Factoring Fraud: What It Is – and How to Guard Against It

Every industry has issues with fraud. But during the last economic downturn, fraud in the factoring industry grew at an alarming rate. What is it – and how can you protect your company from it? Here’s what you need to know:

Factoring is a growing industry – making it a prime target for fraud. 

 

In the current economic climate, the use of factoring is becoming more prevalent. As a result, invoice factoring companies are growing by leaps and bounds. In fact, a simple search on the Internet yields some 373,000 results. Unfortunately, whenever a business sector experiences dramatic growth like this, some people choose to take advantage of it by committing fraud for their own financial gain.

Factoring fraud is fraud committed against a debt factoring company by one of its customers. 

The aim of the fraud is to obtain money through the creation of phony invoices supported by equally phony supporting documents. For instance, a company with an established relationship with a factoring company may try to slip in a fake invoice in the hopes that the factoring company will trust them and forego the usual verification and background proceedings. They might seek $9,200 when the actual invoice is only $920 and blame it on a clerical error.

In other cases, the fraudulent activity may be associated with “spot factoring,” also called “single invoice factoring.” This is where a company seeks to get financing per a “one-time-only” agreement. In this instance, the company seeking factoring is less likely to establish a lasting relationship with the factoring company and more likely to take the money and run. In spot factoring, a fraudster sets up an entirely fictitious business – complete with phony records and credit histories and even a staged verifier who provides made-up information to the factoring company to “verify for accuracy.”

Factoring is susceptible to fraud when there aren’t sufficient controls in place.

In other words, perpetrators succeed when a factoring company skips portions of the verification process because they rely too heavily on the established relationship. And once fraud occurs with a regular client, the client will generally commit it again and again, using “new” fake invoices to pay off “old” fake invoices. The vicious cycle will continue until the offending company gets caught.

If your company is in the factoring business – or thinking about getting into it – how can you guard against fraud? Here are a few key strategies:

Verification is critical, regardless of the relationship.

 

To avoid becoming a victim of a factoring scheme, due diligence through verification and corroboration are key, regardless of a long-standing business relationship. Though persecution of fraudsters does happen (as in the case of Arrow Trucking, which perpetuated millions of dollars in factoring fraud on Transportation Alliance Bank), it can be a difficult, labor-intensive claim to prove depending on the size and multitude of the scam.

Here’s an example of why verification is critical:

A factoring company was looking over a construction company’s financials. The factoring representative requested that the company send the invoice and contract they wanted funded. When the contract was received, the signatures of the general contractor and the subcontractor looked the same. After a quick call to the general contractor, it was discovered no one there had the name of the subcontractor who allegedly signed the contract. It was all a fraud.

Don’t rush transactions.

Any client that is reluctant to provide identifying information to the invoice factoring company should be suspicious. Because invoice factoring is based upon expediency, a client could try to take advantage of this by rushing through the process in hopes the factoring company won’t pay much attention to the documentation. Yet, taking short cuts should never take the place of verifications. Those companies who skip this crucial step are putting themselves at risk.

 Be on the lookout for red flags.

For instance, if a client has an extreme urgency for funding, be wary, especially if they don’t seem to mind the rates or terms. Another red flag to guard against is if a client is reluctant to provide legal documentation to verify their identity, or their location information (such as zip code) is the same as the debtor. Another warning sign is the existence of large invoice amounts relative to the average for a particular customer.

In general, clients should have no problem providing documentation for the business location, tax returns for prior years, a balance sheet and a copy of the contract to verify the debt.

Don’t ignore suspicions.

If you need more information, ask the owner of the company. The more you know, the better you’ll be able to evaluate the situation. Keep in mind, when it comes to lending large amounts of money, you can never be too careful.

In the current economic climate, some people are tempted to cross lines and participate in factoring fraud. However, every attempt at fraud leaves a trail of evidence. It’s your job to be on the look out for it in order to protect your company and your bottom line.