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Unsigned checks linked to image exchange stoke fraud fears DTN 6/26 Regulators seeking to rein in so-called remotely created checks aren’t going far enough to contain the risk these payment devices pose-particularly when they are processed electronically, says one payments expert. ‘I think they should ban them,’ says George Thomas, Radix Consulting. ‘That’s the ultimate solution.’ Concern about demand drafts, or remotely created checks (RCCs), has been building for several years, but now some regulators & observers fear that electronic clearing processes brought on by Check-21 could exacerbate the problem. Often used by phone marketers, RCCs are checks created by merchants on behalf of customers, who give marketers their account & bank-routing numbers online or over the phone. Customers don’t sign the checks, but merchants are supposed to get explicit authorization before submitting the items for payment. In an unknown number of cases, the items turn out to be fraudulent. Last year, the OCC ordered Wachovia to pay up to $144m in connection with a case in which telemarketers were using accounts at Wachovia to deposit RCCs that ended up bilking millions of dollars out of thousands of unsuspecting consumers, many of them elderly. The settlement, which included a $10m fine, $8.9m for consumer education, & up to $125m in restitution, was the second-largest penalty ever imposed by the regulator. Cases like this, coupled with the electronic image-exchange capabilities fostered by Check-21, have regulators worried. With electronic processing, marketers can turn online payment instructions from consumers into electronic files. These in turn can be formatted electronically into files acceptable to image-exchange networks, resulting in faster clearing & settlement than is possible with paper RCCs. With these electronic items, no paper ever existed. That process has alarmed the Reserve Banks. The Fed notified depository financial institutions that the Reserve Banks will hold financially responsible banks sending electronically processed RCCs that were not imaged from paper originals & that result in fraud losses. The new policy, technically a change in the Banks’ Operating Circular 3, takes effect 7/15. In cases of such fraud, the Reserve Banks are stepping out of the warranty chain that normally controls the processing of check images from banks of first deposit through networks like the Fed’s to paying banks, says Rich Oliver, FRB Atlanta. Without a paper item backing up the image, says Oliver, ‘that RCC shouldn’t have been a Check-21 item in the first place.’ While a 7/06 change to Reg CC, the set of rules that govern the checking system, shifted liability for fraudulent RCCs to banks of first deposit, the Fed policy change specifically targets RCCs that never existed as paper items. It means that when such items turn out to be fraudulent, the Fed will step out of the claims process stipulated by Reg CC, Oliver says. ‘The bank of first deposit will have to fight it out with the paying bank.’ But large fines & liability shifts don’t go far enough, says Thomas. Remotely created checks, he argues, are too dangerous to allow, he argues, because banks too often fail to perform due diligence on merchants & because no automated method exists to track the items. Even the Fed doesn’t know how many RCCs are flowing through the checking system. ‘I haven’t the faintest idea. I’ve actually asked that question & the folks at FRB Fed can’t tell me.’ Only when manually examining certain items returned for technical reasons recently did the Fed realize the items were electronic RCCs, says Oliver. ‘We realized someone was creating an electronic image of a check from a template-they all looked alike.’ With another set of returns, it became apparent that some of the items originated from marketers that had been denied transaction privileges by the automated clearing house system, an electronic payment network that can track returns by reason codes & by originator. Some experts fear that criminals chased out of the ACH are migrating to the check system by means of electronic RCCs, a factor that makes it even more crucial for banks to check out merchants. ‘Nobody wants to do the due diligence,’ says Thomas. ‘You’ve got to know your customer’s customer.’