An alleged check-kiting scheme targeting Warsaw, NY-based Five Star Bank is the latest sign of rising check fraud in the bank industry.
According to data from the Financial Crimes Enforcement Network, there were 528,864 suspicious activity reports (SARs) for check fraud at depository institutions in 2023, more than double the 249,812 check fraud SARs in 2021. So far into the first two months of 2024, there have been over 90,000 check fraud SARs at depository institutions.
Financial Institutions Inc. unit Five Star Bank is one of the latest victims, facing losses related to check fraud after a local small business owner allegedly engaged in an check-kiting scheme that resulted in fraudulent transactions of about $18.9 million.
The bank discovered the scheme during routine monitoring, Director of Investor and External Relations Katherine Croft wrote in a statement to S&P Global Market Intelligence. "The company discovered fraudulent activity associated with deposit transactions conducted over the course of several days ending in early March by an in-market business customer of Five Star Bank," Croft wrote.
The company believes the activity is an isolated occurrence related to a single, deposit-only relationship that does not impact the information or funds of other customers, Croft said.
Five Star's February fraud
In a complaint to the US District Court for the Western District of New York, Five Star's parent company alleged that defendant Katherine Mott unlawfully obtained $18.9 million through a fraudulent check-kiting scheme, artificially inflating the balance of her various accounts at the bank.
In a statement to the press, a spokesperson for the businesses owned by Mott and Robert Harris pushed back against the allegations.
"As has become all too common in today's world, allegations that are released to the media are seen as facts," spokesperson Arnie Rothschild wrote in a statement provided to Market Intelligence. "As the legal matters move forward and through the process the company will continue, not only to operate and continue to provide high-quality products and services, but will do so as we always have."
According to the suit, Mott, who with codefendant Harris owns several small businesses through 10 limited liability companies, opened five separate business demand deposit accounts with the bank on Nov. 29, 2022, and "numerous other" accounts between then and Jan. 11, 2024. Although Harris co-owns the businesses, which are also listed as codefendants, Mott exercised sole control over their management and financial affairs, the complaint said.
In February of this year, Mott began the kiting scheme, writing checks between the various accounts and accounts held at other local institutions such as Kinecta FCU, the suit stated.
Kinecta FCU did not reply to a request for comment in time for publication.
Financial Institutions alleges that starting Feb. 23, Mott deposited 68 different checks into the various Five Star Bank accounts exceeding $62 million, more than the balances of the accounts from which they would be drawn, and then withdrew $20.4 million.
Now, Five Star Bank is facing exposure up to $18.9 million, or $14.1 million net of taxes, related to the scheme, according to a March 11 regulatory filing.
No criminal charges have been filed, but Croft told Market Intelligence that Five Star is working with law enforcement and conducting its own investigation of the incident, in hopes of recovering some of the potential losses.
"They're going to try to collect as much of it as they can from the person that committed the fraud, but it's just unknown how successful they'll be," Piper Sandler analyst Alexander Twerdahl said in an interview.
Still, the analyst is not worried about the potential losses, writing in a note March 11 that "we know that the bank will remain well capitalized."
Stephens analyst Matt Breese estimates the holding company's tangible book value (TBV) could decline by 4%-4.5% to between $22.10 and $22.25 compared to the first-quarter TBV estimate of $23.15. The company's tangible common equity as a percentage of total assets could decline by 30 basis points to 5.6%, Breese also estimated.
"While fraudulent activities like these are few and far between, and is most likely a one-off, the amount and impact to TBV and capital is significant with capital as measured by [tangible common equity to tangible assets], already thin, expected to fall," Breese wrote in a note March 11.
Preventing kiting
Five Star Bank's recent situation is one many banks know all too well.
In 2023, fraudsters targeted financial institutions including SB Financial Group Inc., ServisFirst Bancshares Inc., Truist Financial Corp. and Regions Financial Corp., the last of which was hit with reported fraud losses of $135 million between the second and third quarters of 2023.
"Fraud is hard to prevent against," Piper Sandler's Twerdahl said. "[Five Star Bank is] certainly not the first bank we've seen this type of thing happen to and it probably won't be the last."
With fraud on the rise, banks should be proactive in setting up controls to prevent losses. In general, strategies to prevent kiting should include keeping better track of how often customers write checks so banks can catch anomalies more quickly, Frank Teruel, CFO at cybersecurity company Arkose Labs, said in an interview. Banks should also avoid allowing withdrawals of new deposits before a check clears, the CFO added.
"You can allow withdrawals of existing funds, but you just don't allow anybody to withdraw more than enough to cover whatever that check would be if it bounced," Teruel said. "The way to avoid it is you just can't fall into that malaise associated with thinking you know somebody."