Combating Check Fraud: Best Practices for Businesses

Preeti Chaturvedi, Head of Domestic & Emerging Payments HSBC Bank USA, N.A. outlines best practices for combating check fraud, focusing on prevention, detection and reviews the latest strategies corporates are using to move away from paper payments.

Gail Locascio, US Sales Head of Global Payments Solutions HSBC Bank USA, N.A. provides valuable insights into effective strategies with real-world examples of check fraud and how businesses responded by transitioning to electronic payment methods such as Automated Clearing House (ACH), Corporate Cards, and Real-Time Payments.

Understanding Check Fraud

Check fraud remains a significant threat to businesses worldwide, despite advancements in digital payment technologies. As fraudsters become increasingly sophisticated, corporations and businesses must adopt comprehensive strategies to safeguard their financial assets. Couple this with the US economy nearing recession, and high inflation stealing purchasing power from consumers, and you have a perfect storm for a continued fraud pandemic.

According to the US Department of the Treasury¹, check fraud has increased nationwide by 385% since the pandemic. In 2021, financial institutions filed over 350,000 Suspicious Activity Reports (SARs) to FinCEN to report potential check fraud, a 23% increase over the number of check fraud-related SARs filed in 2020. This upward trend continued into 2022, when the number of SARs related to check fraud reached over 680,000, nearly double from the previous year’s filings. Incidents of check fraud are expected to rise this year.

To effectively combat check fraud, it is crucial to understand its various forms:

• Forged Checks: Fraudsters forge signatures to illegally authorize check payments.
• Counterfeit Checks: Fraudulent checks created to resemble legitimate ones.
• Altered Checks: Genuine checks altered to change the payee or the amount.
• Stolen Checks: Using stolen checkbooks to issue fraudulent payments.

Detecting check fraud early is crucial to prevention and involves implementing measures that reduce opportunities for fraud and increase the difficulty of utilizing checks for fraud. Key strategies include:

Adopting Secure Check Stock: HSBC recommends using high-security check stock to help deter fraud. Features to consider include:

• Watermarks: Difficult to duplicate, making counterfeiting harder. 
• Microprinting: Tiny text that becomes illegible when copied.
• Holograms: Visual elements that are challenging to replicate. 
• Chemical Sensitivity: Checks that show visible signs if tampered with by chemicals.

Implementing Strong Controls: Internal controls are fundamental to help prevent fraud. Businesses should:

• Segregate Duties: Separate responsibilities among different employees to ensure no single individual has control over all aspects of check processing. For instance, the person who prepares checks should not be the one who signs them.
• Dual Authorization: Require dual authorization for significant transactions. This ensures that more than one person must approve payments, adding an extra layer of oversight. 
• Automate reconciliation processes: HSBC offers Account Reconciliation and API tools: to automate and promptly detect discrepancies between the company’s records and bank transactions, for example identify gaps in check sequences numbers that might indicate missing or stolen checks.
• Utilize Positive Pay: Positive Pay is a fraud prevention tool provided by HSBC. Positive Pay involves the company providing the bank with a list of checks it has issued. HSBC then verifies each check presented for payment against this list, rejecting any that do not match. This significantly reduces the risk of counterfeit or altered checks being processed.

A mid-sized manufacturing company discovered multiple forged checks amounting to $350,000 over six months. The company took immediate action and froze all check payments and initiated an internal audit. An internal investigation by the fraud response team identified a single employee responsible for forging checks.

Solution: The accounts payable team implemented dual authorization for all payments over $5,000 and adopted HSBC’s Positive Pay services.

Outcome: The company successfully recovered $200,000 through insurance and legal action and has not experienced further incidents since implementing the new measures.

The most effective way to combat check fraud is to reduce reliance on paper checks. The Federal Reserve recommends, whenever possible, switch to secure electronic payment methods².

Converting to electronic payment methods such as ACH transfers, Corporate Card payments and Real-Time Payments can significantly mitigate the risk of fraud.

Automated Clearing House (ACH) Transfers

ACH transfers are electronic payments that move funds between bank accounts through the ACH network. They are secure, efficient, and less susceptible to fraud compared to paper checks. Key benefits include:

Reduced Risk: ACH payments eliminate the physical check, reducing the opportunities for forgery, counterfeiting, and alteration.

Efficiency: ACH transactions can be processed quickly, often within one or two business days, enhancing cash flow management.

Cost Savings: Significantly lower processing costs compared to paper checks.

