC the balanced governance and sustained leadership essential to the agency's continued success.
The OIG again emphasizes its belief that to handle the challenges and issues facing the Corporation, a Board of Directors operating at full strength must be in place.
A primary goal of the FDIC under its insurance program is to ensure that its deposit insurance funds remain viable. Achieving this goal is a challenge, given that the FDIC supervises only a portion of the insured depository institutions. The identification of risks in non-FDIC-supervised institutions requires coordination with the other federal banking agencies. The FDIC engages in an ongoing process of proactively identifying risks to the deposit insurance funds and adjusting the risk-based deposit insurance premiums charged to the institutions. The Division of Finance completes the final phase of this ongoing process by collecting the premium assessments.
Although the FDIC has a continuous program to ensure the viability of the deposit insurance funds, recent trends and events continue to pose additional risks to the funds. The economic landscape changed dramatically following the events of September 11, and recovery is on the upswing, but the potential exists for an increased number of bank failures. Additionally, the environment in which financial institutions operate is evolving rapidly, particularly with the acceleration of interstate banking; new banking products and asset structures; electronic banking; and consolidations that may occur among the banking, insurance, and securities industries resulting from the Gramm-Leach-Bliley Act.
Bank mergers have created "megabanks," or "large banks" (defined as institutions with assets of over $25 billion), and, for many of these institutions, the FDIC is not the primary federal regulator. As of March 31, 2001, there were 38 megabanks in the country. Of the $5.3 trillion consolidated assets controlled by the 38 megabanks, the FDIC was the primary federal regulator for only $162.5 billion in 3 institutions. The megabanks created as a result of mergers and the new or expanded services that the institutions can engage in under the Gramm-Leach-Bliley Act are presenting challenges to the FDIC. The failure of a megabank, for example, along with the potential closing of closely affiliated smaller institutions, could result in huge losses to the deposit insurance funds.OIG Reports on the Failure of Superior Bank, FSB
A significant portion of our work during the reporting period focused on issues related to addressing risks to the insurance funds. Specifically, we conducted a series of reviews based on a congressional request from Senator Paul Sarbanes, Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, related to the failure of Superior Bank, FSB, Hinsdale, Illinois.
Upon the failure of Superior Bank, OTS closed the institution on July 27, 2001. At the time of closure, Superior had total assets of $2.3 billion and total deposits of $1.6 billion. The FDIC was named conservator and transferred the insured deposits and substantially all of the assets of Superior to Superior Federal, FSB (New Superior), a newly chartered, full-service mutual savings bank. The failure of Superior was one of the costliest of all recent failures. The FDIC's most recent loss estimate is $440 million.
On December 10, 2001, the Corporation and the former owners of Superior entered into a settlement agreement. The terms of the settlement included the FDIC receiving a payment of $460 million, of which $100 million was received at closing. The $360 million remainder will be amortized over a 15-year period at a 0 percent interest rate. Various other contingencies will impact the final settlement amount. Superior was the third FDIC-insured failure of 2001 but the first institution insured by the Savings Association Insurance Fund to be closed during that year.
Given the FDIC's role in promoting and preserving public confidence in financial depository institutions, Senator Sarbanes requested that the OIG review why the failure of Superior Bank resulted in such a significant loss to the insurance fund and that we make recommendations for preventing any such loss in the future. The Senator's request contained a list of specific issues for us to address. Because Superior Bank was an institution regulated by OTS, the Department of the Treasury OIG was also asked to conduct a parallel review, as was the U.S. General Accounting Office. The Treasury OIG also conducted a material loss review of Superior.
These reviews all culminated in congressional hearings on February 7, 2002, at which the FDIC Inspector General and others testified.
In addition to Senator Sarbanes' request, we initiated reviews to address four related issues surrounding the failure of Superior:
Lessons Learned from Superior Bank
Specifically, these bank officials:
Superior's external auditors, Ernst & Young (E&Y), rendered unqualified opinions every year from 1990 through 2000 and supported the bank's valuations of residual assets and its methodology for calculating gains on sales of those assets. Even after the regulators began questioning the valuations in January 2000, the firm steadfastly maintained that the bank was properly valuing the assets in accordance with accounting principles. It was not until 1 year later that E&Y reversed its position and agreed with the regulators' opinion that the value of the residual assets should be adjusted to comply with those same principles, which required a $270 million reduction in the bank's accounting records. The regulators later identified $150 million more in write-downs to the residual assets so their value would be fairly presented. Once these accounting adjustments were made, Superior was deemed insolvent.Further, in our opinion, E&Y did not:
While Office of Thrift Supervision examination reports identified many of the bank's problems early on, OTS did not adequately follow up and investigate the problems, particularly the valuation of residual assets carried by the bank. OTS appeared to rely mostly on representations made by the bank and validated by E&Y. OTS also placed undue reliance on the ability of the wealthy owners of the bank's holding company to inject capital if it was ever needed. However, when an injection of capital was needed in 2001, the owners agreed to, but subsequently did not, provide the necessary capital. Warning signs were evident for many years, yet no formal supervisory action was taken by OTS until July 2000, which ultimately proved too late.
Coordination between regulators could have been better. OTS denied a request by the FDIC to participate in the January 1999 examination of Superior. Instead, OTS allowed the FDIC to meet with the OTS examination team off-site to discuss concerns approximately 1 week before the end of the examination. FDIC regional management did not raise this issue to the FDIC Board of Directors to gain access through the FDIC's special examination authority. OTS and the FDIC did work together in the January 2000 examination and more clearly identified the problem with the residual asset valuations. Even then, however, the regulators initially relied on bank management and E&Y assurances that the bank was properly accounting for its securitization activities and did not immediately put a halt to these transactions, to the detriment of Superior.
The early intervention provisions of section 38 of the Federal Deposit Insurance Act, commonly referred to as Prompt Corrective Action (PCA), require regulators to address problems before the financial condition of a failing institution deteriorates significantly. PCA did not work in the case of Superior. The capital ratios at Superior did not accurately reflect the financial position of the institution because the ratios were based on inflated asset valuations. In addition, beginning with OTS's 2000 examination, we believe that OTS used a methodology to compute Superior's capital that artificially increased the capital ratios, thus avoiding the provisions of PCA. By using a post-tax capital ratio for the first time that we were able to determine, Superior was classified as "adequately capitalized." If a pre-tax calculation had been used, Superior would have been "undercapitalized," thus more immediately subjecting Superior to various operating constraints under PCA. These constraints may have precluded Superior management from taking actions late in 2000 that were detrimental to the financial condition of the institution.
The federal banking agencies have attempted to address these PCA issues through the adoption of risk-focused examination programs and risk-based capital requirements. In addition, on November 29, 2001, the agencies issued a new rule that changes, among other things, the regulatory capital treatment of residual interests in asset securitizations. The rule, which became effective on January 1, 2002, addresses the concerns associated with residuals that exposed financial institutions like Superior to high levels of credit and liquidity risk.
Our review identified other areas in which we believe regulatory oversight could be strengthened. Specifically, the bank regulatory agencies should focus attention on policies and procedures for:
OIG Further Pursues Prompt Corrective Action Issues
We conducted another review that further pursued PCA issues. This review was based on discussions with staff of the Senate Committee on Banking, Housing, and Urban Affairs. The committee staff requested that we assess how well the PCA provisions in section 38 of the Federal Deposit Insurance Act were working.
In conducting our work, we concentrated our efforts on the three largest institution failures that have occurred since January 1997. As of December 31, 2001, the failure of those three institutions accounted for $1.17 billion, or 80 percent of the total losses to the deposit insurance funds from the 23 institutions that failed between January 1997 and September 2001. In addition, these three institutions had high concentrations of residual assets. We focused our audit to determine whether section 38 actions were implemented in a timely manner for Superior Bank, First National Bank of Keystone (Keystone), and Pacific Thrift and Loan Company and whether those actions prevented or reduced losses to the insurance funds.
We determined that the federal banking regulators were precluded from initiating section 38 corrective actions timely because Superior, Keystone, and Pacific Thrift and Loan Company valued residual assets in a manner that increased income and inflated their reported capital balances above the minimum capital levels that require the regulators to invoke such actions. In each case, the financial condition of the institution had significantly deteriorated before the regulators were able to invoke PCA. These circumstances indicate apparent limitations in the effectiveness of section 38. First, the capital level can be a lagging indicator of an institution's financial condition, and section 38 lacks other indicators besides capital that may be helpful in signaling the need for regulatory intervention. Second, regulatory agencies use data prepared and submitted by the institutions themselves to determine when PCA should occur, and that data may not be reliable. We recommended that the FDIC study these limitations to determine whether the addition of non-capital measures would increase the effectiveness of section 38 in preventing or minimizing losses to the insurance funds.
Further, although section 38(g) permits regulators to take PCAs based on factors other than capital, it does not provide specific criteria for implementation and imposes some restrictions that limit the timeliness and range of actions taken. Therefore, we also recommended that the FDIC, as part of its study, assess whether regulatory or legislative changes should be pursued to clarify when section 38(g) should be invoked and to eliminate the restrictions imposed by this section.
The FDIC's Decision to Place Superior Bank into Conservatorship
Again, in connection with Superior Bank's failure, we completed an audit of the FDIC's decision to place substantially all of the assets and certain liabilities of Superior into a conservatorship and of the Corporation's efforts to liquidate Superior's assets that did not transfer to that conservatorship.
Our review determined that the FDIC Board of Directors made its least cost decision to place Superior into conservatorship primarily on the Division of Resolutions and Receiverships' (DRR) recommendation and the information presented in DRR's Failing Bank Case. DRR presented two resolution alternatives to the FDIC Board in its failing bank case, but DRR did not include complete financial analyses that supported the projected loss to the deposit insurance fund for these options.
Prior to the presentation of the failing bank case, DRR’s access to Superior records and personnel was limited partly based on the fact that Superior’s owners were in the process of implementing a capital restoration plan that purported to address the capital problems at Superior As a result, DRR did not complete the Information Package or Asset Valuation Review, two critical activities that enable DRR to solicit bids from potential acquirers and compare the offers for determining the least costly resolution strategy, as required by the Federal Deposit Insurance Corporation Improvement Act of 1991. Additionally, DRR did not have sufficient information to develop other possible resolution alternatives for Superior prior to presenting the failing bank case to the FDIC Board.
