In an ominous new scheme, some telemarketers are taking advantage of the nation's automated check-processing system to withdraw funds directly from customers' checking accounts.
The scheme has prompted the Federal Reserve Bank of Richmond, which includes Baltimore, to issue a warning to its members at the request of the FBI. The new practice, the Fed warned, "presents opportunities for fraud that are hard to detect and that may expose financial institutions to large losses."
Those consumers who are victims of the scheme may not discover that money has been taken out of their checking accounts until they receive their bank statements, or may find the amount is more than they had agreed to pay.
Some may find they have paid large amounts of money and don't receive what they expected. They also can face a hassle trying to reconcile the loss with their banks.
Anthony Adamski, of the FBI's Financial Institutions Fraud Unit, said the agency just recently got wind of the scheme.
"This particular demand draft we became aware of here at headquarters about three weeks ago," he said. The FBI alerted the Federal Reserve, the comptroller of the currency and Federal Deposit Insurance Corp., he said.
The telemarketers, many of which are selling various types of questionable credit programs for between $100 and $200, sometimes obtain checking account numbers by telling people they need financial information about them. In other cases, they encourage people to pay for their programs by giving them their checking account numbers so they can "electronically transfer" the funds.
The companies, however, are using demand drafts, paper forms that resemble checks and that are encoded with the numbers necessary to go through the processing system.
They bear no signature and have no written preauthorization from the account holder.
Drafts are required to bear a signature to be properly negotiated, according to John S. Frain, assistant vice president for check operations in the Baltimore office of the Federal Reserve, and to Steven Lovejoy, a state assistant attorney general.
Asked if practitioners of the scheme have figured out how to take advantage of automated check processing, Frain said, "You're absolutely right."
In general practice, checks are handled by machine and aren't examined for signatures.
"As much as everybody talks about a signature, if you're dealing in a large number of checks, you're really only reading the micro line [the numbers imprinted across the bottom of a check]," Frain said.
"It should not be happening," said Rita M. Bladow, a spokeswoman for the American Bankers Association and a vice president at First Interstate Bank in Portland, Ore. "It's all over the United States."
"It looks like a check," Bladow said, adding that normally the draft is not detected until it shows up in the customer's bank statement.
"It would not pass muster," commented John Bowers of the Maryland Bankers' Association.
Traditionally, telemarketers of credit programs have sought to charge fees to a person's credit card or have them call a 900 number, where the charge appears on their phone bill. Both methods give the consumer an opportunity to contest the charge and can result in a chargeback to the company.
Some accept payment by money order or personal check. These methods give the consumer a chance to change his mind and also slow up the process.
A demand draft, however, allows the relatively quick transfer of funds. A draft deposited locally would be processed the next day, Frain said, and those from other parts of the country in no more than three days.
Typically, the telemarketer asks the customer to read the strip of numbers across the bottom of one of his checks. These numbers, known as the magnetic ink character recognition (MICR) are printed in magnetic ink and contain a bank's transit and routing numbers as well as the account number and check number.
Using a magnetic imprinter available in office supply stores, the telemarketer then prints the consumer's number at the bottom of the demand draft.
"Basically it's magnetic ink on a ribbon, like a typewriter," Frain said. "You can get a table-top model for $400."
From there it follows the normal routing procedures and is processed just like a check -- even though it doesn't have a signature.
While high-end check encoders costing in the thousands typically are purchased by banks and data processors, some companies, Frain said, would buy these small machines for various reasons, such as to save bank charges by doing their own encoding.
The warning from the Richmond Fed came in a letter from president Robert Black.
"Banks in several parts of the country, including the Fifth District, have reported this problem recently," he wrote. "In opening business accounts, unscrupulous operators may not tell banks that they are telemarketers or draft processors. Under a variety of pretexts, some extract checking account information from consumers and print unauthorized drafts or drafts in unauthorized amounts. They deposit these drafts, often a large number of them, just before closing time, and wire the funds out as soon as they are allowed to do so."
To make matters worse, Black said, "banks may unwittingly facilitate the scheme by manually repairing inexpertly printed MICR-lines on fraudulent drafts that their automated equipment rejects."
Banking officials stressed that consumers should not give out information about their checking accounts over the phone. Anyone who does and believes such a draft will be processed against his account should contact his bank immediately.
One Vermont man, who said he realized he had been misled as the telephone transaction was coming to an end, notified his bank, which changed his account number immediately. When the draft appeared, it was rejected by the bank's computers.
People who find unauthorized transactions in their bank statement also should contact their bank, which will then return the draft to the bank in which it was deposited, banking officials said.
The appearance of the new scheme also prompted Visa International's security department to issue a fraud alert to the Federal Reserve in California.
"It's brand new. It was just detected," said Visa spokesman Gregory Holmes.
The alert said that Visa Security had also confirmed one attempt by a telemarketer to open an account that would have transferred funds electronically though the Automated Clearing House Network. The ACH, a nationwide system set up by the banking industry, allows transfers to be made though information encoded on magnetic tapes. Had the telemarketer succeeded, he would not have even needed the paper drafts.
Lee Bindseil, president of the Mid-Atlantic Clearing House Association in Linthicum, said any electronic transfer requires not only a written authorization, but also 10 days notice that such a transaction is coming.
"Absolutely, without question you must have a signed authorization form permitting them to debit their account," he said.