Report Says Problems Plague Fed’s L.A. Branch

The cash operation at the Los Angeles branch of the Federal Reserve Bank--which processes $80 billion in coin and currency every year--is riddled with defects in its accounting system, according to a confidential draft audit by the General Accounting Office.

The audit was launched after the disclosure earlier this year that the bank’s cash reports had discrepancies of $178 million over a three-month period last year and that the bank’s management had arbitrarily altered the books to make them balance.

“The L.A. Bank’s inability to precisely summarize currency activity from its cash inventory records raises serious questions about the integrity of its accounting and internal controls,” the GAO report asserts.

The GAO report amounts to a rare attack on what critics say is an imperious institution, resistant to outside oversight and defensive of its independence. The Federal Reserve is seldom exposed to the public spotlight, other than for its economic policy decisions in setting interest rates.

As a result, the Federal Reserve’s far-flung banking operations that control the flow of currency in the economy have not received serious outside scrutiny, despite their huge role in the nation’s financial system.

The GAO report recommends that Federal Reserve officials undertake a comprehensive review of the L.A. bank’s operations, as well as those of two other Federal Reserve banks that use similar accounting systems.

But Federal Reserve officials were indignant over the GAO’s finding, asserting that they have absolute confidence in their accounting system and that GAO auditors misunderstood the cash records at issue.

“We feel we have a great deal of control,” said Elizabeth Christensen, senior financial officer of the Federal Reserve Bank of San Francisco, which oversees the Los Angeles branch bank.

Federal Reserve officials also disclosed Friday that an internal audit completed about one month ago at the L.A. bank found that “the accounting for the cash handled by the branch was accurate and that proper safeguards and controls exist to ensure the integrity of the branch’s financial records.”

Nonetheless, in a letter to be issued today to Federal Reserve Chairman Alan Greenspan, Rep. Henry Gonzales (D-Tex.), a member of the House Banking Committee who had disclosed the cash discrepancies earlier this year, is demanding “immediate reforms to ensure the integrity of the Federal Reserve’s accounting systems.”

The Los Angeles bank handles more cash than any other Federal Reserve bank, except the one in New York City.

Each morning, dozens of armored trucks ring the L.A. bank as they wait to enter the heavily guarded underground vaults. Although the high security gives an impression that the public funds are well cared for, the bank has numerous holes in its security, according to an investigator on the House Banking Committee.

The GAO report raised questions about control of the bank’s so-called general ledger, the main financial accounting tool that keeps track of the massive flows of cash in and out of the bank. The GAO found the general ledger is subject to arbitrary deletions by clerks in the vault.

“These corrections do not require documented supervisory approval as would other general ledger adjustments,” the report said.

“Instead, through direct intervention on the L.A. Bank’s computer system, certain L.A. bank staff have the ability to cause an original transaction to the general ledger to subsequently be deleted.”

The report adds that the GAO auditors could not find any evidence that the bank even reviewed such deletions and “thus, certain staff could make unauthorized adjustments that go undetected.”

For example, the audit cites a $432,000 deposit made Nov. 28, 1995, by a financial institution that was incorrectly recorded as $8,640,000 on the general ledger. The error was corrected on the general ledger by a staff member without notification of a supervisor, the GAO said.

The House Banking Committee investigator said one serious concern is that the Federal Reserve has no way to determine whether embezzlements are occurring inside the vault.

At least two instances of embezzlements have been uncovered at other Federal Reserve Banks.

But Christensen said the Federal Reserve has strict controls on the handling of cash, using three separate accounting systems that rely on both physical counts of cash and a computed balance based on deposits and withdrawals by financial institutions.

Christensen said the general ledger of the L.A. bank has always balanced properly and has never been subject to errors.

The GAO report also indicated that the L.A. bank routinely “forced” its cash inventory reports--a different accounting system than the general ledger--to balance for the last day of each month.

In December 1995, for example, the bank made a $111-million alteration to its books to force an adjustment. The adjustments were done at the direction of bank management, according to the report.

The cash inventory system examined by the GAO is a so-called statistical report, used by the Federal Reserve to keep track of its inventory of various denominations.

Christensen said the bank has never put a high priority on keeping the inventory report precisely accurate, since it is used only to make requests for currency printing and for inter-bank transfers between Federal Reserve banks.