I. PURPOSE OF ARTICLE
This article serves as a summary of several issues that may involve cases of check fraud. Many of the issues referred to in this article are more thoroughly outlined within the following articles: FORGED OR UNAUTHORIZED DRAWER SIGNATURES; FORGED OR UNAUTHORIZED INDORSEMENTS; FORGERY OR ALTERATION: BANK AND CUSTOMER DUTIES; TYPES OF INDORSEMENTS; COMPLIANCE WITH RESTRICTIVE INDORSEMENTS; MISSING OR IMPROPER DRAWER SIGNATURES; CONTRADICTORY TERMS, UNDATED OR INCOMPLETE CHECKS; ALTERED CHECKS; TELEMARKETING AND AUTHORIZED DRAFTS; and CHECK KITING. Since the law of check collections has evolved into a complex system of statutory law, regulations and caselaw, departures from the norms of the collection process often raise questions on procedure, responsibility and liability. The body of law is riddled with technicalities, exceptions, and often, conflicting caselaw. Frequently, the most common question is “Who is going to end up bearing any loss?” This is often a difficult question to answer because of the complexity of the laws involved. The following information is provided as a simplified guideline to many check fraud issues. For further research, it is recommended that you refer to other articles within the Deposit Accounts section (Volume II) of the NBA Compliance Handbook. Quite often, the advice of legal counsel should be sought on a timely basis.
Under normal situations, a drawee bank must debit its customers’ accounts for checks that are “properly payable”; failure to do so would result in the bank’s liability to the customer for “wrongful dishonor.” There are exceptions: e.g., customers may exercise a revocation of a check by a “stop payment” order; banks may refuse to honor “stale dated” checks. In addition, specific procedures by drawee banks are not considered wrongful dishonor, including: returns because of missing or illegible signatures; forgery; alteration of the payee, amount or date; post-dating; insufficient funds; stop payment; garnishment; account closure; uncollected funds; and not “on us” checks. The return of a “dishonored” check is generally made by the drawee bank before the “midnight deadline” (i.e., before midnight of the next banking day after presentment) unless it falls within one or more of the 14 exceptions to the rule. A major exception, for example, is breach of warranty (permitting the drawee bank to return a check with a forged endorsement or material alteration, possibly months or years after the drawee bank has paid the check).
II. SUMMARY OF ISSUES
A. Forgery of Drawer’s Signature
The general rule is that the drawee bank is responsible for knowing its own customer’s signature. This responsibility may be limited by the drawer’s own negligence in the care and preservation of checks, failure to promptly notify the bank or the depositary bank’s knowledge of the forgery. Forged drawer signatures must be reported to the drawee bank within one year from the date of the bank statement that is received by the customer.
B. Forgery of Indorsement
A forged indorsement on a check is ineffective. In general, the depositary bank is held responsible for accepting a forged indorsement under the theory that the bank is in the best position to control the verification and identity of the person attempting to pass the item. The UCC rule is that the person who “looks the forger in the face” usually takes the hit, unless the forger is apprehended and forced to pay. A drawer must report the forgery within three years and failure to report on a timely basis may result in the drawee’s bank refusal to recredit the account from which the check was drawn.
There is important exception to the above-stated rules when the check’s indorsement is forged by an impostor pretending to be the intended payee (e.g., Doe represents that he is Smith and induces Jones to write a check to Smith, subsequently indorsing the check in Smith’s name and taking the cash). The UCC allows such an indorsement to be “effective” with the result that the drawer may end up bearing some or all of the loss for being tricked by the forger into issuing the check to the impostor. The theory is that the drawer may have been in the best position to prevent the fraud. See, § 3-404(a), UCC. The revised UCC has a comparative negligence standard in which this “impostor defense” does not always shift the entire loss to the drawer. If the depositary bank failed to exercise ordinary care in taking the check for collection and such negligence substantially contributed to the forgery, the loss may be apportioned between the drawer and the depositary bank based on their relative degree of fault.
