Demand Draft Fraud

The House Banking Committee

Washington, D.C.

Date:
By: 
Jodie Bernstein, Former Director

Mr. Chairman and members of the Committee, I am Jodie Bernstein, Director of the Bureau of Consumer Protection of the Federal Trade Commission. I appreciate the opportunity to appear before you today on behalf of the Commission to discuss the problem of demand draft fraud, its effect on consumers, and what the Commission is doing about it.(1)

Combatting fraud is one of the Commission’s most important consumer protection priorities. The Commission challenges fraudulent practices generally using its authority under the Federal Trade Commission Act.,(2) which prohibits “unfair or deceptive acts or practices in or affecting commerce.”(3) Under the FTC Act, the Commission may file civil actions in federal district court seeking injunctive and monetary relief. Where appropriate, the Commission may seek extraordinary relief that includes an ex parte temporary restraining order, asset freeze and the appointment of a receiver to halt ongoing fraudulent activities and preserve assets for consumer redress. The Commission also has other tools to combat fraud including the recently issued Telemarketing Sales Rule.(4) The Commission has and will use these tools in attacking demand draft fraud. It is important to note at the outset, however, that the Commission does not have jurisdiction over banks.(5)

Demand draft fraud, or the unauthorized debiting of a consumer’s checking account, is a growing problem. Currently, it is the favorite method of fraudulent actors for taking consumers’ money through fraudulent telemarketing and other scams. The Commission believes that it is a growing problem because strong measures taken by the credit card associations over the last several years have made it increasingly difficult for fraudulent actors to obtain access to the credit card system. As a result, these scurrilous operators have turned to other methods of stealing money, including demand drafts.

How do these fraudulent actors steal consumers’ money through demand drafts? In a word, by lying. Many fraudulent actors persuade consumers, either over the telephone or through the mail, to divulge their checking account numbers by telling them that their bank account numbers are needed to verify prizes or to deposit prize money directly into consumers’ bank accounts. In other cases, fraudulent actors tell consumers that only a small amount will be withdrawn, but in fact withdraw huge amounts of money from the consumer’s checking account. As a further insult, the unauthorized demand draft may generate significant overdraft charges to the consumer if the consumer does not have the additional money in the first instance or has written subsequent checks. Little do consumers know that once they give fraudulent actors access to their bank account information, their money will disappear.

Once a consumer provides his or her checking account number, a fraudulent actor can generate a document that looks exactly like the checks in the consumer’s checkbook -- imprinted with the consumer’s name, address, phone number and, most importantly, the account numbers and the numbers necessary to route the draft through the banks’ check clearing system. The only difference is that in place of the consumer’s signature, there is a notation such as “pre-approved” or “signature on file.” The fraudulent actor deposits this draft the same as any conventional check, and in most cases it clears in exactly the same way as a conventional check; the lack of a handwritten signature is not a problem in processing it. This form of fraud is a very lucrative business. Based on our enforcement experience, the Commission estimates that at a minimum, demand draft fraud has already caused tens of millions of dollars in consumer injury.(6)

Despite the potential for fraudulent misuse, demand drafts are a completely legitimate, though relatively unfamiliar, payment method. Consumers are generally aware that arrangements can be made for recurring payments, such as mortgage payments or car payments, to be withdrawn automatically from their checking accounts. The surprise for many consumers is that withdrawals from their checking accounts can happen on a one-time basis, with no prior written authorization. This one-time third party withdrawal was also a surprise to the Commission when it first observed unauthorized debiting in some of our telemarketing fraud cases. The Commission’s initial conclusion was that demand drafts were just another tool in the fraud operator’s toolbox. Accordingly, the Commission’s initial proposal for a Telemarketing Sales Rule pursuant to the Telemarketing and Consumer Fraud and Abuse Prevention Act,(7) required sellers who use demand drafts to obtain express prior written authorization, which, in effect, would have eliminated demand drafts as an alternative payment method. In response to that initial proposal, the Commission received hundreds of comments from members of the automated payment industry and from legitimate merchants and businesses objecting to the elimination of demand drafts as a payment method. These comments and oral presentations persuaded the Commission that there is nothing inherently unfair or deceptive about the use of demand drafts as a payment method; and, in fact, that demand drafts provide consumers the same convenience and opportunity to purchase goods or services that they could enjoy using credit cards. But like so many other innovative developments in the marketplace, demand drafts are susceptible to misuse by unscrupulous operators.

