Compliance Corner: Second Quarter 2007

How Banks Can Respond to Counterfeit Cashier's Checks and Money Order Fraud

by Kenneth J. Benton, Consumer Regulations Specialist

It has become an all-too-familiar story for many banks: a customer receives a counterfeit cashier's check or money order from a third party and deposits it into their bank account. In accordance with the Expedited Funds Availability Act (EFAA) and Regulation CC, its implementing regulation, the bank makes the deposit available to the customer by the next business day.¹ After confirming that the deposit is available, the customer delivers the goods to the third party, believing the check has cleared. Later, however, when the counterfeit cashier's check or money order is detected and returned unpaid to the depository bank, the bank deducts the amount of the check from the customer's account or demands repayment if the customer has insufficient funds in the account.

While banks are not legally responsible for the unpaid checks a customer deposits, they can sustain losses if a customer lacks funds to repay the amount of the cashier's check or money order. There is also increased reputational risk from angry customers who were defrauded. This article discusses the increasing level of fraudulent activity related to cashier's checks and money orders and responsive measures banks can adopt to help combat this growing problem. While there are no simple solutions to prevent this type of fraud, banks can help reduce the risk by educating their customers and employees.

In recent years, fraudulent activity involving counterfeit cashier's checks and money orders has increased significantly. Bank regulators are reporting new cases of this fraud on a daily basis. In just the first three months of 2007, Bankers On-Line External Link reported 99 alerts from bank regulators involving new cases of counterfeit cashier's checks. Similarly, in April 2005, the New York Times reported on the surge in counterfeit postal money orders.²

The sharp increase in this type of fraud can be attributed, in large part, to sophisticated, low-cost desktop publishing tools that are widely available today. In addition, because each bank designs its cashier's checks with different papers and security features, neither consumers nor bank tellers have uniform expectations of how cashier's checks should look and feel, which makes it harder to detect counterfeits.

Additionally, fraudsters are exploiting a discrepancy between the deadlines federal law imposes on banks for making deposits available to customers and the actual time it takes to clear checks and money orders. Under section 4002(A)(2)(F) External Link of the Expedited Funds Availability Act (EFAA) and section 229.10(c)(1)(v) of Regulation CC , the implementing regulation for EFAA, banks generally must make a deposit available, up to the first $5,000, by the next business day for the following checks: cashier's, Treasury, money order, Federal Reserve Bank, Federal Home Loan Bank, and state or local government. However, it often takes significantly longer for a counterfeit check or money order to be rejected and returned to the depository bank.

For example, the postal service reserves the right to examine money orders submitted for payment and deny payment if the money order is counterfeit, but it does not specify a deadline, stating only that it has a "reasonable time" to make an examination. Even after the postal service pays a money order, it retains the right to demand repayment within a reasonable time of discovering that it is counterfeit or otherwise defective. The Uniform Commercial Code's (UCC) short deadlines for clearing checks do not apply to U.S. Treasury checks or postal money orders.³ This discrepancy between funds availability and the long period for rejection provides a significant window of opportunity for fraud to occur.

Similarly, for cashier's checks, the deadline for dishonoring a check is governed by the check collection provisions of Articles 3 and 4 of the UCC. In particular, a payor bank is liable for the full amount of a check presented unless it returns the item unpaid by midnight on the next banking day (after the banking day on which it receives the check). While a depository bank is waiting to learn whether a check has been rejected by the midnight deadline, it must still provide provisional credit to the customer the next day after deposit. Moreover, some sophisticated fraud scams use altered routing numbers to intentionally slow the clearing processing.

