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Secure Document Alert—Holder in Due Course and More

In this report, we'll look at the issue of document security from two different angles. First, we'll look at the issues associated with securing checks against fraud, including protecting your customers against lawsuits brought against them as part of "holder in due course" and the relatively new liability arising under the Check 21 rule. Then we'll look at other documents that could benefit from added layers of security.

The term "security feature" refers to any special types of paper, inks, and printed features that discourages or deters counterfeiting or the alteration of documents. Some features are visible to the naked eye (overt features) and help document recipients, such as banks and check cashing services, verify that a document is an unmodified original. Others are hidden (covert) features that, unless printed on a warning band, wouldn't be noticed until someone tried to duplicate or alter the document.

When we think of document security, checks immediately come to mind. And yet, when it comes to actually securing checks, there is very little understanding among end user customers as to what features they ought to order and why. The decision usually is based on price, rather than on minimizing financial liability. It's about what features they can fit into the check for the price they want to pay.

Distributors are in a key position to change this, and they should change it for the benefit of their customers. According to Check Fraud and Identity Theft, a white paper (also available in free, downloadable PDF at http://www.safechecks.com/AbagnaleFraudBulletinVol6.pdf), produced jointly by Frank Abagnale & Associates and SafeChecks, check fraud is growing 25% per year. More than 1.2 million fraudulent checks enter the banking system each day. Annual check losses now exceed $20 billion, up from $12 billion in 1996 and $5 billion in 1993.

Not only is check fraud growing, but it's morphing. Over time, old stand-bys become less effective as technology and the skill level of counterfeiters grows. Consider the "copy evident" void pantograph. This used to be a highly effective technique for preventing checks from being photocopied. Today, however, most copy-evident pantographs can be skirted on digital color copiers by manipulating the color controls. Even holograms, originally designed to be expensive and difficult to replicate, are losing some of their punch. In the right situations, savvy counterfeiters can cut them out from high-end, holographic wrapping paper and manipulate them to look like the real thing.

End user customers may think they can minimize losses from fraudulent checks simply by putting a stop payment on the checks once they are discovered. In truth, counterfeiters can cash checks before stop payments even take effect. Counterfeiters can also cash checks 180 days after the stop payment is issued, when most stop payment orders are no longer enforced.

With insufficient or outdated security features, end users often face much greater liability than they realize. Thus, the updating of security features or the layering of additional security features is a win-win for the distributor and the customer.

Holder in Due Course

Regarding end users' liability, one issue that has gotten little attention is "holder in due course."

While no one wants their checks stolen and used in a fraudulent manner, few people realize that, based on changes to the Uniform Commercial Code (UCC) made more than a decade ago, if a counterfeiter forges one of your checks and uses the fake check to defraud someone else, you can be liable for that company's loss, even if you had no idea that your check had been counterfeited. This liability exists if it can be proven that you did not show "ordinary care" to prevent fraud when designing and ordering the checks.

This can be difficult to visualize, so let's look at a hypothetical example of Sam's Auto Insurance.

In order to create its payroll checks, Sam's Auto Insurance buys check stock from Office Max and prints the checks on a laser printer. A friend of one of Sam's employees notices the simplicity of his friend's paycheck. One day, he sees a letter from Sam's Auto Insurance on his friend's desk, signed by the owner of the company. He swipes the letter, scans the owner's signature on his desktop scanner, then goes to Office Max and purchases the same off-the-shelf check stock that the auto insurance company uses. He then uses these elements to create a fake $896.57 payroll check that he takes to Rick's Payroll Cashing Service. To the employee at the cashing service, the check looks authentic and the thief walks away with the cash. When Rick's Payroll Cashing Service deposits the check, it is returned.

Under the UCC, Rick's Payroll Cashing Service is a "holder in due course" and therefore can sue Sam's Auto Insurance for the $896.57, even though Sam's Auto Insurance had no idea that someone had counterfeited one of its checks.

This is why it's so important to understand "holder in due course." It is liability that nearly every business faces. As long as the business prints or orders checks, it opens itself to liability when anyone, anywhere, counterfeits its checks.

