The “Red Flags Rule” is a law that requires “financial institutions” and “creditors” to create, and subsequently follow, certain procedures for spotting signs of attempted identity theft and fraud. Those who don’t are subject to civil penalties of up to $3,500 per violation.
In other words, the Red Flags Rule is basically a way of encouraging the companies that directly affect our finances to help keep our money safe. Even if we took all the precautionary measures in the world, we still wouldn’t be safe if our banks, brokerages, landlords and others don’t do their part, too. So it’s good to know that these businesses have our backs, watching all of our so-called “covered accounts.” That includes checking and savings accounts, credit card accounts, certain investment accounts and more.
So while the rule obviously is corporate in nature, it still benefits consumers. There’s a lot to learn from it, too. For example, knowing what the “Red Flags” are could help you identify fraud in your own life. And if you’re a small business owner, you definitely need to know what, if any, obligations your business may have. With that in mind, we’ll take a closer look at the Red Flags Rule,
particularly its impact on consumers, below.
What Are The Red Flags For Identity Theft?
The Red Flags Rule breaks its warning signs into five categories. They apply to businesses, but there are many parallels to everyday life.
| Types Of Red Flags | Red Flag Examples | Everyday Examples |
|---|---|---|
| Alerts, Notifications & Warnings From Credit Bureaus |
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| Suspicious Documents |
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| Suspicious Personal Identifying Information |
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| Unusual Use Of (Or Suspicious Activity Related To) An Account |
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| Notice Of Possible Identity Theft |
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Who Must Follow The Red Flags Rule?
The simple answer is that every financial institution and creditor must follow the Red Flags Rule. But the requirements are actually a bit more complicated. For instance, just because a business accepts credit card payments or an employer checks a person’s credit to screen a job applicant does not subject either organization to the rule.
Rather, the following criteria are used to determine whether an organization must comply:
A business must comply if it regularly engages in any of the following:
- Bills customers for payment (except for doctors, lawyers and other small businesses)
- Grants/arranges credit
- Plays a part in setting the terms of credit agreements
- Uses consumer reports in the context of credit transactions
- Provides information to credit bureaus in the context of credit transactions
- Advances funds to another party with the expectation of repayment in kind or with pledged property
- Holds a deposit account on behalf of a consumer
If none of the above factors applies, the business is not required to comply.
5 Red Flag Rules Of Thumb
We don’t want to overstate the importance of a corporate regulation to a consumer audience. But it is important to acknowledge the various ways in which the rule can help protect us. That’s what it’s designed to do, after all, along with minimizing costs for financial institutions and law enforcement agencies.
That said, here are a handful of helpful takeaways regarding the Red Flags Rule:
- The rule is an attempt to catch attempted fraud. It is particularly helpful with cases involving repeat offenders or obviously fraudulent information.
- The rule is a good ideas, but the fact that big financial institutions with billions in the bank are subject to penalties of up to just $3,500 per occurrence ultimately calls the rule’s effectiveness into question.
- Many (would-be) identity thieves are clumsy, unoriginal or both. They leave obvious signs – from fictitious phone numbers and addresses to inaccurate security question answers – that they’re imposters.
- Reviewing your credit accounts and credit report on a regular basis is the best way to screen your own financial records for red flags.
- A free 24/7 credit monitoring service like WalletHub’s can strengthen your defenses. It will notify you anytime there is an important change to your credit report, thus serving as an early-warning system for identity theft.
Ask The Experts: Does The Red Flags Rule Work?
The Red Flags Rule is actually law. As such, we sought a legal consult, posing the following questions to a panel of consumer protection law experts. You can find their bios and responses below.
- Is the Red Flags Rule effective? Why or why not?
- What is the most effective measure the federal government has taken to curb identity theft and fraud?
- What step would you like to see the government take to fight identity theft and fraud?
Image: YinYang/iStock.