A couple of years ago, BancInsure paid a fidelity claim involving the “head bookkeeper” for a bank. She was a long time employee of the bank and was very knowledgeable of the bank’s customers. She began transferring funds from various customers’ checking accounts to her own account by the use of internal debit and credit memos and using the funds for her own personal use. She would utilize accounts, generally of elderly customers, that she knew statements were not being mailed to the customers or she would intercept the statements before they could be mailed to them.

On occasion she would use a counter check made out as though it was being drawn on her checking account, but she would MICR encode the check with the account number for one of the accounts she was utilizing to perpetuate her fraud. When the check was processed, naturally it posted to the account of the MICR encoded number and not the head bookkeeper’s account.

The scheme continued for several years until one day a customer received a statement that contained an unauthorized transaction. The customer came to the bank to inquire as to the nature of the transaction. The head bookkeeper was not in the bank. The bank officer responding to the inquiry called the head bookkeeper at home and she confessed to the embezzlement.

At the time of discovery the embezzlement was over $238,000. The bank was able to recover approximately $55,000 from the head bookkeeper. After the application of the bank’s deductible, BancInsure paid approximately $158,000 for the loss. Because the bank had purchased claims expense coverage, BancInsure reimbursed the bank an additional $16,500 for their expenses of documenting their loss.

There is nothing unique about the situation described above. Similar embezzlements have happened before and will happen again if proper internal controls are not in place. However, this true story re-enforces the need for sufficient fidelity coverage with an appropriate deductible and proper internal controls. In addition, the bank had wisely purchased claims expense coverage. Employee embezzlements that have been on going for several years can be very time consuming and expensive to investigate. Often times, as in this case, it requires the hiring of outside accountants or consultants. BancInsure’s Claim Expense Rider provides coverage for reasonable expenses incurred in preparing a covered fidelity claim subject to its terms and conditions of the bond.

While the bank had sufficient fidelity coverage with an apparently appropriate deductible, the internal controls were lacking.

Some of the internal controls to consider are:

1. The use of internal debit and credit memos should require supervisory review and approval.
2. Access to MICR encoding equipment should be limited.
3. All entries to customer accounts other than computer generated entries (interest calculations, etc.) should flow through a teller window. Tellers should not process their own transactions.
4. Account statements on all accounts should be mailed periodically.
5. Employees should be required to be absent from the bank for two continuos weeks each year.
6. Bank should consider review of employee accounts by the internal audit department or other independent persons for unusual activity. (Be careful of privacy concerns.)

These and possibly other internal control methods or procedures will assist your bank in avoiding situations similar to the one described above.

We trust that these comments have been helpful.

BancInsure has become a leading writer of Financial Institution Bonds in the United States by providing a sound, stable market, excellent service and fair claims treatment. If you would like to learn more about BancInsure’s Financial Institution Bond or other coverages, please contact your BancInsure marketing representative.

BancInsure recently has received two unrelated claims involving altered checks, one from California for $57,420, the other from Texas for $100,793.50. The alterations were virtually undetectable. In both cases the bankers called the bank upon which the checks were drawn and were assured that the account was valid and that there was sufficient funds to pay the check at that time. In both cases the checks in question were accepted for deposit and the maximum allowable holds were placed on the amounts deposited. The bankers even called to verify that the checks had been paid before releasing the holds. However, when the checks had made their way through the check clearing system and had been sent to the makers in the checking account statements, it was discovered that the payees of the checks had been altered. Naturally the altered checks were returned to the banks of first deposit with a demand for reimbursement. By this time the funds had been removed from the accounts and were not recoverable from the depositors.

Both of these cases appear to be “Nigerian check scams.” “Nigerian check scams” typically involve the illicit transfer of funds that often end-up in Nigeria through the use of altered, forged or counterfeit checks. The scam involves the enlistment of an accomplice or duping an “innocent” third party into depositing an altered, forged or counterfeit check into his or her checking account and transferring the funds, often by wire transfer, to a third party, usually an overseas entity. When the check is returned as altered, forged or counterfeit, it is very difficult, if not impossible, to recover the funds.

In the California case, the depositor, who had been a customer of the bank only a few months, wire transferred $52,000 to a company in Spain and issued a check for $5,000 as soon as the funds were made available. The check was returned as altered. It does not appear that the bank will be able to recover the funds from the depositor. It appears that the depositor only netted $420 from the deal.

