WHO’S LIABLE?  As a Victim of Check Fraud, It Could Be You!
By Larry La Hue

Check fraud is a problem that is not going away.  Changes in federal government regulations and the growth rate of this particular crime support this.  Business owners must be prepared to look at both internal financial and bank procedures to determine if changes must be made.  Most importantly, companies must educate themselves on the value of controlled check stock paper and other check security features. 

Changes in the Uniform Commercial Code:  How They Affect You

The Uniform Commercial Code (UCC) contains the regulations which govern check transactions between the three participating parties:  the payee, payor and financial institutions.  The UCC (in the last ten years) has adopted several rulings which have altered the placement of liability pertaining to check fraud.  No longer will the bank carry the sole responsibility; but increasingly, liability will fall on business owners.

A Warning to Corporate CFO’s:

Comparative negligence and relative standards of care are relatively new ideas, concerning liability for losses from check fraud.  The UCC adopted these changes in 1990 and 48 states ratified the revisions by 1993.  Initially the aim was to initiate a team effort (by businesses and their banks) to battle check fraud.  Instead, banks and their corporate counterparts battle each other (both verbally and legally), seeking to shift liability from one side to the other in the event of check fraud.

Articles 3 and 4 govern liability for losses from counterfeit or forged checks.  Originally, when a bank paid a fraudulent check, it bore the loss resulting from that payment.  Under the revisions, subtle, but important, changes in language and definitions can act to shift liability for check fraud back to the companies that initially wrote the checks in question.

The rules have changed under the following key UCC regulations:

• Section 3-103:   corporate customers must use reasonable commercial standards prevailing in their area for their industry. 
  
• Section 3-406:  bank customers must utilize ordinary care or companies may not be allowed to seek restitution for check fraud from their banks.
  
• Section 4-406:  customers must reconcile bank accounts in a timely manner and notify the bank of fraud immediately.

Today, the bank’s obligation to provide ordinary care may not include signature verification.  Statistics say that over 64 billion checks are cleared in the U.S. each year.  This is accomplished by high-speed reader-sorters that process up to 2400 items per minute.  With these figures in mind, “sight examination” is usually impractical for a bank’s corporate customers.  Most importantly, the UCC does not see the lack of signature verification as a guaranteed reason for a charge of bank negligence, if a forged check clears its system. 

Check Fraud:  The Facts

Check Fraud is a problem reaching epidemic proportions. No company is immune.

According to Business Week 1997, check fraud losses far exceed other types of financial fraud:

Some background information:

Why do criminals turn to check fraud?  The incredible amount of money to be made makes this crime very attractive.  The chance of being caught and prosecuted is fairly low according to numbers that will be discussed shortly. Banking Information News and the National Association for Banking Securities provide estimates that specify annual losses in the U.S. to be in the $13 billion range.  Over one million bad checks quite possibly enter the banking system daily.

The current state of today’s technology has made check tampering, alteration and counterfeiting a simple matter.  Additionally, the situation may worsen as technology evolves even further.

Business owners need to place fraud prevention at the top of their “to-do” lists because (please note that some of these may apply in the U.S. only):

1. The banks have lost phenomenal amounts of money over the years, absorbing the costs of check fraud.  As a result, banks have taken steps (including lobbying for the UCC changes) to shift forgery and counterfeiting losses to the business community.  Now corporate owners bear the responsibility of implementing current methods to protect themselves against check fraud and/or to show that ordinary care was taken to prevent it.
   
2. It has been said that ignorance of the law is not an excuse.  It can, however, make your company particularly appealing to criminals looking for an easy mark.  It is worth the time and effort to see how you measure up.
   
3. A firm’s greatest asset is its corporate image.  A widely publicized case of check fraud can ruin your company’s reputation.  Customers, clients and vendors may be reluctant to continue their relationships with you. 
   
