9 February 2012

On February 9, 2012, the United States Attorney’s Office for the Northern District of California reported the sentencing of two individuals for committing bank fraud.  http://www.justice.gov/usao/can/news/2012/2012_02_09_roscoe.sentenced.press.html.  Based on the second superseding indictment in the matter (U.S. Dist. Ct., San Jose Division Case No. 5:07-cr-00373-RMW), it appears that the fraud these two individuals engaged in involved overstating the value of inventory on a borrowing base certificate submitted to an asset-based lender that the FDIC insured.  To overstate the value of inventory, the fraud had a three pronged attack: 1) value inventory at retail selling price instead of purchase cost; 2) value inventory at a cost that did not take into account the value of significant discounts the supplier allowed; and 3) inflating the quantity of inventory on hand.  The fraud lasted about two years and overstated inventory by about $16 million dollars.  To detect this type of fraud, a typical due-diligence exam employs test counts and cost tests.  The very first time the lender caught the fraud it could have immediately moved to limit its losses.  A due diligence exam conducted before funding and at least once a year would likely have detected this fraud.  The estimated cost of such an exam, about $14,000 each.