Legal Definitions - padded-payroll rule

The padded-payroll rule, also known as the fictitious-payee rule, is a legal principle that addresses situations where an employee with responsibilities related to issuing payments (such as in payroll or accounting) fraudulently creates a payment instrument, like a check, payable to a person or entity that is not genuinely entitled to receive it. This "payee" might be entirely fictitious, a real person who is owed nothing, or a legitimate vendor for a non-existent transaction. The employee then diverts this payment for their own personal benefit.

Under this rule, if a bank honors such a fraudulent instrument in good faith (meaning without knowledge of the fraud), the financial loss typically falls on the employer rather than the bank. The rationale behind this is that the employer is considered to be in the best position to prevent such internal fraud through proper supervision, robust internal controls, and diligent oversight of their employees.

• Example 1: The Ghost Employee Scheme
  • Scenario: Maria works in the payroll department of a large retail chain. Over several months, she secretly adds a "ghost employee" named "Alex Smith" to the payroll system. She then generates regular salary checks for Alex Smith, intercepts them before they are mailed, and forges Alex Smith's endorsement to cash the checks herself.
  • Illustration: This situation perfectly illustrates the padded-payroll rule because Maria, an employee with direct payroll authority, created a payment (salary checks) to a fictitious person (Alex Smith) who was not entitled to any compensation. When the bank cashes these checks, the loss typically falls on the retail chain, as they are deemed responsible for the fraudulent actions of their payroll employee.
• Example 2: The Unauthorized Severance Package
  • Scenario: David is a human resources manager at a technology company. He creates a fraudulent severance package for a former employee, Sarah Jones, who had left the company amicably six months prior and was not entitled to any further payments. David arranges for the check to be sent to an address he controls, intercepts it, and endorses it with Sarah's name before depositing it into his personal bank account.
  • Illustration: Here, David, an employee, initiated a payment to a real person (Sarah Jones) who was not entitled to receive the funds. His intent was fraudulent, and he diverted the payment for personal gain. Under the padded-payroll rule, the technology company would likely bear the financial loss for the unauthorized severance check honored by the bank, as the fraud originated from within their own HR department.
• Example 3: The Fictitious Consultant Invoice
  • Scenario: Emily manages the marketing budget for a non-profit organization. She creates a fake consulting firm, "Creative Solutions Group," and submits invoices for non-existent marketing strategy services. She then approves these invoices for payment, and the non-profit's accounting department issues checks payable to Creative Solutions Group. Emily intercepts these checks and deposits them into a bank account she secretly set up for her fictitious company.
  • Illustration: While this involves a "vendor" rather than a direct "employee" payment, the core principle of the padded-payroll rule applies. Emily, an employee, caused her employer to issue payments to a fictitious entity (Creative Solutions Group) for services that were never rendered, with the intent to defraud the organization. The non-profit, having entrusted Emily with budget and approval authority, would generally be responsible for the loss if the bank honored these checks, as the fraudulent scheme was initiated by their own employee.