3
A Systems Approach to the Counterfeiting Threat

To assist in understanding current counterfeiting trends and to help assess the potential effectiveness of various countermeasures, the system of distribution and use of U.S. banknotes bears examination. Such an overview can reveal approaches or combinations of approaches that may be more effective than focusing only on one step in the process. For example, much attention may be given to preventing the production of a counterfeit note, but somewhat less attention may be paid to preventing its casual circulation.

While U.S. dollars are recognized worldwide as legal tender, their distribution and use vary in some interesting ways. Currently, approximately $720 billion in U.S. banknotes are in worldwide circulation. This amount is increasing by about 6.5 percent per year.1 The rate of counterfeiting of U.S. banknotes is estimated to be 5 counterfeits per million notes circulating in 2002. As expected, however, more $100 notes than $1 notes are counterfeited; the number of $100 notes is higher than the average, and is estimated at 30 counterfeits per million.2

COUNTERFEITING AT HOME AND ABROAD

Approximately two-thirds of the value of U.S. currency in circulation and 70 percent of all $100 notes in circulation are estimated to reside overseas, in both dollarized and nondollarized countries.3 In many foreign countries, U.S. currency is accepted in transactions as a global currency; it is often stockpiled against political and economic uncertainty; and it can provide a stable, anonymous liquid asset to individuals and corporations. The remaining one-third of the value of U.S. currency is held domestically.4 In contrast to foreign holdings of U.S. currency, domestically held currency primarily circulates; relatively little is held long term.

Counterfeits are discovered in two main ways: (1) The counterfeiters are found through law enforcement procedures and their products are seized, usually in large quantities. (2) Merchants or banks discover counterfeit notes after they have been passed into circulation.

Forensic science can identify common features among discovered notes that can be traced to unique characteristics of the counterfeiting process. These distinctions can allow the counterfeits to be classified

1  

E. Foster, Federal Reserve Board. 2005. Presentation to this committee, May 24.

2  

J. Haslop, De La Rue. 2005. Presentation to this committee, July 21.

3  

E. Foster. See note 1 above. Dollarized economies are those that have adopted the U.S. dollar as their official national currency.

4  

L. DiNunzio and L. Clarke. 2004. The new color of money: safer, smarter, more secure. Proc. SPIE, Optical Security and Counterfeit Deterrence Techniques V, R.L. van Renesse (ed.), Vol. 5310, pp. 425-439.



