SPEAKERS CONTENTS INSERTS
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COMPUTER GENERATED CHECK FRAUD
THURSDAY, MAY 1, 1997
House of Representatives,
Subcommittee on Domestic and nternational Monetary Policy,
Committee on Banking and Financial Services,
The subcommittee met, pursuant to notice, at 10:22 a.m., in room 2128, Rayburn House Office Building, Hon. Michael N. Castle [chairman of the subcommittee], presiding.
Present: Chairman Castle, Representatives Lucas, Barr, Fox, Cook and Flake.
Chairman CASTLE. The hearing shall come to order. We expect other Members to arrive and will be here sporadically. That is the way this works, for those of you who are not used to it, perhaps coming and going as we go on. That should not in any way deemphasize the importance of what we are doing, because all of your testimony will be absorbed and processed by staff in terms of preparation, whatever it is, that we end up choosing to do or not to do here.
This is the Subcommittee on Domestic and International Monetary Policy. The hearing is on computer-generated check fraud. I will make an opening statement, and when Mr. Flake arrives, we will offer him the opportunity as the Ranking Member also to make an opening statement. Otherwise we will go to your testimony and then to questions of the Members who are here at the time.
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The security of our payment system, how Americans pay for their purchases and exchange goods and services, is of critical importance to the American economy. American consumers and businesses want to have a high level of confidence that their chosen form of payment is protected from criminals. Unfortunately, from counterfeit money to credit-card fraud to computer-generated phony checks, criminals are constantly devising new schemes for ripping off Americans personally and in their businesses.
How is this occurring and how can we better combat it? That is the question this hearing is intended to answer. This subcommittee has been especially interested in what has become known as the ''Future of Money.'' We want to understand and perhaps guide our progress to newer high-tech forms of exchange. In the last Congress we held a series of four hearings on various aspects of the future of our payment system. These hearings revealed that the future of money no doubt will be electronic, but that progress toward that future would be uneven and occur at different rates in different parts of the world.
While our Nation leads in developing new forms of technology, the United States also stands alone in the modern world in that we still have a banking and clearance system based on paper checks. We love them. So much so that in 1995 we wrote 65 billion of them. The Federal Reserve estimates that it cost more than $2.50 to process each check through the system. That is $165 billion per year that might be better employed, especially when one considers that purely electronic money transfers can commonly be accomplished for less than 2 cents each. Still, we love our paper checks, and Americans are very conservative about money. We all resist change, no matter how persuasive the arguments. Most of us would prefer to let the next generation worry about bits and bytes and stored-value cards as long as we can keep our checkbooks and write free checks.
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The current system is designed to accommodate just this comfort level and most of the Federal Reserve's employees are devoted to the handling and processing of paper checks. Every evening many of them are busy filling Lear Jets with bundles of checks which are then flown about the country from one regional Federal Reserve bank to another, there to be unbundled and reprocessed.
Comfortable as we have become with this system, it is now threatened by technology. The very technology that makes high-tech electronic transfers feasible also allows anyone with a PC, a laser printer, and a paint program of software to generate near-perfect counterfeits of personal and corporate checks. This knowledge has filtered from computer hackers to organized criminal elements, and the estimated losses attributable to this type of fraud last year range from a low of $400 million, only counting certain bank losses, to a high of $12 to $15billion, including individual and retail losses and expenses. More alarming than the total is the fact that it is growing at a very rapid rate, and could threaten the current payment system with unsustainable losses if it is allowed to grow unchecked.
For these reasons we are here to hold a hearing to investigate this threat and to explore what technological and legislative responses might be in order to combat this latest form of high-tech crime. We may never be able to head off all the latest criminal tricks and gadgets, but perhaps we can make their lives more difficult and hopefully the lives of consumers and business people a little safer and more secure.
There will be two panels of witnesses. The first panel will have Kevin T. Foley, Deputy Assistant Director, United States Secret Service, and Charles L. (Chuck) Owens, Chief, Financial Crimes Section, Federal Bureau of Investigation, who will describe the dimensions and growth of this type of criminal activity. They will be followed by a second panel, which will consist of Erik Stein, Vice President and Manager, Risk Management Administration, Great Western Bank of Northridge, California. Mr. Stein represents the Consumer Bankers Association. The American Bankers Association is represented by Boris Melnikoff, Senior Vice President of First Wachovia Corporation, Atlanta, Georgia, an expert on check fraud. Finally we have one example of the sort of technology that can be marshaled to defeat the criminal use of PC technology, Mr. Ed Greene, Chairman of United States Check Company, Inc., who will describe technology that his company licenses to the industry, not only to speed check processing but also to block the fraudulent scanning and counterfeiting of corporate or personal checks.
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At this time let me yield to Mr. Flake, the Ranking Member, for his opening statement.
Mr. FLAKE. Thank you very much, Mr. Chairman, and truly I think that as America has become much more technology oriented and we have seen the advances that have taken place, with computers and even more so as it relates to the banking industry and the financial services industry as a whole, we have some obligations and responsibilities to assure safety for all American citizens, safety against crime and safety against the kind of factors that seem to be suggesting that this is a growing area of concern for criminal activity.
I would ask that you would allow me to submit my statement for the record, as I have another activity that I must do at this moment, and by unanimous consent I will forward whatever questions I might have through the subcommittee.
Thank you very much, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Flake. We appreciate your being here, and we understand the significance of schedule.
At this time we will turn to our witnesses and then come back for questions.
Mr. Foley, we will start off with you, sir.
STATEMENT OF MR. KEVIN T. FOLEY, DEPUTY ASSISTANT DIRECTOR, OFFICE OF INVESTIGATIONS, U.S. SECRET SERVICE, U.S. DEPARTMENT OF THE TREASURY
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Mr. FOLEY. Mr. Chairman and Members of the subcommittee, I am pleased to be here today. I would like to ask that my written statement be submitted for the record, and I am prepared to summarize that statement.
Chairman CASTLE. Without objection, all written statements by any of the witnesses today will be submitted for the record, and we appreciate that. Thank you.
Mr. FOLEY. As a law enforcement bureau for the Department of the Treasury, the Secret Service is tasked with ensuring the integrity of our Nation's financial systems, and to that end the Service is mandated to conduct investigations of criminal activity where financial systems are compromised and the economy of the United States is impacted.
During the past few years we have seen a dramatic increase in the number of investigations relating to the counterfeiting of checks and other instruments. The suspects in these investigations range from amateur opportunists to highly organized groups who target financial systems and businesses nationwide.
The criminals' goal in these investigations is always money, and the means of accomplishing this goal is to spot and exploit weaknesses in our financial systems. They do their homework, their crimes are the result of careful planning and execution, and ultimately they take advantage of financial systems that have been designed to be consumer or customer friendly.
The suspects in these investigations have traditionally been thought of as white-collar criminals, but the days of the purists are over, and the concept of criminal cross-pollination prevails, because more and more we see organized and oftentimes violent criminal groups who have targeted our Nation's financial systems to finance their narcotics trafficking and other inherently violent crimes.
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The use of computers and desktop publishing software has made it relatively simple for criminals to counterfeit virtually any paper instrument or piece of identification, as this Secret Service display indicates, in a matter of minutes, and often it is of better quality than the genuine article. It is a point-and-click crime, user-friendly technology. Level of skill necessary is low, economic gain is high. They use the same technology available to legitimate businesses that can be purchased at virtually any office products store.
What is problematic in the investigations of these crimes is the mobility, the portability of the printing plants. We no longer are looking for the 500pound offset press as we did in the past. We find these operations to be very, very portable, located in the back of vans, hotel rooms, and vehicles. We have also found that desktop systems have provided the criminal element with means of one-stop shopping for financial fraud. It is not uncommon to seize computers that have been generating counterfeit checks, credit cards, currency, identification, in one place at one time, and again, it is not uncommon to have that same computer be used in the cloning of cellular telephones.
These desktop programs have also been used to generate what we call ''fictitious financial instruments.'' They are not counterfeit because they have not been copied from an original, but they have been created to resemble a legitimate financial instrument known by various names: prime banknotes, certified bankers checks, comptroller warrants. Hundreds of millions of dollars of these have been submitted for payment to financial institutions and Government agencies or provided to unsuspecting victims as bogus investment opportunities. These instruments have also been utilized in attempts to collateralize loans and the payment of debt.