4. Last, but certainly not least, is the hefty price tag of investigation and prosecution.

Desktop publishing and today’s technology have made office work simple and efficient.  However, those very resources have had the same effect on the work of check fraud artists.  Anyone with access to a PC, a scanner, off-the-shelf software and blank check stock can create forged checks that are very difficult to tell from the original document.  Modern check fraud artists utilize the best:  high-end copiers and chemicals to prevail over most security features.  For example: 

• Microprinting can be scanned and replicated; artificial watermarks can be duplicated with a three-percent print screen.
  
• Copy void pantographs can be eliminated on high-end copiers.
  
• Forgers wash laser checks in chemicals for 15 minutes and follow with a bleach bath to eat off the toner and clean the check.  The first chemicals prevent the bleach from destroying the check.

For years, scholars and business experts have promised a paperless, checkless society.  Regardless, check volume still increases.  Credit cards, debit cards and direct deposits, have not replaced checks as predicted, but are seen as welcome additions to the options consumers and businesses utilize.  The bad news for all of this growth is:  occurrences of check fraud will also continue to rise.

A recent Nielsen Report projects that the number of checks written annually will rise by two to four percent through the year 2020.  At the same time, more than 1.2 million worthless checks enter the payment system daily.

What Do Criminals Look for?

1. Checks that are easy to reproduce using a color copier
2. Checks that are easy to tamper with
3. Easy access to checkbook and/or check stock
4. High volume bank accounts where a fraudulent check can easily slip through

Home printing

A computer, laser printer, blank check stock and a criminal mind combine to make a check production “a snap.”

Unauthorized printing within your company

Companies trust their employees, but that doesn’t change the simple fact that the risk of internal fraud is at least equal to the danger of external.  Those with access to all phases of the accounting and check printing processes have ample opportunity to commit check fraud.  Others (cleaning crews, maintenance techs, etc.) who have access to the check printer also represent a risk.

What’s being done about it?

The truth is:  primarily, check fraud is so low-risk because many companies choose not to report it. Further, law enforcement is over-worked and the courts are backlogged, so prosecutors decline to pursue 75% of bank check fraud cases.  Finally, in major cities where there is a greater emphasis on using resources to prosecute violent crime, the number often exceeds 90% (according to the U.S. General Accounting Office).

Liability:  It Begins with Company Financial Procedures

Why is your firm “potentially liable” for a check fraud incident? 

• Failure to securely control storage of “check stock” within the accounting area 
• Failure to securely control storage and access to signature stamps/machines
• Failure to use internal procedures that prohibit forged signatures or alterations
• Failure to supply current documentation to your bank on authorized signers
• Failure to promptly reconcile bank accounts for Payroll and Accounts Payable
• Failure to verify signatures on “canceled checks” during the reconciliation process
• Failure to promptly report potential check fraud occurrences to your bank
• Failure to implement paper safety features in your check paper stock

Preventing Check Fraud and Protecting Your Company

This is not an easy job, but there are many processes that, when jointly implemented, will help reduce your company’s risk from check fraud.  These suggestions to help you fight check fraud are certainly not exhaustive.  And, as stated earlier, no one is immune to check fraud, but you can reduce your potential liability.

1. Read and understand your bank contracts regarding liability.  Know your company’s obligations under current UCC regulations.
   
2. Contact your bank about their suggestions for your internal financial procedures.  Ask for a written copy of the bank’s ideas on fraud prevention, check stock considerations and secure check reconciliation processes.
   
3. Ask your bank about their ordinary care procedures.  Familiarize yourself with their processes (including the possible use of signature verification) and get a written copy of the methods they use to reduce check fraud.
   
4. Use personalized check stock with your own custom colors and logo.  This is an affordable option for most companies.  Pre-printed, generic check stock makes fraud as easy as filling in the blanks.  Remember though, that a design is no substitute for comprehensive security features. 
   
5. Use check stock with security features.  Check stock now has its own security features that help prevent copying or mimicking.  Magnetic toner has also made home printing more difficult and expensive. 
   