The law does provide some protection to the depository bank. If the payor bank fails to dishonor a counterfeit cashier's check prior to its midnight deadline, it can be held liable to the depository bank. For example, in the leading case of Northern Trust Co. v. Chase Manhattan Bank, 582 F. Supp. 1380 (S.D.N.Y. 1983),aff'd, 748 F.2d 803 (2d Cir.1984), Northern Trust Co. (Northern Trust) made payment to Chase Manhattan Bank (Chase) on a counterfeit cashier's check in the amount of $473,272.22 drawn on Northern Trust. Two months later, Northern Trust notified Chase that the check was counterfeit and sought to be repaid the amount of the check. When Chase refused to reimburse Northern Trust for its loss, Northern Trust sued. The court rejected Northern Trust's legal theories because it had already made payment on the check to Chase.

As a practical matter, however, it is often difficult for a bank to justify the cost and burden of litigation against the payor bank when only a few thousand dollars are at stake. Moreover, the depository bank's customer is the party primarily responsible if a cashier's check is returned unpaid. The bank will only suffer a loss if the customer cannot cover the amount of the deposited check after it is returned.

However, customers who are victims of fraud are often left angry and confused. Why did the bank mislead them into believing the check cleared by making the funds available without explaining that it was provisional credit subject to collection from the paying bank? Why didn't the bank warn of the possible delay in rejecting the deposit or of the current problem involving counterfeit cashier's checks and money orders? Why should the customer be responsible since the bank misled them by making the amount of the deposit available?

For all of these reasons, it makes good business sense for banks to focus their efforts proactively on preventing fraud scams from succeeding. Educating customers and employees are two steps banks can take to help mitigate the risk of fraud.

Educating Customers
Educating bank customers is the single most important response banks can initiate. Counterfeit cashier's check scams have been successful primarily for two reasons. First, consumers often assume that a cashier's check cannot bounce. Prior to the revolution in desktop publishing, this was a safe assumption. Because cashier's checks are an obligation of the issuing bank, and bank failures are rare, banks historically did not suffer losses on cashier's checks. Indeed, this is precisely the reason Congress specified in the EFAA that a cashier's check must be made available by the next business day.

But now that it has become relatively easy to create a counterfeit cashier's check or money order, customers must be made aware of the risk from these forms of payment and the steps they can take to protect against this risk. This is admittedly a delicate task because banks want to inform their customers of the risks without alarming them.

One method of educating customers is to have bank tellers discuss the risks or provide a brochure when a customer deposits a cashier's check, money order, or similar item. For example, the Federal Trade Commission has created a brochure for banks to provide to their customers, entitled Giving the Bounce to Counterfeit Check Scams.⁴ Important tips for customers include the following:

Understand the difference between provisional credit for deposits that banks are required to provide and the actual time it can take for banks to clear checks.
Examine cashier's checks or money orders carefully for any irregularities. The United States Postal Service has a webpage that describes characteristics of authentic money orders.⁵
Contact banks issuing cashier's checks and money orders to verify whether they have cleared and were issued in the amount stated. Customers are advised to obtain the bank's phone number from an independent source.
Use caution when getting a cashier's check or money order from a third party with which the customer has no prior relationship. For example, a buyer who sends a payment in excess of the seller's asking price in a legitimate classified sale and then asks to have the overpayment wired back is a red flag of fraud. In addition, because it is more costly to ship abroad, and because a buyer has fewer remedies when dealing with a seller in a foreign country, sellers should use extra caution when selling to persons outside the United States.
Remit payment through a payment service when selling items on the Internet. After the payment has been received through the payment service, the customer can safely deliver the goods purchased.

Banks can also post advisories on their websites about counterfeit check scams and alert customers to red flags of suspicious transactions.

Educating Employees
It is also important for banks to educate their employees, and it is especially important to educate tellers. Tellers should be advised when to discuss the risks with customers. The Federal Reserve has issued a booklet entitled Check Fraud External Link , which discusses check fraud issues and adopting electronic check presentment.⁶

The bank's wire department should also be included in any educational campaign. It is important for wire department staff to be trained to recognize suspicious transactions in which bank customers are at high risk for counterfeit check scams. Typically, these scams involve some or all of the following characteristics: a deposit made within a few weeks of the requested wire transfer with a certified form of payment (cashier's check, money order, etc.), a customer who rarely makes wire transfers, and a wire transfer recipient outside the United States. When customers are apprised of the risks, they can take appropriate action to protect themselves, and by giving additional attention to wire transfer requests, banks can target the higher risk transactions.