In the Texas case, a long time customer deposited what the bank knew was a suspicious check. The bank held the deposited funds as long allowable, verified with the bank that the check had been paid before releasing the funds. As soon as the funds were available the depositor, through a series of wire transfers, sent the funds to overseas entities. The check was returned as altered. We understand that the depositor was promised a large payment for his assistance, but it appears that he did not receive anything. We further understand that the depositor is in jail on unrelated charges and there no funds available for to repay the bank.

Legal proceedings may result in both the above cases to determine legal liability.

Contacting the bank that a large, unusual or suspicious check is drawn on to verify that it is a valid account and that sufficient funds are available to pay the check at that time is a prudent procedure. However, as one can readily see from the above that may not be enough. In addition to contacting the bank on which the check was drawn, you should consider contacting the maker of the check to verify the amount of the check and the payee.

For years it has been the custom and practice of many bankers to grant immediate deposit credit for other banks cashier’s checks even though they may not be drawn on a local area bank. Some bankers have expressed the belief that banks are required to give immediate credit on other banks cashier’s checks. This practice and belief may have presented little risk in the past, but we recently encountered a situation that indicates that banks should review their practices and procedures in this area. One of our insured banks experienced a loss due to giving immediate deposit credit on a number of counterfeit checks including cashier’s checks.

This story begins with the opening of a checking account with a cash deposit of $200. The account had very little activity for approximately seven months. After the account had been open about seven months three electronic transfer deposits were received totaling approximately $11,000. Approximately three months later the customer deposited two cashier’s checks totaling approximately $31,000 drawn on a relatively small bank located about 1,500 miles distant from the bank.

The bank allowed immediate deposit credit for these items and four checks totaling approximately $26,000 cleared the account leaving a balance of approximately $5,500. Several days later the two cashier’s checks that had been deposited were returned as “Counterfeit.” Because the employee handling the return items was new, the significance of the return of large items as “Counterfeit” did not set-off any “alarm bells.”

The same day the first two cashier’s checks were returned, the customer deposited a third cashier’s check that later turned out to be a “Counterfeit” in the approximate amount of $37,000. This deposit covered the charge back of the first two counterfeit checks and provided additional funds. Again the checks were paid from the additional funds, before the third cashier’s was returned as “Counterfeit.” This resulted in an overdraft of approximately $38,000.

The overdraft was “covered” by another fraudulent deposit of $100,000 not involving bank cashier’s checks. Subsequent activity occurred and until the bank recognized the activity and was able to return a number of items as being drawn on uncollected funds. The final loss was approximately $59,000.

BancInsure provides coverage for certain losses due to counterfeit checks, including cashier and other official bank checks. However, neither BancInsure nor any other insurance company that we are aware of provides coverage for losses due to the payment of checks or withdrawals of funds on uncollected funds, except for check kiting when the coverage is available and purchased. The loss described above is due to the payment of checks on uncollected funds. Therefore, unfortunately, BancInsure was not able to pay the loss.

The decision of whether or not to give a customer immediate credit for deposit, or how long of a hold should be placed on a particular deposit, is decision that should made on the basis of the relationship with the customer, the nature of the items, competitive considerations and possibly other considerations. In evaluating the risks involved one should understand that there most probably would not be any insurance coverage for losses due to the withdrawal of funds or the payment of checks on uncollected funds.

The Uniform Commercial Code sets forth time requirements for the availability of funds deposited into an account. Federal Reserve Regulation CC provides additional provisions and pre-empts the Uniform Commercial Code. Regulation CC allows for, but does not require holds on the availability of funds of up to eleven days on certain items depending on the circumstances of the deposit. If you are not familiar with the provisions of the Uniform Commercial Code and Federal Reserve Regulation CC, we suggest that you consult a compliance specialist.

As mentioned earlier, the risk of loss from counterfeit checks is probably greater today than in the past due to the easy availability of computer scanners and desktop publishing. It is now possible to scan a cashier’s check or other check into a computer, make changes and produce a very authentic looking check. It is also possible to simply create a check on desktop publishing. BancInsure’s Financial Institution Bond includes coverage for certain losses due to counterfeit negotiable items, including official bank checks.

BancInsure has become a leading writer of Financial Institution Bonds in the United States by providing a sound, stable market, excellent service and fair claims treatment. If you would like to learn more about BancInsure’s Financial Institution Bond or other coverages, please contact your BancInsure marketing representative.