6. Reevaluate the effectiveness of your check stock security features.  It is true that the more complicated your security features are, the less likely a forger would be to tamper with your checks.  However, you don’t have to have all or even most of the security features available.  A good mix can be very effective and still be cost-efficient.  Intelligent combinations of features will deter sophisticated forgers and expose less-skilled thieves.
   
7. Advise your bank branch officials of the security features in your checks.  Do this in person or in writing and keep a copy of the letter on file.
   
8. Use tightly controlled check printing procedures.  Ensure that employees not involved in the check printing process do not have access to check printing equipment, check stock and/or checkbook.  Periodically change keys and entry codes to secured check and/or check stock storage areas.
   
9. Audit your checks periodically.  This can be difficult because checks are often removed from the middle or bottom of the stack.  Verify that boxes have not been opened and resealed.  Check tops and bottoms of cartons.  Have your checks pre-numbered, whether they are preprinted checks or blank check stock.
   
10. Review your check issuing process.  Be certain it is accurate and efficient.  Internal and external audits can be very effective in detecting patterns of fraudulent activity or potential risk areas.  Conduct “surprise audits:” do any employees appear nervous at the prospect?
    
11. “Checks” and balances.  If you think there is a risk of internal check fraud, make sure that one person does not have access to the entire process.  Fragment the procedures so that a person’s activities will only affect part of the process.  Utilize background checks when hiring employees to work in check issuance and reconciliation areas.
    
12. Use separate accounts for special dollar amounts.  If you issue a large number of checks, particularly with a low amount (e.g. rebate checks), open a separate account and alert the bank staff of an upper limit on that account.
    
13. Reconcile your bank statement promptly.  Now that bank statements are available online, you can do this as frequently as your situation demands.  Make sure authorized signers do not reconcile bank accounts.
    
14. Enforce mandatory vacation policies.  Those employees with access to financial operations are particularly critical.  Large embezzlement schemes often require daily maintenance and may be discovered during a week’s absence.  Do any of these employees appear to live beyond their means?

Additional In-House Procedures to Reduce Fraud

• Separate the accounts receivable and banking functions.  Divide processes in the accounting department between several people.  In Accounts Receivable, receipts and deposits should be done by different people, ensuring that these balance daily.  Likewise, in Accounts Payable and Payroll, the processing of payments, check disbursement and bank reconciliations should be separated.  A dishonest employee could issue a check to him/herself, remove the check from the bank statement and adjust accounting records to hide the embezzlement.  The UCC is clear, that in these situations, it is the company (issuer) that bears sole responsibility for the loss, rather than the bank.
  
• Mailroom personnel should be subjected to background checks and internal guidelines should be implemented to protect incoming and outgoing checks.  Returned checks should go to an independent post office box, by including only that P.O. Box number on disbursement checks.  Omit the company name and address.
  
• Segregate processing of returned checks.  A designated employee (different from the person who disburses checks) should handle any checks that are returned, either by the Post Office, for wrong address, or by the intended payee.  It is critical that the person investigating the return not handle other accounting records, since it is a simple matter to insert another payee’s name—thus altering the original document (complete with authorized signature).
  
• Never include account numbers and/or authorized signatures on any correspondence.  Anyone with access to the letter, fax or E-mail can retrieve this information and use it for his/her own benefit. 
  
• Protect all checks and check stock.  Store all checks, used or unused in a locked location where cleaning crews and other employees have no access.  Even voided or cancelled checks should be locked up, after stamping “VOID” and/or “CANCELLED” on the face of the check—and removing the signature is critical.  Employees usually know that a voided check was replaced and this document will not be missed, if they take it for fraudulent purposes. 
  
• Control check reordering forms.  Remember:  a stolen check reorder form is priceless to a forger.  He/she has only to change the ship-to address and your original checks are in someone else’s possession…  Keep them locked away with your checks and check stock.
  
• Ruin unusable check stock immediately.  When changing bank accounts or opting for new, more secure check stock, always shred or destroy checks and/or blank stock as soon as possible.  If it is impossible to do so, maintain these documents in the same locked area as current checks and check stock.  Even though the account is closed, someone could pass the old to checks to an unaware third party.  The company would be held liable for its negligence.
  