Understanding the Law

Here is how Section §3-302 of the Uniform Commercial Code defines a "holder in due course":

An entity is a "holder in due course" if:

(1) for all intents and purposes, the check looks real and bears no apparent evidence of forgery;

(2) the holder took the check at face value, in good faith, without knowledge that it was forged, and without notice that it contains an unauthorized signature or has been altered.

In other words, if it looks like an authentic check and the average person would think it was an authentic check, it must be treated like an authentic check. So if a check cashing service (or a retailer or any other business or individual) accepts a fraudulent check with the end user's company name on it, and if they haven't built in sufficient security features so that the fake looks like the real thing, then the end user can be held liable for any losses the check holder incurs.

Moreover, the UCC allows a holder in due course to transfer the right to sue for the "face value" of bad checks to someone else. In other words, if a retailer gets stuck holding a bad check but doesn't pursue legal action, it can sell that check and transfer those rights to someone else who will.

Let's go back to the example of Sam's Auto Insurance and Rick's Payroll Cashing Service. Once Rick's Payroll Cashing Service realizes it's taken a bad check, it pins it up behind the counter with all of the other bad checks. Someone familiar with "holder in due course" legislation comes in, sees the check, and says, "I'll buy that check from you for 10 cents on the dollar." Now that customer becomes the holder in due course and can sue Sam's Auto Insurance for the $896.57.

(To read three examples of such lawsuits, visit www.fraudtips.net/holder.htm.)

Complicating matters, a check issuer's term of liability is a lengthy one. According to the UCC, a holder in due course has three years from the date a check was dishonored or ten years from the date the check was issued, whichever period expires first, to sue the maker for any losses incurred. In one case, a successful suit was brought two years after the fraud had actually taken place—see "Triffin Vs. Cigna Insurance."

How to avoid such lawsuits? End user customers must take "ordinary care" to ensure that their checks are secure. This means that their checks cannot be easily replicated by someone with a scanner and off-the-shelf software. In other words, customers must go beyond watermarks, microprinting, and void pantographs, which are available on check stock from the local office supply store, and layer in security features such as thermochromic printing, holograms, and fluorescent fibers that are not readily accessible to the average counterfeiter. Once customers have taken such care, even if a counterfeiter creates an excellent replica, it still will not look or act exactly like the original check, thus minimizing the customer's liability. "Ordinary care" also relates to non-document-specific issues, such as the storage and handling of checks and automatic signature machines, but we're looking only at how it relates to documents here.)

Making the end user customer aware of this liability and then helping them drastically reduce it can be a powerful selling tool for distributors.

Impact of Check 21

It's also important for customers to understand their liability under the Check Clearing for the 21st Century Act, more commonly called "Check 21." Designed to give companies and their banks more flexibility in a post-911 world, Check 21 came into effect in 2004 and gives check holders the ability to scan paper checks and turn them into electronic images (or substitute checks) for transmission to the bank. This eliminates the "float" associated with transporting paper checks from one place to another.

Under Check 21's Final Rule, however, the entity converting the check becomes liable for any loss directly related to the paying bank receiving a substitute check instead of paper. In other words, if Sue's Dry Cleaning inadvertently accepts a fraudulent check, converts it to a substitute check, and the bank pays it, the bank can seek restitution from Sue's Dry Cleaning, even if Sue didn't know she was submitting a counterfeit check.

The entity converting the check does, however, obtain indemnity (or protection in case of loss) if two conditions are met:

1) the original, authentic check contained security features (e.g. true watermark, thermochromatic, or UV inks) that would not have survived the imaging process, and

2) the dollar value of the check is high enough that the paying bank would reasonably have been expected to inspect the original check for security features to determine its authenticity (for most banks, this is anything over $2,500).

This gives the end user customer yet another reason to add security features, specifically non-image survivable features like heat-sensitive inks, true watermarks, and UV ink, which cannot be replicated electronically. "Yes, adding these features will cost [the end user customer] more money, but the increase is a lot less than the cost of legal fees trying to recover the stolen money," says Greg Litster, CEO of SafeChecks, Canoga Park, CA.

How Much Security Is Enough?

With the increasing sophistication of counterfeiters these days, how many security features are enough? SafeChecks, which works with security expert Frank Abagnale (whose life and work was featured in the movie "Catch Me If You Can"), "high security" checks should contain at least eight safety features, including both overt and covert features. Many of these checks will be printed with a padlock icon that indicates that the check is secure.

