Telemarketers' Phony Drafts Hard to Combat

A new high-tech telemarketing scam that is stinging banks and consumers is catching the attention of Washington.

But a proposed law aimed at protecting consumers may do little to limit banks' exposure to the crimes.

The drafted legislation would address the problem of fraudulent demand drafts - a checklike mechanism that can be used to siphon money from checking accounts.

The scam, first reported by the American Banker in May, has cost banks and their unwitting customers tens to hundreds of millions of dollars since it first cropped up late last year, bankers and investigators said.

And despite the big losses, bankers seem to have few ways to combat criminals who use sophisticated check-printing equipment to take advantage of banks' need to quickly process checks and demand drafts.

As a result, Congress may pick up the gauntlet. Rep. Ron Wyden, a Democrat from Oregon, is proposing legislation that would register and set bonds of about $200,000 for each telemarketer.

The bill, for which Rep. Wyden is now seeking comment, could even include restrictions on the types of companies that can buy sophisticated check-printing equipment often used in the crimes.

Giving States Some Clout

Such measures would increase the power of state attorneys general and the Federal Trade Commission to prosecute telemarketers, and could also discourage the use of demand drafts by telemarketing companies.

Demand drafts are used legitimately by a variety of businesses, from insurance companies to health clubs, to collect recurring payments from their customers.

However, when telemarketers attempt to use demand drafts for fraudulent purposes, banks are faced with a dilemma. Because of the Federal Reserve's Regulation CC, which sets deadlines for clearing check deposits, financial institutions are forced to quickly pay these drafts.

Who's at Fault?

If the customer complains that the payment was unauthorized, the paying and the originating banks may be then locked in a tug-of-war over who should foot the bill.

No law currently specifies which party is at fault in these transactions, and Rep. Wyden's draft legislation does not resolve the issue.

The Federal Bureau of Investigation, which is handling some investigations, said it has received word of about 40 such incidents of fraudulent use of demand drafts since the crime surfaced last December.

Charles L. Owens, chief of the FBI's economic crimes unit, said that the bureau had received several notifications in the past few weeks. He said the incidents were not limited to the states most frequently cited: Colorado, Florida, Oregon, Rhode Island, and Texas. The incidence of fraud "has been national in scope," said Mr. Owens.

Because banks' check processing operations are so highly automated, it is nearly impossible for a bank to catch a questionable demand draft.

"There's no automated way to catch [bogus] demand drafts," said one banker who asked not to be named. Usually, "you don't know you have a problem until you get the return items, and by then it may be too late."

In the scam, whose victims are frequently older people, a telemarketer obtains checking account and other codes found on the magnetic-ink character line of checks, often promising in return cosmetics, prizes, or trips. Later, the consumer may be charged for the goods but receive nothing, or receive the promised goods but find them shoddy. Or victims may find that their checking account has been drained of far more money than expected.

The consumer may then turn to the bank, demanding a refund.

Banks Frequently Liable

Once a bank has paid funds from a consumer's account to the telemarketer's, the bank is frequently liable. "The law requires that the bank have proper authorization," said Gradon Forrer, counsel to Rep. Wyden.

Proper authorization means a signature from the customer on file, something telemarketers rarely manage to obtain. Instead, some telemarketing companies charged with fraud have argued that the telephone conversation with the consumer represents authorization. However, "no one acknowledges that taped conversations are [equivalent to] a written authorization," said John F. Barker, senior associate for the National Consumers League, in Washington. "In Rhode Island, one telemarketer claimed that, but the court didn't buy it."

Once a telemarketer knows a consumer's checking account and transit routing numbers, he can use demand drafts as a blank check to withdraw almost unlimited sums of money. This makes the crime potentially more dangerous than credit card scams, where card issuers can limit the amount of money that can be charged at

one time.

But demand drafts are here to stay. Millions of legitimate demand drafts are processed every year, with the vast majority used to pay recurring bills such as automobile loan payments and life insurance premiums.

Delayed Reaction

And the proposed measures, such as requiring telemarketers to post bonds, would protect only the first consumers to notice the fraud. Typically, consumers do not know they have been victimized until after they receive their monthly bank statements.

"The problem is how high do you go" in setting a bond, said Mr. Barker. "Some telemarketers got $1.7 million in small amounts in a six-week period."

A bank's best line of defense is to know its business customers to avoid opening an account with a fraudulent telemarketer. This, however, can be difficult. Sometimes fraudulent telemarketers take over legitimate telemarketing businesses, and the bank has no way of knowing a change has occurred.

But more frequently, the telemarketer will get out of town before customers start receiving their bank statements, or the bank starts receiving large numbers of return items. "Banks are in many cases left holding the bag when the telemarketer leaves town," said Mr. Forrer.

Carole Byrum, an officer with U.S. Bank, Portland, Ore., gave testimony in early July before Rep. Wyden's consumer protection subcomittee. She said that on the day she returned from giving testimony, her bank opened an account for a telemarketing firm that was processing demand drafts.

However, about a week later the bank realized the company was passing demand drafts, and acted quickly.

The telemarketer opened the account on a Monday, and on Tuesday the company deposited 49,000 drafts, Ms. Byrum said. The telemarketing company was poised to deposit 525,000 drafts the following week. "The company claimed it has authorizations from everyone, but the company couldn't show them to us," she said. The bank held on to the company's funds against future return items.

"We just passed a law in Oregon on [fraudulent] credit card drafts, and it's already obsolete," said Ms. Byrum.

Her bank was one of the first to be hit with illegal demand drafts in December 1990.

Tapping the Clearing House

Several attempts by telemarketers to use the automated clearing house system to debit consumer accounts have been reported. However, clearing house officials deny that any of these bogus transactions were completed.

Observers said they believe all the publicity and potential legislation could dampen enthusiasm for this type of fraud. However, they also pointed out that these types of crimes frequently die down and then flare up when bankers and consumers least expect it.

"We've been battling [telemarketing fraud] for years, and they just keep coming up with new wrinkles," said Thomas Connell, spokesman for the Rhode Island attorney general's office in Providence. "Once you close them down in one place, they open up in another location."

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