IT systems at Hackney Council are under forensic examination by police as part of a major fraud inquiry.
Detectives are investigating concerns that genuine accounts on computer payments systems may have been altered to provide new names and addresses to which large sums have been paid. They are believed to be checking records dating back three years.
Inquiries by the Fraud Squad initially centred on a cheque for a "substantial five-figure amount" but have now been widened following fears that offences have been committed on a larger scale. A former council employee has been arrested.
The council refused to discuss what it described as a "low-level" fraud. It said it did not want to prejudice its own investigations.
Concern about the possibility of fraud at Hackney Council was highlighted by the Benefit Fraud Inspectorate in an unpublished draft report in September last year.
The following month Hackney Council voted to terminate a £70m housing benefit and council tax outsourcing deal with ITNet, just three years into a 10-year contract. Problems with the benefits service had created a £3m backlog of payments.
ITNet said it does not believe its systems are involved in the fraud now under investigation.
The Benefit Inspectorate report said, "The poor level of benefit administration will have substantially increased the risk of fraud and error entering the system.
"All new council staff are vetted but this policy did not extend to the recruitment of ITNet staff."
The report attacked the failure to use the document image processing system properly, resulting in a partly paper-based system.
Local authorities are advised to check 10% of all benefit claims for accuracy and quality of assessment.
"ITNet is only completing full accuracy checks in approximately 4% of all assessments. This level of checking gives no assurance of the quality and accuracy of assessments done," said the report.
Max Caller, Hackney Council's managing director, said, "Tighter budgetary and financial controls that have been introduced mean that we are better able to clamp down on fraud. These tighter controls mean that anyone who might have wanted to take advantage of lax systems is now more likely to be found out."
David Brown & Mike Simons