DRR adequately documented the asset and receivership liability claim balances and the deposit premium estimates used in the failing bank case but did not adequately document the assumptions used to estimate the loss on Superior's $2.4 billion in assets. This loss value was instrumental in projecting the cost of Superior's failure to the deposit insurance fund in the failing bank case.
DRR does not have adequate guidance for determining the least costly resolution for large financial institutions in situations where DRR cannot complete the Information Package or an Asset Valuation Review before the institution is closed and, thus, DRR's current guidance was not applicable to the Superior resolution. DRR has made improvements to its resolution process in the last few years. DRR developed information-sharing arrangements with the Office of the Comptroller of the Currency and the FDIC's DOS that have facilitated DRR's early access to failing institutions. DRR also included in its 2002 Strategic Plan an objective to document and retain appropriate background information concerning unique situations encountered for each resolution for future DRR reference or for presentation purposes.
Follow-up Audit Addresses the FDIC's Special Examination Authority and Large Bank Risk Monitoring
We reported the results of our follow-up audit of a study that we conducted of DOS's efforts to monitor and assess risks at insured institutions for which the FDIC is not the primary federal regulator. In a memorandum to the FDIC Chairman in October 1999, we reported that other federal regulators had occasionally restricted the FDIC's efforts to participate in safety and soundness examinations at institutions for which the Corporation is not the primary federal regulator. Such restrictions had limited the FDIC's ability to assess risks to the deposit insurance funds. We also reported that because of limitations in the information routinely provided to DOS by the other regulators pertaining to the nation's largest banks, DOS managers expressed some concerns that they may not be able to adequately assess the risks that the country's largest non-FDIC supervised banks pose to the insurance funds.
The objective of our follow-up review was to assess the progress that the FDIC has made since the issuance of our previous memorandum and to make recommendations that might improve the Corporation's effectiveness in working with the other federal regulators. We reviewed the issues solely based on information provided by the FDIC in its efforts to effectively carry out its mission. We did not perform audit fieldwork at the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, or OTS.
In our 1999 memorandum, we had suggested that the Chairman (1) request delegate authority from the FDIC Board to initiate special examinations without having to secure the concurrence of the primary federal regulator or the approval of the Board or (2) seek a legislative change to vest this authority in the Chairman.
Based on the results of our follow-up review, the circumstances supporting our previous suggestion did not substantially change, and movement in the industry and the consequences of additional failures had increased the risk to the deposit insurance funds. Accordingly, we formally recommended that the FDIC's special examination authority be strengthened. Additionally, as a result of our follow-up work, we reaffirmed the position that we expressed in our prior review by recommending that the Director of the FDIC's DOS develop agreements with the other bank regulatory agencies to provide the FDIC with the real-time information and access to megabanks necessary to carry out the Corporation's responsibilities as the insurer. The Director agreed with this recommendation.
Prior to issuing our report, we had an opportunity to review a draft interagency proposal addressing factors that have restricted the FDIC's special examination authority and the Corporation's concerns regarding information sharing. We also discussed the proposal with DOS management. We commended the Corporation's efforts to address past problems in gaining access to and information on institutions for which the FDIC is not the primary federal regulator. We also expressed several concerns related to limitations that the language of the draft agreement might place on the FDIC's statutory authority to independently assess risks to the deposit insurance funds.
On January 29, 2002, the FDIC's Board of Directors acted on the proposal by authorizing an expanded delegation of authority to grant the FDIC more autonomy in terms of examining banks that pose a heightened risk to the deposit insurance funds. The new delegation also provides for the creation of a dedicated FDIC examiner program at the eight largest banks and is intended to provide more timely access to information related to those banks. After signing the agreement, FDIC Chairman Powell stated, "The agreement establishes a better process for determining when the FDIC will use its authority to examine any insured institution. It will further protect the insurance funds. It shows what the banking regulators can achieve when we work together."
Our report went a step further and recommended that the FDIC pursue a legislative change that would vest special examination authority in the FDIC Chairman. We believed this was the best approach to resolving problems related to the Corporation's special examination authority because any agreement is subject to interpretation and varying degrees of support when there is a change among the leadership of the four federal banking agencies. The DOS Director stated in his response to our report that DOS agreed with this recommendation and that revising section 10(b)(3) of the FDIC Act would achieve a more permanent solution to inefficiencies related to the FDIC's use of special examination authority. As a result, the Director stated that DOS had included amending section 10(b)(3) in its Legislative Priorities list for 2002.
The FDIC shares supervisory and regulatory responsibility for approximately 9,796 banks and savings institutions with other regulatory agencies including the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the OTS, and state authorities. The FDIC is the primary federal regulator for 5,579 federally insured state-chartered commercial banks that are not members of the Federal Reserve System, which includes state non-member banks, including state-licensed branches of foreign banks and state-chartered mutual savings banks. The challenge to the Corporation is to ensure that its system of supervisory controls will identify and effectively address financial institution activities that are unsafe, unsound, illegal, or improper before the activities become a drain on the insurance funds.
Emerging trends and new developments in the banking industry require the Division of Supervision (DOS) to identify and assess risks from:
Further, DOS may have to reevaluate the concepts of risk, capital, and asset valuation in light of recently developing investment products and methods.
There are also continuing pressures for the FDIC to increase the efficiency of the bank examination process designed to identify and assess these risks. Additionally, with the possibility of a serious economic downturn, and given the magnitude of FDIC corporate downsizing, DOS must assess its size and mix of expertise and skills in its workforce to ensure sufficient capacity for addressing increased risks. Considering the lead time for developing new commissioned examiners, the FDIC needs to ensure the examination workforce will be adequate for handling potential problems and bank failures.
OIG Work Addresses Supervision Challenges
The OIG's work related to the Corporation's supervision activities during the reporting period consisted in part of ongoing assistance provided to Phase II of the DOS Process Redesign Project. OIG staff provided input and feedback to proposals and questions. A major focus of recent involvement is DOS's new Maximum Efficiency Risk-focused Institution Targeted (MERIT) Guidelines for examining small, low-risk institutions. The OIG is pleased to play a part in helping to ensure that the programs developed by DOS contain adequate management controls.
Additionally, the OIG issued a report that was one of a series of reviews initiated in response to the failure of Superior Bank, FSB, Hinsdale, Illinois, that was placed into receivership on July 27, 2001. (See earlier discussion of Superior Bank-related work.) We conducted our Evaluation of Rating Differences Between the FDIC and Other Primary Federal Regulators to determine the extent to which there are ratings differences between the FDIC and the primary federal regulator and to evaluate the process for resolving these differences.
We identified few ratings differences during our review period, and, consistent with the FDIC's procedures for Disagreement with Primary Federal Regulator Ratings, case managers told us that good communication and coordination with the primary federal regulator were the keys to resolving differences, and, more broadly, monitoring the condition of institutions not supervised by the FDIC.
Some case managers raised concerns related to the FDIC's special examination authority. These concerns were further addressed as part of our follow-up audit of the FDIC's use of special examination authority and DOS's efforts to monitor large bank insurance risks, as discussed earlier in this report.
The FDIC is legislatively mandated to enforce various statutes and regulations regarding, for example, consumer protection and civil rights with respect to state-chartered, non-member banks and to encourage community investment initiatives by these institutions. Some of the more prominent laws and regulations in this area include the Truth in Lending Act, Fair Credit Reporting Act, Real Estate Settlement Procedures Act, Fair Housing Act, Home Mortgage Disclosure Act, Equal Credit Opportunity Act, and Community Reinvestment Act of 1977.
The Corporation accomplishes its mission related to fair lending and other consumer protection laws and regulations primarily by conducting compliance examinations, taking enforcement actions to address unsafe or unsound banking practices and compliance violations, encouraging public involvement in the compliance process, assisting financial institutions with fair lending and consumer protection compliance through education and guidance, and providing assistance to various parties within and outside of the FDIC.
OIG Reviews Fair Lending Examination Risk-Scoping Procedures
We completed our review of The Division of Compliance and Consumer Affairs' Risk-Scoping Procedures for Fair Lending Examinations during the reporting period. Fair lending is a term used to describe compliance with two federal laws prohibiting discrimination in lending: the Fair Housing Act enacted by Title VIII of the Civil Rights Act of 1968 and the Equal Credit Opportunity Act of 1974.
Our report discusses the adequacy of Federal Financial Institutions Examination Council procedures for the FDIC's pre-examination planning for fair lending examinations of small banks and the FDIC's implementation of those procedures. The procedures were not adequate for many of the banks that the FDIC supervises, and a lack of available monitoring and demographic data often made it difficult for examiners to apply procedures for determining potential discrimination. The Corporation had, however, initiated several compensating actions. Specifically, the Division of Compliance and Consumer Affairs (DCA) issued FDIC Examination Procedures for "Low-Risk" Institutions that discusses how to risk-focus reviews of fair lending requirements. DCA is also in the process of conducting workshops for its examiners that address the conduct of fair lending examinations, including various issues that arise during risk-scoping. Finally, DCA has initiated a referral and consultation program that emphasizes direct contact with the Washington Office for guidance during the fair lending examination process.
We also determined that documentation of the risk-scoping process could be improved. A DCA internal review confirmed that the present level of documentation of the risk-scoping process needs to be improved, and new documentation requirements will be issued in May 2002.
On October 17, 2001, Chairman Powell testified on deposit insurance reform before the Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services, U.S. House of Representatives. The Chairman recommended the merger of the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF), charging riskbased premiums to all institutions, allowing insurance funds to build or shrink around a target or range, establishing assessment credits based on past contributions, and indexing insurance coverage and raising the insurance on retirement accounts.
The FDIC views these recommendations as interrelated and believes they should be implemented as a package because piecemeal implementation could introduce new distortions and aggravate the problems that the recommendations are designed to address. While conceptually the recommendations appear to the OIG to be sound, we have not done work related to all of them. Based on work to date, the OIG strongly supports merging the funds.
Chairman Powell noted the unanimity within the banking community on this particular point. Today, as a result of bank mergers and acquisitions, many institutions hold both BIF- and SAIF-insured deposits, obscuring the difference between the funds. In fact, the Chairman stated that more than 40 percent of SAIF-insured deposits are now held by commercial banks. The resulting fund would not only be stronger and better diversified but would also eliminate the concern about a premium disparity between the BIF and the SAIF. Assessments in the merged fund would be based on the risk that institutions pose to the single fund. The prospect of different prices for identical deposit insurance coverage would be eliminated. Also, insured institutions would no longer have to track their BIF and SAIF deposits separately, resulting in cost savings for the industry.