During the rulemaking, the Commission learned that millions of consumers use demand drafts in lieu of credit cards and that demand drafts are used by Fortune 500 companies, airlines, car rental companies, insurance companies, and mortgage companies. In fact, demand drafts are used by a variety of businesses that are characterized by quick turn-around transactions, and as a payment alternative for consumers who do not have, or would rather not use, credit cards. Demand drafts are a large and growing payment mechanism. One member of the automated payment industry, Telephone Check Payment Systems (“TCPS”), commented in the telemarketing rulemaking that nine of the current twenty demand draft service bureaus process approximately 38,000 demand drafts weekly, totaling over five million dollars for over 700 business clients throughout the country.(8) Accelerated Payment Systems (“APS”) stated at the Commission’s rulemaking workshop in April 1995, that it processes half a billion dollars a year through demand drafts.(9) The vast majority of these transactions are not tainted by fraud. So the lesson the Commission staff learned during the telemarketing rulemaking proceeding, was that it was not the payment method itself that was the problem; rather, the problem was a lack of uniform industry standards, ineffective dispute resolution methods, and consumers’ lack of awareness that their bank accounts could be debited without their written authorization.

In demand draft transactions, consumers are largely unprotected, in marked contrast to credit card transactions, where consumers are protected nationwide against unauthorized or incorrect charges by the Fair Credit Billing Act (“FCBA”).(10) The FCBA creates a mechanism for consumers to dispute charges before they pay, and requires the creditor to investigate a consumer’s dispute. Moreover, under the FCBA a consumer can only be liable for up to $50 for unauthorized charges. By contrast, in the case of demand drafts, there is no legally mandated dispute mechanism, and no limit on liability. Disputes are governed by state law, specifically, state laws that follow the Uniform Commercial Code (“UCC”). The UCC requires that checks or drafts be signed, but unbeknownst to many consumers, the signature need not take any particular form,(11) and the authority to sign can be granted orally.(12) The UCC’s liberal definition of what constitutes a signature creates a problem of proof for a consumer who is victimized by demand draft fraud. Under the UCC, a consumer can only recover money from his or her bank if the consumer can persuade the bank that he or she did not in fact authorize the demand draft in the first place.(13) When a consumer disputes an unauthorized demand draft to his or her checking account, banks often take the position that the mere fact that the consumer’s bank account number is on the draft shows that the consumer gave authority for the draft.(14) Indeed, banks may hold consumers responsible for fraudulent demand drafts because of the consumers’ negligence in giving out their checking account numbers.(15) Although some banks may refund consumers’ money in some instances, it is largely consumers who must bear monetary losses related to demand draft fraud, losses that many consumers cannot afford. As noted by the Federal Reserve Bank of San Francisco in a comment submitted during the Telemarketing Sales Rulemaking proceeding, any protection under the UCC for consumers victimized by demand draft fraud is largely illusory.

It is with this background and knowledge that the Commission has taken various actions to limit demand draft fraud. In adopting certain provisions of the Telemarketing Sales Rule that require consumers’ express verifiable authorizations for demand drafts in telemarketing transactions, the Commission has addressed the problem of nonexistent demand draft industry standards by establishing such standards, at least in the telemarketing context. The Commission has taken and will continue to take a strong enforcement stance against demand draft fraud under the Telemarketing Sales Rule,(16) and, where appropriate, will bring actions under Section 5 of the FTC Act against fraudulent users of the automated payment system that are not covered by the Rule.(17) Additionally, the Commission has taken the lead in establishing a broad consumer education campaign to help consumers learn about and therefore protect themselves against demand draft fraud.

