ln 1975, Carlos Cordova and several other investors founded Capital National Bank (CNB) in Bronx, New York.r Cordova was appointed the bank's chief executive officer and chairman of the board. Over the next several years, the bank opened five branch offices in the New York City metropolitan area. CNB catered primarily to the banking needs of Hispanic-American and immigrant communities in New York City. In 1986, Cordova and the other owners of CNB formed CapitalBanc Corporation, a publicly owned bank holding company registered with the Securities and Exchange Comrnission (SEC).Throughout its entire existence,the principal operating entity controlled by CapitalBancwas CNB. Cordova assumed the titl.ps of president, chief executive officer, and chairman of the board of the new bank holding company. In the fall of 1987, CapltalBanc retained Arthur Andersen & Co. as its independent audit firm. Andersen's first engagement CapitalBancwas to audit the for bank holding company's consolidatedfinancial statements the fiscal year endfor ing December31, 1987.Thomas Curtin, an Arthur Andersen partner since 1979, served as the engagementpartner for the 1987CapitalBancaudit. Curtin delegated the responsibility for much of the audit planning to JamesLukenda, an audit manager with Arthur Andersen since 1983.Lukenda also supervised the staff auditori assignedto the CapitalBancengagement. On December 29, 1987,several Arthur Andersen staff auditors accompanied nembers of CNB's intemal audit staff to the bank's lZth Street Branch. The Arthur Andersen auditors intended to observeand participate in a surprisecount of the branch's cash funds by the internal auditors. Related audit objectives included testing CNB's compliance with certain control procedures and evaluating the competenceof the bank's intemal audit staff.
1. The facts of this casewere drawn from the 1987annual report of CapitalBancCorporation and the following source:Securitiesand ExchangeCommission,Accouiting ond A diti g EnRelclse No,458,28 June 1993. forcetnent
TWO AUDITS HIGH.RISK SECTION OF ACCOUNTS
The accounting personnel at each CNB branch maintained a "vault general ledger proof sheet" that reconciledthe cashon hand to the balanceof the branch's general ledger cash account. During the surprise cash count at the UTth Street Branch,ihe Arthur Andersen auditors discovereda $2.7million reconciling item listed on the branch'sproof sheet.That amount equaled61 percentof the branch's general ledger cashbalanceand 45 percentof the branch's total cash funds thai were supposed to be available on the date of the surprise count. When the staff auditors asked to count the $2.7 million of cash representedby the reconciling item, bank employees told them that Cordova had segregated those funds in a locked cabinetwithin the bank's main vault. Threekevs were reouired to unlock the cabinet.Cordova,who was out of the country at the time, maiirtainedcustody of one of thosekeys. Stymied temporarily, one of the staff auditors telephoned Lulenda. The staff auditor relayed to Lukenda the information regarding the $2.7 million of segregated cash.After considering the matter and discussingit with Curtin, Lukenda instructed the staff auditor to count the cash upon Cordova's retum. Lukenda also reportedly told the staff auditor that it would not be necessary place audit to sealson the doors of the cabinetor to secureit in any other way given the tfueekey security systern used by the branch. Following the telephone conversation wiih Lukenda,the staff auditor advisedbank personnelthat Arthur Andersenauditors would count the cashon the date Cordbva returned from his trip. CNB's practiceof segregating large amount of cashh the locked cabinetwas a clearly not a normal banking procedure.In a subsequent investigaiion, the SEC commentedon this practice. It is an unusual for portionof a bank'scashto be inaccessicircumstance a substantial blefor an...