Internal Controls

Businesses minimize their risk of check fraud by implementing the following controls. Additionally, utilizing the following controls helps to demonstrate legally that ordinary care has been taken to protect funds.

1. Examine Bank Statements Promptly
It is essential to exercise reasonable promptness in examining bank statements. Consider the situation where a company's checks are used illegally because of a forged signature. If the bank establishes that the company failed to exercise reasonable promptness in examining its bank statement, and if the bank establishes that a loss was suffered because of the failure, the bank has no liability so long as it acted in good faith and was not otherwise negligent. Likewise, an important related rule is commonly known as the repeater rule. If a bank customer does not report a forged signature, and the same thief forges a signature on additional checks that paid more than 30 days after the first forged check or bank statement was made available, the repeater rule becomes effective. In such a case, the bank has no liability on the additional forged checks so long as it acted in good faith and was not negligent.

2. Report Losses Promptly
Just as it is important to promptly examine bank statements, it is equally important to quickly report to the bank any unauthorized payments due to forgeries or alterations. There is one important rule: Bank customers are obligated to discover and report a forged signature on a check within one year, or less if the bank has amended the one-year rule. If the customer fails to make the discovery and report it to the bank within one year, they are barred from making any claim against the bank. This rule applies even if the bank was negligent.

3. Maintain Tight Security Over Your Checks
One of the most important steps any business owner or executive can take is to ensure that all checks are stored safely and securely. Implement the following steps.

• Checks should be kept in an area that is locked and secure. Restrict access to only those persons with responsibility for issuing checks. To strengthen security, we recommend that the keys or combination locks that safeguard checks be changed annually.
• Inventory your check supply quarterly. Keep check boxes sealed until they are actually required for use. Turn the sealed boxes over monthly to ensure that the bottom has not been sliced open and checks removed.
• Keep your check reorder form under lock and key. A stolen check reorder notice has a street value of $100. A forger changes the SHIP TO address and mails it in. In two weeks he has your original checks.

Under Articles 3 and 4 of the UCC, if a bank customer is negligent, and if that negligence contributes substantially to a forgery, the bank may have no liability.

4. Separate Financial Responsibilities for Checks
To minimize the likelihood of embezzlement, it is important that you assign separate check issuing and reconciliation responsibilities within your organization. For example, the persons responsible for check stock custody and preparing checks for signature should not reconcile the monthly bank statements. The following rule underscores the importance of minimizing check fraud by separating financial responsibility.

Revised Articles 3 and 4 of the UCC state that if an employer entrusts an employee with the responsibility to sign, endorse, or deposit checks, and if the employee forges the endorsement of the employer on a check payable to the employer, the endorsement is effective if it is made in the name of the employer. The bank does not have to prove any negligence on the part of the employer. As long as the bank acts in good faith and is not negligent, the bank is not liable for the forged endorsement.

5. Conduct Periodic Audits
It is important to conduct periodic surprise audits of the various check control functions. Audits should test the overall system to ensure it is functioning as it should. Such audits should be conducted by independent, experienced persons trained in systems and theft detection.

6. Use Positive Pay
Positive Pay is an automated check-matching service that will identify any check that was not legitimately issued or has an altered dollar amount. The check issuer sends the bank disbursement information (check amount and check number) immediately after each check run. The information allows the bank to validate check numbers and payment amounts before a check is paid.

Positive Pay is the most effective fraud-fighting tool available today. While many banks charge a fee for this service, you might well consider the fee a type of insurance premium for which the benefits far outweigh the cost.

7. Use Secure Check Stock
Highly secure check stock should be your first and easiest fraud-deterrent tool. Inadequate check security invites forgery and alteration attempts. Insist that your check stock contains at least seven security features, including multi-chemical sensitivity. (See the discussion of security features used by SafeChecks.) The best check papers are reactive to 18 chemicals.

Legal experts agree that check security features could well become an important element of the legal definition of ordinary care. Brent Gorey, an attorney who specializes in the banking industry and the legal aspects of checks, says, "In appropriate cases, a strong argument can be made that the failure by a business to use security features to protect its checks constitutes negligence."