On April 4, 2002, the Chairman also spoke about merging the funds at the University of North Carolina Banking Law Center in Chapel Hill, North Carolina. In his statement he said,
If the conditions we have seen for the last several years were to continue, the safest banks and thrifts that paid to build up the funds on balance would be no worse off than they are under the present system. Riskier banks, fast growers, and new entrants would bear more of the assessment burden in the short term. It also means that, if conditions worsen, the safest banks would be better off than they are under the present system, since their premiums during a downturn would be lower.
Bills are currently under consideration in both the House and Senate regarding deposit insurance reform. Testimony by the Treasury and the Federal Reserve System supports the FDIC’s proposed framework for changing the way deposit insurance is paid for. We will continue to monitor this important initiative, as changes in this area will impact the way the FDIC operates and how our office can best support the FDIC in pursuit of its mission.
Accomplishing information technology (IT) goals efficiently and effectively requires significant expenditures of funds and wise decision-making and oversight on the part of FDIC management. The Corporation's 2002 IT budget is approximately $192.5 million.
IT is increasingly impacting every facet of our lives and is evolving at a rapid pace. The Corporation must constantly evaluate technological advances to ensure that its operations continue to be efficient and cost-effective and that it is properly positioned to carry out its mission. The capabilities provided by IT advances, such as paperless systems, electronic commerce, electronic banking, and the instantaneous and constant information-sharing through Internet, Intranet, and Extranet sources, also pose risks to the Corporation and the institutions that it regulates and insures. Many of the risks are new and unique. Solutions to address them are sometimes difficult and without precedent.
In addition to technological advances, the Corporation must continue to respond to the impact of new laws and regulations on its operations. Management of IT resources and IT security have been the focus of several significant legislative acts, such as the Government Performance and Results Act and the Paperwork Reduction Act. The Government Information Security Reform Act requires the OIG to conduct an annual evaluation of the FDIC's information security controls. Our second such review is currently ongoing.
According to the 2002 Annual Performance Plan, the Corporation will continue to be engaged in several major technology initiatives during the remainder of 2002. These include the following:
New Financial Environment. The FDIC is working to replace its financial system, resulting in substantially lower costs and greater functionality when fully implemented. The new financial environment will improve business processes by adapting the best practices built into software packages, simplify and consolidate the financial application and data environment, enhance efficiency by automating manual work, maximize e-business opportunities, and provide better decision-making to ensure continuity of financial operations. (See a discussion of OIG work related to the New Financial Environment later in this report.)
Information security program improvements. The Corporation developed and implemented an information security program to address identified weaknesses. During 2002 the Corporation plans to enhance security performance measurement and contractor and external security.
Enterprise Architecture: A new enterprise architecture process will be introduced to manage technology, applications, and technical infrastructure for the Corporation. The new enterprise architecture process will be integral to corporate and IT planning and should provide a corporate view of and future direction for business processes, information, applications, and infrastructure. It will also provide the standards and procedures to be followed whenever a new information system is being built.
Our work in the IT area during the reporting period identified a number of significant security concerns and opportunities to improve the efficiency and effectiveness of certain applications and data integrity as well. A brief summary of important IT-related products follows.
Follow-up Audit of Internal Controls over the Customer Information and Control System (CICS) for FDIC Financial Systems
CICS is a transaction management program for mission-critical applications, such as the Bank Information Tracking System, Call Processing System, and the FDIC's financial systems. Such financial systems include the Financial Information Management System general ledger, the Accounts Payable Purchase Order System, and the Electronic Procurement Routing Invoice Solution. The financial systems record and report all the financial activity of the Corporation.
CICS provides the interface between these application programs and the computer's operating system. Specifically, it provides the mainframe operating system with the ability to handle transactions from user terminals such as a personal computer.
In order to conduct its functions, CICS uses a System Definition File. The System Definition File within CICS identifies and defines what transactions or programs are available to users of the mission-critical applications. Also the CICS software system includes very powerful capabilities (for example, commands that can shut down the application systems) that must be appropriately controlled to protect corporate applications and data. Consequently, to ensure the integrity of application programs and data, CICS must be integrated with the security software used on the mainframe computer.
Our audit determined that controls were not in place to protect access to the CICS System Definition File within the CICS system. As a result, over 100 non-CICS programmers had full access to the file and had the capability to shut down or disrupt the systems that are critical to the FDIC's mission. When we brought this condition to management's attention, appropriate action was taken to correct the problem.
We determined that other access security controls were adequate for CICS system files, resources, and software monitoring products used by the FDIC financial systems.
Security and Controls over the Risk Analysis and Value Estimation System
The FDIC is charged with the resolution of failing financial institutions. The Corporation's DRR is responsible for resolving troubled financial institutions and selling assets at the least cost and highest recovery to the Corporation's insurance funds.
Fundamental to selling assets for the least cost and highest recovery are the practices developed by DRR to establish asset prices and evaluate the bids received on the failing institution. The asset prices are established using the Asset Valuation Review process.
DRR uses the Risk Analysis and Value Estimation (RAVEN) application to support the Asset Valuation Review process by determining asset samples and calculating asset values. The Asset Valuation Review reports generated by RAVEN are instrumental in determining the least costly resolution of the institution. RAVEN is used to prepare the bid packages given to prospective failing institution bidders and establishes valuations for assets to be liquidated by the FDIC. Institution regulators are charged with maintaining strict confidentiality in matters related to potential institution failures. Consequently, RAVEN contains extremely confidential information related to the institution's asset values and liabilities.
We conducted an audit to determine whether security and controls over the RAVEN data, application software, and operating environment were adequate. We concluded that RAVEN data and operating environment security control practices were not adequate to protect sensitive data. Further, application security and control practices had not been implemented to ensure that application documentation was prepared and retained. Finally, adequate change controls had not been implemented. We made seven recommendations to address these concerns. Management had either completed or was in the process of taking action on all recommendations as of the date of report issuance.
The FDIC's Dividend Processing System
Our audit addressed the FDIC's Dividend Processing System (DPS), the Corporation's accounting application used to determine payment amounts and the corporate system of record for dividends paid to the holders of receiver certificates from failed institutions. DPS generates payment requests based on receivership certificates, administrative expense, and funds available for distribution.
DPS generally met user requirements and improved the efficiency and effectiveness of the dividend payment process. Although DPS was operating as intended, inconsistencies in data structure and content between DPS and the Receivership Liability System (RLS), the FDIC system that issues valid receiver certificates, raised concerns regarding the reliability of DPS data on which dividends are computed and paid. Additionally, some DPS general and application controls were not implemented before DPS was put into operation. Specifically, the Division of Information Resources Management (DIRM) did not obtain memorandums of agreement on data sharing or institute adequate change controls over the application's software, and the Division of Finance did not update its contingency plan or procedure manuals to reflect changes brought about by DPS. We recommended that the FDIC take steps to correct the inconsistencies between DPS data and data in the related applications. We also recommended that the Corporation implement certain general and application controls that were not in place at the time of our audit. Management has either completed or is taking action on our recommendations.
Additional IT Work
Other reviews during the reporting period covered the following matters:
Controls over Outlook Resources. The FDIC uses Outlook to provide electronic mail and calendar services to its employees. Our review determined that the FDIC's policies and procedures did not adequately protect data residing in Outlook folders. Guidance was lacking to properly control the use of Outlook settings that can permit other system users to have access to information created by or intended for the original user. As a result, sensitive data residing in e-mail messages and Outlook folders may not have been secured against unauthorized disclosure, deletion, or modification. The security risk was increased because the version of Outlook in use at the time could contribute to users inadvertently assigning access to their personal folders to all Outlook users. The Corporation took action on the recommendations we made in this report.
The FDIC's Excess Computer Hard Drive Sanitation Procedures. We conducted this audit to determine whether the statement of work contained in DIRM's contract with its inventory management contractor complied with corporate policies and procedures and whether the corporate policies and procedures relating to removing data from excess computer equipment were adequate. We recommended measures to better ensure that all data are effectively removed from the Corporation's excess computers, and the Corporation promptly implemented new procedures in response. We also recommended that the Corporation test the new procedures to ensure their full effectiveness going forward.
The private sector provides goods and services to the FDIC as needed through contracting to assist the Corporation in accomplishing its mission. Contractors provide assistance in such areas as information technology, legal matters, loan servicing, asset management, and financial services.
Maintaining a strong system of internal controls and effective oversight of contracting is critical to the FDIC's success. The Corporation has taken a number of steps in this regard-training, revisions to the Acquisition Policy Manual, and Contractor Oversight working groups. A goal related to contractor oversight was added to the Corporation's Annual Performance Plan, which is formulated in accordance with the Government Performance and Results Act. The Corporation must sustain such efforts going forward. Additionally, with increased downsizing and possibly more involvement of contractors to carry out the FDIC mission, effective oversight will become even more critical.
Projections of calendar year 2002 non-legal contract awards and purchases total 1,400 actions valued at approximately $375 million. Information technology has always been one of the most active areas of contracting. As of March 31, 2002, there were more than 210 active information resources management contracts valued at approximately $350 million that had been awarded in headquarters. Approximately $185 million of this expenditure authority for active contracts had been spent and $165 million remained to be used as of that date.
Contractor Billing Audit
We completed an audit of the billings of an FDIC contractor to determine whether the contractor's billings complied with the terms and conditions of the delivery order. The contractor provided information technology and logistical services such as managing the automated inventory system and operating the equipment distribution centers for DIRM.
Our report contained two recommendations-one to disallow questioned costs of $50,460 and another to determine whether requirements listed in a General Services Administration supply schedule contract or those listed in the FDIC delivery order are applicable to the contractor and ultimately disallow any appropriate portion of the $252,675 of unresolved costs we identified. The questioned costs were all related to billing the FDIC at rates higher than allowable based on employees' education and experience qualifications. Management agreed with both recommendations.
