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The Nightmares of Banking with Electronic Funds Transfers

Recently our firm assisted a client with a devastating problem.  The company discovered that their CFO, who had been in his position for more than 10 years, had fraudulently stolen over $750,000.00 through electronic funds transfers.

The CFO had acquired great responsibility. The owner-operators believed he was loyal and honest, and they allowed him great authority to manage the cash generated by the business.  They were so convinced of his integrity that they never considered a need to monitor his handling of the company’s payroll and operating accounts.

The fraud was accomplished by the CFO directing the company’s payroll company to make unauthorized electronic funds transfers from the company’s operating account in the form of false reimbursements to former employees.   These “reimbursement” fund transfers were electronically deposited in an account bearing the CFO’s name.

The section of the Uniform Commercial Code that regulates electronic fund transfers is structured to protect banks who engage in electronic funds transfers for their customers.  A business’s remedies are limited when they suffer losses as a result of an employees’ fraudulently transfers, even if the transfers were made without management’s knowledge or permission.  The statutes place responsibility on employers to monitor employees (including officers like a CFO). In turn the banks are afforded protections against claims by business customers when their employees acted without authority.

In sum, when a business is harmed because a trusted employee used electronic funds transfers to divert or steal money, the available recourse is likely limited to pursuing the employee.  This is in contrast to the statutes governing fraudulent check endorsements accepted by a bank, where businesses have more remedies available to pursue relief. We cannot overemphasize the enormous risks facing companies who do not monitor the instructions that their employees provide to their banks and payroll companies for transferring funds.

Businesses must be proactive in adopting procedures that prevent fraud and be consistently vigilant.  We recommend these actions:

  1. Establish internal and external procedures to independently check payments and expenses made electronically with more than one level of review.  Your CPA should regularly compare expense category percentages for consistency.
  2. Obtain Employee Dishonesty or Fidelity insurance.    This insurance is generally an endorsement and is not a part of the standard casualty coverage.    The amount of coverage should be as high as can be afforded.
  3. Monitor payroll and expenses regularly (including payroll reports).  This can be accomplished by having bank statements and payroll reports addressed to someone other than the individual who enters electronic transactions.  These documents should be reviewed carefully for inconsistencies, unknown payees and unusual amounts. Banks and payroll companies satisfy their notice requirements simply by mailing (or e-mailing) these statements.

If you have questions about business or corporate fraud as described in this article, contact the legal team at McMillan Metro Faerber, P.C.  Learn more about how A. Howard Metro and Jose Espejo can help you with your corporate and business law issues.