Extending the Float: Check Kiting

John the controller tried to buy a little time with a check kiting scheme to keep two businesses alive. Unfortunately for him, the time he bought was 10 months in prison.   

If you ask someone the definition of check kiting, they often look at you with a blank stare and say, "Yeah, I know what that means. It has something to do with bank accounts." But you can tell they don't really understand. Even when you try to explain that it has to do with checks being written between bank accounts to artificially inflate bank balances, you usually get a response of, "Oh, now I know what you're talking about." But you can still tell that they're not clear on the concept. Actually, many prosecutors aren't either and that makes them less likely to pursue check kiting prosecutions.

According to the ACFE Fraud Examiners Manual, check kiting is defined as the process in which cash is recorded in more than one bank account, but in reality the cash is either nonexistent or is in transit. Kiting schemes can be perpetrated using one bank and more than one account or between several banks and different accounts.

Find the float
A check kiting analysis is a labor-intensive investigation. The investigator must look at 100 percent of the deposits and deposited items during at least three months of the suspected period. This time is sufficient to determine whether a kite pattern exists. If the kite wasn't sustained for a full three months, a shorter analysis period may be used. The key is to determine whether the deposited funds originated from a legitimate third-party source or if they were from another bank account of the subject or under the subject's control. It's also necessary to document the date of the deposit of the check and also the date that the check cleared the originating bank. This difference between the deposit date and the check-clearing date is the float period. (That float time is now greatly reduced due to Check 21.)  

In the United States, check kites are prosecuted under Title 18, U.S. Code Section 1344, which is defined as obtaining the funds of a federal bank under false pretenses. In effect, a check kite is obtaining an interest-free loan from a bank without the bank's knowledge. One of the challenges of check kiting investigations is proving intent; it must be proved that the fraud occurred by design and wasn't due to an accident, mistake, or bad business decision. Intent can be proved through establishing the pattern of the check kite - the consistent movement of checks among bank accounts without any purpose other than to inflate bank balances. When performing a check kite analysis it's also necessary to look at the withdrawal side of the bank accounts because one of the first things a prosecutor asks is, "Well, why did he do it?" Obviously, you need to answer this question. Maybe it was a cash flow problem or the subject purchased expensive assets or went on extorbitant trips.

It's up to the fraud examiner to simplify the check kiting investigation by providing a clear-cut analysis with eye-catching exhibits and to make the check kiting definitions easily explainable to both prosecutors and potential juries. Following is an example of an actual check kiting investigation performed by the Federal Bureau of Investigation. The names have been changed, but the basic facts of the case remain the same.

A tale of two companies
John D. Friedman was the controller of AA Trucking Company. AA Trucking generated approximately $2 million in business a year. The owner, Terri Blanchard, had two checking accounts that were used for the business. She was the signer on account No. 5511 at Avondale Bank, and her employees, Sylvia Smith and Carrie Wiess, were signers on account No. 4466 at Bradford Bank.

Unfortunately, Terri, Sylvia, and Carrie committed one of the fatal mistakes of business - they trusted too much. Terri was a busy lady and she wasn't always around to sign checks so she allowed John to forge her signature when she wasn't available. Terri didn't see a problem with this; she trusted John the controller.

To raise ready cash, AA Trucking would sell its accounts receivable to Cascade Factoring and deposit 80 percent of that amount in account No. 5511, which was reserved only for money from that source. John was only supposed to transfer a few checks from No. 5511 to No. 4466 at Bradford Bank but surreptitiously he moved many more to begin the scheme.

After the crime was discovered, we interviewed Terri, the owner, and decided that she wasn't part of the scheme but we realized that John probably was. She inspected the company checks written from account No. 5511 and determined those that John had signed. (According to Terri, the letter "t" in John's forgeries of her signature had a distinctive loop.)

Blank check problem
John would ask his employees, Sylvia and Carrie, to sign three to five blank checks on account No. 4466 per day. They never asked about the purposes of the checks and never required receipts. John said he needed the blank checks to pay for fuel for trucks or for trailers. We later discovered that he made out these approved blank checks to Friedman Trucking, his own separate trucking company. He was the signer on account No. 3311 for Friedman at Dorchester Bank. According to Terri, Sylvia, and Carrie there wasn't any reason for any checks from AA trucking to be going to Friedman Trucking.