Page 7 PREV PAGE TOP OF DOC The solution? The Secret Service believes that the solution to these crimes lies in an enforcement strategy that transcends normal reactive arrest and prosecution response. A pro-active approach must be utilized to identify and correct weaknesses in the system in an effort to reduce and to eliminate the vulnerabilities that criminals exploit. Combating these attacks requires a comprehensive approach, partnerships and cooperation among law enforcement at all levels, the financial community regulators, and the customers. An integral part of this strategy is a process of linking risk analysis to our criminal investigations to identify how these frauds are committed, and through industry partnerships set about to fix or correct these weaknesses. Beyond the role these organizations play, the ABA, the IAFCI, in bank fraud, they also provide a forum for the exchange of information on criminal activities and emerging trends, and this information has helped us to disrupt and dismantle fraud schemes as they occur in real time.
Security features and enhancements, such as check stock holograms, positive-pay systems, and biometrics have been supported by law enforcement and put forth, but financial institutions and businesses must be involved as well in employing know-your-customer philosophies as well as know your employee, which is critical to prevent insider compromise. Training of bank and business personnel is also pivotal in any comprehensive security program. They must be trained to recognize patterns such as unusual driver's licenses, or recently-issued driver's licenses or identification, because they are the initial point of contact in these schemes, and the first line of defense. The public must be vigilant to protect their identification and their checks.
Regular interaction between law enforcement and the financial communities is critical, and in conjunction with that interaction, it is essential to create investigative task forces.
Finally, sir, we have a program in place to deal with these computer-generated checks. It is called the ECSAP Program, the Electronic Special Agent Program, which is a component of the task force. The program is comprised of agents trained in forensic examination. They are strategically placed across the United States in order to retrieve evidence and provide technical assistance.
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In closing, the Secret Service recognizes the effect that counterfeit and fictitious instruments have on the financial community, and we believe a coordinated effort including deterrence training and partnerships must be implemented. We are committed to this endeavor, and I thank the Members for their time and for inviting us to express our views and concerns.
I would be happy to answer any questions.
Chairman CASTLE. Thank you, Mr. Foley.
I would not have the witnesses worry too much about the time clock. We will tell you if it is too long. If you have important things to say, we want to hear them. We do not want to have you too restricted. Maybe that is a guideline more than anything else.
STATEMENT OF MR. CHARLES L. OWENS, CHIEF, FINANCIAL CRIMES SECTION, FEDERAL BUREAU OF INVESTIGATION
Mr. OWENS. Thank you, Mr. Chairman.
I do have a summary statement I would like to offer, and I have also provided my full statement for the record.
Page 9 PREV PAGE TOP OF DOC Mr. Chairman, as the principal Federal law enforcement agency addressing financial fraud, the FBI in recent years has seen a decided shift in the crime problem facing the Nation's financial institutions, from a serious insider-fraud problem which became apparent during the savings and loan crisis, the financial institutions are now experiencing an increasing external fraud problem. As you can see from the statement I have submitted, counterfeit and other fraudulent checks represented over 44 percent of the criminal referrals submitted to the FBI by the financial institutions in fiscal year 1996, which ended September 30. Losses associated with the criminal activity were substantial, however, were less in terms of dollar losses than certain other types of crimes impacting the financial institutions.
With this volume of criminal activity, the FBI, working with the industry, has assessed the problem and has taken steps to address it. Our assessment is that approximately 50 percent of the stolen and counterfeit check activity is driven by organized groups, including ethnic and other domestic groups. Stolen and counterfeit checks have traditionally been considered a local crime addressed by local law enforcement as much of this activity does not meet Federal prosecutive thresholds, and while we continue to rely on local law enforcement to address a large portion of this problem, the proliferation of organized groups warrants attention by the FBI.
We have been aggressive in addressing this activity. We have investigated LeRoy Schweitzer and the Freemen organization and its members and disciples in 23 of the FBI's 56 field divisions for attempting to pass over $1 billion in face value of bogus comptroller warrants, and have obtained numerous convictions, including the conviction of a primary disciple, Elizabeth Boderick, in Los Angeles. She was sentenced to over 16 years in jail for this activity.
Due to effective law enforcement efforts, this particular problem has largely subsided. Our Houston and Los Angeles divisions in related operations code named Paper Caper and Paperson have charged over 50 individuals affiliated with Vietnamese gangs for counterfeiting and other criminal activity. We have used the full range of investigative techniques, including electronic surveillance and undercover operations in these and other similar cases. In one ongoing undercover operation in a major field office in fiscal year 1996 alone, 152 individuals were charged, and $4.7 million in stolen checks recovered. The operation prevented the negotiation of over $40 million of counterfeit checks and other negotiable instruments.
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While we will continue our efforts to combat organized activity in this area and investigate those cases which meet Federal prosecutive guidelines, as well as coordinate our efforts with State and local law enforcement, prevention efforts are critical to stem the increasing stolen and counterfeit check activity. We have supported implementation of inkless fingerprint policies which have been adopted by over 20 State bankers associations for non-bank customers negotiating checks. Where implemented, these procedures have successfully reduced negotiation of stolen and counterfeit checks by as much as 50 percent. We encourage expanding this program and development of other procedures for technological solutions to this problem in order to minimize the level of stolen and counterfeit checks impacting the Nation's financial institutions.
In closing my initial remarks, Mr. Chairman, I would just like to bring to your attention a booklet which has been produced by the Comptroller of the Currency, and the production of this actually resulted from a working group that was formed as a subgroup of the bank fraud working group including various components of law enforcement, regulators, and others, which serves as a guide to check fraud, how it works, and steps that can be taken both by individuals and banks to try to minimize this problem. I think it is a very good booklet, and it is indicative of the efforts law enforcement and the regulators and the banking industry are taking to try to stem this problem.
Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Owens.
Page 11 PREV PAGE TOP OF DOC Let me ask questions, and when we ask questions, sometimes I do not know who could answer it best. You do not necessarily need to both answer in full, so we can try to sort of keep moving as we go along.
Let me start with this point. As you both I am sure know, some banks are starting to use biometric security methods to prevent check fraud, and one of these techniques is the inkless thumbprint on the face of the check by non-accountholders wishing to cash checks. Apparently, as one could expect, check fraud artists do not want to leave behind hard evidence. First Union reports that in Florida, Georgia, and South Carolina, where this technique has been employed, that there has been a reduction of 40 percent in monthly check fraud losses.
With such impressive results, what is the downside of all that? What problems exist with the biometric techniques in general, but the inkless thumbprint in general, and is there a danger that such information might become part of a large data base contrary to the wishes of individuals who do not want such information on record, or do you think that does not matter, even if they are concerned about it?
Mr. FOLEY. First of all, in terms of an endorsement of the system, to some extent, sir, I think that, as you can see, conventional identification is easily obtained and counterfeited, and I think fingerprints assure a positive ID, and it is a strong psychological deterrent. But there are those that I think have some concerns in terms of privacy issues or the connotations of placing their fingerprints much like one would when being arrested on an item. But I think when we work with those people and try to allay those fears and concerns, and also ensure that in our partnerships with the industry and those who would keep these fingerprints in certain data bases that they not be made available as a secondary market, I believe that, again through public awareness and education, that these issues will be resolved. I think that, again, it can be an internal data base, it can be an internal loop, it does not necessarily have to feed into any sort of a criminal data base, and would not, and there are methods and means by which that could be ensured.
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Chairman CASTLE. Your answer prompts a question, and that is, I don't know, somebody maybe touched on it, you may have touched on it, but what is the extent of this problem today versus 20 years ago? The problem ofI mean, I would assume with the use of computers and lasers and various other things that this problem has increased hugely as compared to just forgery, you know, the check forgery and that kind of thing. Am I right about that?
Mr. FOLEY. I could not provide percentages, sir, but I can tell you that again 10 years ago the available means of manufacturing was the offset press. It took a certain level of skill or expertise to accomplish these things. The second method was cut-and-paste. Just in terms of the effort that is involved in that, I think it reduces the amount and the opportunity of these fictitious instruments that hit the street are altered instruments, because that was basically what they were, unless they were manufactured by the offset method. There is and obviously has been a dramatic increase, I think, in this. The volume of checks over the years has increased as well. I think that all has added to this idea of opportunity to use that technology, but for specific figures I will try to obtain those for you and provide it for the record.