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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes 3 A Systems Approach to the Counterfeiting Threat To assist in understanding current counterfeiting trends and to help assess the potential effectiveness of various countermeasures, the system of distribution and use of U.S. banknotes bears examination. Such an overview can reveal approaches or combinations of approaches that may be more effective than focusing only on one step in the process. For example, much attention may be given to preventing the production of a counterfeit note, but somewhat less attention may be paid to preventing its casual circulation. While U.S. dollars are recognized worldwide as legal tender, their distribution and use vary in some interesting ways. Currently, approximately $720 billion in U.S. banknotes are in worldwide circulation. This amount is increasing by about 6.5 percent per year.1 The rate of counterfeiting of U.S. banknotes is estimated to be 5 counterfeits per million notes circulating in 2002. As expected, however, more $100 notes than $1 notes are counterfeited; the number of $100 notes is higher than the average, and is estimated at 30 counterfeits per million.2 COUNTERFEITING AT HOME AND ABROAD Approximately two-thirds of the value of U.S. currency in circulation and 70 percent of all $100 notes in circulation are estimated to reside overseas, in both dollarized and nondollarized countries.3 In many foreign countries, U.S. currency is accepted in transactions as a global currency; it is often stockpiled against political and economic uncertainty; and it can provide a stable, anonymous liquid asset to individuals and corporations. The remaining one-third of the value of U.S. currency is held domestically.4 In contrast to foreign holdings of U.S. currency, domestically held currency primarily circulates; relatively little is held long term. Counterfeits are discovered in two main ways: (1) The counterfeiters are found through law enforcement procedures and their products are seized, usually in large quantities. (2) Merchants or banks discover counterfeit notes after they have been passed into circulation. Forensic science can identify common features among discovered notes that can be traced to unique characteristics of the counterfeiting process. These distinctions can allow the counterfeits to be classified 1   E. Foster, Federal Reserve Board. 2005. Presentation to this committee, May 24. 2   J. Haslop, De La Rue. 2005. Presentation to this committee, July 21. 3   E. Foster. See note 1 above. Dollarized economies are those that have adopted the U.S. dollar as their official national currency. 4   L. DiNunzio and L. Clarke. 2004. The new color of money: safer, smarter, more secure. Proc. SPIE, Optical Security and Counterfeit Deterrence Techniques V, R.L. van Renesse (ed.), Vol. 5310, pp. 425-439.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes TABLE 3-1 U.S. Banknote Counterfeiting in Fiscal Year 2005: Production Technology, Class of Counterfeiter, and Amount (in U.S. dollars) Primary Production Technology Primary Criminal Class Domestic Passed ($) Domestic Seized ($) Foreign Passed ($) Foreign Seized ($) Ink-jet printing Hobbyist, petty criminal 29,153,845 5,940,531 29,984 642,841 Electrophotography Hobbyist, petty criminal 2,164,475 758,045 8,690 9,920 Offset press (domestic) Professional 2,264,582 1,608,682 72,593 7,186,140 Offset press (foreign) Professional 21,244,276 1,290,340 746,910 11,971,514 Intaglio press (foreign) State-sponsored 1,401,300 5,083,200 3,939,200 531,200 TOTAL   56,228,478 14,680,798 4,797,377 20,341,615   SOURCE: Data provided to this committee by the U.S. Secret Service. according to their sources. Table 3-1 presents a snapshot of the magnitude of U.S. banknote counterfeiting for fiscal year 2005; these numbers are typical of the counterfeiting threat in recent years. The counterfeits are classified by the U.S. Secret Service according to their source, either domestic or foreign, and according to whether they were discovered before or after they were passed into circulation. These data provide some insights into the patterns and practices of counterfeiters. Given the distribution of notes, it is not surprising that the most-counterfeited note abroad is the $100 note. Because foreign cash handlers generally screen U.S. banknotes more carefully than do U.S. cash handlers, the annual dollar value of passed counterfeit notes reported abroad is constant and small. It is estimated at less than $5 million, although this number is not reliably measured.5 The high scrutiny paid abroad to U.S. notes means that foreign counterfeiters must invest more resources to produce a reasonably high quality product. Typically this necessitates traditional methods such as offset or intaglio printing, high-quality paper, and reasonable simulations of security features—and large operations. The U.S. anticounterfeiting strategy overseas, therefore, focuses on enforcement with good success. Seizures of counterfeit banknotes in foreign countries decreased from $350 million in 1995 to $20 million in 2005 as the U.S. Secret Service succeeded in shutting down large counterfeiting operations, particularly in Colombia (reportedly the source of 40 percent of counterfeit U.S. currency) and as diplomatic efforts curtailed operations in Bulgaria.6 Other large producers of counterfeit U.S. currency include Mexico, Nigeria, and North Korea. As compared with foreign counterfeiting of U.S. banknotes, domestic counterfeiting is considerably more opportunistic, is generally smaller in scale, and focuses on smaller bill denominations. In the United States, the $20 note is the most widely used note, primarily because it is most commonly distributed through automated teller machines, or ATMs. It is also the most counterfeited note domestically. Note that, according to data in Table 3-1, in foreign countries counterfeit seizures outstrip passed notes by a factor of four. However, the reverse is true in the United States. Domestic counterfeits tend not to be stockpiled, and in the United States, passed notes exceed seized notes by a factor of four. Counterfeiting technology follows digital reproduction technology trends. In 1995, for example, less than 1 percent of counterfeit notes detected in the United States were digitally produced. By 2005, that number had grown to nearly 35 percent worldwide and 54 percent within the United States, according to 5   L. Felix, Bureau of Engraving and Printing. 2005. Presentation to this committee, May 24. 6   L. Felix. See note 5 above.