C. Unauthorized Signatures
When an unauthorized signature is an indorsement, the depositary bank is normally responsible. If the unauthorized signature is made as a drawer of the check, then the drawee bank is normally responsible. The respective three and one year reporting time limits discussed in paragraphs A. and B. above will apply. Although the law places a duty on the customer to examine bank statements for unauthorized signatures or for alterations, this duty to examine will protect the bank only if the bank itself has not been negligent by failing to exercise “ordinary care” in paying checks. Under the UCC, “ordinary care” is the “observance of reasonable commercial standards, prevailing in the area.” With the current process of signature verifications or the use of bulk filings, if there are no other procedures used to discover unauthorized signatures or material alterations (e.g., for “small dollar” checks), then the bank may have difficulty in proving it had exercised “ordinary care.”
D. Material Alteration
The general rule in the case of material alteration of a check is that the depositary bank is held liable, except when the drawer is shown to be negligent. The time limit for a drawer to report a material alteration is one year from the date of the statement and the drawee bank need only recredit the excess amount of the altered check.
E. Bond Coverage
Although check kiting fraud may not be covered by a banker’s bond, insurance coverage is generally available when the bank is held liable for the loss and the loss is a direct result of the fraudulent activity.
III. CHECK FRAUD SCHEMES
A. New Accounts
This type of fraud usually involves the opening of a new account with the use of false identification. Once the account is open, there may be attempts to negotiate either stolen or counterfeit checks and transacting split deposits or making minimal cash deposits with a subsequent attempt to deposit out-of-state checks. Typically, a false address and telephone number is involved. Another scheme is the opening of a business account, using the name of a real business but without its authority, and attempt to deposit legitimate business checks into the account for later withdrawal.
B. Business Accounts
Often referred to as the case of the “unfaithful servant,” the fraudulent activity is comprised of either forgeries or unauthorized transactions (e.g., split deposits) committed by an employee of a legitimate business.
C. One-Time Check Cashing
More common schemes revolve around attempts to cash either forged or counterfeit checks by a non-customer of the bank. Another scheme may involve cashing a legitimate check knowing that there is a likelihood that the check will be subject to a stop payment order (e.g., for goods or work contracted for but not delivered or performed). Other fraudulent activity under this category may involve a perpetrator claiming he or she is the payee or may involve alteration of the check.
D. Check Kiting Schemes
Check kiting is the knowing deposit of uncollected funds and then drawing checks against those uncollected funds for the purpose of deposit in another account to pay uncollected fund deficiencies. The practice may occur in a number of ways and may involve several financial institutions. Banks most susceptible to check-kiting schemes are those that do not employ proper internal controls and reporting systems to monitor this and other suspicious activity or do not enforce internal procedures already in place. The perpetrator may seek out those banks with liberal practices relating to funds availability. If the bank is found to make exceptions to bank internal controls that approve drawings against uncollected funds and overdrafts, the bank may be considered a good target in that such practices may become routine to the point that bank personnel overlook the risks involved.
IV. PREVENTION TECHNIQUES TO CONSIDER
Many of the check fraud schemes attempted today have been used for decades, but with the sophistication of computer desktop publishing, criminals have the ability to create near perfect copies of personal, business, cashier’s and government checks or money orders. Through the use of computer scanning and reproduction, a legitimate signature can be obtained and later used for counterfeit check or forgery purposes. Other age-old scams involve: the use of false identification in the cashing of checks; unauthorized transactions by business customer employees; check kiting; or failure to obtain adequate identification for new account customers that have opened accounts for fraudulent activities.
The bank’s tellers are the first line of defense against check fraud. Teller training should include the following recommended procedures:
V. CONCLUSION
The reduction of check fraud losses occurs when all employees of the bank are involved in making identification and prevention a high priority. Development of training programs, attendance of training conferences, education for teller staff and other key bank employees, consumer and merchant education in the form of statement stuffers, seminars and discussions, open lines of communication with law enforcement and other financial institutions and the appropriate filing of Suspicious Activity Reports are all integral in the effort to prevent check fraud. Monitoring of losses, centralized reporting to bank security, auditing or loss control staff and communication with senior bank management about potential and actual losses is also a good strategy to quantify, identify and analyze methods, to assess operating policies and to implement necessary changes in an effort to reduce future losses.