Mr. OWENS. I think one of the greatest contributing factors to that has been this proliferation of the organized groups that are involved in this activity in simply taking advantage of the system here. We estimate about 50 percent of the counterfeit check activity, fraudulent check activity in the country is associated with these groups, and with the proliferation of that activity, I think that has been one of the major contributors, and that is why we are attempting to focus our efforts in that area.
Chairman CASTLE. In your testimony you named terrorist groups, identified some terrorist groups, you mentioned ethnic groups, and professional criminals. I assume the ethnic groups also involve professional criminals as well. That is all part of your 50 percent that are doing this?
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Mr. OWENS. Absolutely.
Chairman CASTLE. When we as Members of Congress are faced with a problem like this, a law enforcement problem, we have a great temptation to legislate, to the fear of most of the public. In your opinion, what additional legislation is needed, if any, to better equip law enforcement to deal with this growing problem of the PC-generated financial fraud that we have been talking about today?
Mr. OWENS. I think it is important anytime we look at new legislation as law enforcement entities that we coordinate with the Department of Justice, the prosecutive element there. I do not think lack of statutory authority here has been a problem. I think there are many other problems associated with this activity that make it difficult to investigate and prosecute, but from my perspective, I think we have adequate statutory basis to pursue this problem at this time.
Mr. FOLEY. Mr. Chairman, I agree. There is an array of Federal statutes available, and with your help in the passage of 18 U.S.C. 514 for fictitious instruments, I think that you plugged a hole that was there. Beyond that I think your assistance to the Secret Service in terms of overseas offices has helped us to attack these crimes at their source through the organized ethnic groups. But again, I believe that as we work with the industry ultimately we want to prevent these crimes, and hopefully that issue will go away.
Chairman CASTLE. So the problem is in the technology and just new evolving ways of doing this, or even the problem lies in the use of using paper checks, you know, because we do so much more than most of the industrialized countries of the world. Maybe we should be thinking about some shift away from that. As I said in my opening, I do not think that is a very simple thing to achieve, but when you look at costs and you look at issues of fraud, it would appear that perhaps we should be thinking in that direction.
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Mr. FOLEY. Yes, sir. Also I think that when you go to the next medium, be it electronic ''smart'' cards, you still have the potential, because these are smart fellows. I mean, these organized criminal groups that Mr. Owens referred to are out there to make money, and they will find weaknesses in the system. They will spot any open door or back door in the development of the new ''smart'' card or electronic commerce. We just have to stay ahead of that curve, and again the way to do that is a top-to-bottom overall security system with whatever medium you have to deliver your payments.
Chairman CASTLE. Well, just as long as they are not as smart as you and Mr. Owens, we will be OK. That is all we have to worry about.
Mr. FOLEY. I would not assume that, Mr. Chairman, me at least.
Chairman CASTLE. We will take questions from other Members in the order of their arrival, and Mr. Cook will be next.
Mr. COOK. Thank you, Mr. Chairman. I want to express my pleasure on recently becoming a Member of the Subcommittee on Domestic and International Monetary Policy. You have indicated that we really do not need any new legislation. Did I understand that correctly, that it is simply a matter of continuing to enforce the statutes to grab ahold of this problem?
Mr. OWENS. Yes, I would say it is all of that, and I agree with Mr. Foley also, as well as effective law enforcement efforts here, there has to be an effort with the industry to try to implement steps to prevent the crime.
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Mr. COOK. Well, that is what I was going to ask you. Would there be any need to regulate banks more closely to help solve this problem?
Mr. OWENS. I think there are many things that go into why this problem is occurring, and I will not personally address the need for regulatory reforms, but I think all elements of law enforcement are involved in this problem. Certainly State and local law enforcement agencies traditionally have addressed this problem, and you see an increasing presence of Federal law enforcement again because of the mobility of these criminals, the nomadic nature of many of them, so forth. So I think we have to all continue to work together, but again, I would reiterate from my position at least that statutory concerns are not really that great.
Mr. COOK. Then, when this kind of thing happens, when there is either a personal computer-generated fraud, or these identification document kind of frauds, and they are able to get money out of an account, who is immediately at risk? Who are the victims? The person who owns that account, do they lose that money, or does the bank take that liability? I am unclear as to what happens when someone pulls off something like this. Who are the victims?
Mr. OWENS. It would depend to a large extent on the individual transaction, but for the most part, the banking institutions are suffering the losses here.
Mr. FOLEY. Again, if that kind of a check is presented to a financial institution, the institution would take the loss. If it is presented to a small business, the business would take the loss.
Page 16 PREV PAGE TOP OF DOC Mr. COOK. The taxpayers do not absorb these?
Mr. FOLEY. Yes, sir.
Mr. COOK. I notice that in the new $100 bills there are more security devices, or things contained within them that make it less likely to counterfeit. They are quite different now. I am wondering if there is something we could do with checks themselves that is kind of analogous to what you have been doing with currency?
Mr. FOLEY. Congressman, and this relates back to your question about new legislation, and if I may revisit that, I think that there are an array of statutes available to us, but as we work with the industry and this technology evolves, we may have to revisit that area. Again, this subcommittee has been excellent in that regard in terms of keeping an open door for us to address new problems and provide new legislation, but when we work with the industry and do this, as I mentioned in my opening statement, look at the systemic problems, the regulators, the banks, the public, are all involved in this process.
One thing that we did was become members, because I think we are viewed as the premier law enforcement agency in the area of counterfeit and fictitious instruments, we were involved in the Currency Design Task Force, starting in 1983, to try to get ahead of the curve on this technology, desktop publishing, reproductive technology, and these features that were put into the new currency have application on any paper product as they do with any plastic product, and I think you will see that with our meetings with the industry in terms of check stock there are holograms that exist, there are fine-line printing that exists for some businesses that have checks and issue checks, but there is no standard design, and that is part of the problem. You could potentially walk into a business with a check written on the back of a paper bag, and as long as you had, you know, a signature on there, and the NCIR encoding, you are off to the races.
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Mr. COOK. Thank you.
Chairman CASTLE. Thank you, Mr. Cook.
Mr. LUCAS. Thank you, Mr. Chairman.
Gentlemen, you made the comment about the organized effort to defraud through the use of these kind of instruments. Could you expand for a moment on the groups out there that seek to do these kind of things, and the successes or the challenges that you face in trying to meet this effort? I mean, clearly this is a problem not only from what might be described as criminal groups, but some that might almost be described as anarchy groups who go about these efforts.
Mr. OWENS. There are several problems associated. For instance, we have seen a high degree of this activity occurring in California, principally the Middle District of California, the Los Angeles area. You see that type of activity exported out of that area into other regions of the country.
In my brief statement, I referred to the code named operations Paper Caper and Paper Sun. Paper Sun actually grew out of Paper Caper because we saw the connection of the individuals moving from L.A. into Houston. So you had the interstate activity associated with that problem.
You also have, in many instances, ethnic groups who generally keep things pretty close to the vest. If we do get into the group, it is difficult to gain their cooperation. Identity sometimes becomes a problem associated with these groups. The varying types of criminal activity that they are associated in. The fact that the hierarchial structure of these groups is different than maybe a traditional type of organized element like the La Cosa Nostra. One person in the group doesn't necessarily know the full scope of the criminal activity that is ongoing, so there are multiple problems in attempting to associate with this.
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That is one reason we have tried to use electronic surveillance and undercover operations and proactive techniques to get in there, so we can sort of see first-hand how they are operating.
Mr. FOLEY. Congressman, beyond that, we take the approach, the task force approach, to combating these organized criminal groups because of commonality in language and culture. They are, again, I mentioned the concept of cross-pollination. They are into everything, they are just not into financial crimes. They are into narcotics, weapons trafficking.
We find it brings the collective efforts of agencies with expertise together at the table. We may differ a little in philosophy, we may differ a little in approach. I think that is healthy. My most recent field assignments were New York and Charlotte and Miami, arguably three of the busiest offices in the country. There is nothing better than to bring those elements together at the table and have them discuss means of approaching a problem and attacking a group and I think we are very successful in that area.
Also, our overseas presence. And you, again, this Committee, has allowed us to increase our presence there. That is where we need to go, we need to go to the source and we are with an expanded foreign presence. Because they operate, they send their money back there, the narcotics emanate from there and I think that a total global, transnational approach to this is the way to go.