On its high-security checks, for example, SafeChecks includes the following overt security features:

Fourdrinier Watermark: Watermark that is pressed into the paper at the mill and is visible from either side when held to the light.

Thermochromatic Ink: Heat-sensitive ink that changes colors when heated. This thermochromatic seal cannot be replicated on electronic printers or copiers and can be rubbed for instant authentication.

High-resolution Borders: Intricately designed borders that are difficult to duplicate. The design often distorts when copied.

Microprinting: Printing so small that it appears as a broken line or pattern to the human eye. When scanned or photocopied, microprinting will often blur on the copy.

Chemical Wash Detection Boxes: Specially designed boxes engineered to deter check washing. The stock used by SafeChecks is sensitive to over 80 chemicals and the box makes chemical tampering instantly evident.

Prismatic Printing: Subtle gradations between multiple colors. This level of color distinction is difficult to reproduce on most color copiers.

Laid Lines: Lines of varying width and spacing printed on the document to deter cut-and-paste alterations.

Warning Band: Explicitly describes specific overt security features and advises the recipient to look for these features before accepting the check. This warning band may also deter a forger from "experimenting" with the check.

SafeChecks also includes the following covert features:

Controlled Paper Stock: The stock is not readily available (or is completely unavailable) on the open market. One of the paper stocks used by SafeChecks is not available in America, making it nearly impossible for a forger to replicate the check.

Chemically Reactive Paper: One of the papers used by SafeChecks reacts to 85 different chemicals. When chemically washed, the paper and its chemical wash detection box discolor and no longer look like the original document.

UV Light-Sensitive Ink: Under UV light, the word "AUTHENTIC" appears on the SuperCheck, which serves to authenticate the check as original.

UV Light-Sensitive Fibers: The imported paper used by SafeChecks contains ultraviolet light-sensitive fibers that fluoresce under UV light and further serve as an authentication tool.

This is just one example of one supplier's choice of security features. Every manufacturer or supplier provides its own combination.

The use of a sufficient number of various security features gives an end user customer extraordinary protection against liability. But as technology changes, so does the effectiveness of many features. A decade ago, for example, many check manufacturers offered artificial watermarks printed in opaque ink that could be viewed when holding the check at an angle. But with easy access to this ink and the introduction of more sophisticated color copiers that could replicate the subtlest of images, artificial watermarks were replaced by true watermarks.

Thus, the relentless march of technology and the ingenuity and resourcefulness of counterfeiters means that customers should review their security features every few years.

Some high-security document suppliers may also develop their own security features. SafeChecks recently introduced the nation's first secure name and number font, designed to prevent physical alterations of the payee name and dollar amount on laser-printed checks. This font and software prints the payee name and dollar amount twice, the second time in a laser "screen" that gets baked into the check and cannot be removed without destroying the check.

ProDocumentSolutions has also introduced a variety of patented technologies. AlterSafe, a feature in which a word, such as "$AFE" is ghost engraved as a transitory image on a special tamper resistant material that, once signed or printed on, cannot be easily altered. If an attempt is made to remove the "$AFE" strip, the word "void" will appear in the background. And because most "anti-copy" paper is not truly secure, ProDocumentSolutions developed CopySafe+, which works on the principle of unique light reflection and absorption, causing interference patterns to prevent the printed content information from being legibly copied.

New Secure Document Opportunities

When thinking about helping your customers increase their document security, it's important to think well beyond checks, however. While checks demand the highest volumes of printing, there are vast numbers of documents that also benefit from added security. These include certificates, high-value bank notes, college transcripts, and more (see list below).

While we don't often think of these documents as needing security, imagine the damage that can be done by altering a birth certificate, a death certificate, or a will. Also consider the amount of money that is lost when counterfeiters change or duplicate high-value event tickets or gift certificates. In addition, the implications of faked medical licenses or prescriptions go far beyond financial liability.

Even coupons are becoming considered valuable documents. Few companies are concerned about $.50 off a can of soup, of course, but coupons offering free merchandise (even low-value merchandise), when multiplied out to millions of potential redemptions, become high-value documents. Electronics retailers, for example, may also want to protect high-value coupons ($100 off orders of a certain value; or percentage discount coupons) for special promotions.