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes data in Table 3-1 (ink-jet printing and electrophotography).7 Currently, ink jet is the primary technology that can easily and cheaply simulate the look of a current Federal Reserve note (FRN). The widespread availability of a variety of ink-jet printers means that notes may be printed in widely dispersed locations on a very irregular schedule and may be almost impossible to track. The total dollar value of domestically passed notes is around $40 million to $50 million annually and is approximately constant over time.8 Because Federal Reserve machine readers capture all counterfeits that pass through Federal Reserve banks at the end of the currency’s life, this number is a good lower bound of the counterfeiting activity in the United States. However, the estimate does not include counterfeit notes that are withdrawn from circulation by a recipient who neither reports it nor passes it on to others. THE IMPACT OF COUNTERFEITING Counterfeiting can have a number of impacts on individuals, companies, financial institutions, and the nation that issues the currency. The most obvious impact may be perceived to be economic. However, the total value of counterfeit notes passed (about $61 million in 2005) is less than 0.01 percent of the value of currency in circulation and an even smaller portion of the total U.S. economy.9 Counterfeiting of banknotes is very small compared, for instance, with counterfeiting of credit cards or of branded goods. The counterfeited-products business engenders huge losses, ranging to 5 to 8 percent of worldwide sales of brand products, and credit card fraud accounted for more than $750 million in losses in the United States in 2004.10 Good design and strong enforcement policies have enabled U.S. currency to achieve one of the lowest rates of counterfeiting of any major currency—only five notes per million—despite its worldwide circulation. In contrast, the euro is estimated to be counterfeited at 65 notes per million, the British pound at 160 notes per million, and the Canadian dollar at 1,000 notes per million.11 Counterfeiting may also have psychological effects. Governments (and their enemies) have long realized that counterfeiting is a national security issue. For instance, in an attempt to destabilize the Continental government, the British government counterfeited U.S. currency during the American Revolution;12 likewise, the Union sent counterfeit Confederate dollars south during the Civil War,13 and during World War II, the German government manufactured a high-quality counterfeit of the British 5-pound note (termed the White Fiver).14 The psychological impact created by counterfeiting can be measured in economic terms, however. As in most economic markets, the consumer response to a threat is not proportional to the threat itself: stock market crashes are the archetypical example. An illustration of the psychological impact of counterfeiting is provided by the Bank of Canada, which reports that when counterfeit Canadian $100 notes reached a level of 300 notes per million, as many as 11 percent of merchants stopped accepting $100 notes.15 Thus, U.S. anticounterfeiting strategies are intended to maintain consumer confidence in U.S. currency, just as terrorist-sponsored counterfeiting is intended to undermine it. 7   L. Pagano, U.S. Secret Service. 2005. Presentation to this committee, May 24. 8   L. Felix, Bureau of Engraving and Printing. 2005. Presentation to this committee, May 24. 9   U.S. Department of the Treasury. 2003. The Use and Counterfeiting of United States Currency Abroad, Part 2. The second report to the Congress by the Secretary of the Treasury, in consultation with the Advanced Counterfeit Deterrence Steering Committee, pursuant to Section 807 of Public Law 104-132. Available at http://www.federalreserve.gov/boarddocs/rptcongress/counterfeit2003.pdf. Accessed April 2006. Note that the percentages of counterfeits will vary if reported as the percentage of banknotes or the percentage of monetary value. 10   Credit card fraud in the U.S. 2005. The Nilson Report, Vol. 830, p. 8. 11   J. Haslop, De La Rue. 2005. Presentation to this committee, July 21. 12   See, for example, http://www.secretservice.gov. Accessed March 2006. 13   G. Tremmel. 2003. Counterfeit Currency of the Confederate States of America. Jefferson, N.C.: McFarland. 14   Bank of England Fact Sheet. 2003. Available at http://www.bankofengland.co.uk/banknotes/factnote.pdf. Accessed March 2006. 15   J.F. Chant. 2004. Bank of Canada Review. Ottawa, Ontario: Bank of Canada. P. 43.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes TABLE 3-2 Some Classes of Counterfeiters, Their Methods and Technologies, and Deterrent Features on U.S. Banknotes Criminal Class Methods Technologies Deterrent Features on U.S. Banknotes Primitive Uses manual artistry and crafting supplies Skilled artistry, bleaching Fine lines and microprinting, security strip Hobbyist Uses electronic devices and crafting supplies commonly found in homes, offices, and universities Ink-jet printers, color copiers, scanners, all-in-one devices Paper quality and watermark, special inks and printed images, fine lines and microprinting, security strip Petty criminal Deliberately seeks commercially available materials to augment available digital processes Specialty inks and materials, bleaches Fine lines and microprinting, special inks and printed images Professional criminal Has the means to manufacture special materials or to appropriate controlled materials Lithographic printing, materials for sophisticated simulation of features Machine-readable features State-sponsored Has full resources to duplicate all technology Duplicate of technology used by the government Machine-readable features The economic impact of a loss of confidence in U.S. currency could be high. If the billions of dollars in U.S. currency currently residing overseas were suddenly “called in,” there would be ramifications throughout all sectors of the U.S. economy. More subjective, but also critical, is the political advantage to issuing a global currency. The loss of U.S. prestige and influence abroad owing to a lack of confidence in the dollar is not readily measurable, but it would be nonetheless severe. Finally, although the total economic cost of counterfeiting is low, the personal cost to someone left holding a worthless note may be high. When a counterfeit note is identified, it loses its value. Because this cost accrues to an innocent party—usually a retailer or service provider—it is in the best interest of any government to protect its citizens from this threat. PORTRAIT OF A COUNTERFEITER According to the former chair of the U.S. House Banking Committee, Congressman Michael Castle, “The classic movie cliché of the ink-stained master engraver painstakingly touching up his counterfeit printing plates, has now given way to amateurs.”16 This statement describes the new class of counterfeiters that has emerged in step with the evolution of modern information technology tools. Counterfeiters can be characterized in five groups of criminal types. Each criminal group represents a different threat based on the technology available to them, and different features of FRNs address these different threats. Each of the features on current U.S. banknotes has been simulated or duplicated by members of these various groups. The five types of counterfeiters can be characterized by the technologies and the methods they use, as indicated in Table 3-2, or by the characteristics of their activities as described in Table 3-3. The two tables together provide a reasonably complete indication of the activities and capabilities of each type. Table 3-4 expands on counterfeiters’ methods for passing notes. The relative threats associated with each criminal type are shown in Figure 3-1. These data indicate that the vast majority of counterfeit FRNs are created by hobbyists and petty criminals. Moreover, these 16   M.N. Castle. 