Mr. LUCAS. Clearly, Mr. Cook brought up a very valid point about who is impacted by this, who really is hurt in this kind of a fraud. Clearly, of course, I can see up front it is the people who own the financial institutions who take the first hit. But by the magnitude of this kind of fraud you then impact the depositors and then, consequently, you impact the insurance that is provided to financial institutions who get stuck with these instruments.
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So all the taxpayerseverybodysuffers from this kind of crime. I think you have a very challenging process ahead of you and I wish you the best of continued success. If these folks are truly successful, then they will undermine the entire system and that is where it is just unacceptable.
Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Lucas.
Mr. BARR. Thank you, Mr. Chairman.
One thing that strikes me in looking at this problem is the vast range of estimates cited in various publications and various times concerning the losses, or so-called cost, of check fraud in the U.S. today of fraud of all types.
Can any of you explain why there are such vast discrepancies in the numbers used and is there any consensus at all on what the totals are so we can get a handle on the true magnitude of the problem?
Mr. OWENS. I know the Chairman made reference to that range from $400 million to $12 to $15billion. The $12 to $15billion figure, I think, is virtually in all of commerce, you know, the losses that businesses take as well as the banking institutions in taking bad checks. So just with regard to the financial institutions, I think that the number is somewhat closer together. But I think that is one of the reasons for the great disparity.
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There is not real good information out there. The Federal Reserve did a survey recently that is most often referred to but, again, it is very difficult to capture exactly what the losses are.
Mr. BARR. So there really isn't any consensus as to what the figures are, what the real magnitude of the problem is other than it is big?
Mr. OWENS. Well, the best numbers with regard to the banking institutions are the most recent Federal Reserve study.
Mr. BARR. Those are, in your view, fairly accurate?
Mr. OWENS. I believe they are, yes.
Mr. BARR. Could either of you comment on any recent trends that we are seeing with regard to international money laundering in this area? Is there anything new that you are seeing out there?
Mr. OWENS. I am not sure with regard to new techniques. Certainly, as Mr. Foley mentioned, a lot of these groups that have ethnic origins outside the country, they continue to transport some of that money outside the country but I am not sure that is really new. I think it has been ongoing as long as this activity has been occurring.
Mr. BARR. I am thinking particularly in terms of computerized banking. Are some of the major cartels really utilizing some of the new techniques, the new technology, the new services that are available for laundering money? I realize that gets off a little bit from the issue of fraud, per se, but certainly that is part of it. I was just wondering, while both of you are here today, if in your experiences you are seeing any new trends that are alarming?
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Mr. OWENS. I would have to research it a little bit. I mean, nothing sticks out in my mind. I mean, clearly there is a huge money laundering problem there and the potential as to how you launder funds is almost infinite and, clearly, the cartels do it but I am not aware of any particularly new twist on it.
Mr. BARR. Mr. Foley, are you?
Mr. FOLEY. No, sir, I am not, no more than Mr. Owens.
Mr. BARR. OK, thank you.
Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Barr.
I want to ask a couple more questions if I can. One of these I will admit a bias to as we go into it, because I did not agree with the Fed's proposal to add an extra day to the clearance of checks at all. But, as you probably recall, the Fed proposed that what is called the Expedited Funds Availability Act be amended to allow an extra day of hold on checks under Regulation CC and it is very controversial and very unpopular among the public. I think deservedly. It seems to be going backward in 1997 to be proposing an extra day with the technology we have.
If the banking industry expects Congress to respond with the requested remedy in this instance, they need to fully articulate their case before the public. I probably will ask this question of the groups coming after you, which are mostly banking representatives, but do you have any comments concerning that in terms of your work? Does that extra day do any work for you?
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Mr. OWENS. In my opinion, clearly, that has contributed to the problem. There are merits, obviously, on both sides of the scale there. But, clearly, the requirement to process those things so quickly has contributed to the problem.
Mr. FOLEY. I can tell you, sir, what is remarkable. We had an operation in Orange County as well, Operation Paper Dragon, and they hit probably 26, 27 cities. The only city that had no fraud was New York and that is because they refuse to take non-customer checks. Every other financial institution that would cash because they had a relationship with the business, would cash those checks, were victims.
I am not sure that answers your question but that gives you an indication that that's out there.
Chairman CASTLE. That raises an interesting point and that is that some banks, particularly in New York, just don't takeNew York seems to have special rules for a lot of things, but they just don't take non-customer checks at all. That means that if you are not a customer of that bank and you walk in, you cannot cash a check.
Mr. FOLEY. That is my understanding, sir.
Chairman CASTLE. Interesting.
You may not know the answer to this, either, and again I may want to ask this of others, but how much of an increase in per-check cost is incurred when adding security features that are now available, such as security threads, watermarks, high-resolution borders and holograms, some of which are shown on this display, some of which we see in the $100 bills? Do you have any sense of the cost of all of that?
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Mr. FOLEY. Mr. Chairman, I don't. I can probably provide that information at a later date. I know there are, obviously, increased costs, but I couldn't give you a figure at this point.
Chairman CASTLE. Thanks.
Mr. Cook or Mr. Lucas, do you have any further questions at this time of these gentlemen?
Mr. COOK. Yes, thank you. Just one quick question.
How much of what you do to enforce these things, or to take action when a bank calls you up and says there has been some hit, somebody has obviously gotten into this person's deposit through a completely phoney checkhow much can the techniques that you use be considered an invasion of privacy? Are invasion of privacy issues going to become more important as this enforcement, obviously, is going to increase?
What rights do you have in terms of going into bank account statements that a lot of people might not totally be aware of, might be upset about?
Mr. OWENS. I don't think these investigations are really different than any others in terms of how we conduct them and the protection of the privacy rights of individuals. It is a matter of gathering the evidence and then using the regular investigative techniques to try to investigate them.
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To the extent that we use proactive techniques, undercover techniques and so forth, there are very stringent guidelines within the Department of Justice on approvals that are required in order to do that, which take into consideration the privacy rights and requiring that there is predisposition on the part of these people to commit the crimes.
So I think that is taken into consideration in this and virtually every other investigation.
Mr. FOLEY. To add to that, we coordinate our investigations with and through the United States attorney and ensure that process, when required, is provided and I think that, as Mr. Owen would say, there is no new twist to these investigations. But we do have strict internal regulations and also are aware of what the law requires us to do.
Mr. COOK. I take it from an answer to a previous question I had before that you are not looking to expand any rights. You are not looking for anything additional in terms of fighting this problem legislatively?
Mr. OWENS. No, but I think with regard to this inkless fingerprint policy, which is a very effective policy and much of a deterrent. I think there is much of an educational process that needs to come to the fore there and when people understand, I don't see that really as an invasion of privacy. In fact, everyone benefits from it.
As Mr. Lucas indicated, the full range of people that suffer, including every citizen, from higher bank costs and taxpayer bailouts if the problem ever rose to that point, everyone benefits by implementing policies like this that can minimize the amount of this crime. I think when people fully understand that policy, they will see that really isn't an invasion of anyone's privacy beyond what would be reasonable to attempt to deter a very serious crime problem.
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Mr. COOK. Thank you.
Chairman CASTLE. Thank you, Mr. Cook.
Mr. LUCAS. Thank you, Mr. Chairman.
You know, gentlemen, I know a lot of folks out there who, when they think about this sort of thing, focus on business checks or on personal checks. But enlighten me for a moment about the problem that may exist on financial instruments drawn on banks, particularly cashiers' checks, those kind of things. What kind of a problem do we have there on fraudulent, nonexisting banks or counterfeit items on real financial institutions?
Mr. OWENS. There is somewhat of a problem with cashiers' checks with traditional financial institutions but a bigger problem we have experienced in the past are some of these fictitious instruments like prime bank notes. Some of these type of instruments which have the appearance of being legitimate instruments drawn on legitimate institutions and the con artists are successful for relatively short periods of time in presenting these types of instruments.
That is really about all I could offer you off the top of my head.
Mr. LUCAS. The reason I asked that, there are instances in my region where people have shown up with rather substantial cashiers' checks drawn on nonexistent banks in efforts to pay off mortgages and large financial obligations.
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Mr. FOLEY. I think, Congressman, that falls into the fictitious financial instrument prime note warrant category. These people don't discriminate. If they can manufacture any sort of instrument that they can negotiate, they will try it.
