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MRSC FOCUS › Finance Advisor March 2006
 
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MRSC has joined with Toni Nelson, Small Cities Specialist, State Auditor's Office, Gayla Gjertsen, Finance Director, City of Tumwater, and Mike Bailey, Administrator of Finance and Information Services, City of Renton, to bring you the "Finance Advisor" column. The "Finance Advisor" will feature a new article each month with timely local government finance information and advice you can use.*

Check Fraud Risks

March 2006

By Toni Nelson, Small Cities Specialist and Joe Dervaes, Fraud Specialist, State Auditors Office

Bogus Warrants and Checks

It is important for all public entities to understand the risk posed by bogus warrants and checks. Warrant and check fraud in the United States is a $16 billion industry that is growing at the rate of about $1 billion per year. During the last few months, a number of clients have informed the State Auditor’s Office that counterfeit warrants and checks have been presented to their bank for payment. In fact, bogus warrant and check transactions occur almost weekly at a public entity somewhere in the state.

Producing bogus warrants and checks is a simple process. Anyone with a few thousand dollars in computer and peripheral equipment can produce high-quality bogus documents. It doesn’t take more than a day to recover this initial investment.

Banks have accepted responsibility for most of the losses resulting from these fraud schemes because public entities have promptly detected the bogus warrants and checks during the independent party bank reconciliation process. In some cases, banks have detected the counterfeit warrants and checks when presented for payment.

In response to this risk, many public entities have established either “positive pay” or “reverse positive pay” systems at their banks. This is a daily reconciliation of the warrants and checks issued versus the negotiable instruments being presented for payment. While both systems work, positive pay is the preferred method of choice, even though it is the more expensive of the two options.

  • Positive pay. This automated service is provided by banks. It is extremely effective when the entity sends specific information to the bank on days when warrants and checks are issued. The bank compares the documents that come in by number and amount to a file of documents issued by the entity. If the bank has no in-file match, it contacts the entity to determine the negotiable instrument’s authenticity. Two days are usually allowed for this process, but the process works better if the review is performed immediately. Counterfeit warrants and checks are then returned unpaid.
  • Reverse positive pay. This method allows the entity to conduct its own daily matching procedures. Most banks offer customers a daily transmission of paid items that can be compared with the entity’s issued warrant and check file. The entity must promptly research each suspicious document and advise the bank of items to be returned.

If a public entity warrant or checking account becomes the target of a fraud scheme in the private sector, the Fraud Department at Equifax, a check guarantee company, can also put a hold on the account. The company can be reached at 1 (800) 337-5689. The local law enforcement agency should also be contacted. Closing the bank account is another option.

The State Auditor’s Office takes this issue very seriously and wants to make sure that all public entities understand the risk. For example, two cases have been reported in which legitimate vendors created warrants for an employee purchase and a delinquent loan payment.

To counter these threats, public entities must ensure that an independent party performs the bank reconciliation in a timely manner. Entities must:

  • Notify the bank of bogus warrants within 24 hours of redemption. One public entity suffered a $45,000 loss because one of three bogus warrants were not promptly identified. Another public entity identified three bogus warrants promptly and avoided a $450,000 loss.
  • Notify the bank of bogus checks within 30 days of the bank statement date. However, performing the bank reconciliation immediately upon receipt is preferred. One public entity suffered a $26,000 loss because bogus checks were not promptly identified. Two losses were prevented when a public entity and its bank identified a $300,000 bogus check that an individual was attempting to cash, and a bogus check in which the amount was increased from $18 to $4,500.

How people obtain a public entity’s routing and bank account number is critical to understanding the problem. Every warrant and check a public entity issues provides all the information an individual needs to begin a bogus warrant or check fraud scheme. This same information can be obtained from improperly discarded trash. Individuals have been known to pay people for allowing them to optically scan warrants and checks with hand-held devices at or near check-cashing facilities.

We recommend all public entities:

  • Require an independent party reconcile warrant accounts daily and checking accounts immediately upon receipt of the bank statement.
  • Include either positive pay or reverse positive pay procedures in banking agreements.
  • Ensure warrant and check stock meets industry standards and has a sufficient number of security features.

Automated Clearinghouse and Electronic Fund Transfers

A public entity’s bank account information can also be used to create bogus debits or bogus electronic fund transfers. We recently were notified of two cases in which these methods of compromising bank accounts were used. The activity in some bank accounts is by check only. In others, the activity is by electronic fund transfers only.

The Uniform Commercial Code does not cover these transactions. These transactions are final within 24 hours and are covered only by the underlying rules and regulations of the National Automated Clearinghouse Association.

We recommend all public entities notify the bank to filter or block irregular transaction types from their warrant, checking and savings accounts, either totally or selectively.

References

The following references should help you in relaying this valuable information.

These references provide that local government checks and warrants are official public records and must be retained by issuing local governments for six years from the date of issue. The retained record may be either the negotiable instrument or a CD-ROM of the instrument:

This reference requires state agencies and local governments to notify SAO of suspected or known losses (funds and assets) and illegal acts:

These references provide background information on the rules and regulations governing the processing of warrants, checks, automated clearinghouse transactions, and electronic funds transfers. They also cover the dangers of check fraud and the many remedies available to any organization when addressing this risk:

Toni Nelson is the "Small Cities Specialist" for the Washington State Auditor's Office, providing both on and off site financial training and assistance to smaller cities and towns throughout the state. Ms. Nelson has been working with the Auditors office for 6 years and prior to that was the Clerk/Treasurer for a small town for 9 years. She has co-authored the "Small Cities Manual" a detailed reference guide for new clerk/treasurers on governmental accounting procedures and presents numerous training workshops throughout the state for AWC, WFOA, WMTA, WMCA and local/regional organizations such as EWFOA and SCWMCA. Ms. Nelson is also a member of and conference track coordinator for the WFOA Education Committee.

*The Articles appearing in the "Finance Advisor" column represent the opinions of the authors and do not necessarily reflect those of the Municipal Research & Services Center.