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Protect Your Financial Records: Be Aware Of Employee Fraud

Many small businesses may consist of ten or fewer employees, where one or two employees may have access to the company’s checkbook or its readily liquid assets. One employee forgery, embezzlement or other fraud scheme can literally put out of business a family enterprise that took generations to establish.

Many busy small business people trust their checkbook to a longtime office manager or executive assistant, and that trust is sometimes betrayed, especially in the tough economic times that we are in today. A recent leading study of fraud in the workplace found that the impact of an economic recession causes dramatic spikes in “garden variety” financial fraud, including employee embezzlement, forgery, inventory theft, etc.

In the 1960s and 1970s, Congress and many state legislatures were very consumer friendly, enacting financial regulation and credit card rules that were fairly pro-small business and pro-consumer. Thus, the law used to provide a long period of time within which an employer who discovered fraudulent activity in the bank account could seek recovery from their bank, on the theory that the bank had been negligent by failure to notice the forged checks. However, the law has increasingly come to favor banks and other financial institutions, at the expense of small business and consumers.

The Uniform Commercial Code, which has been adopted by almost all of the fifty United States, provides that banks can lawfully put a notice on their bank statements which limits a customer’s remedy to reviewing the statement and requiring the customer to report unauthorized checks within a period “not exceeding thirty days.” See for example California Commercial Code Sec. 4406 (part of the Uniform Commercial Code at Section 4-406). The courts have also routinely held that where a bookkeeper intercepts the monthly statements and “prevents” the small business person from reviewing them, this does not excuse the employer of their duty to review the statements, and bars untimely claims made after the lapse of thirty or more days. See, e.g., Kiernan v. Union Bank (1976) 55 Cal. 3d 111.

Courts have increasingly given banks additional defenses to claims from the small business that the bank was responsible or negligent in processing forged or irregular checks. In a leading California case, Espresso Roma Corp. v. Bank of America (2002) 100 Cal. 4th 525, a long-term bookkeeper began stealing blank checks in 1997 and was not caught until mid-1999, two years after she began embezzling, and after she had eventually embezzled more than $330,000. In Espresso Roma, the court barred the company from recovery under a “repeater rule” which is found in the Commercial Code at 4-406 (d), which provides that if a customer fails to timely report the first unauthorized check forged by a wrongdoer within thirty days, the customer could be precluded from recovering from any subsequently forged checks by the same wrongdoer, as long as the bank can show it used ordinary care in processing checks. Bank of America raised the argument that it files so many millions of checks through its system, that it does so as a “bulk filer” where it cannot visually examine checks, and although it uses fraud filters, it cannot catch every “crooked employee who forges his employer’s checks, which only the employer would know or forge.” The court accepted this analysis as showing “ordinary care” by the bank.

Given that our Congress seems in thrall to Wall Street and the big multinational banks, it is very unlikely that these laws favoring big banks, at the expense of small business, will be modified or rolled back any time soon.

What is the remedy for this problem? A small business person must be scrupulous and extremely careful in reviewing on a regular basis all of the bank statements, check ledgers, financial statements, profit and loss statements, inventory reports, and other essential financial reports any company needs to have at its fingertips, to ascertain what its current financial picture is, and to ensure it continues to meet payroll and its vendor obligations.

For a free consultation about your business, or any problematic legal issues you may be having, contact William W. Bloch at Excelus Law Group Inc., by emailing him at