Author: Adam R. Brownstein
Despite a large decrease in recent years in the volume of paper checks processed by US financial institutions, there has been an alarming rise in fraud involving paper checks. According to the US Department of the Treasury's Financial Crimes Enforcement Network (FinCEN), check fraud reports have risen dramatically in recent years: There were 299,020 reports from March 2020 to February 2021, 350,000 during 2021 and 680,000 during 2022.1 As just one example, in 2022, law enforcement identified a check fraud ring in Southern California involving nearly 60 people who committed more than $5 million in check fraud against 750 people.2
This alert explores the methods that criminals use in committing check fraud, proposes methods for combating check fraud and identifies insurance coverages available for financial institutions to potentially cover check fraud losses.
Mailed checks are increasingly vulnerable to theft
Check fraud frequency has increased because criminal organizations have identified weaknesses in the handling of paper checks, primarily targeting the processes of the United States Postal Service (USPS). Left unguarded in USPS collection boxes, residential mailboxes and commercial buildings, mail containing checks is vulnerable to criminals. Further, instances of assaults on USPS employees — to steal their master keys for opening mailboxes — is also on the rise.
After stealing checks from the USPS, organized criminal groups change or "wash" the checks, replacing the payee information with their own or fraudulent identities or with business accounts that the criminals control. During check washing, these illicit actors also often increase the dollar amount on the check, sometimes by hundreds or thousands of dollars. Washed checks may also be copied, printed and sold to third-party fraudsters on the dark web and encrypted social media platforms in exchange for convertible virtual currency.
Additionally, criminals exploit stolen bank routing and account information to create fraudulent checks. Criminals may cash or deposit checks in person at financial institutions, through automated teller machines (ATMs) or via mobile deposit applications directly into bank accounts, which they typically open specifically for check fraud schemes. Once the stolen funds hit their account, the criminal actors typically withdraw the funds through ATMs or wire them to other accounts they control. By the time the crime is noticed, the funds are usually beyond the reach of financial institutions or law enforcement.3
Methods of discouraging or combatting check fraud
The American Bankers Association has several tips for financial institutions looking to identify potential check fraud. Signs of potential check fraud may include the following.
- Checks are deposited into accounts without any deposit history, with the intention of subsequently withdrawing or transferring the funds.
- Abnormal deposits of checks are followed by rapid withdrawals or transfers, often via electronic means.
- Large withdrawals are made by check to a new payee.
- Checks are cleared out of sequence with past checks.3
- Check stock differs from the stock used by the issuing bank or its customer.
- A new account is opened with a large check or multiple checks.
Vigilance is often not enough. Most financial institutions have adopted at least some of the following methods of discovering check fraud before cashing fraudulent checks.
- Positive pay — Bank-provided software verifies the account number, check number and dollar amount for each check against a preauthorized list submitted by the paying entity.
- Secure check stock — Checks have built-in security features, such as watermarks, microprinting and security threads, to make it difficult to replicate or alter checks.
- Identity verification — Procedures identify customers from the moment they open a checking account, which can be subsequently verified when a check is presented for payment.
- Validation software —Software evaluates and flags potential fraudulent checks, including client signatures, prompting a separate client verification.
- Training — Bank staff must be kept abreast of the latest means to prevent check fraud and must be consistent in employing those techniques and technologies.4
Potential insurance coverage for check fraud
Coverage for check fraud may be available in one of two types of policies: the financial institution bond or, for other types of businesses, in the commercial crime policy.
For financial institutions, coverage, if available, is almost always located in the financial institution bond, which typically contains several potential insuring grants that may be applicable depending on the facts and circumstances surrounding the claim. Some of the more common scenarios and the applicable coverage extensions include the following.
- Forgery or alteration coverage, which may apply when an insured, in good faith, pays or transfers property in reliance on any check that bears a forged or altered signature.
- Fraudulent deposits coverage may apply when there's a loss that results from the insured paying funds or establishing credit on the faith of any check that's not finally paid, provided that the check or draft was deposited or exchanged for cash by an individual with the intent to commit fraud.
- A less frequently applicable coverage is for check kiting, a situation in which a customer deposits or negotiates a check knowing that there are insufficient funds in the account to cover the amount of the check.
In summary, check fraud continues to be a significant threat to financial institutions, with criminals finding new ways to exploit vulnerabilities. The rise in check fraud incidents highlights the importance of proactive measures to prevent and detect fraudulent activities. All financial institutions should consider partnering with an insurance broker who specializes in tailoring an insurance and risk management program to the challenges facing their industry. Gallagher is ready to help.