New Approach to Contract Audits
In coordination with the Division of Administration, we are developing a new approach to conducting audits of contractor billings as well as performance-type audits in the contracting area, and several audits are in process using the new approach. Audits of contractors will focus more specifically on contract provisions to determine the allowability of costs. Performance-type audits in the contracting area will focus on such issues as how well contracts are administered and the adequacy of contractor oversight. In the past, these objectives were often combined into one audit.
We plan to separate out any FDIC contract administration and oversight issues from our contractor audits and incorporate those issues into a performance-type audit where we can analyze trends and make more meaningful recommendations. Audits of contractors will have a narrow scope and a streamlined process, which should result in a shorter period needed to issue the final reports.
The Government Performance and Results Act (Results Act) of 1993 was enacted to improve the efficiency, effectiveness, and accountability of federal programs by establishing a system for setting goals, measuring performance, and reporting on accomplishments. Specifically, the Results Act requires most federal agencies, including the FDIC, to prepare a strategic plan that broadly defines each agency's mission, vision, and strategic goals and objectives; an annual performance plan that translates the vision and goals of the strategic plan into measurable annual goals; and an annual performance report that compares actual results against planned goals.
The Corporation's strategic plan and annual performance plan lay out the agency's mission and vision and articulate goals and objectives for the FDIC's three major program areas of Insurance, Supervision, and Receivership Management. The plans focus on four strategic goals that define desired outcomes identified for each program area: (1) Insured Depositors Are Protected from Loss Without Recourse to Taxpayer Funding, (2) FDIC-Supervised Institutions Are Safe and Sound, (3) Consumers' Rights Are Protected and FDIC-Supervised Institutions Invest in Their Communities, and (4) Recovery to Creditors of Receiverships Is Achieved. Through its annual performance report, the FDIC is accountable for reporting actual performance and achieving these strategic goals, which are closely linked to the major issues discussed in this semiannual report.
The Corporation has made significant progress in implementing the Results Act and will continue to address the challenges of developing more outcome-oriented performance measures, linking performance goals and budgetary resources, establishing processes to verify and validate reported performance data, and addressing crosscutting issues and programs that affect other federal financial institution regulatory agencies. The FDIC is committed to fulfilling both the requirements of the Results Act and congressional expectations that the performance plans and reports clearly inform the Congress and the public of the results and outcomes of the FDIC's major programs and activities, including how the agency will accomplish its goals and measure the results.
OIG Formulates Results Act Review Plan
In late 1998, the House Leadership formally requested that the Inspectors General of 24 executive agencies develop and implement a plan for reviewing their agencies' Results Act activities. The Congress attaches great importance to effective implementation of the Results Act and believes that Inspectors General have an important role to play in informing agency heads and the Congress on a wide range of issues concerning efforts to implement the Results Act. We believe the congressional views on such a review plan represent an appropriate direction for all Offices of Inspector General.
OIG's Results Act Review Plan
The FDIC OIG is fully committed to taking an active role in the Corporation's implementation of the Results Act. We have developed a review plan to help ensure that the Corporation satisfies the requirements of the Results Act and maintains systems to reliably measure progress toward achieving its strategic and annual performance goals. Our review plan consists of the following three integrated strategies:
OIG Reviews Draft FDIC 2002 Annual Performance Plan
During this reporting period, the OIG reviewed and provided advisory comments to management on the FDIC's draft 2002 Annual Performance Plan. Our comments were based in large measure on a consideration and analysis of corporate objectives and priorities emphasized by the FDIC Chairman at the February 2002 Leadership Conference for executive staff. We believe the high-level communication of clear corporate performance and accountability expectations at the conference was commendable and fully consistent with the concepts of the Results Act, including the concept of linking corporate performance to individual accountability.
Our comments included a comprehensive matrix analysis of the linkage between the Leadership Conference 2002 Performance Measures and the draft FDIC 2002 Annual Performance Plan. The Leadership Conference performance measures established performance objectives for 2002 that provide the framework for quarterly performance reporting and executive accountability to the Chairman. Our analysis of the linkage indicated that a substantial number of the Leadership Conference measures had not been fully incorporated in the draft FDIC 2002 Annual Performance Plan.
We suggested that management review the Leadership Conference performance measures and consider incorporating them as annual performance goals in the 2002 Annual Performance Plan, especially the corporate-level measures. Management officials agreed conceptually with our view and suggestions, but the timing was not sufficient to make adjustments in the 2002 plan. Management indicated they would consider our suggestions in the 2003 plan.
The OIG will continue to develop and refine its integrated oversight strategy to help ensure that the FDIC's Results Act-related efforts fully conform to the spirit and intent of the Act. We plan to continue to work with the Corporation to improve the FDIC's performance measurement and reporting through our audits, evaluations, and management advisory reviews and analyses. The OIG will also continue to monitor and review legislation proposed in the Congress to amend the Results Act and will actively participate to refine appropriate OIG Results Act roles, responsibilities, and activities through the President's Council on Integrity and Efficiency and the interagency groups it sponsors.
The FDIC has been in a downsizing mode for the past 10 years as the workload from the banking and thrift crises of the late l980s and 1990s has been accomplished. Over that time-frame, the workforce (combined from the FDIC and the Resolution Trust Corporation) has fallen from approximately 23,000 in 1992 to 6,175 as of March 31, 2002. In addition to reductions in the size of the workforce, as the Corporation's needs have changed, employees have been relocated to best serve those changing needs. The Corporation is continuing to streamline its staff to reduce operational costs, especially its management overhead and program support costs. A number of division mergers and reorganizations are taking place or planned. By early 2003, the Corporation hopes to substantially complete required downsizing and correct existing skills imbalances. To do so, the Corporation has in motion a comprehensive program that includes early retirement offerings, separation incentives, solicitations of interest, reassignments, retraining, outplacement assistance, and possible reductions-in-force. As the Corporation adjusts to a smaller workforce, it must continue to ensure the readiness of its staff to carry out the corporate mission.
The Corporation has predicted that almost 20 percent of FDIC employees will be eligible to retire within the next 5 years. The Corporation must continue to conserve and replenish the institutional knowledge and expertise that has guided the organization over the past years. Hiring and retaining new talent will be important, and hiring and retention policies that are fair and inclusive remain a significant component of the corporate diversity plan.
Another consideration is determining where corporate employees will be housed over the long-term. Millions of dollars are spent on leases throughout the country. Given the changes in the industry, trends such as telecommuting and increased use of technological tools to perform work, and continued attrition, the Corporation may need to consider additional relocations or establish new work sites and capabilities for its staff.
In that regard, during the reporting period, the Corporation's Board of Directors approved construction of a new nine-story building at its Virginia Square office complex in Northern Virginia. This building will house FDIC staff for the most part now working in leased space in the District of Columbia. The expansion will cost approximately $111 million; however, the Corporation anticipates substantial savings in the long run-more than $78 million (in today's dollars) over the next 20 years. At the Division of Administration's request, the OIG will be conducting a type of pre-award audit to ensure that the process for soliciting and hiring contractors to perform the work of constructing the new site is carefully controlled and properly carried out.
To implement an overall successful human capital framework, organizations need information systems that allow managers to identify skills imbalances and project future needs. Also important is that the Corporation's human capital strategy and workforce planning system are directly linked to the FDIC's overall strategic and performance plans. The Corporation's 2001-2006 strategic plan includes workforce issues and a discussion of corporate resources.
The Corporation has established a Human Resources Committee. This committee is an executive steering committee that reports to the Chief Operating Officer and is responsible for developing policy recommendations regarding major human resource issues and monitoring implementation of corporate human resource strategies. One priority of the committee is the Chairman's initiative to establish a corporate university and job rotation program, as announced at the February Leadership Conference.
Designing, implementing, and maintaining effective human capital strategies are critical to improving performance and accountability and must be the focus of sustained corporate attention. The OIG is conducting an evaluation review of aspects of the Corporation's human capital efforts. Our work is focusing on the design of the Corporation's current training, education, and development policies and programs to ensure the Corporation maintains a highly skilled workforce for handling anticipated and unforeseen workloads. We expect to issue the results of our work in the next semiannual report.
The Corporation continues to try to identify and implement ways to contain and reduce costs, either through more careful spending or assessing and making changes in business processes to increase efficiency. As steward for the Bank Insurance Fund and the Savings Association Insurance Fund, the FDIC looks for cost reductions and efficiency improvements to minimize the draw on the funds.
The Corporation has taken steps to increase emphasis in this area. As discussed in the previous section of this report, savings will result from the Corporation's planned building of its new Virginia Square site. Several other initiatives are in process to better understand what the various business processes and activities within the FDIC cost, how they can be made more efficient, and how they compare to private and public sector entities. The Corporation may also need to recognize and plan for unmet needs which can add to operating costs. Such needs may include, for example, further ensuring information resources security and building security.
FDIC Chairman Powell has underscored the importance of efficiency and effectiveness of the FDIC in various communications with FDIC employees. Certainly, the Corporation's planned organizational streamlining and downsizing will seek such efficiencies and economies. Additionally, the Corporation is evaluating the cost of certain corporate operations against appropriate benchmark organizations. The results of such studies will help the Corporation identify areas in which its costs may be higher than other organizations and potential "best practices" to reduce these costs.
Further, the Corporation is implementing a service costing initiative-new procedures to charge receiverships for services provided by the Corporation by applying standard rates. This initiative should also result in further allocation of receivership expenses. The OIG is conducting a review of the Corporation's efforts in this area.
OIG Work Evaluates Corporate Efforts for Efficiencies
Completed OIG work during the reporting period related to this major issue included a review of the FDIC's management of its headquarters-owned buildings and a review of the Corporation's planning for its New Financial Environment.
Regarding the headquarters-owned buildings, we recommended that the Corporation develop a policy that formally establishes a building management program that incorporates at a minimum, the following requirements:
We also recommended that the Corporation assign a higher priority to installing fire suppressant sprinkler systems at several specific FDIC buildings.
With respect to the New Financial Environment, we conducted an evaluation to assess the reasonableness of the cost/benefit analysis and the system architecture vision prepared to plan the FDIC's future financial environment. We identified limitations in the cost/benefit analysis estimates, but the need to modernize the Corporation's financial management systems suggested that the Corporation should proceed with acquisition planning for a commercial off-the-shelf financial management system. We expressed concerns regarding the estimates, ambitious time frames, and uncertainties with what financial system components would be integrated or interfaced. We pointed out that the Board should have more complete and accurate information before approving such a large investment in technology. We therefore recommended that the Chief Financial Officer use an incremental two-case approval process to obtain the Board's approval to proceed with the New Financial Environment.
