What To Do When Fraud Strikes

Financial institutions have experienced an increase in fraud across various payment methods, resulting in increased losses that tools might otherwise have prevented. Such losses create a question of what to do with the fraudulent funds the bank now holds. In many states, indemnity rules for unclaimed property reporting can make escheatment to the state a valuable solution to remove fraudulent funds from a bank’s custody.

These issues enable financial institutions to revisit their current policies, procedures and processes and respond both to fraud and handling escheatment of fraudulent funds to achieve a best-in-class risk mitigation program in both areas.

Strengthening Fraud Mitigation
Given the recent increase in fraud, financial institutions should incorporate more risk mitigation tools. For example, financial institutions may consider updating their account agreements and disclosures. State laws generally let financial institutions shorten the notification period in their account agreement for customers to notify them of any unauthorized or fraudulent items on their account statements. Financial institutions should also create stronger defenses under state laws by building out disclosures that identify specific security procedures to shift the burden to customers to either require use of these security procedures or acceptance of liability. Several financial institutions are amending or adding dispute resolution procedures to account agreements with customers as an added line of defense.

It is important to review policies, procedures and documentation to confirm a financial institution has processes in place to act quickly. Having updated fraud affidavits, indemnification and hold harmless agreements and demand letters on hand minimize the time between fraud discovery and the request to potentially freeze assets at other financial institutions.
Financial institutions have also experienced considerable difficulty making timely warranty claims on items to other financial institutions. To minimize this risk, the Electronic Check Clearing Housing Organization (ECCHO) provides participating members additional warranties for electronic checks sent for collection that might not otherwise meet warranty deadlines under state law. In addition, the American Bankers Association responded to this problem by establishing a directory that provides contact information for banks needing to send warranty breach claims to other banks. The Independent Community Bankers Association of America has also released a practical guide for altered, forged and counterfeit checks.

Because fraud mitigation requires a comprehensive review across a variety of payment methods, financial institutions should consult outside counsel well versed in these issues to achieve a successful outcome.

Addressing Unclaimed Property
When fraud occurs and the financial institution is left holding fraudulent funds that cannot be returned to the depositor, the question of what to do with such funds arises. Usually, the financial institution cannot claim ownership of the funds. One option is to escheat the funds to the state as unclaimed property. Once the decision to escheat the funds is made, the question becomes when, where and how to report these fraudulent funds.

One part of this multifaceted issue is determining who should be considered the owner of the property. If the original depositor does not have a legal right to the funds, many states’ definitions of owner may prohibit reporting in the name of the fraudster. From there, a financial institution must consult their state-specific due diligence requirements to determine what efforts, if any, they need to identify or locate the rightful owner. If a determination is made that the rightful owner cannot be identified, then, in many states, the property can be reported with an unknown owner. However, state rules on this can vary greatly, so financial institutions should familiarize themselves with reporting requirements.

It’s equally important to ascertain the correct state for reporting. The general rule is that when an owner’s location is known, property is reported to the owner’s state. When an owner is unknown or unlocatable, property is generally reported to where the financial institution is incorporated or headquartered.

Understanding these reporting requirements may require a multistate analysis to ensure that the correct state is chosen, the due diligence requirements are met and the property is truly considered owner unknown or unlocatable before escheating funds to the state.

Additionally, owner unknown funds can complicate the reporting process due to state-specific rules. In some states, classifying property as owner unknown makes ordinary dormancy period rules optional. Additionally, in some states owner unknown property may be reported in aggregate, while in other states each individual property must still be separately reported.

Financial institutions should seek outside counsel to understand the reporting process and communicate with the state as needed to achieve a smooth compliance process.