1998. Opening statement for a hearing on using personal computers to counterfeit U.S. currency. U.S. House of Representatives Committee on Banking and Financial Services, Subcommittee on Domestic and International Monetary Policy. Available at http://financialservices.house.gov/banking/33198cas.htm. Accessed March 2006.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes TABLE 3-3 Classes of Banknote Counterfeiters, Their Tools, Location, and Impact Class Typical Practitioner Primary Tools Location Impact of Activity Primitive Unusually motivated individual Manual artistry Domestic or foreign Very low Hobbyist Opportunistic young adult, typically works alone Home office equipment Domestic Created largest increase in $20 domestic passed currency (together with petty criminals) Petty criminal All ages, criminal intent, typically works alone Home office equipment plus specialty materials and processes Domestic   Professional criminal Criminal, trained in printing technology, often part of a criminal group Offset printing, high-end ink-jet printers, specialty materials and processes Domestic or foreign Low, stable level of activity State-sponsored Professional, profiteer or terrorist, member of a large organization All materials and processes, including specialty paper, intaglio and offset printing, security features Foreign Strategic concern TABLE 3-4 Methods and Extent of Dissemination of Counterfeit Banknotes, by Class of Counterfeiter Class Production Level Stockpiling How Notes Are Passed Primitive Very small None Individually, by counterfeiter Hobbyist Small, as needed None Individually, by counterfeiter or friends Petty criminal Small to moderate, often over years None to moderate Individually, by counterfeiter or criminal associates Professional criminal Large Large Through criminal networks State-sponsored Large Unknown, presumably large Through various legitimate and illegitimate networks, often by unwitting accomplices TABLE 3-5 Digital Technology Access, by Class of Counterfeiter Class Ink-Jet Printer All-in-One Device Color Copier Flatbed Ink-Jet Printer Digital Press High-Quality Scanner Imaging Software Primitive Not applicable—does not use digital technology Hobbyist ++++ ++++ ++ — — — +++ Petty criminal ++++ ++++ ++++ + + ++++ ++++ Professional criminal ++++ ++++ ++++ +++ ++++ ++++ ++++ State-sponsored Not applicable—reproduces government processes directly NOTE: Within all counterfeiter classes, additional nondigital techniques may be used to improve note simulations (e.g., craft supplies to reproduce features that use color-shifting ink). ++++, high likelihood of access; +++, good likelihood of access; ++, some likelihood of access; +, low likelihood of access;—, does not use this technology.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes FIGURE 3-1 Comparison of the percentages of counterfeit notes detected in 2004 and 2005. The top two bars represent the percentage of $100 counterfeits by source and show the primary source to be professional criminals. The lower two bars represent percentages by source for the sum of $5, $10, $20, and $50 counterfeits, showing the growing dominance of amateurs (the light grey segments). Note that state-sponsored counterfeits are identified only for $100 notes (the black segments) and that primitive counterfeiters do not account for enough counterfeits to appear on this chart. SOURCE: Data provided to the committee by the U.S. Secret Service. are precisely the types of counterfeiters most likely to benefit from the new digital scanning, image-processing, and printing technologies. Table 3-5 shows access to various kinds of digital technology by type of counterfeiter. Following is a more detailed portrait of each of the five types of counterfeiter. These descriptions serve as a prelude to developing a systems view of counterfeiting that will permit associating trends in digital imaging technology with the enhanced capabilities that each type of counterfeiter could employ in the future to reproduce specific features of FRNs. Primitive The primitive perpetrator of counterfeiting may use manual artistry to modify a piece of currency in order to increase its value and obtain financial gain. These phony notes are easily detected by attentive cash handlers and when examined by the general public. An example is a note that has cut-and-pasted numbers increasing the denomination of a $10 bill to $100. The primitive counterfeiter’s products are often obvious to the point of parody. They are clearly incompatible with automatic currency authentication equipment and must be passed person-to-person. If the substrate is an existing FRN, it retains the correct feel and may have advanced security features such as a watermark and a security strip, albeit for the wrong denomination. Such a note may be passed in a number of ways, however. For example, the counterfeiter may try to distract the cashier to prevent scrutiny of the counterfeit. He or she may also rely on the reluctance of a cashier to question the authenticity of a banknote in a point-of-sale situation.