The Chief Financial Officer agreed with the spirit of our recommendation but explained that an incremental two-case approval process was not feasible within the existing budget and procurement plan cycle. However, the Chief Financial Officer indicated that the Board would establish parameters on funding and periodic reporting which would impose external discipline on the process, and we considered these controls responsive to our concerns.
In our last semiannual report, largely in light of the events of September 11, we identified an emerging issue that the FDIC needed to address-physical and personnel security. The Corporation has devoted considerable attention to these areas and continues to do so. It has enhanced important physical security features of its properties. It has worked to keep employees informed of security matters and events occurring in the Washington, D.C., area that may impact employee safety and security. It also developed a draft Emergency Response Plan on which the OIG provided extensive comments to the Chief Operating Officer during the reporting period.OIG Offers Comments on Emergency Response Plan
In commenting on the draft plan, we noted that several lessons could be learned as a result of September 11, including the following:
We indicated in our comments that the draft Emergency Response Plan met some of those needs, but not all of them. We communicated our comments to prompt further corporate analysis and planning.
We also completed fieldwork on an evaluation of the FDIC's physical security of Washington, D.C., area facilities during the reporting period. Our objectives were to assess whether the FDIC's security program was established and implemented to protect real and personal property, assess risks, make decision-makers aware of risks, and act promptly and appropriately in response to risks. We are continuing to perform fieldwork related to these same issues in FDIC field sites and will issue the results of our work in the upcoming semiannual reporting period.
During the reporting period, the OIG brought the following emerging issue to FDIC management's attention.
Recent highly publicized business failures, including financial institution failures, have raised significant questions about the quality of financial reporting and auditing of these businesses. Various dimensions of this issue have been, and continue to be, widely discussed and reported in various forums, most notably with continuing congressional hearings on the failure of Enron Corporation. Aspects of the problem as it relates to financial institutions have been documented in recent OIG work on bank failures-Superior Bank as discussed earlier in this report, and Keystone Bank, as presented in prior semiannual reports. During the reporting period, the OIG shared its views on this issue with FDIC management in the Office of Internal Control Management and DOS. We suggested that the Corporation disclose and discuss the issue in its Chief Financial Officers Act Report as an internal control matter warranting continued monitoring. The Corporation determined that it would include the matter as an emerging issue in the Financial Industry Highlights section of the report.
The issues involve interrelated roles of management (including Boards of Directors and Audit Committees), independent auditors, and regulators. Management is primarily responsible for the reliability of financial reports with auditors providing an independent audit function and regulators relying on the financial data.
Affected regulators include the Securities and Exchange Commission as well as the FDIC and other financial institution regulators. The need for reliable financial data affects the ability of regulators to effectively achieve their oversight missions. To the extent that the financial reporting of businesses (including financial institutions) is not reliable, the regulatory processes and mission achievement can be adversely affected. Financial institution regulators are affected by the quality of reporting of financial institutions and businesses transacting with financial institutions. Critical operational processes of financial institution regulators can be adversely affected. Essential research and analysis (used for economic analysis and decision-making) and bank supervision (examinations) can be complicated and potentially compromised by poor quality financial reports and audits.
In addition to supervision safety and soundness issues, the FDIC, in its roles as receiver and insurer, is potentially affected by financial reporting and audit quality, regardless of whether the FDIC is the primary federal regulator. Receivership management operations, relying on accounting and auditing contractors, can be adversely affected. Potentially, the insurance funds can be affected, for example, by financial institution and other business failures precipitated in whole or in part by financial reporting irregularities.
The financial reporting and audit quality issues are complicated by a number of interrelated risk factors, including: auditor independence; complexity and sophistication of business structures and transactions; adequacy and complexity of standards; fraud; auditors' document retention procedures; adequacy of auditor oversight; and qualifications and fitness of Audit Committees, Boards of Directors, and Officers.
The issues above have been acknowledged by various parties that function in an oversight capacity. For example, the Securities and Exchange Commission and the accounting profession have, to varying degrees, acknowledged most or all of these issues and initiated certain actions to address some of them, although it is unclear exactly what may be done or how effective the potential solutions may ultimately be. Likewise, legislation to address a number of these issues is under consideration by the Congress. Moreover, in a recent speech to the American Bankers Association Community Bankers Conference, FDIC Chairman Powell raised concerns about the reliability of bank data and auditing as well as the possible need for more regulatory action in these areas.
We continue to believe that issues related to the quality of financial reporting and auditing of financial institutions (and businesses transacting with financial institutions) constitute a risk to regulators in effectively achieving their oversight responsibilities. We believe this risk is of significant magnitude to be acknowledged and monitored by the FDIC in its role as a financial institution regulator and insurer. Obviously, due to the nature of the risk (involving a lack of reliable quality data), the true magnitude and impact of the problem cannot be reasonably quantified or projected. However, the potential impact of the risk could be material and significant.
To further pursue aspects of this issue, the OIG is conducting an audit of FDIC examiner reliance on the work performed by independent public accountants.
The Office of Investigations (OI) is responsible for carrying out the investigative mission of the OIG. Staffed with agents in Washington, D.C., Atlanta, Dallas, and Chicago, OI conducts investigations of alleged criminal or otherwise prohibited activities impacting the FDIC and its programs. As is the case with most OIG offices, OI agents exercise full law enforcement powers as special deputy marshals under a blanket deputation agreement with the Department of Justice. OI's main focus is in investigating criminal activity that may harm, or threaten to harm, the operations or the integrity of the FDIC and its programs. In pursuing these cases our goal, in part, is to bring a halt to the fraudulent conduct under investigation, protect the FDIC and other victims from further harm, and assist the FDIC in recovery of its losses. Another consideration in dedicating resources to these cases is the need to pursue appropriate criminal penalties not only to punish the offender but to deter others from participating in similar crimes.
The OIG works closely with U.S. Attorney's Offices throughout the country in an attempt to bring to justice individuals who have defrauded the FDIC. The prosecutive skills and outstanding direction provided by Assistant United States Attorneys with whom we work are critical to our success. The results we are reporting for the last 6 months reflect the efforts of U.S. Attorneys' Offices in the District of Massachusetts, the District of New Jersey, the Northern District of Ohio, the Central District of Illinois, the Southern District of Iowa, the Southern District of West Virginia, the Northern District of Georgia, the Northern District of Mississippi, the Western District of Oklahoma, the Northern District of Texas, the Western District of Texas, the Central District of California, and the District of Hawaii.
Over the last 6 months, OI opened 21 new cases and closed 36 cases, leaving 102 cases underway as of March 31, 2002. Our work during the period led to indictments or criminal charges against 21 individuals and convictions of 11 defendants. Criminal charges remained pending against 21 individuals as of the end of the reporting period. Fines, restitutions, and recoveries stemming from our cases totaled over $536 million. The following are highlights of some of the results from our investigative activity over the last 6 months:
Fraud Arising at or Impacting Financial InstitutionsUpdate on Prosecutions Resulting from Investigation of Failure of the First National Bank of Keystone
As has been the case in our last several reports, we are again reporting additional results emanating from the investigation involving the failure of the First National Bank of Keystone (West Virginia). The investigation and prosecutions involving Keystone are being conducted by a multi-agency task force composed of special agents of the FDIC OIG, FBI, and IRS and prosecutors from the United States Attorney's Office for the Southern District of West Virginia and the U.S. Department of Justice. The FDIC Division of Resolutions and Receiverships has also provided valuable assistance in support of the task force investigations.
An examination that was conducted by the Office of the Comptroller of the Currency in 1999 uncovered information that ultimately resulted in the closure of the First National Bank of Keystone (Keystone) on September 1, 1999. Based on the estimated losses to the insurance fund attributable to the Keystone failure, it is 1 of the 10 most costly bank failures since 1933.
The investigation initially targeted the attempts of the bank principals to obstruct the examination of the bank. Following the successful prosecution of several of the bank officers on obstruction charges, the task force turned its focus to the underlying fraud in the operation of the bank that led to its failure. During the current reporting period, the former bank chairperson of Keystone, who was also formerly the mayor of Keystone, was convicted in October 2001 on 16 counts of money laundering and conspiracy to embezzle funds from the estate of J. Knox McConnell, who was the institution's president until his death in 1997. In March 2002, she was sentenced to serve 16 years and 5 months in prison to be followed by 3 years of supervised probation and was ordered to pay $6.12 million in restitution. During the same trial in October 2001, the former senior executive vice president and chief operating officer was convicted on four counts of embezzlement, four counts of mail fraud, and a single conspiracy count. In March 2002, she was sentenced to 22 years and 7 months in prison to be followed by 3 years of supervised probation and was also ordered to pay $6.12 million in restitution. She is also currently awaiting sentencing in connection with her guilty plea in January 2002 to a criminal information charging her with bank fraud and conspiracy to commit money laundering. She is currently in prison serving a 57-month sentence, which she received in July 2000 following her conviction on charges of obstructing the examination of the bank that ultimately resulted in its closure. Her most recent jail term is to be served consecutively with the prior sentence.
On December 17, 2001, five other former officials of Keystone were sentenced in U.S. District Court for the Southern District of West Virginia in connection with their prior guilty pleas to various illegal conduct involving their employment at the bank. The former executive vice president of Keystone Mortgage Corporation, a subsidiary of Keystone, was sentenced to 12½ years in prison to be followed by 5 years of probation. He was also fined $25,000 and was ordered to pay $515 million in restitution. He was already in prison serving a sentence in excess of 4 years for obstructing the examination of the bank in 1999 that resulted in its closure. Following his sentencing in July 2000 in the obstruction case, he pled guilty in November 2000 to charges of conspiracy, money laundering, and bank fraud. His most recent sentencing was on those charges. A news article by the Associated Press on the sentencing reported the following comments by the sentencing judge: "I felt like anything less would not be sufficient. It's difficult to measure the harm and suffering caused by what has happened here. Many people lost their life savings." Based on an assessment of what he is currently able to afford, the former executive vice president was ordered to make monthly payments of $300 toward the restitution.