Case Study: Transitioning to ACH

A large corporate heavy equipment manufacturer who was issuing on average 550 checks each week, fell victim to check counterfeiting, with fraudulent checks totaling $500,000.

Solution: The manufacturing firm worked with HSBC to transition to ACH payments for all vendor transactions. This involved setting up HSBC’s eMarketplace product which informs vendors about the new payment method and converts those paper payments to ACH.

Outcome: Within six months, the manufacturing firm reduced its check fraud incidents by 90%. Vendors appreciated the timely payments, further strengthening business relationships.

What really stood out was the tremendous cost savings. After their 1st year look back, the AP team reported a conversion of almost 26,000 checks to electronic with an annual associated direct expense savings exceeding $300,000. The savings were based on their internal cost review, uncovering an estimated expense of $11.50 per paper check: approximately $0.26 per check for printing and materials, with labor costs ranging from $2.50 to $4.50 per check for handling, signing, and mailing. Postage added an additional $0.50 to $1.00 per check. Bank processing fees averaged $0.75 per check. Operational inefficiencies associated with vendor inquiries, reconciliation, escheatment, stop payments, re submits, overnight mailings etc. significantly elevated expenses in some cases by as much as $50 per check.

Corporate and Virtual Card Payments

Corporate and Virtual Card payments involve using company-issued credit cards for business transactions. This method offers several advantages:

Security: Enhanced security features such as chips, tokenization, and real-time monitoring help reduce the risk of fraud.

Convenience: Simplifies expense management and provides detailed transaction records.

Rewards: Increasing corporate card spend can extend working capital and increase rewards programs that can benefit the business.

A professional engineering services firm encountered several cases of check forgery that resulted in substantial financial losses.

Solution: The firm introduced HSBC Corporate Cards for all routine expenses along with Virtual Cards for one off payments. Employees were trained on the proper use and security measures of the cards.

Outcome: The treasury team saw an immediate reduction in check-related fraud. The detailed transaction reports provided by HSBC also simplified expense tracking and reconciliation.
Moreover, shifting from paper checks to credit cards extended their working capital timeline, reducing the time funds are tied up in the payment cycle. This acceleration optimized their cash flow by delaying the outflow of funds until their credit card billing cycle ends, effectively extending their payment timeline as much as 45 days.

Real-Time Payments (RTP)

Real-time payments enable immediate fund transfer and availability. The RTP^® network provides immediate confirmation of transactions, making it highly secure and efficient. Benefits include:

Speed: Funds are transferred and available instantly, improving liquidity management.

Cost Savings: Streamlined payment processes without the need for expensive physical checks or bank visits.

Security: Real-time payments are digital transactions with detailed data enhancing transparency and are less susceptible to the delays and vulnerabilities associated with check processing.

Case Study: Adopting Real-Time Payments

A global logistics and freight company, suffered from delayed payments and check fraud, impacting cash flow and operational efficiency.

Solution: The logistic companies’ accounts payable team adopted HSBC’s RTP solution for all customer and vendor transactions and integrated HSBC’s Balance and Transaction API capabilities into their existing financial systems.

Outcome: The implementation of real-time payments virtually eliminated check fraud and significantly improved cash flow management. The CFO also reported significant benefits from the enhanced transparency and faster reconciliation processes achieved from the API integration. Vendors and customers appreciated the immediacy and reliability of real-time payments, further strengthening business relationships.

Emerging technologies hold enormous potential to improve financial security. Incorporating APIs with instant transaction processing and notifications to detect and prevent fraudulent activities promptly. Advanced machine learning algorithms analyze transaction patterns in real-time, quickly identifying anomalies and suspicious activities. Blockchain technology, like HSBC’s patented distributed ledger technology, enhances security by creating immutable transaction records, while biometric authentication in HSBCnet ensures the legitimacy of payments processed. Additionally, encrypted QR codes and digital watermarking provide layers of security, making it harder for fraudsters to manipulate or counterfeit checks. These integrated technologies form a robust defense against check fraud in an era of rapid digital payment advancements.

Combating check fraud requires a multifaceted approach that includes detection, mitigation, and response strategies. By implementing strong internal controls, leveraging advanced payment technologies, and maintaining a proactive stance, businesses can significantly reduce the risk of check fraud. Continuous education, regular audits, and a commitment to continued conversion of manual paper-based processes to electronic are essential components of an effective anti-fraud strategy.

Contact your HSBC representative to learn how your business can benefit from increased use of electronic payments.