That is a little more sophisticated, though, in terms of the nature of the scheme. I mean, it is a fairly well planned, well organized, well executed scam. It is like the sting. Again, with the fictitious checks and other commercial instruments, I don't think it raises to that level. But there are organized efforts on both fronts and they will try whatever they can to get away with it.
Mr. LUCAS. And we are focusing on all of those problems across the board from your perspective?
Mr. FOLEY. Yes, sir.
Mr. LUCAS. Thank you.
Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Lucas.
Thank you, Mr. Foley and Mr. Owens. We appreciate you being here and we wish you luck in your pursuits.
Page 27 PREV PAGE TOP OF DOC We will take a couple of minutes here to have the second panel convene and change names around and we will resume in 2 minutes.
Chairman CASTLE. OK, we will resume if we can. I already identified who our witnesses are. Erik Stein is the Vice President and Manager of Risk Management Administration of the Great Western Bank of Northridge, California, and is representing the Consumer Bankers Association today. Mr. Melnikoff is representing the American Bankers Association and is a Senior Vice President of First Wachovia Corporation. Mr. Greene is Chairman of United States Check Company, Inc., and will describe some of the technology that his company licenses to the industry.
So those are our witnesses and we will go across in order and start with you, Mr. Stein.
STATEMENT OF MR. ERIK STEIN, VICE PRESIDENT AND MANAGER, RISK MANAGEMENT ADMINISTRATION, GREAT WESTERN BANK OF NORTHRIDGE, CA, ON BEHALF OF THE CONSUMER BANKERS ASSOCIATION
Mr. STEIN. Thank you. Good morning, Chairman Castle and Members of the subcommittee.
I have 20 years of banking experience, including 7 years managing operating losses, including check fraud, from an administrative level. I am pleased to appear before you today on behalf of the Consumer Bankers Association.
Page 28 PREV PAGE TOP OF DOC Check fraud has long been an area of concern to financial institutions. While the law protects consumers from certain types of check fraud losses, financial institutions which bear the brunt of these losses have had to work diligently to keep up with a constantly evolving array of frauds, including improved counterfeiting. Congress can help by ensuring stiff penalties are available for prosecuting criminals and by providing the bank regulatory agencies with enough authority to alter regulations as may be necessary.
A combined effort among private industry, local, State and Federal law enforcement agencies, consumers, regulators and legislators is essential to combat check fraud. Today, I will focus on protections afforded to consumers under current law and methods used in combating check fraud.
As my written testimony discusses in more detail, most check fraud losses are borne by banks and not by their customers. This is because checks which are counterfeit, altered or bear forged endorsements or signatures are not properly payable and cannot be charged to the customer's account. This rule operates unless the customer's negligence has substantially contributed to the check fraud.
Ultimately, legitimate customers pay for check fraud losses. We actively attempt to mitigate these losses so as not to pass the costs on to our customers. As an industry, we have been proactive in our efforts to stay ahead of check fraud, however, people are very clever when it comes to beating the system.
As you know, modern computer equipment that can be purchased for less than $5,000 makes it easy to create not only counterfeit checks but also fraudulent forms of identification. A significant component of risk mitigation is close monitoring of the effectiveness of policies and procedures which are aimed at preventing check fraud.
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Generally speaking, banks will attribute these losses to three categories, policy and procedure, performance and noncontrollable losses.
Losses that stem from procedural errors are those in which the employee adhered to existing policy but a loss was still sustained. Losses stemming from performance error are those in which a policy is in place but an employee fails to adhere to the policy. In addition, banks are always subject to unforeseen losses.
To prevent fraud within a financial institution, some banks have formal relationships between their human resources and risk management divisions, educational programs to raise employee awareness, procedural control requirements, audit verifications and anonymous tip hotlines.
One longstanding method of combatting fraud is centralized monitoring. Banks track information such as consumer spending patterns and the range of check numbers currently in use. Out-of-pattern transactions alert bank personnel to the potential for fraud. Also, many banks have online systems that flag tellers to unusual activities such as frequent ATM or in-branch withdrawals on the same day.
Signature verification and other forms of identification are good fraud deterrents. That is why some banks won't cash non-customer checks which are not drawn on their bank. Some banks will not cash non-customer checks at their drive-in windows.
Many banks improve their identification techniques by employing inexpensive versions of fingerprinting using a new, nontoxic chemical. Great Western has required inkless fingerprintings for all new account openings and non-customer check cashings since December 1996.
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You may have seen a recent VISA check card commercial featuring Bob Dole, where a local merchant in Russell, Kansas, who knows Bob well refuses to accept his check without identification. Our fingerprint policy is just as strictly enforced.
Our experience has shown relatively high consumer acceptance of inkless fingerprinting and Great Western has experienced significant decreases in check fraud losses projected to decline by 40 percent in 1997 due to inkless fingerprinting as well as numerous other initiatives simultaneously underway.
CBA's members, including Great Western, are also exploring other new forms of technology for improved identification techniques. Many of these are still experimental and very expensive. Progressive identification techniques include PIN pads and biometrics such as digital storage of a customer's voice signature or an image of their retina, iris or fingerprint. These advanced forms of identification are modern versions of having a signature on file.
Many banks also use check scanners allowing them to analyze MICR lines. While poor quality MICR is commonly the result of check mistreatment, it may also identify counterfeit checks. However, this method is not foolproof as criminals now have access to laser MICR toner cartridges and some checks, international checks, for example, don't utilize MICR. Thus this method is only effective in limited cases of fraud and even the number of devices required is often cost prohibitive to financial institutions.
The CBA supports the Federal Reserve Board's recommendation to Congress to amend the Expedited Funds Availability Act to extend the maximum allowable hold period by 1 day. Most CBA members make limited use of the maximum holds allowed under the current regulation and only selectively apply holds when necessary to do so to protect the bank. Our policy is to generally make funds available the following day after deposit.
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Great Western does not plan to change its policy if Reg CC is amended. We, as most CBA members, would make use of the extra day when the bank appears to be at risk of suffering a loss.
It has been my experience that the checks which ultimately result in a loss to banks are consistently received by the bank of first deposit one business day after the maximum standard hold allowable under Reg CC has expired. The ability to extend selectively the hold on these items by one additional day when warranted could significantly reduce fraud losses at my bank.
Thank you for the opportunity to testify before you today. I would be happy to answer any questions.
Chairman CASTLE. Thank you very much, Mr. Stein.
STATEMENT OF MR. BORIS MELNIKOFF, SENIOR VICE PRESIDENT, FIRST WACHOVIA CORPORATION, ATLANTA, GA, ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION
Mr. MELNIKOFF. Thank you, Mr. Chairman, and Members of the subcommittee.
I am Boris Melnikoff, Senior Vice President, Wachovia Corporation. I am pleased to be here today to discuss check fraud as a subject that I have taught for many, many years, but I will not divulge how many.
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Notwithstanding several decades of predictions of a checkless society, check volumes have consistently grown. New payment mechanisms such as credit cards, debit cards, direct deposit have actually complemented the checking process.
With the growth of check volume has increased check fraud. In fact, ABA's Check Fraud Task Force found that over 100 percent increase in check fraud from 1991 to 1993.
In the conservative figures that were mentioned earlier, the $615 million to $15 billion, I suggest that the financial industry's losses have been in the range of $4 1/2 to $5billion. The retail industry is in all probability $4 1/2 to $5billion and, if you look at overall fraud in this Nation, we are looking at $200 billion. Fraud is a major problem.
In addition, the figure excludes losses suffered by many consumers and customers who do not report these fraudulent items in a timely fashion. The industry has been very, very active in its efforts to prevent check fraud and encourages the use of technology to detect fraud, educate bankers and customers on procedures and works closely with law enforcement.
The ABA has been particularly active in this area. For example, I am leaving the Committee a copy of our recent publication which I think is quite good. It is wrapped. Fraud Prevention. Do you have a copy, Mr. Chairman? Very good, sir.
Chairman CASTLE. Bestseller. I have had a copy for some time.
Page 33 PREV PAGE TOP OF DOC Mr. MELNIKOFF. Yes, sir. There is an invoice in this one. Excuse me. No checks.
In addition, banks are sensitive that some of the anti-check fraud measures may be misunderstood by the customer, consumer representatives, the public or the media who may perceive them to be intrusive, inconvenient or offensive. Due to these erroneous perceptions, procedures adopted to prevent check fraud sometimes meet resistance.