Also sentenced on December 17, 2001 were:
As a special condition of their sentences, all five defendants who were sentenced in December were also permanently banned from working at or being affiliated with any federally-insured financial institution.
Former President and Two Former Board Members of Hartford-Carlisle Savings Bank Indicted for Bank Fraud and Obstruction of an Examination; Two Other Former Officials of the Bank Plead Guilty to Illegal Conduct
On November 27, 2001, a federal grand jury in the Southern District of Iowa returned a 34-count indictment charging the former president of the now defunct Hartford-Carlisle Savings Bank (HCSB), Carlisle, Iowa, and his two brothers, both of whom were former board members of HCSB, with various bank fraud-related activities.
As alleged in the indictment, the three brothers made false representations to Firstar Bank to obtain $1.75 million in loans, which they used to gain control of HCSB. The brothers lied to the Federal Reserve Bank regarding the source of funds used for the purchase of the bank. They also allegedly falsified documents to conceal $2 million in fraudulent loans from HCSB that were used, in part, to repay Firstar. The former president is also accused in the indictment of misleading FDIC officials by creating and providing fraudulent documents to FDIC examiners and by removing proof tapes and loan documents from the bank. The missing items were subsequently recovered during a search warrant obtained by the FDIC OIG and executed by the OIG and FBI.
According to the indictment, the brothers used proceeds from fraudulent loans from HCSB to buy property, sport utility vehicles, and pleasure items. The indictment includes a forfeiture claim through which the government seeks possession of all property acquired through the alleged fraud. Listed specifically in the forfeiture claim are: a condominium at Tenderfoot Lodge in Keystone, Colorado; land and a custom-built home in Randleman Ridge in Carlisle; 60 acres of property in Carlisle; a cabin located in Clear Lake, Iowa; a 1999 Cobalt power boat; a 1999 Chevrolet Tahoe; a 1999 Chevrolet Suburban; stocks; and home entertainment equipment.
On January 17, 2002, another former director of HCSB pled guilty in U.S. District Court for the Southern District of Iowa to a one-count information charging him with making false statements to HCSB. In addition to being a former director of HCSB, the defendant was also a shareholder in the HCSB's holding company. His plea relates to a loan application he submitted to HCSB as president of an oil company wherein he stated that the specific purpose of the $500,000 loan was for "term/equipment." Upon receipt of the loan proceeds, he invested the money in the bank holding company, thus injecting capital into HCSB.
On February 21, 2002, a former vice president and director of HCSB pled guilty in U.S. District Court for the Southern District of Iowa to a one-count information charging him with making a false statement to the FDIC. In his position with the bank he submitted Consolidated Reports of Condition (call reports) to the FDIC. The information to which he pled guilty charges that he submitted a call report to the FDIC on behalf of HCSB covering the period ending June 30, 1999 that failed to identify the existence of a $1 million loan made by the bank to the former president of HCSB.
Note: The hardcopy report has photo inserts of the custom-built home in Randleman Ridge in Carlisle, a condominium at Tenderfoot Lodge in Keystone, Colorado, and a cabin located in Clear Lake, Iowa.
HCSB was an FDIC-regulated institution that was closed on January 14, 2000 by the Iowa Division of Banking and was reopened the next day under new ownership. State banking regulators questioned the validity of about $6 million in loans when the bank was closed. The FDIC removed the president, who is now facing criminal charges, a week before the bank was closed. At the time, the FDIC concluded that he had probably engaged or participated in acts, omissions, and practices that constituted "violations of law and regulations, unsafe or unsound banking practices and breaches of his fiduciary duties to the bank."
This case is being investigated jointly by the FDIC OIG and the FBI and is being prosecuted by the U.S. Attorney's Office for the Southern District of Iowa.
Former Chairman of Bank of Honolulu Pleads Guilty and is Sentenced for Wire Fraud and Bankruptcy Fraud
On March 21, 2002, the former chairman and owner of 76 percent of shares of the now-defunct Bank of Honolulu was sentenced in the U.S. District Court in Honolulu, Hawaii, to 36 months of incarceration to be followed by 5 years of supervised release. However, he will be subject to immediate deportation upon release from confinement. As part of the sentencing, he was also ordered to pay restitution totaling $3,115,523. He has paid $2,051,861, leaving an unpaid balance of $1,063,662 of restitution. The defendant had previously pled guilty in October 2001 to violating the federal wire fraud statute as part of a scheme whereby he and his brother fraudulently obtained the proceeds of two loans totaling $3 million made by the Bank of Honolulu. He also pled guilty to knowingly and fraudulently concealing property as part of the bankruptcy proceeding he filed in 1998. The bankruptcy fraud violations involve two tax refund checks from the State of Hawaii totaling $757,249, which he received and failed to turn over to the Bankruptcy Trustee.
As we previously reported, the defendant was initially indicted in August 2000 and was charged with additional violations in superseding indictments in October 2000 and May 2001. The latter superseding indictment also included charges against five other individuals who were alleged to have helped him hide money from the bankruptcy court and creditors. The additional defendants included two of his brothers, two of his business associates, and his girlfriend.
As a condition of his plea agreement with the government, all other charges against him were dropped, as were the charges against his girlfriend and one of his brothers. The charges in the second superseding indictment against his two business associates and his other brother still remain outstanding.
This case was jointly investigated by the FDIC OIG and the FBI and was prosecuted by the United States Attorney's Office for the District of Hawaii.
Former Vice President of First State Bank of Pekin Pleads Guilty and is Sentenced for Misapplication of Bank Funds
On March 14, 2002, the former vice president of residential real estate lending at the First State Bank of Pekin (Illinois) was sentenced in the U.S. District Court for the Central District of Illinois to 3 months of home detention to be followed by 2 years of probation and was fined $2,000. The sentencing followed the defendant's prior plea of guilty in December 2001 to a charge of misapplication of bank funds.
As described in the Plea Agreement and Stipulation of Facts, the defendant admitted that he had created unauthorized loans by altering documents and other deceptive means and funded them by using unauthorized cashier's checks. As a part of his ongoing scheme, he also funded the unauthorized loans using various methods including using customer loan payments and unauthorized draws from customers' construction loans. In total, the former vice president created or otherwise manipulated, all without authorization, 37 loans with a composite value of over $2.5 million. He subsequently admitted his complex manipulations to the executive vice president of the bank and was fired. He also detailed his activities to the agents of the FDIC OIG and FBI who conducted a joint investigation of this matter. He paid the bank approximately $54,000 to cover any deficit he caused the bank, and the bank's insurance covered associated costs and some anticipated loss. Therefore, the bank's loss was negligible. The plea agreement, which allowed him to plea to a single count of misapplication of less than $1,000 of bank funds, reflected his acceptance of responsibility, the negligible loss to the bank, and his cooperation in the investigation. He also voluntarily signed a consent order in September 2000 prepared by the FDIC prohibiting him from any future employment by, or affiliation with, a federally-insured financial institution.
Former Loan Secretary Sentenced for Embezzling from Bank of Falkner
On February 25, 2002, a former loan secretary at the Bank of Falkner (Mississippi) was sentenced in the U.S. District Court for the Northern District of Mississippi to serve 3 years of probation, perform 150 hours of community service, and pay $21,040 in restitution to the FDIC. As previously reported, the defendant pled guilty in September 2001 to a one-count information charging her with embezzling $21,040 from the bank. The FDIC OIG is conducting a joint investigation with the FBI regarding suspected fraudulent activity that occurred at the bank prior to its failure on September 29, 2000. As a part of her plea agreement with the government, she is cooperating with this ongoing investigation. Information obtained by the FDIC Division of Resolutions and Receiverships during its post-closing review of the bank has significantly assisted the investigation.
Former President of Oakwood Deposit Bank Indicted on Charges of Embezzlement and Money Laundering
On February 26, 2002, the former president and chief executive officer of Oakwood Deposit Bank Co., Oakwood, Ohio, was indicted by a federal grand jury in the Northern District of Ohio on charges of embezzlement and money laundering. He had previously been arrested on February 2, 2002 based on a complaint alleging similar illegal conduct.
The FDIC closed Oakwood Deposit Bank on February 1, 2002 after the discovery of information indicating irregularities in the amount of deposits reported in the records of the bank. According to the charges filed against him, the former president is alleged to have used approximately $40 million of the bank's funds to invest in gambling boats located in South Carolina and Florida. Part of the evidence used to support the charges against him was seized during a search of his home.
This investigation is being conducted jointly by agents of the FDIC OIG, the IRS Criminal Investigations Division, and the FBI. Prosecution of the case is being handled by the U.S. Attorney's Office for the Northern District of Ohio.
OIG Electronic Crimes Team
In our last report we described the formation of an Electronic Crimes Team (ECT) in the Office of Investigations to provide technology assistance during investigations. Currently, the ECT is staffed by two agents and a supervisor, all of whom have been trained as Seized Computer Evidence Recovery Specialists (SCERS). Additionally, over $50,000 worth of computer forensic hardware and software has been procured to enable the SCERS to conduct forensic examinations both in a fixed lab that has been established in Washington and in a mobile lab that can be established at investigative sites where ECT support is needed.(Note: hardcopy report displays images of the Electronic Crimes Team at bank closings and their equipment)
At the closing of Hamilton Bank in Miami, Florida, in January 2002, the OIG initiated an investigation to pursue suspected fraud that may have occurred at the bank prior to its closure. To assist in preserving possible evidence, the ECT participated at the bank closing and successfully imaged over 20 of the bank's computers. Subsequently, the ECT participated at the closings of Bank of Sierra Blanca in Sierra Blanca, Texas; Nextbank in San Francisco, California; Oakwood Deposit Bank, in Oakwood, Ohio; Net First National Bank in Boca Raton, Florida; and New Century Bank, Shelby Township, Michigan. The OIG has initiated investigations of possible illegal activities that may have occurred at each of these institutions prior to their closings.
Former Officer Indicted for Misapplying Funds of the Institution for Savings of Newburyport, Massachusetts
On March 6, 2002, a former officer of the Institution for Savings (IFS) of Newburyport, Massachusetts, was indicted by a federal grand jury in the District of Massachusetts on 59 counts of misapplying funds. As alleged in the indictment, the former officer of IFS misapplied a total of approximately $162,000 between February 1997 and March 2001 by negotiating her personal checks at IFS and then removing them from the bundle of items that IFS was sending to the Federal Reserve Bank for processing. Later, when the missing amounts were reported back to IFS, she would make entries in the books and records of IFS to conceal the missing funds. The indictment also includes a forfeiture allegation through which the government seeks to recover the proceeds of the alleged illegal misapplication of funds.