Establishing Industry Standards In Telemarketing

The Telemarketing Sales Rule prohibits the use of demand drafts in a telemarketing transaction without a consumer’s express verifiable authorization,(18) and establishes an industry standard for what constitutes such authorization. Express verifiable authorization may be obtained by any one of three methods: (1) written authorization; (2) tape recording; or (3) written confirmation notices sent to a consumer before the demand draft is submitted for payment.(19) Any tape recorded authorization must clearly demonstrate that the consumer has received each of six specific pieces of information about the transaction -- the date of the draft(s); the amount of the draft(s); the name of the consumer from whose account funds will be withdrawn; the number of draft payments authorized, if more than one; a telephone number answered during normal business hours that the consumer can call with questions; and the date of the consumer’s authorization.(20) Moreover, the recording must demonstrate that the consumer has authorized that funds be taken from his or her bank account based on the required disclosures that the seller or telemarketer has provided. If the tape recording method is used, the seller or telemarketer must provide the consumer’s bank, upon request, a copy of the consumer’s verifiable authorization.(21) If the written confirmation method is used, the notice must contain the same items of information required in a tape recorded authorization, and the seller or telemarketer must offer, and at the consumer’s request, provide a full refund to the consumer in the event the confirmation is inadequate or incorrect.(22) A merchant using demand drafts in connection with telemarketing must keep consumers’ authorizations for two years.(23) If a merchant fails to obtain a consumer’s express verifiable authorization, the merchant could be liable for civil penalties of up to $10,000 per violation, nationwide injunctive relief, rescission of contracts, damages, and disgorgement of any money obtained in violation of the Rule.(24)

The Rule also reaches individuals and organizations who do not themselves telemarket to consumers but who generate and process demand drafts for those who do. Who are these processors of demand drafts? Generally, if a seller or telemarketer does not generate demand drafts on its own, it uses what is known as a service bureau. In this context, a service bureau is a third party processor who takes bank account information provided by a merchant and, through a computerized system, generates the actual demand draft document based on that information. A service bureau will then forward the demand draft to the merchant, who will deposit the demand draft into the merchant’s bank account for processing in the same manner as a conventional check. Demand draft service bureaus, unlike sellers or telemarketers, are not subject directly to the Rule’s demand draft requirements because they are not themselves engaged in selling goods or services through telemarketing. However, because service bureaus may provide substantial assistance to a seller or telemarketer in connection with a telemarketing transaction, they are covered by the Rule’s “assisting and facilitating” provision.

Under the Rule, a third party can be held liable as an assister or facilitator if the third party substantially assists a seller or telemarketer and knows or consciously avoids knowing that the seller or telemarketer is violating the Rule.(25) Therefore, if a service bureau knows or consciously avoids knowing that a merchant or telemarketer is not obtaining verifiable authorizations before submitting consumers’ checking account information for debiting -- or indeed, that the seller or telemarketer is engaging in any other activity that violates the Rule -- that processor may itself be in violation of the Rule and may be liable for civil penalties or the equitable remedies applicable under the Rule. The Commission is optimistic that the Telemarketing Sales Rule will prove to be a potent weapon to discourage demand draft fraud in telemarketing transactions.

Additionally, the Commission believes that consumers will now have the ability to support their claims to banks in the case of unauthorized demand drafts. In many cases banks have interpreted the presence of a consumer’s checking account number on a demand draft as proof of the consumer’s authorization. Before adoption of the Telemarketing Sales Rule, a consumer had few means at his or her disposal to enable the consumer to prove to a bank that a demand draft alleged to be unauthorized was in fact unauthorized. In the context of a telemarketing transaction, the Rule shifts the onus of proving that a demand draft is authorized to the merchant submitting the demand draft. Now, in that context a consumer can insist that his or her bank request that the merchant produce the consumer’s verifiable authorization. Under the Rule, the merchant must provide proof of authorization to the bank upon request. If that merchant cannot or does not provide the bank with the consumer’s verifiable authorization, the merchant is in violation of the Rule. Moreover, in such a situation, the consumer also has solid grounds to support his or her claim that the consumer's account was debited without the consumer’s authorization. Because the Rule enhances the ability of banks to determine whether a demand draft has a consumer’s authorization in connection with a telemarketing transaction, consumers may be more likely to succeed in obtaining refunds from banks for unauthorized demand drafts.

