Take On Payments, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Take on Payments and look forward to collaborating with you.

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June 29, 2009

Fraud Enforcement and Recovery Act of 2009

On May 20, President Obama signed into law the Fraud Enforcement and Recovery Act of 2009. Among other things, the law "authorizes" substantial funding in 2010 and 2011 for various federal agencies, including the Department of Justice, the Postal Inspection Service, the Securities and Exchange Commission, and the Inspector General of Housing and Urban Development, to investigate and prosecute financial frauds of all types. (Note that an authorization does not necessarily mean any appropriation of additional funding to these agencies above their existing funding will result.)

One of the law's chief sponsors, Sen. Patrick Leahy, included the following in his comments on the law:

"At its core, the Fraud Enforcement and Recovery Act authorizes the resources necessary for the Justice Department, the FBI, and other investigative agencies to respond to this crisis. In total, the bill authorizes $245 million a year over the next two years to hire more than 300 Federal agents, more than 200 prosecutors, and another 200 forensic analysts and support staff to rebuild our nation's 'white collar' fraud enforcement efforts. While the number of fraud cases is now skyrocketing, we need to remember that resources were shifted away from fraud investigations after 9/11. Today, the ranks of fraud investigators and prosecutors are drastically under stocked, and thousands of fraud allegations are going unexamined each month. We need to restore our capacity to fight fraud in these hard economic times, and this bill will do that."

Supporters of the law have promoted the idea that this funding of efforts to fight financial crimes will in effect result in a good return on the government's investment as it will result in higher recovery of funds lost to fraud. Some cite Justice Department estimates that each dollar spent to prosecute fraud results in more than $20 being ordered in restitution and fines for victims and the government.

This law (if funded) could result in a sea change in the focus of federal law enforcement to address a wide array of financial crimes in the future. It bears watching to see if this effort has a measurable impact in tamping down the growth and spread of financial-related fraud and whether it will in particular have any impact on payments fraud issues, such as the persistence of check fraud schemes or the development of new fraud schemes leveraging gaps in emerging payments modes.

By Clifford S. Stanford, assistant vice president and director of the Retail Payments Risk Forum at the Atlanta Fed

June 29, 2009 in fraud, law enforcement | Permalink


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June 22, 2009

Payments fraud no longer just a white collar crime

Definition: white collar crime - a crime committed by a person of respectability and high social status in the course of his occupation. — Edwin Sutherland, 1949

I recently ran across a news article that was a shocking reminder of the widening criminal network involved in payments fraud. On May 13, the district attorney in San Diego announced the arrest of 60 people on felony charges in connection with an elaborate bank fraud scheme. It was the culmination of a 10-month-long investigation of a $500,000 check cashing scam at Navy Federal Credit Union. Not an unusual story until I read who masterminded the scheme—a San Diego street gang.

According to the press release, this was the first time a violent street gang was targeted for its involvement in complex bank fraud in California. The gang members worked in cooperation with existing account holders to deposit counterfeit checks into their accounts and then withdraw the cash before the credit union could determine the check was fraudulent. In return, the account holder would receive a commission of up to several hundred dollars on checks ranging from several thousand to tens of thousands. The District Attorney concluded that the size, scope, and sophistication of the operation indicated that the criminal street gangs in San Diego are expanding their criminal enterprise into white collar crime.

A similar case of check fraud and gang activity occurred in Phoenix last year. "Operation Blank Check" was a year-long investigation that uncovered a check fraud scheme totaling nearly $3 million. Postal inspectors initially contacted the Phoenix Police Gang Enforcement Unit about gang members being involved in mail theft and fraudulent schemes. Further investigation revealed that the suspects had been involved in violent gang activity and transitioned to white collar crime. A broad partnership of local, state and federal law enforcement agencies worked on the case and was able to arrest more than 100 individuals, 77 of whom were "hard core gang members" representing 22 local gangs.

There have also been several cases of identity theft involving street gangs in recent years. An April 2007 report by the President's Identity Theft Task Force noted that law enforcement agencies across the country have observed a steady increase in the involvement of groups and organizations of repeat offenders or career criminals in identity theft. Some of these groups are formally organized and well-known to law enforcement because of their longstanding involvement in other major crimes, such as drug trafficking. Others may be more loosely organized but are able to connect and coordinate their activities through the internet.

The comparative ease of committing financial crimes has made it more appealing to street gangs as a way to support other criminal activities. The investigators in the Navy federal case speculated that the gang members used the half-million dollars to help fund illegal gang activities and pay for a lavish lifestyle.

Multiagency collaboration key to combating fraud
The key to apprehending the defendants in this case was a coordinated operation involving the U.S. Secret Service, San Diego Regional Fraud Task Force, San Diego Police Department Gang Detectives, San Diego District Attorney Investigators, U.S. Postal Inspection Service, Naval Criminal Investigative Service, Navy Federal Credit Union, and the California attorney general's office.

Each agency played a significant role in the investigation that was initiated when the Naval Credit Union investigators noticed suspicious activity in 2005 and reported it to the Secret Service. For example, the San Diego Police gang detectives helped to identify and interview the suspects. The U.S. Postal Inspection Service helped locate suspects and investigate the counterfeit checks. The San Diego Regional Fraud Task Force, district attorney's office, and attorney general's office became involved due to their experience handling complex fraud investigations.

This case is just one example of the importance of cooperation between local, state, and federal law enforcement in effectively combating payments fraud. By forming interagency task forces that allow for expertise and intelligence sharing, law enforcement can be in a better position to prosecute and, hopefully, deter fraudsters.