The investigation of this case is being conducted jointly by agents of the FDIC OIG and the FBI who arrested the defendant on March 8, 2002. Prosecution of the case is being handled by the United States Attorney's Office for the District of Massachusetts.
Customer Pleads Guilty to Conspiring to Defraud First State Bank of Harrah
On January 31, 2002, a customer of the First State Bank of Harrah (FSBH), Harrah, Oklahoma, entered a plea of guilty in the U.S. District Court for the Western District of Oklahoma to a one-count information charging him with conspiring to defraud the bank. The customer of FSBH was heavily indebted to the bank. The information to which he pled guilty charges that from August through December 1998 he conspired with a former executive vice president of FSBH and others in a scheme to defraud the bank by creating two forged FSBH cashier's checks totaling $1,052,000. The checks listed the defendant as the remitter, although he had not expended any funds to purchase those checks.
As previously reported, the same former executive vice president of FSBH and another customer pled guilty in February 2001 to conspiracy to defraud FSBH by creating a series of 11 fraudulent nominee loans. Both are still awaiting sentencing on those charges.
The investigation of the activities involving FSBH is being conducted jointly by the FDIC OIG and the FBI; the case is being prosecuted by the U.S. Attorney's Office, Oklahoma City, Oklahoma.
Owner of Company Providing Automated Teller Machine Services Indicted for Wire Fraud, Bank Fraud, and Money Laundering
On January 30, 2002, the owner and president of two companies, an armored car service company and a company that owns and operates automated teller machines (ATMs), was indicted in the U.S. District Court for the District of Colorado on 10 counts of wire fraud, 33 counts of bank fraud, and 3 counts of money laundering.
The indictment alleges that between January 1998 and March 1999, the defendant devised a scheme to fraudulently obtain money and property from BestBank, Boulder, Colorado, and the Pueblo Bank and Trust Company (PB&T), Pueblo, Colorado. In total he is alleged to have obtained and misappropriated in excess of $9 million in bank funds for his own use and the use of others.
The indictment charges that he obtained cash from BestBank and PB&T to stock and operate ATMs that were owned by one of his companies. However, he periodically ordered more cash than was needed. He then commingled the extra cash with cash obtained to stock ATMs that his other company had contracted to service. As a part of the scheme, he is also alleged to have provided BestBank with spreadsheets and fabricated cash logs falsely depicting that his ATM service company was housing millions of dollars of BestBank's cash in its vaults in Dallas and Houston, Texas. He used the money generated by the scheme, in part, to fund his consolidation and control of the ATM service company and to finance a rapid expansion of the company.
Pursuant to a warrant issued by the U.S. District Court, the defendant was arrested in Dallas, Texas, on February 1, 2002, by agents of the FDIC OIG and the FBI, who are conducting a joint investigation of this matter. The U.S. Attorney's Office, District of Colorado, Denver, Colorado, is directing the prosecution of this case.
Assets of Construction Company Seized and Bank Accounts Frozen
Following an asset sale on Saturday, October 13, 2001 that was held by a construction company located in Blountsville, Alabama, agents from the FDIC OIG and FBI seized over $70,000 in proceeds and some unsold items including a semi-tractor trailer and two motorcycles. On the following Monday, all of the company's bank accounts were frozen pursuant to a U.S. District Court order. These actions were taken as a part of an ongoing investigation being conducted by agents from the FDIC OIG, FBI, and IRS dealing with suspected fraud involving Community Bank, Blountsville, Alabama.
Misrepresentations Regarding FDIC Insurance or Affiliation
Former Financial Relationship Manager for Bank of America Texas Ordered to Pay $496,475 in Restitution
On November 5, 2001, an amended judgment was filed in the U.S. District Court for the Western District of Texas ordering a former financial relationship manager with the Bank of America (BOA) Texas, N.A., San Antonio, to pay restitution of $496,475.
As previously reported, this defendant and his former accomplice, who owned a San Antonio investment company, pled guilty to criminal charges in connection with their scheme to defraud six investors by misrepresenting to them that BOA certificates of deposit (CD) totaling approximately $433,000 were issued in their names. In doing so they also misrepresented that the CDs were FDIC-insured. In fact, the six CDs were issued in the name of the investment company on BOA's records and then pledged as collateral on loans.
Following his guilty plea in January 2001 to one count of 2nd degree theft and one count of 1st degree securities fraud under the Texas Penal Code, the accomplice was sentenced in April to 15 years' imprisonment, fined $1,000, and ordered to pay $382,985 in restitution. The former BOA employee pled guilty in November 2000 to two counts of making and issuing forged securities, and in January 2001 he was sentenced to 15 months' imprisonment to be followed by 3 years' probation. Restitution was not ordered at the time of his sentencing due to ongoing plea negotiations with his accomplice. However, the most recent amended judgement setting the restitution amount completes the criminal prosecution of this case.
Iowa Resident Sentenced After Pleading Guilty to Using Counterfeit Documents to Pose as an FDIC Special Agent
On March 22, 2002, a former customer of Hartford-Carlisle Savings Bank, Carlisle, Iowa, and Firstar Bank, Des Moines, Iowa, was sentenced in the U. S. District Court in the Southern District of Iowa to 36 months' probation. The customer had been indicted in October 2001 on two counts of counterfeiting a document of the FDIC and two counts of uttering the counterfeited documents (that is, passing them to financial institutions). In December 2001 he pled guilty to using a counterfeit document in his dealings with Firstar Bank.
As alleged in the indictment, the customer forged two documents on FDIC DRR letterhead purportedly signed by a "Special Agent" which he submitted to the two financial institutions in order to maintain checking account privileges. The letters indicated that his accounts had been compromised by fraudulent activity at Hartford-Carlisle Savings Bank, referencing an ongoing criminal investigation being conducted by the OIG and the FBI at that bank.
The customer had previously accepted full responsibility for his actions and entered into an agreement for pretrial diversion in November 2000, whereby he agreed to abide by certain specified conditions for a period of 12 months and to perform 100 hours of unpaid community service. However, the United States Attorney's Office for the Southern District of Iowa terminated the agreement when it learned that he had violated one of the conditions. Subsequently, he was indicted as described above on the same alleged conduct that precipitated the prior pretrial diversion agreement.
Restitution and Other Debt Owed the FDIC
Bank Fraud Felon Agrees to Pay $5 Million to FDIC
On March 5, 2002, a settlement agreement between the United States and a real estate developer was filed and accepted in the U.S. District Court for the District of Massachusetts whereby the defendant agreed to pay $5 million he owes the FDIC as result of a restitution order imposed on him following his conviction on bank fraud charges in 1991. Pursuant to the terms of the agreement, he paid $500,000 in March 2002 and will pay the remaining amount in installments over the next 5 years. The settlement money will go to the FDIC as the successor of the two now defunct banks that he was convicted of defrauding.
The agreement was reached to settle a pending civil suit that was filed by the U.S. Attorney's Office for the District of Massachusetts in October 2000 against the developer and a number of other individual and corporate defendants. In the suit the United States alleged that the developer, who was also sentenced to 5 years' imprisonment following his bank fraud conviction, is the "true owner" of Bay Communities, a real estate company based in Palm Coast, Florida, that develops luxury waterfront condominiums throughout Florida's east coast.
The government alleged in the suit that the defendant operated Bay Communities while in prison and continued to control it after his release on parole. According to the lawsuit, he used his girlfriend, who is listed as the company's CEO, to hide his control and thereby avoid paying the restitution. At the time the suit was filed, he had paid $40,000 of the restitution and maintained that, as an employee of Bay Communities, he could only afford to pay $1,500 of the restitution every month.
When the suit was filed, the defendant and his girlfriend were living together in an 8,535 square-foot home with an assessed value of $3.9 million. She was listed in property records as the owner of the home, which is located in an exclusive development in Boca Raton, Florida.
As a part of the settlement agreement, the girlfriend executed a personal guarantee for the entire $5 million. In addition, both the defendant and his girlfriend executed an Agreement for Judgement that will be held in escrow by the United States Attorney's Office and will be filed in the event of a default. The agreement further provides that the United States may reinstitute the civil suit in the event of default by either.
In addition to the defendant and his girlfriend, the suit named a number of other defendants that were alleged to have been involved in one or more of the 17 different trusts, companies, and corporations the developer had created beginning in 1994. A settlement agreement with one of those other defendants was also filed on March 5, 2002, and similar agreements are being negotiated with the remaining individual defendants named in the suit.
Strawbuyer Sentenced for Perjury
A financial facilitator who purchased an asset from the FDIC was sentenced in U.S. District Court for the District of Massachusetts to serve 6 months' home detention and 2 years' supervised probation and was fined $5,000. As reported previously, the defendant had pled guilty to one count of making a false declaration to a federal grand jury.
During the late 1970s and through the early 1990s, the defendant served as a commercial loan officer for several financial institutions. He also worked for a short time in the Resolution Trust Corporation (RTC) receiverships and was a workout specialist with the RTC/FDIC Franklin Office. In 1994 he agreed to a removal order issued by the FDIC prohibiting him from participating in the conduct or affairs of, or exercising voting rights in, any insured institution without the prior consent of the FDIC. Subsequently, he began providing services to individuals who owed money to the FDIC and RTC to help them workout their debts. His plea of guilty to perjury was in connection with his testimony before a federal grand jury that was investigating purchases of assets from the FDIC. The defendant purchased an asset from the FDIC in 1994 and resold it 4 months later to the original owner.
DOS Associate Examiner's FDIC Employment Terminated
By letter dated December 3, 2001, a grade-12 Associate Examiner in the Lubbock, Texas, office of the Division of Supervision (DOS) was notified that his employment with the FDIC would be terminated effective December 5, 2001. The termination was based, in part, on information obtained during an OIG investigation which disclosed conduct unbecoming an FDIC employee including using FDIC equipment to conduct stock trading activities on official time, lying to his supervisors regarding these activities, and requesting that the OIG Special Agent who interviewed him provide false information to his supervisor regarding the interview. The OIG investigation was conducted based on a referral from DOS. The employee's termination was also based on unsatisfactory performance.
