Did you know that Ulysses S. Grant had fallen victim to a pyramid scheme? He had a family friend who wanted to start a brokerage business, with Grant as the figurehead and not involved in the daily operations. Grant’s name provided the business venture an element of credibility that encouraged people to want to invest in the company and eventually resulted in severe financial troubles for the former president. The point is this: anyone can fall prey or become a victim of fraud.
This story, along with the some of the points below, is from the book How to Smell a Rat. Although the book focuses on financial and investment fraud, some of these signs are similar to what we may see in factoring. What are some of these signs?
The package is too good to be true. I don’t think we need to go into what this means here… we have all seen this type of deal.
What the business does or what their billing process is seems “too complicated” to describe; remember, if it is not clear, ask again. Then, if you still do not truly understand, ask again. Don’t be taken off guard should the prospective client seem frustrated with you… it may be purposefully complicated. One important fact: part of a fraud is that you do not understand.
If you do not understand the billing, then it would be impossible, or at the very minimum challenging, to review the invoices and documentation to know: what is being billed for, if it is completed, if there are hidden or unknown offsets or reasons for non-payment to occur, if there are required contracts or forms that need to be completed and submitted with the billing, etc. This would also fall into the category of not understanding an industry.
For example, if you are not familiar with the construction industry, it would be easy to over bill on invoices, or jobs. In addition, you would not understand the risks of funding on retainage invoices or ensuring subcontractors for material and labor are paid timely. You would have the potential of having factored invoices that were not approved, as the work had really not been completed for the amounts presented. This may mean only 70% and not 90% of the work had actually been done. Or, the work billed for was not allowable under the contract. No change order had been presented (i.e., the contract was for $150,000 and the invoice was for $175,000 because the client had received only a verbal request to do additional work). And, on those subcontractors not being paid timely… you could run the risk of receiving short pays on invoices as part of the monies were sent directly to the subcontractor or material supplier.
Another sign: You did not do your own due diligence, relying on a trusted friend or intermediary. This also includes the “friend of a friend” scenario. Sometimes, good reputations can be built or manufactured by those who provide charitable donations, who are active in politics, or who are part of affluent groups. Think of Madoff, who once had a strong reputation; many people gave him money because of his reputation… not because of the facts or their own due diligence or investigation.
What about the referral from a friend, or from someone within an affluent circle? Underwriting or completing due diligence is an ongoing part of what we do as factors. Ensuring that this process is completed by you as the factor is also just as important. You cannot rely on a broker, a friend, a third party or another factor to do this for you, as you do not really know what kind of due diligence they have done.
It should be noted that some fraud can also be internal to the factoring company. Yes, just as in any business, it can happen. Having checks and balances in place may prevent employee/client collusion. For example, does the same person verify invoices, review paperwork, buy schedules, post checks, and collect on invoices? Who wires out money to the clients, and who ensures that money went to the clients? Is there anyone else within the organization who audits or double checks that these duties are being done accurately? What checks and balances do you have in place for these activities?
There are obviously many more signs of fraud that can and do exist. These were just a few highlights selected from this particular book, as it was the title that originally caught my attention.
Wishing you continued success. The Factor Guru.
