what is check kiting
What is Check Kiting?
Check kiting involves transferring funds between two accounts before either of the checks can be cleared. The Buzzle write-up below explains what check kiting is.
"Kiting happens on a daily basis at just about every financial institution. It may be a customer with a longtime relationship or a new customer. Most kiting occurs with individuals that have businesses that don't have enough income or revenue to keep going. They supplement with check kiting."
Kiting is a fraudulent scheme that has been in practice for quite some time. This is especially common during a recession, according to experts. It is a method wherein one uses a financial institution/instrument as a means to gain extra credit. More commonly, it involves altering a check on a bank that has insufficient funds. More commonly known as check kiting, it is also known by other names, relevant to the business in which the fraud was conducted. This includes corporate kiting, circular kiting, retail kiting, etc. Statistics reveal that a majority of the cases are done so surreptitiously that they go undetected almost all the time. Financial institutions however, have been taking certain steps off late to prevent the constant recurrence of kiting frauds. In the paragraphs below, you will understand how check kiting works and how to detect the same.
― Robert Young, Loss prevention manager
How does it Work?
- Check kiting and lapping have the same underlying concepts.
- Lapping is a method that includes any kind of fidgeting done with the accounts section of the balance sheet. It involves attributing the collection of one receivable to the theft of another.
- Check kiting works in a similar manner. Assume that a check is written on one bank with an amount that is more than what is contained in the bank currently. Now, before the check could be cashed, another check is written on another bank to cover up the insufficient cash of this account.
- In other words, a check is drawn for a larger amount than the balance, and deposited into another account. Prior to the clearance of the first check, the amount on the second check is withdrawn and deposited back into the first account.
- Thus, technically, one is carrying out balance inflation, to allow clearance of the written checks instead of allowing them to bounce.
- Quite a few years back, written checks would take a longer processing time than today. This fraudulent act was apparently done during that period.
- Reportedly, such acts are performed by individuals who are temporarily unemployed or need urgent loans.
Examples
You will understand the concept better with a couple of check kiting examples.
Example I
- Assume that there are two banks - A and B.
- Let's say George has accounts in both. Now, he first deposits USD 2000 in A. Then, he writes a check of USD 5000 on A. Technically, this is impossible, since the balance is short of USD 3000.
- He deposits this check in B. B proceeds to clear the check.
- Meanwhile, George draws a check on B for USD 5000 and deposits it in A.
- Thus, George is basically securing an illegal, interest-free loan, and neither of the banks are aware of the bad check transfer.
Example II
- Consider a similar example again. Let's say Ursula has two checking accounts at banks A and B, and she uses B to pay her bills.
- Now assume that she deposits USD 1000 in A, but her total bill amount exceeds to USD 3000.
- In this case, if she engages in kiting, she will draw a check on A for USD 3000, despite the lesser funds. She will deposit this check in B, and will be granted credit immediately.
- But Ursula is aware that A does not have sufficient cash. She will now write a check of USD 3000 on B, and deposit it in A.
- Her fraud will thus go unnoticed due to the time it takes to clear the checks.
Detection
- Ordinarily, it is very difficult to spot check kiting, since the paper hangers (professional kiters) do it so cleverly.
- The transaction details did not appear on the account sheet, and the kiters used to get away scot-free.
- Detection was even more difficult in case of circular kiting, which involves multiple account holders writing fraudulent checks to each other, drawn on each other's accounts.
- However, the electronic payment system that has been introduced recently has reduced the periodic occurrence of kiting.
- Also, the settlement time for check clearance has been reduced considerably.
- Banks also make it a point to charge heftily for bounced checks.
- They look for accounts that have regular deposits and withdrawals for large amounts.
- They also consider the deteriorating credit score and other financial aspects to detect check kiting.
Is it a Felony?
- There is no doubt about this, check kiting is a felony. It is a white collar crime - a very serious offense.
- In cases of corporate accounts, kiters have played around with millions and millions of dollars.
- As per state laws, it may be considered a demeanor. But it is equivalent to embezzling the account.
- Check kiting may go on for a period of time, until the bank suspects something amiss and catches the offender. In this scenario, the number of bad checks issued are plenty, resulting in severe legal trouble.
- Corporate kiters may face criminal charges. Also, since this is handled by the federal government, the offender could face state and federal charges.
Penalties
- There is penalty for check kiting, of course. The penalties vary as per the state jurisdictions.
- Hefty fines may be imposed, perhaps more than USD 500,000.
- The kiter may very well go to prison, possibly between 10 to 20 years.
- In case the floating has been carried out by groups of individuals or businesses, the penalties are even higher.
Legal Matters
- As mentioned above, check kiting is a serious offense.
- In case the kiter takes the problem to court, it may be very difficult to find a defense lawyer, because no one would be willing to get into a case that is an obvious failure.
- One of the reasons is because check kiting is not something that is done accidentally.
- For these reasons, even conjuring up a suitable defense becomes difficult.
- However, in case you have been threatened to perform check kiting, or your signature has been forged, you may be let off legal action, though you need sufficient evidence for the same.
- A criminal defense lawyer may be able to help you out with the case. Do not proceed without acquiring proof, though.
Cases
- One of the very famous check kiting cases was that of E.F. Hutton & Co., a stock brokerage firm founded in 1904.
- It was a huge, successful business, though the check kiting scheme was carried out in 1980.
- Most of the branches of the company had started writing checks on accounts that had insufficient balance.
- That means the money was being used in both the accounts until the check was cleared.
- This sloshing had taken place in almost 400 banks, and as per reliable reports, the company gained an amount of USD 250 million per day, thus providing itself an interest-free loan.
- The scandal caused a tremendous loss of capital and reputation, after which many customers terminated their accounts with the company.
- The fraud was called 'chaining', and it took almost three years for it to get detected, after which the company faced federal criminal charges and had to pay a humongous amount as penalty.