For example, taking an inkless fingerprint as my colleague mentioned, for non-customers cashing checks has been criticized as an intrusion into privacy. Equally, requirements for identification to open checking accounts and refusal to cash checks for non-customers have been questioned, even though new account fraud is a tremendous problem that we face.
Some legislators and reporters have failed to appreciate why some banks will not cash apparent Government checks presented by strangers with apparently valid identification. Part of the challenge for banks is to balance prudent check prevention measures and customer convenience and satisfaction. The other challenge in the industry is to educate consumers, the media and lawmakers that fraud prevention is a worthy goal and helps customers and the public in general.
In response to the growing check fraud problem in 1991, ABA established a Check Fraud Task Force. Its purpose is to identify issues surrounding check fraud and to minimize the loss exposure by developing proposed solutions. The 1994 report prepared by ABA's Task Force attributed the increase in check fraud primarily to the proliferation of desktop publishing software and the use of laser printers in the production of counterfit checks. Not only do we have the problems with computers, we have the problem with printers. Legitimate printers are not the problem, it is the illegitimate printer that has the equipment that will produce a check with micro encoding. That is still a problem. And the increase in organized criminal elements.
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The increase in competition among financial institutions creates an atmosphere that has really relaxed adherence to policies, procedures in favor of sales and services. I believe that it will be useful for the subcommittee to understand that in some of the most popular check fraud schemes, check fraud artists rely on two methods of stealing, one from valid accounts or creating bogus accounts.
A check fraud artist will open a fraudulent account and, using it with altered identification or false information about employment, their addresses, phone numbers and things of that nature. Initially these accounts are without fault until they have become familiar with the bank's policies and, in most cases, the thief and the money are gone before the fraud is detected.
Fraud artists also rely on valid accounts. They create counterfit checks drawn on a customer's account. They can chemically wash stolen and canceled checks and reuse them with a new payee and a new amount.
Other check fraud schemes are very simply criminals use counterfit checks. That is really our biggest fraud problem. Altered checks, forged signatures, forged endorsement and stolen check stocks.
The industry is constantly searching for new ways to prevent check fraud, relying on technology, enhanced internal procedures, education and suspicious activity reporting. Fingerprints and biometrics are excellent examples of how technology can be used to detect and deter fraud.
Page 35 PREV PAGE TOP OF DOC Because valid identification is critical for transacting business, counterfit identifications are easily manufactured. Banks and others are looking to fingerprints or other biometrics to verify the identity of these individuals.
While not yet readily available, biometrics are developing and will play a role in the future of fraud prevention. My colleague mentioned hand, face profile, iris and retina recognition.
The cheaper and more familiar identification systems rely on fingerprints. One of the new fingerprint policies is frequently explained incorrectly and has drawn criticism from the media and some individual consumers, privacy advocates and State legislatures. The negative reaction illustrates the public relations challenge for our industry in adopting antifraud policies.
The check cashing fingerprint process is easy, clean, nontoxic and can take a second and actually does indeed reduce the losses. In Texas, Nevada, Alabama, the use of fingerprints has reduced their check losses anywhere from 40 to 80 percent.
For another example, Mr. Barr's home State of Georgia has now incorporated fingerprinting on driver's licenses which are digitized and a record is retained by the State, therefore not allowing individuals to create a new identity or to get State ID cards. That will help significantly.
However, I might add, Mr. Chairman, that the thieves and the fraudsters are pretty good also. They have now developed a way whereby they merely use clear fingernail polish on their thumbprint and then go in and affix that blob, if you will, to a check. Unfortunately, tellers aren't trained to read fingerprints. As long as the mark is there, the item will be negotiated. So all of a sudden, our new technology is being thwarted by old technology, fingernail polish.
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We haven't sat on our duffs in the industry. We have developed products to help prevent check fraud such as positive pay, anti-kiting software, earning warning monitoring systems, direct connection, banking at home, electronic check presentmentwhich allows the industry to transmit the microline to the paying bank prior to the check being received by that bank by at least 8 to 12 hoursso we are doing these things to combat check fraud through electronics.
The micro-encoded readers now availableyou see a lot of them at retail outlets as well as some bankswhere they can authenticate the micro-encoding line. Is it really micro-encoded or is it a laser printer?
These are the technologies that the banks are using.
Finally, the check printers and paper manufacturers have developed check paper stock that is difficult to copy or counterfeit, but I will share with you it is difficult, Mr. Chairman, for a teller cashing a check to determine whether or not the appropriate safeguards are on the item they are negotiating. It is difficult to hold a consumer's check up to the light to be certain there is a watermark, so we still have some obstacles to overcome.
Check printers, depository institutions, corporate customers and individual consumers must protect their check stock. There is no question about it. Identification procedures are both critical in accepting checks and opening accounts. Banks must also evaluate new applications appropriately, educating employees and customers about protecting the check stock. Bank employees must be familiar with acceptable identification and new account procedures and how to recognize counterfeits, the warning signs, and to use the check database services that are available.
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ABA strongly agrees with the Fed's recommendation. While it may not be possible to prove there is a connection with respect to Reg CC and the clearance of items, we still feel that additional day on clearing the item before payment will help us significantly.
Since the 1980's, financial institutions have had to report possible violations of law to law enforcement authorities, bank regulators using criminal referral forms, now called Suspicious Activity Reports. Banks are required to report suspected violations such as check-kiting, check fraud, or other violations that resulted in losses to the institution.
The ABA has worked very, very closely with law enforcement and bank regulators to ensure that we receive current information on the latest check schemes.
The SAR system has proven to be very successful for law enforcement and bank regulators. According to the data recently received from FinCEN, at the 1 year anniversary of filing requirements under the SAR we have filed 76,156 total SAR violations with close to 21 percent of them indicating check fraud and another five percent indicating counterfeit.
This shows an industry committed and dedicated to reporting check fraud.
According to the FBI, check fraud is the second most investigated activity after mortgage loans and 65 percent of all bank fraud cases involving losses of $100,000 or more are committed by outsiders, non-employees. However, the high dollar amount thresholds equates relatively little time spent on investigating check fraud.
Page 38 PREV PAGE TOP OF DOC ABA urges Congress to consider other measures to assist in fraud prevention.
For example, the increasing problem of identifying or taking one's identitywe recommend passage of S. 512, which establishes a new crime of identity fraud. We support that 100 percent.
In conclusion, the ABA appreciates the opportunity to testify before the subcommittee. While gradual migration to electronic payment systems may reduce check fraud losses in the long-term, check fraud will continue to be a problem and check volume remains steady. The criminals invent new techniques to overcome the latest technology, education, reporting, and law enforcement.
We hope that our testimony has improved the subcommittee's understanding of the scope of the problem and the challenge to the bank.
Mr. Chairman, one thing I would like to say is over the years the ABA, the banking industry, law enforcement, and legislators have worked very, very closely on the money laundering problem. We have made great strides through this ability to communicate and understand each other's problems. I certainly hope that you and your subcommittee will look favorably on this and we will have the ability to continue dialogue in this area and hopefully reduce some of these staggering losses.
Thank you, sir.
Chairman CASTLE. Thank you, Mr. Melnikoff.
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Before we go on to Mr. Greene, because we don't have others here, I would like to ask you a couple of questions about the extent of this, because I don't think the public begins to understand the extent of this and I am not sure that I did before.
I wrote this down. Maybe I wrote it down wrong, but did you say the fraud and what we are talking about now, dealing with the check problems, is $200 billion?
Mr. MELNIKOFF. No, sir. I was referring with respect to the $200 billion in all fraud committed in this Nation from, for example, sir, I just happened to, if you will give me two secondscheck fraud, credit card fraud, true name fraud, loan fraud, embezzlements, food stamp fraud, workers' comp fraud, welfare fraud, student loan fraud, invoice fraud, and insurance fraudand that is just skimming the top.
Chairman CASTLE. Do you have that broken down by the amount in each category?
Mr. MELNIKOFF. I believe I have that available in my office, sir.
Chairman CASTLE. Be thinking about this while Mr. Greene testifies. I'll come back to you.
I would be curious to know what the bank check fraud aspect of this is, versus the credit cards, food stamps, as a percentage, roughlyif you could think about that and maybe somebody could help you develop that answer.