• Return unused check stock to the locked location immediately after the check run.  Laser checks left in the printer tray are targeted by other employees and cleaning crews.  It’s obvious, but often overlooked—lock them up!
  
• Always mail checks directly to the vendor or payee.  Some departments seek to establish dual accounting controls by mailing their own checks.  This is absolutely unnecessary and creates increased opportunities for fraud.
  
• Prevent erasure alterations by:

1. Replacing impact printer ribbons at the first sign of wear—the more ink, the harder to erase.
2. Never use correctable ribbon when typing or printing checks—plastic tape can lift the type.
3. Use type font of 12 points or larger—small fonts can be easily erased and covered with larger type font.

• Shred all negotiable documents in the presence of a witness or use a bonded shredder.

Checks Issued Manually

Regardless of the sophistication of a company’s computer systems, there are times when checks must be issued manually.  Forgers know a few simple tricks and can transform these documents into quick money for themselves.

If checks are typed, it is important to remember #2 under “Preventing Erasures” above.  A disgruntled employee with only a little finger dexterity can place tape over the plastic type on a check, rub lightly with a pencil and remove either the payee name or dollar amount.  The new information can be typed in—the authorized signature is already in place.  Fraud was easy, because of the correctable typewriter ribbon.

Handwritten checks are also simple to alter.  Ballpoint ink (even “permanent” ink) can be quickly dissolved by acetone, without damaging the check, if the check paper isn’t chemically-sensitive. 

The best solution is to utilize single-strike, fabric typewriter ribbon.  These are cheap, usually around $5 and drive the most ink into the paper.  Ink cannot be removed with tape, like plastic type for correctable ribbon.  It can be removed (with difficulty) by using chemicals.  Using multichemical-sensitive check paper can make these fraud attempts obvious.

How Secure is the Padlock—If Everyone has the Key?

Many check printers advertise their use of controlled check paper, but these claims are very often exaggerated.  The controlled paper is restricted in both its distribution and its use by the paper manufacturer.  The manufacturer requires the printer to store the paper rolls in a locked facility, shred pre- and post-run waste, and in at least one case, regulates the type of companies that can use the paper.  A handful of very large printers manufacture their own custom paper.  Then they undo their good work by printing millions of laser checks, complete with artificial watermarks, laid lines and void pantographs, and sell them entirely blank to thousands of companies.  Everyone has access to each other’s identical check stock!  If forgers obtain original check paper, they can perfectly replicate the check.  Virtually all of the most popular check papers are available in mail order catalogs.  If a check is sold entirely blank by a mail order firm or a software company, the paper is not controlled. 

Legal experts agree that check security features could well become an important element of the legal definition of ordinary care.  Brent Gorey, an attorney who specializes in the banking industry and the legal aspects of checks, says, “In appropriate cases, a strong argument can be made that the failure by a business to use security features to protect its checks constitutes negligence.”

Check Security Features--You need to do exactly what the federal government does: 

(a) Use your own custom check stock.

(b) Use difficult to reproduce, custom graphics. 

(c) Number each check with a unique control number (whether preprinted checks or blank check stock).

There are a multitude of check security features available today, with new innovations coming out continually.  It may be practical to use as many of the security features as you can get!  The more unique you can make your check, the less likely it will be duplicated or altered.  A good mix of at least seven of these features will better protect your company against fraud and liability.

Secure Check Stock 

Highly secure check stock should be your first and easiest fraud-deterrent tool.  Inadequate check security invites forgery and alteration attempts.  Insist that your check stock contains at least seven security features, including multi-chemical sensitivity.  The best check papers are reactant to high polarity solvents (alcohols) and oxidants (bleaches).