By Jennifer Grier, senior payments risk analyst at the Atlanta Fed

June 22, 2009 in checks, fraud, identity theft, risk | Permalink


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Watch this trend: Electronic records like e-mail and text messages are revolutionizing white collar investigations. http://legal-beagle.typepad.com/wrights_legal_beagle/2009/07/edd-analytics-and-interpretation-tools.html --Ben

Posted by: Benjamin Wright | July 6, 2009 at 11:02 AM

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June 15, 2009

Zero balance? Credit card companies may zero in on "deadbeats"

Payment industry experts suggest that credit card companies will make up for lost income from congressionally-mandated curtailment of fees and penalties by going after credit card "deadbeats," which may not mean what you think. To credit card companies, "deadbeats" are customers who pay off their balances regularly and provide little or no revenue to the card issuers. Because banks are expected to lose substantial revenues as a result of the new legislation, they are looking to replace those revenues, more than likely through a revival of annual fees and the elimination of reward programs that the credit card deadbeats currently enjoy.

Congress passed credit card reform legislation in early June to limit some of the unscrupulous pricing schemes that have evolved in recent years—sudden, unexpected hikes in interest rates and double-cycle billing, for example. The law goes beyond codifying the Federal Reserve's regulatory rules already scheduled to go into effect in July 2010 by adding tougher restrictions and extending consumer protections.

Reform may have been necessary, but will the current legislation result in unintended consequences for consumer retail payment behavior?

Pricing for risk
In the early days of the credit card product, banks charged a flat interest rate and an annual fee, which made sense since they only gave cards to their most creditworthy customers. The development of credit scoring models in the late 1980s enabled banks to expand their market by allowing them to measure their potential credit risk for an individual cardholder and price for that risk accordingly.

As the competition for credit card business heightened in the 1990s, competitive pricing schemes evolved with teaser periods permitting low- or no-interest payments on new accounts and transferred balances. This practice permitted consumers to transfer balances frequently for introductory period financing. At some point, the transfer game would inevitably get out of hand and the consumers would become overextended financially. As those overextended cardholders began to experience debt service problems, the credit card issuers responded by repricing their card products to compensate themselves for the additional risk. In fact, some issuers targeted the subprime customer segment exclusively.

Since the reform effectively reduces revenue potential at a time when charge-offs are rising, card issuers will likely rethink their pricing models. If they shift these lost revenues as additional costs or reduced benefits for creditworthy customers, will these customers opt for other payment mechanisms?

Credit or debit?
Will increased costs for credit card products drive credit card deadbeats to use their debit cards instead? While they are different products governed by different sets of laws, many issuers now provide the same consumer protections for debit cards that they do for credit cards. Yet credit cards still have their advantages in terms of the "pay now" or "pay later" decision option. And if you have a dispute over a credit transaction, you still don't have to make the payment until the problem is resolved. With a debit card dispute, the money has already left your account, and your arguments are focused on how to get it back. So a few distinctions favoring credit cards remain. Whether or not deadbeats will pay for them remains to be seen.

By Cindy Merritt, assistant director of the Retail Payments Risk Forum at the Atlanta Fed

June 15, 2009 in cards, payments, risk | Permalink


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June 7, 2009

How much risk lurks in the shadows of daylight overdraft?

With the U.S. banking system in financial distress, the Fed provides payments services to a greater number of problem banks. So how much of an issue is the credit risk associated with retail payments today? As you know, financial institutions, much like the commercial and retail customers they serve, from time to time experience the need for overdraft credit—short-time loans to accommodate the management of incoming and outgoing funds. The Fed provides daylight overdraft protection to financial institutions that experience timing differences in ACH service offerings so that they can meet their cash flow obligations, in the same way a financial institution provides overdraft protection. The Fed, like any prudent lender, also maintains a responsibility to carefully manage the credit risk exposure from these provisions of credit. The need for the Fed to monitor ACH activity for overdraft exposure becomes critical when a financial institution's health is in question.

How does the Fed monitor the financial health of financial institutions?
It is important to remember that the Fed is also a bank regulator, and it works collaboratively with other bank regulators to monitor bank conditions. When a bank's financial condition deteriorates, the agencies communicate the institution's regulatory rating and other relevant information to the Fed in its U.S. payments oversight role. Wearing that hat, the Fed may choose to restrict lending in a number of ways, such as limiting access to daylight credit.

Real-time monitor
One tool that can be used to restrict daylight credit access is "real-time monitoring" (RTM), which is implemented through the Account Balance Monitoring System (ABMS). With RTM, the Fed can reject certain transactions from posting to an institution's account if that posting would cause the institution to exceed its daylight credit limits. Under RTM, any funds transfers from the account or ACH credit originations (which are required to be prefunded) that would cause an institution to exceed its daylight credit capacity would be rejected.

Interest on reserves and daylight overdrafts
One conundrum in this equation is that the need for overdrafts has diminished recently as banks began maintaining higher reserves, prompted by the Fed's decision to start paying interest on reserve balances. Before, banks were reluctant to hold too many reserves because they were a nonearning asset. Since the Fed didn't compensate banks for holding the reserves, banks could find more rewarding uses for their funds. With more reserves in the system, the need for intraday borrowing from the Fed has decreased. Whether that trend will continue as the economy improves and the financial condition of the banking sector stabilizes, thereby creating more lucrative uses for excess reserves, remains to be seen—but then maybe we won't have as many high-risk banks as the economy improves. Let's hope not.

By Cindy Merritt, assistant director of the Retail Payments Risk Forum at the Atlanta Fed

June 7, 2009 in ACH, banks and banking | Permalink


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