Selling Positive Pay to Your Bank's Corporate Clients

(2003)

A Checklist: Important Information for Positive Pay Prospects

Selling the concept of positive pay to your corporate banking clients requires educating them on their vulnerability to enormous problem of check fraud, their potential liability and need to comply with standards of "ordinary care," and the ease and low-cost of implementing the preventative measure of positive pay.

By Every Measure, Check Fraud Continues to Grow

Due to the varying ways that check fraud statistics are calculated, industry estimates of annual check fraud cover a wide range. However, It is agreed by industry experts that check fraud is a growing problem and is projected to continue growing for many years to come. Check fraud affects businesses of every type and size.

Industry Statistics Review

• In 2003 check fraud exceeded $20 billion per year, up from $12 billion in 1996 and $5 billion in 1993.
  - Nilson Report
• For the period of April 1, 1996 through September 30, 2003, the FBI received 268,536 Suspicious Activity Reports (SARs) for criminal activity related to check fraud, check kiting, counterfeit checks, and counterfeit negotiable instruments. These fraudulent activities accounted for 47 percent of the 569,294 SARs filed by U.S. financial institutions (excluding Bank Secrecy Act violations), and equaled approximately $8 billion in losses.
  - FBI Financial Institution Fraud and Failure Report - Fiscal Year ending Sept. 30 2003.
• Recent Secret Service investigations indicate that there has been an increase in . counterfeiting of corporate checks and other negotiable instruments . created with the use of computer technology. The US Secret Service estimates $5 billion a year in the United States alone is the toll of check fraud. In fact, the chief of the agency's financial crimes division calls check fraud "the number one way criminals today are attacking our financial systems."
  - U.S. Secret Service
• The top 1,000 U.S. companies have been surveyed, asking them to rank the crimes that hurt their business the most, both internally and externally. Check fraud made the list approximately 10 years ago, when it ranked ninth. Today, it ranks second.
  - KPMG International
• Check fraud ranks second, behind embezzlement, on the list of crimes that most hurt America's top 1,000 companies.
  - 11/02 issue of the American Payroll Association's PAYTECH magazine
• Check fraud is among the fastest-growing problems affecting financial institutions with check fraud attempts at U.S. banks reaching $4.3 billion in 2001, almost twice the $2.2 billion in 1999.
  - 2002 ABA Deposit Account Fraud Survey Report
• More than 500 million checks are forged annually in the U.S., with losses totaling more than $10 billion.
  - Ernst & Young
• Losses from check fraud are expected to grow by 2.5 percent annually in the coming years.
  - American Banker magazine
• Check fraud and counterfeiting are among the fastest-growing problems affecting the nation's financial system.
  - National Check Fraud Center

Why Is Check Fraud Growing?

The unfailing popularity of paper checks is one reason check fraud is booming. Banks have been working hard to transition customers from using paper checks. However, bank customers continue to use checks in very high number. Banks have discovered that many customers prefer paper checks to debit cards, automatic bill payments, electronic banking, and other alternatives intended to reduce the volume of paper checks. One reason for the ongoing popularity of paper checks is the benefit provided by the float period that provides additional time for bank customers to deposit funds or earn interest on account balances. Customers also value paper checks as a tangible record of cash disbursements.

Newer bank regulations, that require banks to make funds available within 2 days for local checks and within 5 days for out-of-town checks, are also a factor in the proliferation of check fraud. These regulations, and competitive pressures to accelerate availability, encourage banks to make funds available for checks before those checks have actually cleared, and this makes it easier for criminals to successfully negotiate fraudulent checks.

Another reason for rising check fraud is the availability of low-cost, professional desktop publishing and copying technology. Using color copiers, laser printers, scanners and publishing software, counterfeiters can easily create excellent-quality duplicate, forged, or amount-altered checks.

Types of Check Fraud

Businesses remain the primary targets of check fraud professionals - especially by organized rings of criminals. In terms of counterfeiting and alteration, payroll checks and accounts payable checks are big targets. Counterfeiting/duplication, alteration, forgery, paperhanging, and check kiting are some of the more popular forms of check fraud.

Liability and Compliance

Unfortunately, check fraud is a relatively low-risk crime that goes unreported or unprosecuted much of the time. Because of demands on law enforcement, prosecutors fail to pursue 75% of bank check fraud cases. And according to the U.S. General Accounting Office, in major cities where there is greater emphasis on using resources to prosecute violent crime, the number often exceeds 90%.

UCC Regulations Define the Rules
It is important for a bank's corporate customers to be aware that check fraud is no longer the exclusive concern of financial institutions. 1990, revisions in the Uniform Commercial Code (UCC) introduced the concepts of comparative negligence and relative standards of care related to whether a bank or its customers would be liable for check fraud losses. All but two states ratified the revisions by 1993, the goal of which was to make banks and disbursing corporations allies in the war against check fraud. But the actual consequence of the 1990 changes has been to make banks and corporate treasurers adversaries in finger-pointing battles (and sometimes court cases) over whom is to blame when check fraud occurs.