Here are just some of the other high-value documents customers may want to protect:

Needless to say, you aren't going to foil stamp a coupon, but you might foil stamp a gift certificate or medical diploma. The level of security must be matched to the value of the document in question.

Many individual industries, such as the coupon industry, have come up with their own best practices for securing these documents. For example, the Coupon Information Corporation has developed a hologram that it recommends for all free product coupons. At one angle, the coupon appears to have the normal manufacturer's coupon and expiration date statement. When the coupon is tilted, the hologram appears, with the CIC logo repeating across the warning band. CIC also recommends that the warning band indicate that the coupon is valid only if it has a hologram on it and encourages companies to incorporate warning statements into the terms and conditions listed on the coupon. Possible examples include: "Void without hologram" or "Security Feature: Hologram."

Holograms do require an additional investment, but considering the volume of these coupons, a single incident of fraud can cost a company millions of dollars. PepsiCo's QTG division is among those utilizing this hologram, which it incorporates into coupons produced for its Quaker, Tropicana and Gatorade brands. Some manufacturers have also begun using foil coated paper technologies to print entire coupons.

(For more information on coupon fraud, visit www.cents-off.com.)

Higher Profit Margins

If the end user's best interest and distributors' ability to use their knowledge of security features to deepen customer relationships isn't enough of an incentive, profit margin should be. Although the volume of secure documents is less than that of checks, the profit margin on these sales can be significantly higher.

For this reason, ProDocumentSolutions left the general-issue check business to produce other types of security document. "Checks are commodity products," explains George Phillips, president of ProDocumentSolutions. "Over the last 10 years, the trend is for the distributor to continually sell generic-type security products [such those that use only microprinting and void pantographs that come standard on all checks today] at a low cost. We've concentrated our focus on higher end documents."

One of the document types the company heavily promotes is medical forms and prescription pads. As it notes on its website, these documents are becoming a popular target and have dual risks of potential fraud. "On one end, prescription drugs can bring criminals high-dollar value on the street. On the other end are prescription abusers who see prescription form counterfeiting as an easy way to supply a habit. Secure Prescription Pads are being adopted, not only by medical practices but also state governments who wish to control this problem."

Indeed, many states have mandated security features. In the case of California, this includes microprint, secured pantographs, watermarks, warning borders, and thermochromic inks. In addition, ProDocumentSolutions layers in its secure paper, which offers microfibers and chemical reactivity, among other features; and for the thermochromics, uses its patented TouchSafe technology, which is easy for pharmacists to verify.

Three Security Building Blocks

In this marketplace, Phillips sees the need for four primary security building blocks:

1. Non-generic and controlled watermarks. Paper should incorporate a true watermark that is not a generic pattern easily accessible over the Internet.

2. Latent image by thermochromic. Many thermochromic inks can be purchased over the Internet and hand stamped or easily silk screened. For the highest level of security, thermochromics should be used to print a latent image, such as a background, hidden within the document itself and that is revealed only when the document is warmed.

"Latent thermochromic images are an exceptional security feature because this is an extremely difficult process done by offset litho that requires the density of the background to match the density of the thermochromic," says Phillips. "The blend has to be perfect at 70 degrees or room temperature. This is not something that can be replicated by the average counterfeiter."

3. Transitory image. This an expensive and unusual printing process used to produce latent images that shift and change based on how you view them. It can be produced only by unique engraving techniques or intaglio printing, an expensive process that only the most sophisticated counterfeiters can replicate.

4. ANSI-approved NASPO risk mitigation and supply chain of custody standards. The mission of the North American Security Products Organization (NASPO) is to preserve, protect, promote, and ensure the integrity and use of print media and their related technologies as a secure process for transactions and communication with the public domain.

Regardless of the type of document or the combination of security features used, the goal is to help end users create documents that can't be spit out on a household laser printer or even replicated or altered on more sophisticated techniques. For distributors, it takes a little extra effort to learn the business and be able to educate customers; and for customers, it takes a little extra investment, too. But this is a case in which even a little extra effort and investment can result in benefits of exponentially greater value.

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