Commission Enforcement Actions

Although the Rule has only been in effect since December 31, 1995, the Commission has already established its commitment to enforce compliance with the Rule’s demand draft requirements. On March 12, 1996, the Commission filed an enforcement action in the District Court for the Northern District of Georgia against a cluster of allegedly fraudulent sellers of magazine subscriptions who had used demand drafts in violation of Rule.(26) This was the first action filed under the Rule, but it certainly won’t be the last. The Commission intends to continue to take quick enforcement action against fraudulent actors who use demand drafts in violation of the Rule and is already working closely with state law enforcement agencies who will bring these actions as well. Under the Telemarketing and Consumer Fraud and Abuse Prevention Act each state Attorney General and the District of Columbia can enforce the Telemarketing Sales Rule in federal court and obtain nationwide injunctions and redress for their citizens.(27) This means that now there are an additional fifty-one cops on the nationwide telemarketing fraud beat. The Commission anticipates that this innovative enforcement scheme will be a strong new weapon in the arsenal against demand draft fraud and telemarketing fraud in general. The Commission will also continue to use its authority under Section 5 of the FTC Act to bring federal district court cases against companies and individuals that engage in demand draft fraud in non-telemarketing contexts.

Consumer Education

In addition to regulation and enforcement actions, the Commission is targeting demand draft fraud through consumer education. It is clear from the Commission’s own learning experience about demand drafts that, for the most part, consumers are not aware that money can be taken from their checking accounts without their written authorization. Because of this lack of knowledge, many consumers fall prey to demand draft fraud by failing to protect their checking account information -- even though these same consumers might never dream of giving out their credit card numbers to strangers. Ultimately, consumers are the first line of defense against any fraud. Thus, the Commission believes it is crucial to supplement its strong enforcement presence in this area with consumer education. Consumers must be armed with knowledge of the fraud and how to avoid it if they are to protect themselves effectively.

In support of its consumer education goals, the Commission’s Bureau of Consumer Protection has formed the Partnership for Consumer Education. The Partnership is a cooperative effort among federal agencies, private industry, and consumer groups, to provide effective and coherent educational campaigns against fraud on a much broader scale than would be possible for any member acting alone. As its first goal, the Partnership is developing and implementing consumer education campaigns against telemarketing fraud. The Partnership campaigns supplement the Commission’s own educational materials produced by the Commission’s Office of Consumer and Business Education.

Members of the automated payment industry were at the forefront in launching the Partnership’s first educational campaign against demand draft fraud. Since March 19, five of the largest industry members have been providing consumers with information that consumers can use to protect themselves against demand draft fraud.(28) We estimate that in the first month of this campaign, over 1.5 million consumers will receive this information. The Commission and the Partnership will continue to inform consumers that they must protect their bank account information.

Consumers can protect themselves and their bank accounts by never disclosing their checking account information to anyone they do not know or for any purpose other than to pay for a purchase through direct debiting of their accounts. Consumers need to know that the only purpose for which anyone ever requests them to disclose their checking account numbers is to deduct funds from their accounts. When this information is requested, consumers can be sure that the company is not legitimate if it misrepresents that the information is for any other purpose. Legitimate companies that use demand drafts as a payment method fully disclose the terms of the sale and the payment method, including their purpose in asking for bank account information, and that the information will be used to obtain payment for goods or services by debiting funds from consumers’ checking accounts.

Victims of demand draft fraud will likely be unable to stop payment on the draft unless they become aware of the fraud and contact their banks immediately after divulging their account information. Nevertheless, consumers should complain to their banks immediately upon learning of any demand draft against their checking accounts that they have not authorized or that is inconsistent in any way with any authorization they have given to any seller to obtain payment by means of a demand draft. They should insist that the bank require proof from the seller that the demand draft was appropriately authorized, and insist that the demand be dishonored if such proof is not forthcoming. Finally, consumers should report incidents of misrepresentation or fraud regarding demand drafts to their state Attorney General. Consumer complaints are an invaluable tool in identifying appropriate targets for enforcement action. To maximize the effectiveness of this tool, the FTC also urges consumers to report any type of telemarketing complaint, including those involving demand drafts, to the telemarketing fraud hotline operated by the National Fraud Information Center (NFIC), a project of the National Consumer League. NFIC compiles complaint information received through its hotline and enters it on a daily basis into the computerized telemarketing complaint database jointly maintained by the FTC and the National Association of Attorneys General. Over one hundred federal, state and local law enforcement agencies use this database to help in identifying overall trends in telemarketing fraud as well as individual operators that are likely candidates for prosecution or other law enforcement action. By reporting demand draft fraud to the NFIC hotline, consumers greatly enhance the ability of the Commission and other law enforcement agencies to take action.