Page 40 PREV PAGE TOP OF DOC I am curious as to how big this particular problem is that we are dealing with today.
STATEMENT OF MR. EDWIN B. GREENE, PRESIDENT, UNITED STATES CHECK COMPANY, INC.
Mr. GREENE. Good morning, sir. My name is Edwin Greene, and I thank you, Mr. Chairman, and Members of the subcommittee for giving us the opportunity to discuss how United States Check Company is contributing toward improving check processing in general, and to fight against check fraud in particular.
This morning you have heard much bad news about check fraud. I hope you will find what we have to report is good news.
U.S. Check is in the business of developing advanced automated document authentication and imaging enhancement technology primarily for negotiable instruments. The company has decades of combined experience in document imaging and was the first to patent an ultraviolet scanning method and document imaging enhancement.
I personally have over 30 years experience in document imaging. I have authored several technical publications and have several U.S. and foreign patents in this field.
U.S. Check's mission is to contribute to the fight against check fraud and at the same time facilitate intra- and inter-bank products and services. Our goal? Ways to stop payment of fraudulent checks before they are negotiated; making illicit photocopying and desktop publishing fakes irrelevant; reducing the expense of fraud prevention and make it faster; and to take advantage of new and current standards.
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As you can see by the sample over here on the easel, and I have samples here that I would like to give them up to the ChairmanOKU.S. Check's unique technology adds a strict, machine-readable overlay element to a document but retains virtually all of the flexibility of current check designs. With this technology, the check writing public maintains their important individual choice, yet industry can process the legacy check through the banking system, which looks for one common element on all items for determining authenticity and detecting alterations.
We believe this optimum common element is what we have named UV Smart.
UV Smart was introduced into the marketplace last year. The Chase Manhattan Bank, among others, has adopted UV Smart technology for applications ranging from automated document authentication to forward presentment of images to customers. UV Smart-enhanced systems have already stopped counterfeit checks. Today there are over 15 banks ranging in asset size from $25 million to over $320 billion and more than 150 corporations processing and/or issuing UV Smart-enhanced documents.
It does not appear to us that checks are going away any time soon. As you have noted before, Mr. Chairman, there were over 60 billion checks written last year. Perhaps growth may level off over the next decade but while the check is undergoing an attack as a popular and safe method of payment, opportunity abounds to reinvent the check and make it a safer form of payment by creating a new hybrid document combining both paper and electronics and even using the Internet.
Page 42 PREV PAGE TOP OF DOC I will explain more in a moment and the record we are submitting goes into more detail on these possibilities.
Sophisticated desktop publishing systems are proliferating in the marketplace. Unfortunately, their use is not always for legitimate purposes. By some estimates, fake checks account for over a third of the $12 billion in losses to banks and businesses.
These scanners can duplicate virtually every known security feature commonly used on checks today. However, scanners or color copies are not capable of reproducing features that cannot be seen by the eye, like covert materials that require a light source outside of the visible range to make them visible. Ultraviolet is such a source.
The use of UV technology is well known and accepted as a useful tool in fighting fraud. It is widely used in passport control, currency protection and even on U.S. Treasury checks for passive authenticationthat is, after the item has been processed.
The use of fluorescent ink on selected areas of the document is now a requirement for most checks in the United Kingdom. The American Bankers Association's own Check Security Guideline promotes the use of fluorescent and phosphorescent inks as useful tools in fighting fraud. The Accredited National Standard Committee X9B new technical guideline provides for the use of UV snippets for image-friendly document redesign and as a method to improve the ability for check imaging systems to identify important variable information on the document such as the payee and the amount fields.
Unlike currency, check authentication poses a tremendous problem because of the virtually infinite numbers of designs and colors. Many suppliers to industry have gone to great lengths developing security features for checks. However, in almost all cases every time a new feature or ''lock'' is developed they are simultaneously supplying the key to open that lock. More importantly, current features cannot be easily detected automatically, thus leaving these features to be useful only long after the fact, to prove a phony or altered check may have been paid.
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Industry could move toward establishing more rigid designs such as those employed in systems common in European countries. However, as we mentioned before, we do not think the American public is willing to be forced into such limited choices, nor do we believe it is necessary.
The alternative direction U.S. Check is leading is to add a new dimension to the legacy check. This powerful new dimension adds intelligence to the document, not just a system scanning it. UV Smart can authenticate, detect alterations, identify information the check writer adds, and reduce data transmission and storage requirements by as much as 85 percent over current document-scanning technology.
NCR Corporation, the world leader in item image processing for financial institutions, is represented here today by Mr. Richard Zedeker and Mr. Steve Ebertover hereannounced this March the availability of the UV Smart process on their scalable document processing system. There are also plans for UV Smart authentication-based systems for point-of-sale transactions.
In addition to NCR, U.S. Check has licensed qualified security printers such as Deluxe, Clarke American, Federal Business Products, NCR Systemedia, Standard Register and others to manufacture UV Smart-enhanced documents.
We believe the ultimate solution to significantly reducing fraud is a systematic approach to authenticating documents and capturing images at the first transaction point. This is often referred to as ''truncation at the bank of first deposit'' and would be similar to how the credit card industry works. Truncation will significantly reduce the tons of paper moved between banks every day, but in this transformation industry must also be concerned that it is not trading tons of paper for mountains of unmanageable data.
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In summary, there is no single magic bullet against check fraud. There is no substitute for banks and industry adhering to best business practices. However, if there is one most important element in thwarting fraud, I would have to say it is speedspeed in processing. That is, getting the check or the authenticated information from that check in the form of image snippets back to the paying bank and/or person who wrote it in the first instance before funds are finally made available to the payee.
This is not a trivial task, but we believe UV Smart can go a long way toward helping making this a reality for most of the banking community.
Thank you, Mr. Chairman, Members of the subcommittee, for your time. My colleagues and I would be happy to answer your questions. If you have further questions after this hearing, I would be happy to be of service.
Chairman CASTLE. Thank you very much, Mr. Greene.
I do have a variety of questions and I think to keep it fairly simply I'll ask questions specifically of each of you and then if you want to hold your comments, when I get to you, you could fill in on something you didn't totally agree with.
Let's go back, Mr. Melnikoff, to the circumstances of just where this fraud is.
I would love to see a total breakdown. To me, this is incredible. I mean, we are sitting here and putting up with, if the numbers are correct, $200 billion worth of fraud in this country.
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I mean, you know, we sit here and break our backs over robberies and burglaries and embezzlement and things that don't amount to anywhere near the numbers in the total history of them that these do. Yet we seem to haveand not to suggest that we shouldn't punish those criminals, because it involves personal danger and harm toobut to suggest that we should allow other people off the mat so easily just bothers me. This is a huge number in terms of our economy, far beyond anything the public perceives, so I'll be curious as to the breakdown of it, as to how much of it deals with the issues of the fraudulent checks, the stolen checks, the altered checks, the manufactured checks, the forged checks perhaps, as opposed to the credit card, food stamps or whatever. So let's try to start there and see if we can establish that base.
Mr. MELNIKOFF. Thank you, Mr. Chairman.
To give you the most accurate information humanly possible, my colleagues, Mr. Byrne and Mr. Greco, have agreed that they will present to you, hopefully in less than 30 days, the exact breakdown. We will go back and conduct a thorough industry survey once again in those specific categories you just mentioned, from forgeries to counterfeits, printers versus desktop publishing, and put those numbers together to be certain what we supply you is as accurate as possible.
I also would like to share this number of $615 million, reportedly. That number really consists of what we call large ticketed items, those items that will cause an investigation by the institution.
The smaller items in all probability were never reported. That is really what we have to look at. One more thing in that cost, Mr. Chairman, and that is the amount of money that the financial, as well as the retail, industry spends on their investigative staffs and the tools the investigative staffs need to investigate these crimes, because law enforcement is understaffed and cannot handle, in our opinion, the case load.
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Chairman CASTLE. Let me understand. There are other costs that are indirect costs dealing with this?
Mr. MELNIKOFF. Yes, sir.
Chairman CASTLE. Let me make sure I have the basic numbers right, at least.
What are you saying the annualized basic number on fraud is? I realize it is all a little bit of a guesstimate.
Mr. MELNIKOFF. I'd say approximately for the retail industry, the financial industry, and including the insurance industry, it's reaching $10$15 billion.
Chairman CASTLE. On an annualized basis?