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes Hobbyist Over the past decade, desktop publishing has become the dominant tool for counterfeit printing operations in the United States. In fiscal year 2001, an impressive 93 percent of suppressed counterfeiting operations used digital processes; this is a phenomenal increase, from fewer than 20 percent in 1995.17 This trend, begun in the United States, has continued worldwide. Digital publishing tools, powered by information available on the Internet, are the engines that propel hobbyist counterfeiters. Hobbyists are typically young adults with a median age of perhaps 18 years. They work as individuals, making only a few notes at a time and printing them “on-demand” from their residence or place of employment. They typically pass these notes personally or via friends in retail transactions. Their counterfeits span a wide range in quality, from a single-sided bill18 to impressive duplications requiring many hours of refinement in touching up colors, aligning front and back images, and refining enhancements to the printed image to simulate advanced security features using arts and crafts supplies. The $20 note is the common target of this class of counterfeiter because it is the expected note in many transactions. As is true for primitive counterfeits, the vast majority of these products made by hobbyists are detected at or near the point-of-sale. They rarely are passed more than once and generally are not discovered by a Federal Reserve Bank; rather, 80 percent of these counterfeits are turned over to the U.S. Secret Service by commercial establishments, financial institutions, and law enforcement.19 The hobbyist’s tools are those typically found in a college dormitory room or home office and include color copiers, scanners, and ink-jet printers. Increasingly, hobbyist counterfeiters are also using all-in-one scanner-and-printer combination devices. The devices may be controlled by a computer with image-processing software to modify the image and connect to the Internet. Instead of learning from master engravers and offset print operators, the hobbyist uses Internet searches to obtain know-how and may tell no one else or share it with a few friends. The designation of “hobbyist” implies that this counterfeiter uses only equipment that is commercially available and that has been obtained for more legitimate uses. A hobbyist’s youthful age and exploratory approach often lead to situations with unexpected consequences. For these reasons, advertisement of the U.S. Secret Service’s impressive conviction rate—better than 90 percent—for counterfeiters could significantly reduce the hobbyist’s temptation to “make a little money.”20 Petty Criminal The counterfeiter in the petty criminal class has a clear criminal intent. These practitioners use the same digital tools as the hobbyist and may supplement their efforts with specific materials such as the best paper and inks. Using the Internet, they develop and share a set of tricks to improve their simulations and to help them pass their phony bills. This includes methods to bypass or negate certain authentication methods, such as the “iodine” starch-detecting pen, as well as to handle the encounter when their creation is questioned. This type of operation is still an individual or small effort, but it differs from the activities of the hobbyist in duration, quantity, or distribution area. Some of the best counterfeits in this class 17   U.S. Department of the Treasury. 2003. The Use and Counterfeiting of United States Currency Abroad, Part 2. The second report to the Congress by the Secretary of the Treasury, in consultation with the Advanced Counterfeit Deterrence Steering Committee, pursuant to Section 807 of Public Law 104-132. P. 60. Available at http://www.federalreserve.gov/boarddocs/rptcongress/counterfeit2003.pdf. Accessed April 2006. 18   How Counterfeiting Works, available at http://www.howstuffworks.com. Accessed March 2006. 19   The Use and Counterfeiting of United States Currency Abroad. 2000. Report to the Congress by the Secretary of the Treasury, in consultation with the Advanced Counterfeit Deterrence Steering Committee, pursuant to Section 807 of PL 104-132. 20   L. Pagano, U.S. Secret Service. 2005. Presentation to this committee, May 24.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes display innovative ways to simulate the security strip, the watermark, and the specialty inks. This class of counterfeiters will likely be the first to challenge the automatic currency authenticators. As detailed in Table 3-1, it is estimated that the petty criminal and hobbyist together were responsible for 56 percent of the counterfeit notes passed in the United States in 2005. Professional Counterfeiter The professional counterfeiter class generates phony bills that are easy to pass to the public. These counterfeiters simulate all of the critical features of genuine notes to some degree; in fact, the simulations often require additional criminal activity in order to acquire controlled materials such as security inks and paper. These counterfeiters are typically part of a larger criminal organization that can include dedicated specialists who sometimes have professional training in the printing business. Their efforts involve generating significant quantities of counterfeits, along with developing the necessary distribution methods—which may also be tied to other criminal endeavors, such as counterfeiting identification cards or other security documents. This type of distribution far surpasses that of the petty criminal. The U.S. Secret Service actively pursues these criminal organizations, tracking their activity by classifying recovered counterfeits into groups. Each note received by the U.S. Secret Service is characterized, classified with the telltale information that reveals the source, and put into a database. In this way, law enforcement and commercial banking organizations around the world can assist in counterfeit identification. Much professional counterfeiting activity is located outside the United States, although a substantial fraction of the counterfeit notes may be passed domestically. The target denominations of professionals include the $20, $50, and $100 notes, with the $100 note being the most counterfeited overseas. Judging by the typical amount of currency seized when the government shuts down professional operations, this class of counterfeiters can pose a serious threat. However, continuous enforcement efforts by the U.S. government, often working with foreign governments to change and enforce laws, as well as attention to foreign currency-handling procedures and the introduction of the new currency designs, has kept this potentially significant source of counterfeiters at a low level. State-Sponsored Counterfeiter State-sponsored counterfeiters not only plan criminal financial gain but may also have a political goal to reduce confidence in U.S. currency. Thus, they are willing to invest in technologies to duplicate U.S. banknote features exactly. State-sponsored counterfeits may be passed by both legitimate and criminal means. The very-high-quality Supernotes, which duplicate nearly all security features in U.S. $50 and $100 banknotes, are created by this class of counterfeiter and passed by unwitting travelers as well as by terrorist organizations. Some state-sponsored organizations make their own paper with watermarks and colored threads, make their own specialty inks, and re-author the engraved image. They use the same printing methods—intaglio and letterpress—and may integrate their own forensic features that would enable their own internal discrimination. While these notes would fool most cash handlers and even some machine authenticators, they can still be identified by the Federal Reserve Bank and the U.S. Secret Service. The

