PREPARED STATEMENT OF
THE FEDERAL TRADE COMMISSION
PRESENTED BY JODIE BERNSTEIN
DIRECTOR OF THE BUREAU OF CONSUMER PROTECTION
DEMAND DRAFT FRAUD
BEFORE THE HOUSE BANKING COMMITTEE
WASHINGTON, D.C.
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 Commissions 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 consumers 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 consumers 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 consumers checkbook -- imprinted with the consumers 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 consumers
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 Commissions initial conclusion was that demand
drafts were just another tool in the fraud operators
toolbox. Accordingly, the Commissions 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 Commissions
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 consumers 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 UCCs 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 consumers 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 consumers
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 consumers 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 consumers bank, upon request, a copy of the consumers 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 consumers 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 consumers 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 merchants 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 Rules 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 Rules 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 consumers checking account number
on a demand draft as proof of the consumers 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 consumers 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 consumers 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 consumers authorization. Because
the Rule enhances the ability of banks to determine whether a
demand draft has a consumers 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 Rules 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 wont 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 Commissions 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 Commissions 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 Commissions own educational materials
produced by the Commissions Office of Consumer and Business
Education.
Members of the automated payment industry were at the
forefront in launching the Partnerships 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 Commissions 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); FTCs 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.