Conclusion
When EFAA was enacted, counterfeit cashier's checks and money orders did not present a significant risk, but now that technology has enabled individuals to create sophisticated counterfeits inexpensively, shorter hold periods under EFAA present a challenge for banks and consumers. At the recent March 8, 2007, Consumer Advisory Council External Link meeting at the Board of Governors, check holding guidelines and practices were discussed, with a focus on fraudulent official checks, counterfeit cashier's checks, and money orders. Ultimately, the full adoption of Check 21 and electronic payment systems will greatly reduce the use of checks for payment. But in the meantime, banks should focus on educating their customers and training their employees to mitigate the financial impact of these scams.

If you have any questions about this article, please contact Consumer Regulations Specialist Kenneth J. Benton or Supervising Examiner John D. Fields through the Regulations Assistance Line at (215) 574-6568.

The Federal Reserve Board's Consumer Advisory Council
In 1976, Congress directed the Board of Governors of the Federal Reserve System (Board) to establish an advisory committee on consumer issues. In response, the Board established the Consumer Advisory Council. The Council is composed of 30 members from across the country, representing consumers, communities, and the financial services industry. The Board appoints members, who serve staggered three-year terms.

The council meets three times a year in Washington, D.C., and the meetings are open to the public. Several members of the Board of Governors typically attend the meeting along with the director and staff of the Board's Division of Consumer and Community Affairs (DCCA), which develops policies and activities that address financial services industry issues related to consumer protection, financial education, and access to banking services.

The Council provides for regular discussion and debate on consumer issues from the perspective of consumers, regulators, and the financial services industry. As Sandra Braunstein, the director of DCCA, commented at the October 26, 2006, meeting:

"One of the things that the Board members and the staff—that we like so much about the Council—is the diversity of opinion. We have often felt that the purpose of this group was not necessarily to reach consensus on an issue, but it was to air all the views on an issue, because that does help us as we go forward with rulemaking and developing policy and guidelines and other kinds of issues that we are dealing with."⁷

Several weeks after each meeting, the Board provides a full transcript of the Council's deliberations, along with the meeting's agenda, at: www.federalreserve.gov. External Link

¹ The full text of Regulation CC, Availability of Funds and Collection of Checks, is available on the Board of Governors' website. The full text of the Expedited Funds Availability Act is available online at www.law.cornell.edu.
² Tom Zeller, Jr., "A Common Currency for Online Fraud, Forgers of U.S. Postal Money Orders Grow in Numbers and Skill," New York Times, April 26, 2005. Available on the United States Postal Service (USPS) website.
³ The UCC's rules in article 3 only apply to a "bank," which is defined as "a person engaged in the business of banking, including a savings bank, savings and loan association, credit union, or trust company," UCC 4-105(1). In addition, section 42 of Regulation CC specifically states that the "expeditious-return (Â§Â§229.30(a) and 229.31(a)), notice-of-nonpayment (Â§229.33), and same-day settlement (Â§229.36(f)) requirements of this subpart do not apply to a check drawn upon the United States Treasury, to a U.S. Postal Service money order, or to a check drawn on a state or a unit of general local government that is not payable through or at a bank," 12 C.F.R. 229.42.
⁴ Giving the Bounce to Counterfeit Check Scams.
⁵ Please see the USPS website.
⁶ The Federal Reserve's booklet, Check Fraud.
⁷ The full text of the October 26, 2006 Consumer Advisory Council meeting.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.

Compliance Corner: Second Quarter 2007

How Banks Can Respond to Counterfeit Cashier's Checks and Money Order Fraud

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