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes U.S. government has recently confirmed earlier suspicions that Supernotes are a state-sponsored activity of North Korea.21 It has been reported in the media that more than $45 million is estimated to have been passed by this source since 1989.22 A SYSTEMS MODEL FOR COUNTERFEITING Counterfeiting begins—but does not end—with the printing of bogus banknotes. After producing (and possibly stockpiling) notes of a sufficient quality and quantity, the counterfeiter still has work to do. To realize a profit from these efforts, he or she must then exchange the counterfeit notes for cash, goods, or services. After a counterfeit note has been passed, it will circulate until it is detected and removed from the system. Then, and only then, is the economic loss of counterfeiting realized: the last one holding the fake banknote loses. As shown in Figure 3-2, the counterfeiting threat can be described as a system composed of four components. Counterfeit notes flow down the system (1) from production, (2) through stockpiling (3) to the passing of counterfeits, and (4) into circulation, as indicated by the arrows. At each stage, disruptions to the system can be introduced by removing counterfeit notes or by deterring their production; thus, counterfeits may also flow from the components (boxes) to the removal processes (ovals). Note that some counterfeits may spend little or no time in a stockpile, and that a stockpile may sometimes be as simple as a criminal's pocket. In order to best analyze this system, flows for each class of counterfeiter—in numbers of notes per year, or fractions per denomination—should be measured for each arrow in Figure 3-2. While certain rates are known, such as the rate of seizures, many of the other rates remain unknowable. Without quantification, there is no definitive way to understand (or run experiments to explicate) the effectiveness of any particular feature or combination of features. Such measurements are complicated by the variation in quality of counterfeits, which means that the percentage of fakes successfully passed, for example, will vary with their quality. While it may be easy to spot some fakes, other, very good counterfeits may take a high level of scrutiny. A common outcome for such scrutiny is to increase the number of false positives, meaning that some genuine notes may be identified as fakes. Therefore, an effective analysis of ways to disrupt a counterfeiting system may include the mathematical probabilities but would also incorporate an assessment of the real-world variables that matter.23 Using such a strategic analysis would allow a comprehensive examination of methods for combating counterfeiting. Even without knowing the actual flows, it would be possible to make some allocation decisions if one could estimate, at each stage of the system, the likelihood of detecting a counterfeit bill as a function of the resources expended for detection at that stage. This structure calls for the consideration of ways to deter or prevent production, to empty counterfeit stockpiles, to disrupt the passing of counterfeits, and to remove counterfeits from circulation. A valuable outcome of combining experience with modeling could be a method to allocate funds to detection activities at the different stages to maximize the number of counterfeit bills detected. 21   See http://www.state.gov/p/inl/rls/nrcrpt/2006/vol2/html/62144.htm, http://www.usdoj.gov/usao/dc/Press_Releases/2005_Archives/Oct_2005/05370.html, and http://www.usdoj.gov/criminal/press_room/speeches/2005_4193_rmrksOprSmokngDrgnNroylChrm082405O.pdf. Accessed March 2006. 22   B. Gertz. 2005. N. Korea charged in counterfeiting of U.S. currency. Washington Times. December 2. Available at http://www.washtimes.com/world/20051201-103509-5867r.htm. Accessed March 2006. 23   G.G. Brown, W.M. Carlyle, J. Royset, and R.K. Wood. 2005. On the complexity of delaying an adversary’s project. The Next Wave in Computing, Optimization, and Decision Technologies, B.L. Golden, S. Raghavan, and E.A. Wasil (eds.). New York: Springer. Pp. 4-17.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes FIGURE 3-2 A systems model for counterfeiting. The boxes indicate the components of the counterfeiting system. The ovals represent processes by which counterfeit notes are removed from the system. Arrows indicate the flow of counterfeit notes. Banknotes themselves can also be analyzed with this system. They contain a number of overt features, or those that can be verified using normal sight and touch. They also contain a variety of machine-readable features that can be verified through the use of an auxiliary device, such as a black light. How all of these features interact to deter production and disrupt circulation is an important part of the systems approach. Deterring or Preventing Production The challenge for counterfeiters is to make a simulation that in their judgment can be passed successfully. The Bureau of Engraving and Printing (BEP) counters this threat by integrating security features into U.S. currency to increase the level of effort necessary to achieve a quality simulation. The BEP’s goal is to anticipate threats to the security of U.S. currency and to preempt or counter these threats.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes To this end, the BEP participates in the following efforts as part of a comprehensive program to combat the counterfeiting threat: The commissioning of various types of studies of currency features and threats, such as studies involving focus groups,24 and those carried out by the National Research Council; Its participation, through the Central Bank Counterfeit Deterrence Group and the Central Bank Cash Machine Group, in international counterfeit-deterrence group activities; The design and implementation of new currency features to counteract perceived threats;25 The testing of features and counterfeiting technology in-house and with the U.S. Secret Service and also with external groups organized to test the quality of new features;26 Working with equipment manufacturers and their organizations to develop use limitations on devices that are likely to be used for counterfeiting;27 The support of academic modeling efforts and red teaming;28 The development of secure material supply agreements; Working with the U.S. Secret Service on early detection leading to seized counterfeits; The development and implementation of educational programs to promote awareness of banknote features; and The providing of test notes to assist companies in designing reliable machine authentication technologies. The first opportunity to combat counterfeiting occurs by deterring note production. An array of new, digital tools is being used by counterfeiters in their attempts to simulate banknotes. The low cost and accessibility of these technologies make them available to far more potential counterfeiters than in the past. These new tools continue to challenge the currency designs, especially image-based features. One deterrence strategy is to prevent production directly, by limiting the availability, the capabilities, and the use of counterfeiting technology. In fact, this was the first anticounterfeiting strategy implemented by the U.S. government in the 1860s. The distinctive look and feel of intaglio printing could be achieved only by printing processes that were of very limited availability. The usefulness of digital imaging tools can be limited both by technology in the printers and by limiting access to them. By international agreement, commercial color printers prevent the printing of banknotes by recognizing certain features of various major currencies and refusing to process the image further. Similar technology is implemented in digital image-processing software and in some digital scanners. Although these limitations undoubtedly deter casual counterfeiting, they are not proof against a determined hacker. Thus, technology “blocks,” even when well implemented, are not a panacea, and if they are poorly implemented they could have serious consequences for the operability of the equipment. A second way to deter counterfeit production is by incorporating features in the note design that are necessary to create a convincing counterfeit and are also difficult to simulate. Current U.S. currency combines numerous features that present varying levels of challenge to the counterfeiters. Although highly qualitative, Table 3-6 provides some insight for optimizing the use of the limited space on the note and avoiding a saturation of features. The analysis presented in Table 3-6 is based on a logical analysis of 24   L. Setlakwe and L. DiNunzio. 2004. Comparative analysis of public opinion research in the U.S. and Canada. Proc. SPIE, Optical Security and Counterfeit Deterrence Techniques V, R.L. van Renesse (ed.), Vol. 5310, pp. 13-24. 25   More information is available at http://www.newmoney.com. Accessed March 2006. 26   The Reprographic Research Center is a state-of-the-art facility for the testing of banknote designs and counterfeit-deterrent features. Central banks provide funding and set policies for its operation, while banknote printers and law enforcement personnel use the facility for adversarial testing. 27   S.E. Church, R.H. Fuller, A.B. Jaffe, and L.W. Pagano. 2000. Counterfeit deterrence and digital imaging technology. Proc. SPIE, Optical Security and Counterfeit Deterrence Techniques III, R.L. van Renesse and W.A. Vliegenthart (eds.), Vol. 3973, pp. 37-46. 28   A red team is a group of independent reviewers organized to provide an objective assessment.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes TABLE 3-6 Usefulness of Overt and Machine-Readable Security Features in Deterring Counterfeiting, Evaluated by Class of Counterfeiter Features Primitive Hobbyist Petty Criminal Professional Criminal State-Sponsored Overt   Substrate ++++ ++++ +++ + — Tactility (or feel) ++++ +++ +++ ++ — Watermark ++++ ++++ +++ + + Plastic strip ++++ +++ +++ ++ — Intaglio printing ++++ ++++ +++ + — Offset color blending ++ ++ + — — Optically variable ink ++++ +++ +++ + — Intaglio microprinting ++++ ++ + — — Offset microprinting ++++ ++ + — — Colored threads ++++ ++ + — — Machine-readable   Paper fluorescence ++++ +++ ++ — — Magnetic ink ++++ ++++ +++ ++ — Magnetic ink pattern ++++ ++++ ++++ + — Color-shifting inks ++++ ++++ ++++ ++ — Digital CDS ++++ + — — — Digital BDS — — — — — Fluorescent thread ++++ ++++ +++ ++ + NOTE: Overt features can be verified using normal sight and touch. Machine-readable features are those that can be verified through the use of an auxiliary device. CDS, counterfeit deterrence system; BDS, banknote detection system. Symbols indicate the following: ++++, high deterrence value; +++, good deterrence value; ++, some deterrence value; +, low deterrence value;—, does not use this technology. threats posed by different classes of counterfeiters, the impact of the technologies used by each class of counterfeiter, and the impact of technology on features of FRNs. While many currency features are difficult for low-level counterfeiters to simulate, there has still been substantial growth in the hobbyist class of counterfeiting in the United States. Clearly, feature-based deterrence is only part of the equation; preventing passing and circulation of obvious counterfeits, as discussed below, is required to make the hobbyist’s illegal endeavors unprofitable. Of course, large counterfeiting organizations, particularly state-sponsored counterfeiters for whom profit may be secondary, are minimally deterred by banknote features. Other deterrence methods, including law enforcement and political pressure, are required in these cases. Emptying the Stockpile There is no opportunity for counterfeit notes seized from a stockpile to cause harm, so seizing stockpiled counterfeit notes is an effective way to disrupt the counterfeiting system. A stockpile can be