Between a bank and its corporate customer, liability for losses resulting from a counterfeit or forged check is governed by Articles 3 and 4 of the UCC. When a paying bank pays a counterfeit or forged check, ordinarily it will bear the loss resulting from the payment. However, the UCC revisions have incorporated subtle (but important) changes in language and in definitions that can act to shift liability for check fraud back to the companies that initially wrote the check in question.

According to UCC Section 3-103 (7), "ordinary care" now requires corporate customers to follow "reasonable commercial standards" prevailing in their area for their industry or business. Under 3- 406, if they fail to exercise "ordinary care", companies may be restricted from seeking restitution from their bank if their own failures contributed to a forged check or alteration. Additionally, Section 4-406 requires that customers exercise timeliness in reconciling bank statements and promptly notifying the bank if payment has been made on a counterfeit or forged check.

Unfortunately for many corporate customers, the banks' duty to provide "ordinary care" no longer necessarily extends to inspecting signatures. According to industry sources, over 64 billion checks are cleared in the U.S. each year, a task that is performed by high-speed reader-sorters that process up to 2,400 items per minute. With the number of checks being processed, "sight examination" is many times impractical and is not an automatic reason for a claim of bank negligence if a bogus check slips through the system.

To encourage corporate customers to utilize special check security measures such as positive pay, banks have begun to insert statements into their deposit agreements that absolve them from liability when those measures are offered to their customers, but are not utilized. Under such an agreement, a bank would be protected in paying a check that had been verified using positive pay and would be justified in refusing to pay checks that do not pass the security screens. Although the UCC prohibits a bank from disclaiming its responsibility (or limiting its damages) for lack of good faith or for failing to exercise ordinary care, the UCC rules don't prevent parties from agreeing to shift more liability from the bank to the account holder.

What can be done about it?

Positive Pay Is a Way To Successfully Combat Check Fraud
Banks and large businesses are protecting themselves and are promoting a technique called positive pay as a method of fighting check fraud artists. Generally speaking, positive pay works like this:

• 1. Using accounting and database software, a company regularly sends its bank a positive pay file that lists all the checks written against that company's account(s). That file includes a record of each check's issue date, amount, check number/account and payee name.
• 2. When a check reaches the bank for payment, the bank compares the check against the positive pay file. Any discrepancies in a check's information trigger a flag that the check in question may have been altered.
• 3. The bank notifies its corporate customer that the discrepancy has been noted and asks the company to verify the authenticity of that check.

The Positive Pay/Check Clearing Process
The issuing company (maker) sends checks to its suppliers and transmits an electronic positive pay file to its bank (paying bank).The positive pay file sent to the paying bank must include records of all checks written and must be regularly transmitted to effectively detect potential fraud.

Since checks are paper-based documents, they are inherently subject to theft, forgery and alteration, from both internal and external sources. The recipients of the checks deposit those checks with their respective banks (depository bank), which then submit them for payment to the paying bank. If the paying bank finds that a check does not match the electronic file previously received from the issuing company, the paying bank notifies the company of the discrepancy.

According to FBI statistics, most check fraud occurs externally. The potential for the largest dollar losses comes from forged (never issued) checks that are presented for deposit. The issuing company (maker) reviews the check and either OKs it for payment or notifies the paying bank not to pay the check. If upon review the check is not authorized for payment, the paying bank returns the check to the depository bank and the altered check is either not paid or is now the responsibility of the depository bank. By adopting a positive pay strategy, companies can substantially limit their exposure and potential liability for fraudulent checks.

But is Positive Pay an Affordable Solution for Every Size Business?

Yes! AP Technology's SecurePay positive pay software provides the answer your corporate clients are seeking.

To date, positive pay has been primarily adopted by large companies left vulnerable to check fraud by virtue of their high-volume check-writing needs. Each of these companies has spent literally tens of thousands of dollars to integrate their accounting systems with their banks' individual positive pay applications. The complexity of positive pay implementation has been further compounded by a lack of industry standardization and has resulted in a plethora of file transmission requirements based upon individual bank specifications.

Due to the high implementation costs, only a small percentage of the small and mid-size businesses that comprise 90% of corporate America have been able to adopt a positive pay strategy. Despite aggressive efforts by many banks to enroll their corporate accounts in positive pay programs, most companies have a difficult time converting check data into the format required by their bank. They lack the necessary financial and/or technical resources and must rely on expensive outside sources for custom programming to perform this daunting task.

SecurePay: The Industry's First Universal Positive Pay Solution
SecurePay provides any size business with a way to quickly and economically implement positive pay. The SecurePay solution will generate check issue files directly from your client's accounting application and transmit them to your bank per specification. SecurePay is compatible with virtually any accounting application and operating system - providing the flexibility required as a company grow or change. In addition, with multiple security levels, file encryption, and an encrypted login screen, your clients are assured of the highest possible level of security when creating and sending their positive pay files.

For more information about SecurePay or a product demonstration, please contact Donovan Perkins at 1-800-258-5901 or dperkins@acuprint.com.