Computer problems related to Chemical Banking Corp.'s merger with Manufacturers Hanover Corp. allowed more than $350,000 in fraudulent transactions to be made at the bank's automated teller machines, according to internal documents obtained by the American Banker.

The fraud incidents, which number almost 1,000, arose when some Chemical ATM cardholders found they could withdraw cash without its being debited from their accounts.

A series of Chemical memos indicates that system conversion problems last spring -- specifically in transferring control of Hanover ATMs to Chemical's computers - were responsible for the security lapses.

|Bug in the Software'

On May 11, the day when Hanover's ATMs were linked, "there was apparently a bug in the software which allowed customers who opened new accounts and received a temporary ATM card to obtain credit card cash advances where no credit linkage was ever established," one memo said.

The memo goes on to say that 974 fraudulent transactions occurred with a total dollar amount of approximately $357,000.

A chemical spokesman confirmed the existence of the fraud, but declined to elaborate on its size or the cause.

The losses, much of which Chemical is now trying to recover from its customers, highlight the high stakes involved in merger-related computer conversions.

In addition to giving customers access to credit card accounts that did not exist, software glitches resulted in customer accounts being erroneously linked to one another.

The bank was slow to identify the fraud because response time on the systems that Chemical uses to research irregular transactions has been hampered by a move to new computer hardware. Hanover's old research system is being moved to the Tandem Computer Inc. systems that run Chemical's ATM operations, the memo indicated.

The conversion problems created a backlog that kept the bank from promptly identifying the existence of fraud, said bank officials who requested anonymity.

Employees Involved?

Chemical declined to comment on a suggestions in one of the memos that bank employees also were initiating some of the bogus transactions.

The improper transactions are an extension of ATM-related problems that Chemical has been having since April. Since then, many of the bank's customers frequently have been unable to withdraw cash or obtain account balances.

When the problems first were reported last month, Chemical executives blamed the services lapses on ATM hardware failure and on complications in the card issuance process. They denied reports that the source of the ATM problems was the systems area.

Tracing the Thefts

The reason the bank expects to recover much of the money, sources said, is because it has records of the cards used to initiate the illegal transactions, and it also has photographs of the people withdrawing cash.

Bank executives, speaking on the condition of anonymity, indicated that as of the end of May, Chemical has solved the systems problems that had allowed the fraud.

But as previously reported, ATM service outages have continued.

Chemical executives now admit that these services lapses are the result of communications glitches that have developed as the bank has migrated to a new core software system.

Subpar Performance

While they declined to give specific performance levels for May, June, and July, Chemical executives indicated that ATMs were down more frequently in those months than in April, when the terminals were operating only 95% of the time.

Chemical, like most large banks, has internal standards that require its cash machines to be operational at least 98% of the time.

ATM performance reached its nadir in late July, according to bank officials.

ATM experts were critical of how the bank managed the consolidation of its cash machine network.

"Ordinarily, the type of problems that Chemical are seeing are fixed in 30 to 40 days and are then dismissed as things that routinely happen in big merger," said one technology consultant familiar with Chemical operations, who requested anonymity.

Some industry observers also were skeptical of Chemical's earlier claim that its ATM problems were largely due to their aging fleet of cash machines manufactured by Omron Systems of America Inc., a company that withdrew from selling the machines in the United States in 1990.

"Omron machines, if well-maintained, are as reliable as any machines in the industry," said David T. Parlin, president of ATM Exchange Inc. in Cincinnati, a seller of used cash machines. "The suggest otherwise is ludicrous."

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