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes any storage location prior to the passing of the counterfeit; it could be a warehouse, a suitcase, or the pocket of a criminal. The possession of counterfeit currency is a crime investigated by the U.S. Secret Service. Founded in 1865 to suppress the widespread counterfeiting of U.S. currency, the U.S. Secret Service maintains exclusive jurisdiction for investigations involving the counterfeiting of U.S. currency. To carry out its mission, the U.S. Secret Service works with state and local law enforcement agencies, the Department of the Treasury, and foreign law enforcement agencies to pursue counterfeiters. The committee attributes the low rate of counterfeiting of U.S. banknotes relative to other major currencies in great part to the talents and methods of the U.S. Secret Service in detection and enforcement. The decrease in foreign counterfeiting volume between 1995 and 2004 supports this claim. While there are no statistics to indicate what fraction of stockpiled counterfeits the U.S. Secret Service captures, the fact that the value of seized counterfeits (about $100 million in 2004) is vastly greater than passed counterfeits (less than $15 million annually) indicates great effectiveness in the disruption of the stockpiling of counterfeit banknotes. The particular effectiveness of the U.S. Secret Service has been attributed to its unique role as a law enforcement unit with an express charter to counter all efforts to counterfeit U.S. currency. There is no question that the U.S. Secret Service provides a unique resource and is the cornerstone of counterfeiting enforcement efforts in the United States and abroad. Disrupting the Passing of Counterfeits A counterfeit note does not profit the maker until it is exchanged for other value and passed into circulation; if the note cannot be passed, there is no incentive to counterfeit. Efforts to combat counterfeiting must include strategies to disrupt the passing process. These efforts typically focus on educating the human cash handler and employing reliable machine authentication. People who use U.S. currency are the first line of defense against counterfeiting. Because the primary opportunity to pass a counterfeit note is the first point-of-sale, the key people are those who handle currency as a part of their job. Therefore, the evident first line of defense is the public, the often inexperienced clerk at the counter or the taxicab driver, those who are the most likely points-of-sale for the criminal fraternity. In Canada, studies have shown that 78 percent of counterfeits are detected by individuals and businesses.29 Even the high-quality Supernote was first detected not by a machine, but by an experienced cash handler who noticed an improper “feel” to the note.30 Clearly, the most efficient way to prevent the passing of counterfeit notes is to design banknotes that can be authenticated at the point-of-sale, and the optimal overt security feature is distinguishable and inimitable for the casual handling of the banknote in the split seconds it is transferred. Specifically, the note should contain security features that are visible, usable, and known. An effective visible feature is one that is easy to authenticate regardless of light levels and the fitness of the note, and therefore creates minimum delay at the point-of-sale. A usable feature does not require out-of-the-ordinary methods such as a magnifying glass, transmitted light, or a machine. The third factor, ensuring that a feature is known, is the most elusive. Knowledge of features does not necessarily mean that a user can name them, but it may be evidenced in an unconscious kind of habitual knowledge. The number of features and the fact that older banknote issues are not devalued can make such education a complex and layered undertaking. As a result of the public education effort for the new $20 note, public recognition of the currency features increased to 85 percent in the United States. While the impact of feature recognition has not been quantified in the United States, similar educational efforts in Canada have dramatically decreased the acceptance of counterfeit notes by cash handlers.31 Thus, educating cash handlers to recognize security features is undeniably an important factor in counterfeit deterrence. 29   J.F. Chant. 2004. Bank of Canada Review. Ottawa: Bank of Canada. P. 45. 30   S. Church, Bank of Canada. 2005. Presentation to this committee, July 21. 31   S. Church. See note 30 above.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes Education and knowledge are tremendously important for combating the passing of counterfeit notes. In 1996, the Federal Reserve System and the U.S. Department of the Treasury began a worldwide public education campaign with the objectives of, first, communicating to the general public that there will be no recall or devaluation of older FRNs, and, second, providing information that will enable the public, law enforcement personnel, central banks, depository financial institutions, and other cash handlers to authenticate the new series notes. The BEP’s outreach program has included cash handlers, merchants, business and industry associations, and the media. One of the most basic yet revolutionary methods intended to disrupt passage of counterfeits is the growth of machine authentication. This is not a new concept—in the 18th and 19th centuries, gentlemen of business carried pocket-size scales to ensure that the coins they received were of the correct weight for their value. In those days of coin shaving, it was prudent and socially acceptable to authenticate coins before accepting them. In the 21st century, the concept is being revisited by electronic currency authenticators. Over the past 15 years, advances in low-cost sensor technology have enabled the machine-reader market to grow in size and scope, while machine readers shrink in cost and footprint. Currently, over $64 billion passes through vending-type note acceptors per year in the United States, with 10 million to 20 million daily transactions;32 in addition, the retail and banking sectors process billions through machine counters yearly. As sensors continue to decrease in size and cost, machine readers will add authentication capabilities and will become even more pervasive, particularly in consumer cash-handling applications. Because notes rejected by a machine reader at the point-of-sale are currently neither tallied nor removed from circulation, no comprehensive statistics are available on the impact of machine readers on the passing or attempted passing of counterfeits. However, industry representatives report that even low-end denominators detect and capture 90 percent of domestic counterfeits, with authenticators nearing 100 percent.33 Therefore, machine readers represent a significant deterrent to the passing of counterfeits. Because rejected notes are typically returned to the consumer, this tool does not require the cash handler to deal with the consequences of accepting a counterfeit, making machine readers particularly attractive to the retail sector. Such authenticators are already in widespread use in Europe and Canada, and their offer of hassle-free security from counterfeits may be attractive to U.S. retailers as well. An increase in the use of machine authenticators could result in a commensurate decrease in the frequency of passing. As machines replace human cashiers, they may increasingly become the first line of defense against the passing of counterfeit notes. It is therefore important to design notes for reliable machine authentication. Current machine denominators and authenticators sense a variety of features, and it is important for currency design to maintain and add features that target the requirements for both human and machine authentication. Specifically, the ideal machine-readable feature— Can be sensed by a point sensor moving across the note, Is readable from both long-side-first and short-side-first feed directions, Emits a strong and reliable signal, Is independent of orientation and face, Can be reliably located despite manufacturing and reading tolerances, and Provides series identification. Removing Counterfeits from Circulation Once a counterfeit note is finally identified, it should be removed from circulation. Even though repeated passing does not result in additional monetary damage, it is the final person in the chain who will feel the impact. Unfortunately, removing counterfeits from circulation is not always as straightforward as 32   R.R. Bernardini. 2004. New security features and their impact on low-cost note readers. Proc. SPIE, Optical Security and Counterfeit Deterrence Techniques V, R.L. van Renesse (ed.), Vol. 5310, pp. 52-62. 33   Cummins-Allison Corporation, Mount Prospect, Ill. 2005. Discussions during a subcommittee visit, October 7.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes it seems. Several factors affect the efficiency of counterfeit removal and any subsequent law enforcement investigation. Currently, there is no incentive for public interception of a counterfeit note close to the initial distribution point. In fact, there is a disincentive to turn in a counterfeit, as the finder of a counterfeit note receives no compensation and may even be subject to uncomfortable questioning by law enforcement officers and a considerable time penalty.34 The committee agreed that they themselves, as hypothetical holders of a counterfeit note, would rather destroy it (or keep it as a souvenir) rather than contact the authorities. Similarly, manufacturers of currency-handling equipment report that some retailers tend not to purchase dedicated counterfeit-detection modules for their machine counters in order to avoid the inconvenience of dealing with counterfeits that cash handlers accepted at the point-of-sale.35 There is no question that such an attitude toward counterfeit identification interferes with the identification and removal of counterfeit notes, as well as with the eventual capture of the counterfeiters responsible.36 It may be possible to provide incentives to citizens who turn in counterfeit notes. A primary objection to such a policy is that it would provide an opportunity to counterfeiters to exchange their products for genuine currency. But more importantly, it might engender an impression in the public eye that counterfeiting is a victimless crime in which the government sustains the loss. This would result in even less incentive for citizens to identify or condemn passers of bogus notes. A system is desirable, however, that would decrease the time, trouble, and stigma of turning in a counterfeit. A culture that encourages finding and turning in counterfeits to authorities would be very valuable. As currency circulates, particularly domestically, it is processed through the banking system, often many times before it wears out. Branch banks typically process their cash deposits through desktop currency-counting machines, which incorporate authentication technology. Nearly all branch banks also use machine counter-sorters that can sort, face, count, authenticate, stack, and band notes. Both of these classes of machines have a near-perfect identification record for counterfeit notes, so when they are used, passed counterfeits are removed from circulation when they pass through a bank. Any counterfeit notes that might escape the branch banks’ systems are captured at the Federal Reserve Bank, which use a proprietary machine reader that senses a wide range of overt and machine-readable features. CONCLUSIONS Looking at the counterfeiting threat as a system may reveal approaches or combinations of approaches which may be more effective than that of focusing only on one step in the process. For example, much attention may be given to the preventing production of a counterfeit note, but somewhat less attention may be paid to preventing its casual circulation. At the present time, U.S. currency has one of the lowest rates of counterfeiting of any major currency. These factors help maintain U.S. banknotes as a global currency. However, even when counterfeiting rates are low, the psychological threat can be high. For example, if the counterfeiting risk is perceived to become too large, foreign holders could divest their U.S. currency, causing widespread economic impacts as well as a loss in U.S. political prestige. It is therefore in the national interest to preserve the actual and perceived security of U.S. currency. Counterfeiters may be classified into five categories: Primitive counterfeiters—who do not use digital technology, but create counterfeits using little more than manual artistry to modify a piece of currency in order to increase its value and obtain financial gain; 34   A well-meaning citizen will receive negative compensation in this case, because the counterfeit must be surrendered to authorities! 35   Cummins-Allison Corporation, Mount Prospect, Ill. 2005. Discussions during a subcommittee visit, October 7. 36   The U.S. Secret Service estimates that up to five times as much counterfeit currency is in circulation as is recovered each year.

