Fraud: 'A Serious Problem'

Isaac Says Prevention Calls for More Enforcement from Regulators
Fraud continues to hamper financial institutions around the globe, and the problems will only worsen, unless banks and credit unions put forth effort and dollars to mitigate risk.

"It's staggering how much the fraud losses are, and so it's hard to over-invest in fraud prevention," says William Isaac, author of "Senseless Panic: How Washington Failed America" and senior managing director and global head of financial institutions for FTI Consulting.

Banks must be willing to spend money to improve the fraud problem, says Isaac, who served as chairman of the Federal Deposit Insurance Corp. during the 1980s. "You really have to spend whatever it takes to get it right," says Isaac in an interview with BankInfoSecurity.com's Tracy Kitten [transcript below].

Fraud, together with volatile markets around the globe, especially in Europe, is hindering institutions. Yet no matter how gloomy the broadcast sounds, the problems are fixable, Isaac says. "What is lacking today is the political leadership and will to get it done," he says. But if the public pushes strong and urges the government to fix the current financial crisis, "I think we have a really good future ahead of us and I think the markets will start to soar," he says.

During this second part of a two-part interview, Isaac discusses:

  • How fraud is adversely affecting the integrity of financial records throughout the world;
  • Why regulators, who are taking fraud seriously, need to do more; and
  • How global political changes are impacting not only the fight, but the mandates with which global financial institutions must comply.

Be sure to check Part 1 of our interview with Isaac, when Isaac discusses the impact financial regulatory reform, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act is having on financial institutions, and why the future of U.S. community banks is threatened.

Isaac is the senior managing director and global head of financial institutions for FTI Consulting. He also serves as chairman of Fifth Third Bancorp. Isaac's expertise in the financial sector crosses corporate governance, financial management, forensic and litigation consulting, government liaison and negotiation consulting, lender advisory services, and risk management. Prior to joining FTI Consulting, Isaac founded the Secura Group, a leading financial institutions consulting firm. LECG acquired the Secura Group in 2007 and Isaac remained with the group at LECG through early 2011. Before forming Secura, Isaac headed the FDIC during the banking crisis of the 1980s, serving under Presidents Carter and Reagan from 1978 through 1985.

Fraud Prevention

TRACY KITTEN: I want to talk a little bit about some of this regulatory scrutiny that is overshadowing today's financial market, and a lot of it does relate to fraud and the need for banking institutions to do better jobs at detecting and curbing fraud losses. When we look at it from that perspective, investments and stronger fraud prevention and detection would compliment the need to trim budgets and comply with new and emerging regulatory mandates. How seriously are regulators, in your opinion, taking some of these cyber threat issues? And when we talk about Durbin of course, we are looking at reducing debit fraud, but as you've rightly noted perhaps legislation itself is flawed.

WILLIAM ISAAC: I think you have two different issues in there, if I understand your question. One is the issue of fraud. That's a serious problem, particularly in the credit card arena. There's a lot of fraud that goes on continually and companies like American Express and others who are in that business spend a lot of money on fraud prevention. And they do that because the fraud is costing them so much money. I mean it's a lot. It's staggering how much the fraud losses are, and so it's hard to over-invest in fraud prevention if you are running a big consumer financial company, a retail banking company. I think that spending will continue if the banks are smart, and they are. And I think the regulators will encourage that.

The other is the threats from cyberspace and I understand that can be a fraud threat but it can also be more than that. It can be extremely disruptive to a business. That's a very, very serious threat and it's not just a fraud threat. It's a threat to the integrity of the bank's records for example. People tap in and get information about Bill Isaac and others who do business with banks. That's a very high priority for banks to protect against those kinds of threats, and it's a very high priority for the regulators that banks should protect against those threats.

KITTEN: Sure, that makes sense.

ISAAC: I can tell you, I was on the board of American Express bank for a number of years and I always knew as a board member that one of the most serious issues facing the company was to maintain the privacy of our customer information. If customers don't believe you're going to be able to keep their information private, they are not going to do business with you. It's as simple as that. It really is a threat to the franchise if you don't get that one right, and you really have to spend whatever it takes to get it right.

Check and Mortgage Fraud

KITTEN: Then what about other less high-tech threats such as counterfeit check fraud and mortgage fraud. We've touched a little bit on the housing crisis. Both of these types of fraud, check fraud and mortgage fraud, continue to drain millions and billions of dollars from the financial sector annually, yet institutions seem reluctant to make investments in technology that can adequately address those types of problems. Why is that?