The kite fell apart when Cascade Factoring notified Terri that account No 5511 was overdrawn. Terri then confronted John who said he did what he had to do to keep AA Trucking in business. With the circle of checks among accounts now at a standstill, we discovered that Bradford Bank had sustained a loss of $88,000.

We analyzed 100 percent of the deposits made from March 1, 2002 through May 18, 2002 (the date the scheme fell apart) for accounts No. 5511, No. 4466, and No. 3311, to determine if the deposits were transfers between the three accounts or if they were legitimate third-party deposits. Following are results of the analysis of deposits for each of the three accounts. (Stay with me here.)

For account No. 5511, all the kited deposits into the account came from account No. 3311 from March 1 through May 18. For March, actual deposits from third parties were $221,000, and kited deposits were $392,000. For April, actual deposits were $205,000, and kited deposits were $600,000. For May 1 through May 18, actual deposits were $100,000 and kited deposits were $350,000. (See exhibit A below.) 

Exhibit A is no longer available 

For this same period, we analyzed all the deposits for account No. 4466. All the kited deposits into the account came from account No. 5511. For March, actual deposits were $26,000, and kited deposits were $659,000. For April, actual deposits were $11,000, and kited deposits were $779,000. For May 1 through May 18, actual deposits were $60,000 and kited deposits were $415,000. (See exhibit B below.) 

Exhibit B is no longer available 

For this same period, we analyzed all the deposits for account No. 3311. All the kited deposits into this account originated from account No. 4466. Account No. 3311 had no actual deposits but did have kited deposits of $550,000 for March. For April, the account had no actual deposits but did have kited deposits of $700,000; for May 1 through May 18, the same account had no actual deposits but did have kited deposits of $400,000. (See exhibit C.) The zero actual deposits during the period indicated that account No. 3311 was used solely to perpetrate the check kiting. There was no legitimate revenue from Friedman Trucking being deposited into this account during the entire analysis period.

Exhibit C is no longer available 

This check kite was unusual in that John would take funds from account No. 3311, use those funds to purchase cashiers' checks, and deposit those into account No. 5511. Remember that only deposits from Cascade Factoring Company were supposed to be going into account No. 5511. For the entire analysis period of March 1 through May 18, actual deposits into the three accounts were $623,000, and kited deposits were $4,845,000. (See exhibit D.) This means that only $623,000 of the deposits into the three accounts during the period analyzed were legitimate third-party funds, and almost $5 million of deposits into the accounts were just funds running in circles among the three accounts.

Exhibit D is no longer available 

Bank balances above zero dollars
Although the bank balances were continually above zero dollars during the check kiting analysis period, the actual balances were continually a negative $60,000 or greater, meaning that if the kite terminated at any time during the analysis period the banking system would have been subjected to a loss of at least $60,000. (See exhibit E.) The actual balance is calculated by documenting the daily bank balances directly off the bank statements, then subtracting the checks in float on that particular day. For example, on April 17 the bank balance was $8,000 but the actual balance was a negative $93,000, meaning that the amount of checks in float on that date was $101,000.

To recap: investigators only need to examine three months of deposit activity because that's a sufficient amount of time to establish a check kiting pattern. (An even shorter analysis may be adequate for check kiting that occurred in less than three months.)

Exhibit E is no longer available 

Cash-flow problems made him do it
We determined that the motive for this case was cash-flow problems at both AA Trucking and Friedman Trucking. John was desperate to keep both companies afloat, and he was kiting checks just to pay the bills. Through inflating the bank balances, he was able to write checks out of the accounts to pay bills even though there weren't sufficient funds in them. He may have thought he had good intentions but he broke the law and was indicted.

John served 10 months in prison and paid $88,000 in restitution to Bradford Bank. The other two banks didn't suffer a loss. A proper segregation of duties would have prevented this fraud. If only Terri, the owner of AA Trucking, had reconciled the accounts No. 5511 and No. 4466 herself or had someone other than John reconcile them, it's unlikely that this check kite would have occurred and you wouldn't be finishing this article.

Maria S. Hamernik, CFE, CPA, is a financial analyst with the Federal Bureau of Investigation in Omaha, Neb.