The following is an article reprinted with permission from The WWR Letter:
An Introduction to Check Kiting
If you were to ask someone what check kiting is, most likely you would receive a response such as, “Yes, I know what that is, it has to do with bank accounts…right?” More often than not, that response will be accompanied by a blank stare. But check kiting is a real threat and it is forcing U.S. banks, credit unions and other financial institutions to take an ardent interest in exactly how their customers and members make deposits and withdrawals.
Check kiting can be defined as the consistent passing of checks among bank accounts with the sole purpose to inflate bank balances. According to the Association of Certified Fraud Examiners’ Manual, check kiting is the “process by which cash is recorded in multiple bank accounts but in reality the cash is either in transit or nonexistent.” Basically, check kiting is an ill-gotten gain in the form of an interest-free loan that the financial institution has no idea it is giving. The kiting scheme is a form of fraud generating nonexistent revenue and produces questionable account balances. The fraudster knowingly draws against these uncollected funds to pay for purchases or other various expenditures to third parties. When the fraudster is involved in such a process, he or she is committing the prosecutable offense of check kiting.
In order for the scheme to be successful, the fraudster must have a good working knowledge of the financial institution’s presentment procedures and clearing times for checks. Because a successful check kiting scheme is dependent on the “float”, (i.e. the time it takes the presenting financial institution to actually receive the funds from the issuing financial institution) check kiters usually use out-of-state financial institutions in order to extend the float time.
Let’s walk through a typical check kiting scenario:
1) A check kiter, let’s call him Jim, opens two checking accounts with two different credit unions, Credit Union 1 and 2 respectively, depositing $5,000.00 into each.
2) Jim then writes a $5,000.00 check drawn on the Credit Union 1 account and deposits it into his Credit Union 2 account.
3) Now, before Credit Union 1 is even aware that that draft has been written, Jim writes another check for $10,000.00 drawn on Credit Union 2 and deposits it into Credit Union 1.
4) The fraud will be successful and complete upon Jim writing and cashing a check for $15,000.00 from his Credit Union 2 account drawn on his Credit Union 1 account.
As mentioned above, check kiting is a prosecutable offense as a misapplication of funds. The essential elements of misapplication are as follows: (1) the accused must be a covered person; i.e. an officer, director, agent, employee of or connected in any capacity with (2) a particular Federally connected institution, (3) the accused must willfully misapply monies, funds or credits of or entrusted to such institution (4) with the intent to injure or defraud the institution. United States v. Brock, 833 F.2d 519, 522 (5th Cir.1987).
Stated simply then, misuse of correspondent bank balances may be charged as a misapplication in circumstances in which there is a detriment to the bank and a benefit to an insider. See United States v. Mann, 517 F.2d 259 (5th Cir.1975), cert. denied, 423 U.S. 1087 (1978). Further, a check kite may also be prosecuted as a bank fraud pursuant to 18 U.S.C. §1344. United States v. Giordano, 489 F.2d 327 (2d Cir.1973); see also 18 U.S.C. §1005.
Keep in mind, while prosecuting under one of the above-mentioned statutes, knowledge or intent may be inferred from the kiter’s reckless disregard of the interests of the financial institution. United States v. Adamson, 700 F.2d 953, 965 (5th Cir.) en banc, cert. denied, 474 U.S. 833 (1983). It should also be appreciated that while it must be proven, as an essential element, that the financial institution was deprived control over its funds to have a misapplication, there is no need to prove that the institution suffered an actual loss. United States v. Cauble, 706 F.2d 1322, 1354 (5th Cir. 1983), cert. denied, 465 U.S. 1005 (1984). Typically, the mere probability of loss to the bank is enough to prove the kiter’s intent to injure or defraud and neither the possibility of some benefit to the bank or the possibility of restitution is a valid defense to misapplication. United States v. Beran, 546 F.2d 1316, 1321-22 (8th Cir.1976), cert denied, 430 U.S. 916 (1977). However, evidence of a benefit or restitution may be used to disprove the intent to injure or defraud. United States v. Riley, 550 F.2d 233 (5th Cir.1977).
Detecting a check kiting scheme is laborious and there is no one fail-safe way of preventing it. Faster presenting and clearing times (see Check Clearing for the 21st Century Act (12 CFR Part 229) and Reg. CC)) make the scheme harder to pull off, but not impossible. Enforcing check holds can be helpful in stopping kiting. Remember to file a Suspicious Activity Report for non-employee check kiting schemes involving $5,000.00 or more.
If caught and successfully prosecuted, the check kiter spends time in jail, but the credit union is the one left holding the bag…and the bag is empty. Therefore, credit unions need to establish greater controls to identify the fraudulent activity and institute frequent reviews and assessments of such procedures. This is essential to reducing the credit union’s risk of loss caused by check kiting schemes.
Jim Doran and Benjamin M. Turk are both Associates in the Legal Action Recovery department of the Cleveland office. Jim can be reach at (216) 685-4289 or firstname.lastname@example.org and Benjamin can be reached at (216) 685-1122 or email@example.com.