Why Banks Struggle to Fight Check Fraud

Experts Say Low-Tech Fraud Is a Lingering Challenge for Banks
Why Banks Struggle to Fight Check Fraud

A $15 million check-kiting scheme that flew under the radar of leading banking institutions for more than three years illustrates that check fraud continues to be one of the banking industry's greatest pain points.

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Last week, federal authorities in California arrested 14 of the 15 individuals charged for roles they allegedly played in the check-kiting and account bust-out scheme that ran from February 2010 to October 2013.

The defendants allegedly defrauded top-tier institutions, including Bank of America, JPMorgan Chase, U.S. Bank and Wells Fargo Bank, according to the indictment. None of those banks would comment about the scheme or the steps they've taken to enhance fraud prevention since the scheme was uncovered.

Julie Conroy, a leading financial fraud analyst at consultancy Aite, says check-kiting schemes, which take advantage of the amount of time it takes a bank or credit union to settle a check and ultimately determine it's fraudulent, remain a leading concern for the industry.

"While cyber-fraud continues to grow rapidly, good old-fashioned check fraud continues to represent a point of pain for banks," Conroy says.

Transaction analysis often can help institutions detect check-fraud schemes such as this one. But increased information sharing is critical.

"While the financial industry has done a tremendous job sharing information on cybersecurity issues, as compared to other industries, there is still a significant opportunity to share more information for fraud-prevention purposes," says fraud expert and information security analyst Al Pascual of the consultancy Javelin Strategy & Research. "It's time for the good guys to come out of the shadows."

The Scheme

The latest scheme involved "processors" who fabricated fake checks ranging from $2,300 to more than $28,000, prosecutors say. So-called "brokers" then allegedly found legitimate accountholders by placing ads in Korean-language newspapers and persuaded them to allow the defendants to deposit counterfeit checks into their accounts.

Once deposits were made, "runners" or "washers" immediately withdrew the funds - ultimately busting out the accounts, authorities claim. These runners and washers allegedly used funds from the bust-outs to purchase goods, services and gift cards.

By the time the banks figured out the checks were fraudulent, the funds were no longer available and thus could not be recovered, investigators say.

Pascual says this scheme likely duped banks because the bogus checks were allegedly drawn against legitimate accounts. Without real-time settlement of the checks, there would be no expedient way to determine that the checks in question were counterfeit, he adds.

Difficult to Detect

Shirley Inscoe, a former fraud executive Wachovia Bank who now works as an analyst for Aite, says most banking institutions are adept at detecting check-kiting schemes. This scheme, however, which involved multiple institutions, was unusual.

"Technology is a great tool, but I am not aware of any kiting [detection] system that would have been able to detect a scheme as complex as the one described in this case," she says. "Collusion really does make fraud far more difficult to detect."

"As the number of individuals involved increases and the number of banks involved increases, it is more and more difficult to detect a kiting scheme," Inscoe adds. "These criminals were luring good customers of the banks into participating in this fraud scheme, making it even more difficult to locate the common link and realize that this was an organized crime."

But Avivah Litan, an analyst with the consultancy Gartner Research, says banking institutions are vulnerable to check fraud because they've failed to make adequate investments in solutions designed to curb these types of schemes.

"Check fraud detection systems are woefully behind the curve. Banks have not invested much in them under the theory that check volumes are declining," Litan says. "Still, check fraud is one of the largest categories of bank fraud."

Additionally, it's never a good practice to allow customers to withdraw funds from deposited checks before the checks have cleared. Had the banks impacted by this scheme cleared the checks first, they could have avoided the $15 million in fraud, she says.

The Indictment

All 15 defendants been charged with conspiracy to commit bank fraud as well as bank fraud. The indictment also contains an asset forfeiture allegation, which allows the government to recover any property derived from the proceeds of the scheme in the event of any defendant's conviction.

If convicted on both counts in the indictment, each defendant could face a maximum sentence of 60 years in prison.


About the Author

Tracy Kitten

Tracy Kitten

Director of Global Events Content and Executive Editor, BankInfoSecurity & CUInfoSecurity

A veteran journalist with more than 20 years' experience, Kitten has covered the financial sector for the last 13 years. Before joining Information Security Media Group in 2010, where she now serves as director of global events content and executive editor of BankInfoSecurity and CUInfoSecurity, she covered the financial self-service industry as the senior editor of ATMmarketplace, part of Networld Media. Kitten has been a regular speaker at domestic and international conferences, and was the keynote at ATMIA's U.S. and Canadian conferences in 2009. She has been quoted by CNN.com, ABC News, Bankrate.com and MSN Money.




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