Mr. MELNIKOFF. Yes, sir.
Chairman CASTLE. What percentage of that, and I know this has to be ballpark for now and I appreciate the effort to get us an answer in 30 days that will be more precise, but roughly, what percentage of that $10$15 billion deals with bank fraud and bank issues, check issues?
Mr. MELNIKOFF. I'd say at least 40 percent, minimum.
Chairman CASTLE. Forty percent of that? It's a huge number that we are dealing with.
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Mr. MELNIKOFF. Yes, sir.
Chairman CASTLE. Why doesn't then every bank use fingerprints or other biometrics such as the iris of the eyes, whatever they may be? Is it a cost issue or is it a public resistance issue?
Mr. MELNIKOFF. It's notno. Mr. Chairman, it's not a cost issue. Not at all, sir.
One of the biggest problems, in all honesty, sir, when First Union went to the fingerprinting in the State of Georgia there were demonstrations at their institution. The mediait was played out of hand, sir, and additionally two State legislators decided to introduce legislation where thereby they would prohibit banks or anyone else from doing it, to include the Georgia State Patrol when issuing driver's licenses.
Chairman CASTLE. OK. I mean, personally, if I had my druthers, and this is just me speaking, I would go to the strictest mechanisms we could use for identification, you know, and I wouldn't worry about that extra day for clearance, whatever it may be. I'd make the identification so hard upfront that you wouldn't have to worry about that.
Speaking of that, is it not true that there arewell, I'll ask this question of Mr. Greene, I think.
Let me go to Mr. Stein for a minute. Why do banks cash non-customer checks anyhow? I mean, it seems to me that it was stated earlier that New York doesn't do it, because they probably have greater problems in New York and therefore they save this whole round of a fraudulent process.
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Why do banks in general do this? What kind of customer service is that? Because it is not generally, at least directly to their customers.
Mr. STEIN. We need to define first what we mean by non-customer checks, because you have a group of non-customers with checks drawn on your institution which are considered non-customers. Those are the ones, for example, at Great Western that we're doing the inkless fingerprinting with. You have non-customers who don't bank with you.
Some examples of this, there are many financial institutions who have a branch either nearby or on a military base, so for example, they will cash U.S. Treasury checks for the military personnel. They are non-customers. Those are not checks drawn on them. It is a service that they provide.
Chairman CASTLE. Great.
Mr. STEIN. I don't know of many financial institutions that as a whole cash non-customer checks not drawn on them outside of those limited circumstances.
Chairman CASTLE. OK. You said that there was a high consumer acceptance of inkless fingerprinting in your experience.
I would like to hear more about that as well, because that is one of the issues that will get raised when the customers don't want it or whatever it may be. Now can you expand on that a little bit?
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Mr. STEIN. Absolutely, and by definition what I mean by that is that we didn't have a huge consumer backlash in the two States in which we rolled it out. We have had very few complaints, either formal or informal, with respect to inkless fingerprinting.
I think part of that is for a couple of reasons.
Number one, the States that we're in are California and Florida. California, for example, you have to be fingerprinted to have your driver's license issued. You have to be fingerprinted when you do property title transfers. You are fingerprinted if you are bonded in many industries, such as banking, so consumers certainly in California have become accustomed to providing their fingerprints.
I think that also we did a fairly good job with educational material for the consumer that explained why we were doing it, what happens with it, and so we did not experience the backlash that Boris has talked about with the First Union situation.
Chairman CASTLE. What I am trying to do is ask my questions before I have to run and vote, so I am going to ask for fairly brief answers and I'll let you get out about a half an hour earlier if we do that, so if you can help me, there's just one other quick question.
Are other biometric methods being considered that you know of by the banks with which you deal? Either of you could answer that on a quick basis.
Other than the inkless thumbprints, are you considering irises, those things, at this point?
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Mr. STEIN. There are a number of things under consideration. Part of the issue is consumer acceptance.
We are not sure how avid consumers are going to be about putting their eye up to a scanner and having a laser trace their eye.
Chairman CASTLE. Could that be done without them knowing it?
Mr. STEIN. It's very difficult because the eye really has to be relatively stable to do a proper scan, so there is a consumer acceptance issue.
It is relatively expensive. I know that ATM companies are experimenting with thumbprint or fingerprint scanning for ATM withdrawals and those kinds of things.
It is just not quite there yet. It is a cutting edge technology that isn't ready yet for mass rollout.
Chairman CASTLE. Have to ask people to take their dark glasses off, things like that, right?
Let me ask Mr. Greene a question or two, if I may.
I understand that there are 65 billion paper checks written in the United States annually. There's only 80 billion in the whole rest of the world is the figure that we have up here. I don't know if you have heard that before or not.
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Mr. GREENE. Yes, I have.
Chairman CASTLE. Would a replacement system of payments that superseded paper checks with all-electronic, or hybrid paper plus electronic authentication systems, be more resistent to fraud?
Is that something we should be looking to in the United States? Or should we be looking to it anyhow, just as a matter of ease of transaction of business, or do you perceive there to be as many difficulties in the electronic type of banking as there are with the paper banking we have today?
Mr. GREENE. In my opinion, sir, there are many roadblocks to an all non-check economy. Yes, it could happen, but in my opinion the only way it is going to happen, and I don't mean to be flippant, but if we start today with all newborns and implant a chip in the bellybutton and make sure that every place that sells even so much as a stick of gum has some means of communicating to a central place, maybe by the time those people grow up we may have a non-check business. But in the lack of that I don't see a substitute for it. The paper transaction is just so well ingrained.
Chairman CASTLE. How about places like Florida State University and other schools that have gone completely to using Smart cards for all transactions, where you have 25,000 kids and a whole community that is getting used to it?
How about the Federal Government going to the use of Smart cards, and so forth? Is that going to start to change all of this?
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Mr. GREENE. It may, but again you fall back to that same problem. That means every vendor has to be equipped with a means of accepting that, including the newsstand boy, the shoeshine boy, a beverage store, out in the backwoods. Every place has to be geared to accept that in order for that to be useful to the person who is using it, and yes, it can happen, but it is a long time in coming.
Chairman CASTLE. OK. I don't want to pick an argument on the extra day on the Federal Reserve. We have each established our positions on that and we apparently do not agree. But am I not correct in stating that there are banking entitiesmaybe they aren't directly banksout there which are expediting the clearance? I think I have read that someplace, or am I wrong on that? They are trying to somehow or another move things along even faster, rather than less fast?
Mr. MELNIKOFF. Well, the electronic check presentment, those items are sent electronically, the microencoded lines right after the proof processing are read, they are imaged, and they are shipped to the bank, the payee bank, which in turn has the ability of giving you a yes or a no on that particular item, opened or closed, or NSF, well within the timeframe.
In other words, they get it sooner than physically receiving the item. They get it between 8 and 12 hours sooner. That is a positive step toward reducing that exposure on institutions drawn out of your geographic area.
Chairman CASTLE. I appreciate everything you have said, all of you. I think we have hit upon a subject which is of vital importance. Again, I want to tell you that as far as my own personal convictions are concerned, as the subcommittee Chairman, I am very interested in helping you with this particular problem.
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I think it's absurd that we have all this kind of fraud going on out there. Ultimately it costs every one of us. We all know that and the costs have to be passed on in some way or another and we should deal with it in some sense, so as you go about your business if you find ways that we could be of help to you, I wish you would get back to us and tell us in terms of legislation, and some of that was mentioned today.
Mr. Melnikoff identified some specific pieces of legislation that we should be looking at and we will do that.
We are very interested in what the modern practices are going to be. I think it is important that the public understand better the extent of this problem. I don't think they'd be real happy about it, but I think if they understood it better, perhaps there wouldn't be as much resistance to some of the things that have to be done or sought when one deals with banking instruments, to make sure that we are preventing fraud.
Obviously, a lot of the Members could not be here today. We may have additional questions that we want to submit to you in writing. We hope you will accept those and I look forward to the correspondence on exactly how you understand where these different levels of fraud are.
I intend to, while maybe not making it a crusade, at least making it my purpose to make sure there is a better understanding of all this in Congress so we can deal with this.
I thank you very much for being here. I would say goodbye to you, but I am going to have to do that from here because I have to run out the door and get there in time for the vote.
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Thank you very much. We stand adjourned.
[Whereupon, at 11:53 a.m., the hearing was adjourned.]