Check Those Checks Closely

Posted on Wednesday, November 15, 2017

You might think that check fraud is on the decline with the increase use of debit cards, electronic funds transfers and other high tech ways of moving and paying money. But you would be wrong.

How a Business Owner Used Bank Affiliates in a Kiting Scheme

An Ohio Bank was defrauded of $1.7 million in a check-kiting scam run by a businessman who used accounts at different bank affiliates to make use of a one-day float.

The 55-year-old man pleaded guilty to bank fraud in a maneuver that involved moving money back and forth between checking accounts of two gravel supply companies he owned.

According to the FBI and court documents, this is how the "internal check-kiting" scam worked:

The businessman set up commercial checking accounts for his two businesses at a Cincinnati affiliate of the bank and opened controlled disbursement accounts at an affiliate in another part of the state. The different locations created a one-day float between the accounts.
He would deposit 10 to 14 checks daily in each of four commercial checking accounts of one company written against the checking account of the other company, falsely inflating balances.
The one-day float arose because every day the controlled disbursement checking accounts were zero balanced and cleared against their related commercial checking accounts. The float gave the man time to cash checks against the artificially inflated accounts.

The scam went on from 2001 until it was discovered in December 2005. In a settlement agreement, the man paid about $1 million of the bank's claims of nearly $1.7 million in losses. (U.S. v. Gary L. Varney)

According to the most recent fraud survey by the Association for Financial Professionals (AFP), checks remain the top method of fraud, with 91 percent of organizations reporting attempted or actual instances of this crime. Annual losses from check fraud have been estimated in the billions of dollars.

With the pervasiveness of this crime, your company and its employees should learn these five primary types of check fraud and take steps to combat them:

1. Counterfeiting - This can range from creating fake checks using easily acquired sophisticated desktop publishing equipment or simply duplicating checks with advanced color photocopiers.

2. Alterations - Scammers use chemicals and solvents such as acetone, brake fluid and bleach to remove or modify such information as the name of a payee or the amount of a check. Criminals can either alter small areas of a check, known as spot washing, or alter the full check, a process called check washing. According to the AFP survey, 59 percent of check frauds involved altered payee names, while 27 percent involved changes to employee paychecks.

3. Forgery - For businesses, check forgeries typically involve employees issuing a check without authorization, forging an official signature and making the check payable to themselves or an accomplice. Forgeries also occur when checks are stolen and fraudulently endorsed to someone other than the intended payee.

4. Closed accounts - Also known as paperhanging, this involves writing checks against accounts that are closed and contain no funds.

5. Kiting - This fraud involves opening checking accounts at two or more institutions and covering checks drawn on one account with deposits of checks from the other account that does not have funds. By relying on the float time involved in processing checks, the fraudster carefully times deposits of the worthless checks to artificially inflate the balance of an account. (See right-hand box for an illustration of how one check-kiting scheme worked in Ohio.)

The key to preventing check fraud involves recognizing not only the type of check fraud, but also how -- and by whom -- the particular fraud is typically committed. Your accountant can advise you about the red flags for each type of fraud.

Different rules and regulations apply to the way your organization's bank handles losses from the various types of check fraud. Techniques for investigating fraud involving an employee, for instance, will differ from those used to look into counterfeit checks.

To detect and prevent check fraud your company should focus on both internal and external efforts. For example:

Take these Internal Steps. Review your organization's controls related to receiving, storing and issuing checks. Among other things, your business should reconcile bank statements in a timely manner, segregate check writing from account reconciliation, and limit the number of employees with signing authority. You may want to get a professional assessment of your organization's controls.
Take these External Steps. Talk to your bank about ways it can help protect your account. The cost may depend on the size of the bank and the volume of checks your business issues. One defense most banks offer is called Positive Pay. In its simplest form, this process matches the account number, check number and dollar amount of each check against a list of checks your company has previously authorized and issued. The bank will not cash the check unless all three components match.

If your organization is -- or suspects it is -- the victim of check fraud, contact law enforcement officials, your attorney and your accountant. They will know how to handle the investigation and can offer guidance on the best practices to prevent and investigate crime at your business.

Posted in Fraud & Forensics Group

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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