ISAAC: Well I don't know that I can verify the premise of your question that firms are reluctant to spend money in these areas. I would tell you that any area that is costing an institution a lot of money, they are going to spend the money to fix the problem once the problem becomes unbearable from a cost point-of-view. I believe if fraud losses in those areas are really a big issue, then I believe the money will be invested to try to prevent those fraud losses. You're right, there was a lot of fraud in this last go-round that led to the mortgage crisis. I think the government has really dropped the ball there. It seems to me that the FBI and the Justice Department ought to be looking and the banking agencies ought to be looking at it a lot more aggressively about bringing criminal prosecutions.

I know that when I was chairman of the FDIC during the 1980s, we took it very seriously when we found somebody had defrauded a bank. You saw a lot of civil suits from the FDIC against the officers and directors of banks that failed, and I don't see any where near the activity this time around. Now, of course we had bigger problems in the '80s. We had 3,000 bank failures during the 1980s, compared to 400 this time. But I don't even think the numbers this time around are proportional. I almost don't see prosecutions; they are very hard to find, and I think that's a mistake. The best prevention against fraud is when you find it you really drop the hammer on people.

KITTEN: And why do you think that? Why do you think that we're seeing fewer prosecutions?

ISAAC: I don't know. It may be because budget resources are so stretched. We are running these big deficits that nobody wants to commit the resources to it. That could be. Although I would say that the FDIC's civil litigation in the 1980s I'm sure more than paid for itself. A lot of money was recovered in those civil suits and I think a lot more money was recovered then was spent in prosecuting those suits.

Regulation and the Global Economy

KITTEN: I want to go back for a moment and talk a little bit about some of the international impacts that we're seeing on the global economy, and I wanted to ask about international regulatory mandates such as the UK Bribery Act. What kind of impact are these regulatory mandates having on U.S. institutions?

ISAAC: Probably not much on most U.S. institutions, but the global institutions have to develop systems to be compliant with all of the rules around the world, and generally speaking what that means in a practical matter is you take the toughest rules and you comply with them. It's not feasible, if you are operating in let's say 50 different countries it's not feasible to have a system for each of the 50 countries. On each issue you've got to look at it and say, "Who has the toughest rules," and generally speaking that's going to be the U.K. or the U.S. Most of the large banks comply with the best practices as established by let's say the U.S. or the U.K., or other countries that have strong regulatory regimes. Those banks are affected by what the rules are around the globe because they have to comply with those rules. The community banks don't care what is going on in Germany or France because that doesn't effect them.

KITTEN: What about the global political state? How do you see political reform taking place in different parts of the world impacting some of these global financial institutions?

ISAAC: I think Europe seems to be in as big a mess right now politically as the U.S., which takes some doing. It's actually worse because at least we only have one federal government. In Europe you have a European Union, and it's a European Economic Union. It hasn't been a European Political Union. They are still sovereign countries that have a strong voice in whatever happens. It's a lot more difficult for the Europeans to get their act together. Here the problem is we've got Republicans and Democrats, we've got two parties that are really at odds right now with a big election coming next year, and neither party wants to give the other party any kind of advantage in that election. It's a very important election. That's what's disabling us right now politically, and in Europe it's a bunch of sovereign countries that are not on the same page and they have no mechanism for resolving their disputes other than by voluntary arbitration. That is not working very well, so we've got serious political problems in Europe and the U.S. and that's why Europe and the US are not doing very well economically.

Problems Are Fixable

KITTEN: Exactly, because all of that does impact the economy. Before we close, I just wanted to ask, what final thoughts would you like to leave our audience with as it relates to some of the topics that we've discussed generally?

ISAAC: I guess a final thought I would like to leave is that there's nothing wrong with the U.S. that we can't fix, and fix rather easily, in terms of we know what needs to be done. We truly do. The Commission gave us the roadmap, three dollars in spending cuts for every dollar of increased revenue, and a flatter tax, fewer deductions. They've given us the roadmap; we've just got go to muster the political will to put it together. We've been through Civil War. We've been through a couple of World Wars and we've been through a lot of financial panics and droughts and so forth in this country. We've had a lot of major problems more serious than anything we're facing today and harder to fix than what we're facing today. What is lacking today is the political leadership and will to get it done. ... I don't mean this as a political statement because it isn't. I hope in this election, in 2012, the public really gives a mandate to our federal officials: Fix the economy and get this fiscal crisis under control. If that mandate comes out very strong in 2012, I think we have a really good future ahead of us and I think the markets will start to soar.




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