Conclusion

The Commission recognizes that demand draft fraud is a serious problem and has attempted to address this problem within the scope of its jurisdiction. The Commission believes it has provided a strong tool in the Telemarketing Sales Rule to curb its fraudulent use in telemarketing. The Commission will continue to take a leading role in enforcing the Rule against demand draft fraud as well as attacking such fraud with other enforcement actions that are not covered under the Rule. The Commission also will continue to take the lead in educating consumers about how they can protect themselves and their checking accounts.

The Commission is pleased to provide this information to the Committee and welcomes the opportunity to provide any further assistance.

(1)The views expressed in this statement represent the views of the Commission. However, my response to any questions you may have are my own and do not necessarily reflect the Commission’s views or the views of any individual Commissioner.

(2)15 U.S.C. § 41 et seq.

(3)See, e.g., FTC v. Universal Credit Corp., No. SA CV 96-114 LHM (EEx)(C.D. Calif. filed Feb. 7, 1996)(alleging, among other things, demand draft fraud).

(4)16 C.F.R. Part 310.

(5)See Section 5(a)(2) of the FTC Act, 15 U.S.C. § 45(a)(2).

(6)In just two cases that the Commission recently filed, out of potential consumer injury totalling twenty-four million dollars, injury resulting from demand draft fraud could exceed over 12 million dollars. See FTC v. Diversified Mktg. Serv. Corp., No. 96-388 (W.D. Okla. filed Mar. 13, 1996)(consumer injury estimated at approximately twenty million dollars with significant percentage caused by demand draft fraud); FTC v. Windward Mktg., Ltd., et al., No. 96-CV-0615-FMH (N.D. Ga. filed Mar. 12, 1996)(consumer injury estimated at approximately four million dollars, almost all attributable to demand draft fraud).

(7)15 U.S.C. § 6101.

(8)TCPS Comment at 1.

(9)Workshop Transcript at 547.

(10)15 U.S.C. § 1666.

(11)See, e.g., UCC §§ 1-201(39), 3-401(2), 3-403(1) (1990).

(12)See, e.g., UCC §§ 1-201(43), 3-401 (1990).

(13)See UCC §§ 4-401, 4-406 (1990).

(14) See UCC § 3-407(3) (1990).

(15)See UCC § 3-406 (1990); FTC’s Statement of Basis and Purpose to the Telemarketing Sales Rule, 60 Fed. Reg. 43,850 (1995)(discussing Federal Reserve Bank of San Francisco Comment).

(16)16 C.F.R. Part 310.

(17)See 15 U.S.C. § 41 et seq.

(18)16 C.F.R. § 310.3(a)(3).

(19)16 C.F.R. § 310.3(a)(3).

(20)16 C.F.R. § 310.3(a)(3)(ii).

(21)Id.

(22)16 C.F.R. § 310.3(a)(3)(iii).

(23)16 C.F.R. § 310.5(a)(5).

(24)See The Telemarketing and Consumer Fraud and Abuse Prevention Act, 15 U.S.C. § 6105 (providing that any person who violates the Rule shall be subject to the penalties provided under the FTC Act, 15 U.S.C. § 41 et seq.) and § 6103(a) (providing that state officials may obtain damages, restitution, or other compensation on behalf of residents of such State for violations of the Rule).

(25)16 C.F.R. § 310.3(b).

(26)FTC v. Windward Mktg., Ltd., et al., No. 96-CV-0615-FMH (N.D. Ga. filed Mar. 12, 1996)(TRO and asset freeze issued Apr. 3, 1996).

(27)15 U.S.C. § 6103.

(28)These companies include: Accelerated Payment Systems, Check/Debit, Autoscribe, Intell-A-Check, and QuickCard Systems, Inc. Although Autoscribe recently terminated its business, its clients have been absorbed by the other listed companies and will continue to receive educational messages through those companies.