The best approach is to include both “overt” and “covert” security features.  The overt approach makes it clear to everyone handling your check exactly which features you have implemented.  The outright effect is to provide bank staff (and yours) with an easy method of identifying tampering—and to deter would-be crooks!  Covert features are intentionally hidden to surprise and fool criminals.

Tamper Detection

Popular methods of check fraud are dollar amount and/or payee alteration by erasing or using various chemicals.  Some background inks and some papers react to these chemicals by disappearing, fading or staining in a very obvious manner.

Neutralizing the Threat of the Color Copier

The most recent wave of fraud was brought on by the advent of the high-end color copier.  These are terrific for many office functions, but again, they make the fraud artist’s job easier.  As such, security features currently beyond the copier’s capabilities have been developed.  These include:

1. Fluorescent Fibers and Ink:  Color copiers have trouble reproducing fluorescence.  Secure checks may include some printing in fluorescent ink, and/or fluorescent fibers woven directly into the paper.  If your checks contain these features, a bank’s special UV lights can look for the glow.  A forgery produced on incorrect paper will not glow.

2. Visible Fibers:  These are utilized for the same reason.  Just like in U.S. currency, a close examination of a copied check will show the absence of these fibers.

3. Artificial Watermarks:  Depending on the type, this can be a light gray screen with custom wording or white ink, which can be viewed from one or both sides of the form when held up to the light at a 45 degree angle.  Either type is very difficult to scan, photocopy or duplicate.

4. Void Pantographs:  These are messages in the background, printed in a special way, so as to make them difficult to see with the naked eye.  Because of the resolution used on many copiers, this printed message becomes quite obvious when copied.

5. Microprinting:  This process uses very tiny text that looks like a fine line for borders and/or signature lines.  Under magnification the lines can be read, but current copiers cannot reproduce the extremely small letters.

Warnings

Several types of warnings are available to discourage criminals and raise alarms that something is wrong.  Your checks may have some of these now:

A message such as “The face of this check is blue and contains the security features listed on the back,” is very effective.

A padlock symbol indicates that your check contains the minimum set of security features standardized by the Financial Stationers Association.

The “MP” symbol is used to indicate that elements of the check have been micro-printed.

As previously stated, a mix of these and other features (all of which are either “overt”    or covert”) will help to decrease the likelihood of fraud.  Additionally, in the event check fraud does occur, these features will help to shift liability for the loss from your company, back to the bank.

Your Obligation:  Fraud Risk Reduction

Check fraud cannot be eliminated.  There will always be a clever (devious) mind out there, who can get around last week’s security innovation.  However, at the core of all of the information presented here are three steps, which when used together, can vastly reduce the risk of fraud losses.  These include:

1. Understanding sight-review procedures at your bank.  What good are security features and controlled paper if the bank doesn’t look at the checks?  You should know what they look for--they should know what you’re trying to achieve.

2. Establishing/maintaining good internal controls.  Incorporate as many of the tips listed above, under “Preventing Fraud” and “Additional In-house Controls” as possible.  Do an internal audit of your company’s accounting AND mailroom procedures.  How do you stack up in the battle against fraud?

3. Using a high-security check built on using controlled paper.  The paper should be chemically reactant and have security features within the paper itself.  The graphics should be difficult to reproduce and the checks should be pre-numbered, so you can audit your inventory.  (Many of these features are described in the previous table:  Overt/Covert Special Features). 

The Bottom Line:  Liability

Check fraud is increasing and the UCC has changed its regulations to shift partial responsibility to the business owner, rather than placing it solely on the banks.

My viewpoint as a business owner is simply this:  You need to implement and use complex deterrent processes.  In addition, you must be able to prove beyond a reasonable doubt that you have exercised reasonable commercials standards and ordinary care regarding your check usage.  Companies seek to maximize profits—they must also seek to minimize liability. 

Note:  If your company is victimized by check fraud, whenever possible, file a 1099 on the perpetrators and let them deal with the IRS for the rest of their lives. 

References

www.businessweek.com

www.ckfraud.org

www.cpaonline.com

www.ebanklink.com

www.safechecks.com