Wednesday, October 2, 2013

Small Businesses Sometimes Learn Hard Lessons About Check Fraud

Dr. Luis Fabelo, a Miami Dentist, recently found out that he'd lost about $500,000 in a check fraud scheme perpetrated by an employee (now former employee).  The employee, Elizabeth De Leon, allegedly stole patient checks made out to the dentist and then deposited the checks into her own account through Wells Fargo's ATM machines.  The dentist discovered the losses when alerted by a patient whose payment was not posted.  The dentist then checked the security cameras on premises and was able to uncover the wrongdoing.  The employee had deleted account records while at the office or during social functions.  After she left his employ, she did the same fraud at another office.  De Leon is now facing charges for grand theft and fraud.  Wells Fargo refused to return the funds to Dr. Fabelo.

But what about the losses of Dr. Fabelo?  Dr. Leon has brought suit against Wells Fargo claiming it "has no system, policy, and/or procedure in place to verify the depositor/account holder, was entitled to cash the checks."  Sure the theft of the checks appears to raise the issue of a conversion claim under UCC 3-420, but there is more to this.  Under UCC 3-405, where an employee delegates responsibility to an employee and entrusts the employee with indorsing checks, if the employee converts the check for his own use, the bank is generally not liable.  So, the message to employers is take care in hiring those entrusted office employees.  The rule is not absolute, though, it continues on:
If the person paying the instrument or taking it for value or for collection fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss resulting from the fraud, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss

Here is the heart of Dr. Fabelo's argument against Wells Fargo, I suspect (unless the employee was not actually an entrusted employee). Does a bank exercise "ordinary care" when it allows ATM deposits of checks deposited into an account other than that of the payee (i.e. third party checks)? Alternatively, does a bank take the loss when it takes these items. This is a far less clear issue than the general rule of employer responsibility. In today's marketplace thieves have the ability to avoid discovery of check fraud through ATM, smart-phone and other remote deposit mechanisms where identity is not verified by banks. I suspect that Wells Fargo is not alone in permitting deposit of third party checks remotely. If banking practice includes this type of remote deposit of third party check, then Dr. Fabelo will have a tough case to make out.
The ability of a customers to do remote depositing surely is a convenience benefit, but also carries with it a potentially higher increase in fraud as there is convenience for the thieves as well.  See, Mobile Check Boom Brings Risks.  Many banks put daily and monthly limits on the higher risk deposits, though, as well as placing holds on account funds.  In the case of Dr. Fabelo, the types of security procedures used by Wells Fargo will surely be at issue.  With the rapid changes in banking pushing more customers into remote banking features, banks are well advised to continue to assess risk strategies to reduce the level of fraud in this area.  UCC 3-405 makes clear that banks have a role to play in mitigating the risk of emerging banking practices to put in place the right safeguards. 

As to small business owners, UCC 3-405 makes clear that they should continue to carefully screen employees to ward off this type of theft as well.  Otherwise, the hard lesson of substantial loss may come as a hard one.