Check Fraud: Is Your Institution at Risk

By:Robert Eidson, Jr.

Fraud can occur at a bank or financial institution in a variety of ways. Some of the biggest losses due to fraud at a bank are the result of check fraud. Statistics have shown that check fraud accounts for approximately $12 billion in losses each year, and $53 billion is lost each year due to check fraud and the use of worthless checks. It is also important to note that check fraud losses exceed credit card fraud, ATM losses, and armed robberies combined. These facts in themselves are staggering, but keep in mind that check fraud is estimated to grow annually at 25 %.1

In order to confront this problem most effectively, one must first understand the methods that these “fraudsters” use. Popular types of check fraud include forgery of makers’ signature, forgery of endorsement, check kiting, washed or altered checks, and counterfeit checks. Each of these topics could independently fill an article; therefore we will discuss altered and counterfeit checks here.

Altered Checks

Checks can be altered in several ways. Some check fraud is committed by simply creating the appearance of a watermark or drawing on the check. This is done by simply drawing on the check to cover the original information, and then fraudulently reentering the check information. These checks would typically not hold up to any level of scrutiny, but the problem lies in the fact that they are often used at large retail stores. These stores do not pay a great deal of attention to the check and they are batch processed by the bank, where increased automation and efficiency issues allow them to once again bypass scrutiny.

Another method of altering checks is the simple act of adding a line to the payee of corporate checks. This is often done to checks on which the payee was originally filled as a company or organization and the fraudster has simply added a name. For example, the check was originally written payable to Company X, and the fraudster will add a line to make the check read John Fraudster, Company X. Many times this type of fraud is evident through the misalignment or difference in the font of the added line as compared to the remainder of the check information.

Checks can also be altered by “washing” them. This involves the use of chemicals to remove check information, which is then fraudulently reentered. This process usually leaves the “washed” areas of the check discolored, which is relatively easy to detect. Education of bank personnel is the best way to guard against check fraud utilizing altered checks. Although it is not efficient for employees to thoroughly examine each check, a general awareness of these acts could lead to the discovery of many instances of check fraud through the normal course of processing.

Counterfeit Checks

Counterfeiting is regarded as becoming the fraud of choice. The “FBI and Secret Service report that a significant portion of check fraud is committed by organized, transnational, ethnic criminal groups located in most major cities1. ” These organizations are often highly organized with various levels of leaders and subordinates. It has been found that counterfeiters have preferred styles of checks, which include MIPPS and Versa checks. The counterfeiting process basically involves the acquisition of an authentic check, and then the reproduction of that check. The quality of these counterfeit checks is increasing due to advances in technology and reduced prices for that technology. It is becoming nearly impossible to identify a quality counterfeit check, and many of them are only identifiable when the company realizes that additional checks are being run through its account and are showing up on its statements. It should also be noted that in many instances, the authentic checks are being obtained through insiders that are working for the company or a financial institution and that have access to lock boxes and checks. There are several precautionary measures that an institution can take to reduce the risk of loss due to counterfeit checks. These include:

• Timely reconciliation of bank statements
• Effective controls over check stock
• Effective controls over cleared checks and bank statements
• Appropriate segregation of duties between accounting and financial responsibilities regarding check issuance and register maintenance
• Create and use rigorous hiring practices
• Require vacations
• Get to know employees - pay attention to changes in personality and life style
• Have independent audits performed regularly
• Effective controls over access to sensitive financial information (account numbers, etc.)
• Implement dual controls over payroll, accounts receivable, accounts payable, and bank deposits
• Utilize check stock with security features
• Utilize Positive Pay products, electronic payment systems, and/or computer banking1

It is also recommended that institutions create control procedures for large checks. The value of a “large” check should be determined based on the characteristics of the bank’s operations. For all checks over this amount, the writer should be called and asked to verify the information on the check, especially the payee since that information is what the fraudster must change in order to receive funds.

Final Thought

Check fraud is likely something that has concerned us all, but we may have never fully understood the frequency or magnitude of these actions. As the losses due to fraud continue to rise, it has become apparent that actions must be taken sooner rather than later to reduce the vulnerability to loss. Although the aforementioned procedures are good, basic ways to lower this risk, each institution must assess its own control environment and structure to determine its individual weaknesses and control needs.

For additional information please see:

• Office of the Comptroller of the Currency — Check Fraud: A Guide to Avoiding Losses
• National Check Fraud Center

References:

• 1: Bank Fraud Trends and Fraud Awareness. By Jesse B. McCoy. 2004 GSCPA Financial Institutions Conference. 17 Sept. 2004.

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