Information Systems Assistant Suspended Following OIG Investigation of Missing Computer Equipment
An investigation conducted by the OIG at the request of the FDIC's Security Management Section resulted in a 30-day suspension from duty and pay of an Information Systems Assistant employed in the FDIC Division of Administration. At the direction of his former supervisor, the employee reported the missing equipment to the FDIC Security Management Section. After conducting a preliminary inquiry, the security office referred the matter to the OIG for further investigation. Although the employee initially claimed he did not have the equipment or know where it was, it was subsequently located and retrieved during a consensual search of the employee's residence conducted by OIG special agents.
Former Examiner Arrested for Filing False Claims with the FDIC
On March 1, 2002, special agents of the OIG arrested a former examiner with the FDIC DOS. The OIG initiated an investigation of the former employee based on a referral by DOS indicating she may have submitted false claims to the FDIC for reimbursement of relocation-related expenses. The warrant issued for her arrest was based on an affidavit by the OIG case agent, which set forth facts obtained during the investigation. As described in the affidavit, between February and May 1998, the employee submitted vouchers for relocation-related expenses totaling $32,978. Included in the expenses claimed on those vouchers were inflated charges for temporary quarters. The employee terminated her employment with the FDIC in May 2000.
During the month of October, two Office of Investigations Special Agents were assigned to the New York Joint Terrorism Task Force (JTTF), which is composed of approximately 22 federal agencies, including agents from 16 Offices of Inspector General and several hundred New York Police Department detectives. The JTTF is investigating leads possibly related to terrorism that are received by the government via special 800 numbers and Web sites as well as information from other government entities. Since its inception following the attacks of September 11th, the JTTF has followed up on thousands of leads and made a number of arrests, primarily for immigration violations. FDIC OIG agents participated in the arrests of five individuals during the course of this assignment and were involved in a number of investigations, some of which remain ongoing due to additional information of interest being developed. One OIG agent's detail ended on October 18 and the other's on October 26. The agents spent a combined total of nearly 400 hours on this assignment. No additional OIG support of the New York JTTF is planned at this time.
During this period the Office of Investigations also completed a review of financial records of 30 now-defunct financial institutions looking for information on the terrorists or suspects. This work was performed in response to a request by the Federal Bureau of Investigation's (FBI) Financial Crimes Section for special assistance from the OIG community in investigating the funding used to perpetrate the recent acts of terrorism and links to possible future acts.
As described in our previous report, in September 2001, seven OIG special agents participated in the Evidence Recovery Team at the Pentagon in response to a request by the FBI and the Department of Defense for assistance. On February 4, 2002, the Inspector General presented certificates of appreciation from the U.S. Army to the seven Office of Investigations Special Agents who volunteered for this duty. Each agent also received an angel and a card prepared by the students in grades 4 through 6 of Sulphur Intermediate School in Sulphur, Oklahoma. In total, the students made and sent over 300 angels and cards to be presented to rescue workers at the terrorists' attack sites, concentrating mostly on the people who worked at the Pentagon site.
Note: Hardcopy report has images of awards and recognition memorabilia pertaining to work associated with events of September 11, 2001.
The OIG believes a spirit of partnership is essential in conducting its work. In this spirit, we have continued to seek opportunities to strengthen our relationships both within the Corporation and with other audit and regulatory groups. Through joint efforts, conferences, and meetings, we have coordinated our work with the FDIC and shared best practices and information regarding current and emerging issues in the banking industry and with others in the audit community.
During this reporting period, the new Chairman presented his comprehensive vision for a smaller, revitalized FDIC that is reorganized, refocused, accountable, and more proficient. He stressed that for FDIC to fulfill its responsibilities, it must be the leader in several areas: banking information, research and analysis; supervision; and policy. He also announced a commitment to creating a flexible workforce that is knowledgeable and ready. He advocated an FDIC University to promote corporate identity and learning all aspects of the Corporation's mission and a job rotation program to help cross-train staff. He placed a high priority on further streamlining and realigning the Corporation through an early-out and buyout opportunity followed by a reduction-in-force, if necessary. These measures will put a greater percentage of the Corporation's resources on risk assessment and management. As the Corporation identifies its priorities and develops its strategies to operate into the future, the OIG recognizes it must stay abreast of the Corporation and reevaluate its priorities and strategies in light of the Corporation's needs.
The OIG has taken several steps during this reporting period that parallel various aspects of the Chairman's vision, including expanding its efforts to streamline its workforce and work processes. The Inspector General called for a similar shift in the way the OIG perceives itself and its business with a smaller, more flexible workforce that is aligned with the OIG's mission. He announced that the OIG will participate in the Corporation's early-out and buyout program and modify its structure to realign OIG operations with the critical business of the FDIC, geographically as well as functionally. This will result in restructuring and reducing the workforce and a reallocation of resources within the OIG.
Our Office of Audits will organizationally align along four strategic objectives, with one crosscutting directorate. The major directorates will be: (1) Supervision, Insurance and Consumer Affairs; (2) Resolution, Receivership, and Legal Affairs; (3) Information Assurance; (4) Resources Management; (5) and Corporate Evaluations. Other OIG offices are restructuring geographically and/or combining functions and seeking ways to improve overall process efficiencies.
We value opportunities to communicate about our work and work processes and practices as a way to improve and add impact to our work. During this reporting period we sought additional opportunities to discuss our work and also provided the Corporation with technical assistance in a number of ways. Executives from the Office of Audits and other OIG audit staff met with FDIC executives and staff to provide information regarding our audit strategic framework, audits, and audit processes and practices. We outlined audit objectives in four strategic areas (Supervision, Insurance, and Consumer Affairs; Resolution, Receivership, and Legal Services; Information Assurance; and Resource Management). By structuring our audits strategically in these areas, the OIG hopes to better address the Corporation's needs by focusing on areas that are believed to be at risk. Similarly, our Office of Investigations staff have continued to participate regularly in the Division of Supervision's (DOS) Commissioned Examiner Seminars, providing general information on the types of investigations the OIG conducts, our coordination efforts, and "red flags" for examiners related to the failed First National Bank of Keystone. The Office of Investigations has also provided information on teller machine fraud schemes during DOS training.
The OIG also provided technical assistance and review to the Corporation in a joint project with the Office of Internal Control Management and the Division of Administration to determine whether FDIC policies ensure accounting and auditing contractors comply with the U.S. General Accounting Office's (GAO) new independence standards. As discussed in our Major Issues section, we also provided a risk analysis to the Corporation, which discussed a significant emerging risk to the FDIC on the Quality of Bank Financial Reporting and Auditing. This risk potentially affects the FDIC in its role as regulator, receiver, and insurer. Further, the OIG provided advisory comments to FDIC management on the FDIC's 2002 Annual Performance Plan, which focused on the linkage between the Corporation's Leadership Conference 2002 performance measures and the goals and objectives of the Performance Plan itself.
Externally, we jointly sponsored a 2-day symposium with Offices of Inspector General of the Department of the Treasury and the Board of Governors of the Federal Reserve System to identify emerging risks or issues related to the banking industry. This forum brought together a number of regulatory and congressional speakers who shared their perspectives on the changes facing banking and financial and financial services industries and their regulators. We also worked with the GAO and other regulatory agencies on significant projects such as planning material loss reviews and joint audits or investigations. Further, the Inspector General testified before the Senate Committee on Banking, Housing, and Urban Affairs regarding the OIG's analysis of the failure of Superior Bank, FSB. Senior OIG staff also met with congressional staff to discuss the OIG's work regarding the FDIC's Court-Ordered Restitution Program. Finally, through our new Office of Policy Analysis and Congressional Relations we have significantly increased our overall communication with congressional staff regarding policy issues impacting the Corporation and the financial services industry.
The OIG continues to look to increasing the value of our people and the performance capacity of the OIG, while restructuring to a smaller workforce. Therefore, strategically managing our human capital in a high-performance culture continues to be a top priority in our organization. During this reporting period we drafted a Human Capital Strategic Plan, continued to support staff participation in events to celebrate the diversity of our staff, and completed our fourth external client survey.
The OIG identified the alignment of our human resources with our mission as a new proposed strategic goal to be included in the OIG's revision of its Strategic Plan. Our proposed Human Capital Strategic Plan complements the other strategic goals of the Strategic Plan by aligning and integrating human resource policies and practices with our business practices. It also mirrors some of the Chairman's recent goals of having the right number of people with the needed skills in the right places. Our plan focuses on four areas that are key to maximizing the return on our human capital and sustaining a high-performance organization: workforce analysis; competency investments; leadership development; and a results-oriented, high-performance culture. We introduced our human capital strategic goal--to align OIG human capital resources with the OIG mission--at the OIG's October 2001 office-wide conference and are seeking input from OIG staff and others on the proposed plan.
Strengthening our workforce capacity will be particularly important in the next several years to prepare and position us for the future in light of our smaller workforce. As part of the Human Capital Strategic Plan objective on workforce analysis, we are developing a business knowledge inventory system to assess existing workforce knowledge and skills and determine where gaps may exist in the business knowledge needed to accomplish future workload. Another element of the plan involves making investments in the competencies of our staff that result in continuous improvement in OIG expertise that can match ongoing workload changes. The OIG developed and implemented a new training software package to increase the efficiency of the OIG training application and registration process. This paperless system is aimed at streamlining the process and increasing accessibility and efficiency, allowing employees and supervisors to be more in control of targeting their own training and development.
In the interest of constantly improving OIG operations and products, the OIG completed its fourth external client survey to obtain views and feedback from senior and operating FDIC management. The survey results will allow us to better assess the quality of our products and the effectiveness of our office in communicating the objectives and results of our work.
During the period, the OIG has continued to support staff participation in a wide variety of diversity activities within the Corporation, and the OIG Employee Advisory Group continues to be involved in dialogue between the staff and the Inspector General on many issues important to OIG staff. To answer OIG staff's questions and answers that have been generated by the early retirement and buyout opportunity, OIG management created a Questions and Answers page on the OIG Web site.
OIG Organizational Chart
[ NOTE:This report has been physically divided into two sections in order to maintain download performance ]
Link to Section II of the OIG's Semiannual Report (including the 2001 Performance Report)
|Last Updated 06/27/2002||Contact the OIG|