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Is That Real? Identification and Assessment of the Counterfeiting Threat for U.S. Banknotes Hobbyists—who counterfeit occasionally and use typical desktop computer equipment and available crafting supplies, sometimes in creative ways; Petty criminals—who counterfeit in a dedicated manner and actively invest in specialized computer equipment and materials; Professional counterfeiters—who focus the efforts of a large group of people on the sophisticated production and distribution of counterfeits; and State-sponsored counterfeiters—who may use the very same high-precision equipment that the government uses to manufacture notes. Today, domestic counterfeiting—dominated by the first four classes of counterfeiters—focuses on the $20 note and is primarily a for-profit enterprise. Foreign counterfeiting—primarily primitive, professional, and state-sponsored—currently centers on the $100 note and may be engaged in to generate revenue as well as to support other illegal activities. It is possible, however, that several trends, including the following, will affect this balance: Lower-cost, higher-performance image-printing equipment; Improved global purchasing access—which could allow counterfeiters to find and purchase specialized materials or surplus printing machinery more easily; and Improved communication that facilitates information sharing among counterfeiters—which may include access to expertly processed image files, leads on sources for specialty raw materials, ideas for ways to simulate features, and connections to a distribution network for counterfeit products. These trends enable a professional counterfeiter to expand operations dramatically with minimal cost; they may also allow a petty criminal to enter the realm of the professional without previous connections to the underworld. For example, wide distribution of counterfeit notes may be possible through communication within an Internet-based community. The counterfeiting threat may be described by a systems model with four components. Counterfeit notes flow down the system from production through stockpiling to passing and circulation. Counterfeit deterrence focuses on disrupting or preventing each of these components. Thus, a comprehensive response to counterfeiting must include ways to do the following: Prevent or deter production, through the use of technology blockers and note features that are difficult to simulate; Empty counterfeit stockpiles, through law enforcement programs; Disrupt passing of counterfeit currency, by means of public education and machine authentication of currency; and Remove counterfeits from continued circulation, through the identification of counterfeit currency by individuals and by special methods within the banking system. Banknote features are important elements of counterfeiting deterrence at each stage of this system. Because each class of counterfeiter engages in the four components differently, the impact of different deterrence efforts will vary among the counterfeiting classes; however, each effort fulfills an important role in preserving the security of U.S. currency.

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