Identifying and Preventing Credit Fraud
Credit criminals never sleep, so neither can you. They will always be thinking up new scams to trick the unwary. Your best defenses are relentless vigilance, a deeply suspicious nature, and a strict policy of protecting your company with cash up front or other security measures when a prospective customer sets off your credit fraud alarm. "Most legitimate orders come in as a result of salespeople making sales calls," notes Paula Thorpe, national credit manager for MediaCom Inc. (Etobicoke, Ontario). "And in most of these cases, it's challenging to convince the customers to provide industry references, rather than key suppliers."
So when an unsolicited order arrives with references, it may be cause for concern. "Some credit managers may assume that the applicant a professional company for doing business this way, and they may not even bother to call the references," she says. In other instances, they may be so excited about the order that they authorize shipments and plan to check the references later. Or they may attempt to call the references, and, if they have difficulty getting through or if they receive "glowing reports," not bother to investigate further or to seek bank references. Scam of the Month
What is happening, of course, is that these creditors are being taken in by any variety of scams that seem to be growing more numerous and ingenious all the time. It can be something as simple as the calls being answered by friends of the "customer," who provide glowing references. Or it could be the "customer" himself answering the calls, using technology (e.g., call-forwarding or transfer boxes) to make the supplier believe he is calling the "suppliers" in different cities, when in reality the call is being answered by the "customer" in his own office. To guard against these kinds of problems, Thorpe recommends verifying references very thoroughly on unsolicited orders, and requiring a bank reference, too, with a phone number and an address you can verify. Another way MediaCom guards against fraud is to require cash up front or credit card payment for first orders that are too small to warrant the cost of credit checking. "In the past, we often extended credit to small-order, first-time customers, feeling that we weren't risking large losses," she explains. "However, we began to see that a large percentage of these types of orders became fraudulent or uncollectible." Cash Up Front
Now MediaCom requires cash up front (postdated checks or credit card payments) for all first-time orders. "We operate on the philosophy that a line of credit is designed for long-term customers," she explains. There is no way to determine whether a customer is going to be long-term, of course, on the basis of a single order. And even before performing services, Thorpe may contact the customer's bank to make sure there are sufficient funds in the customer's account to cover the check being offered as prepayment. "If the customer places a second order, we usually have them fill out a credit application at this time," she continues. Thorpe will then conduct a thorough credit investigation: If she finds sufficient information to verify that the customer is creditworthy, she will open a line of credit for an appropriate amount. Or if she finds minimal information on the customer, but not enough suspicious information to suggest potential fraud, she will offer the customer 30-day terms contingent on a postdated check. "If the check doesn't clear, we'll know immediately," she says, "and it's easier for us to go through the legal system to collect on it than it is to try to collect on a contract or purchase order that could be disputed."
She is especially alert for customers who
- Move assets offshore.
- Become secured creditors. Example: The customer invests $100,000 in his business, grows it to $5 million, claims that his investment in the business is now worth $2.5 million, and lists himself as a secured creditor for that amount.
- Convey company assets to themselves. One company owner with whom Thorpe is familiar arranged for his accountant to depreciate his company's art collection (purchased with company funds) to zero over the course of five years, purchased the collection for $1, and turned it into his own private collection. "The collection may actually be worth about $300,000," reports Thorpe.
- Convey company assets to relatives (e.g., spouse during a marital separation agreement, children, grandchildren) in the form of gifts, dividends, or bonuses.
- Arrange for assets to be worthless to creditors. "There are people who move into a business for a year or two while it's hot, take the profits, leave the remaining inventory when it is virtually worthless, and move on to start other companies," observes Thorpe. Examples are "fad" products that have a popular life for a year or two, and high-tech items.
- Operate as legitimate businesses for a period of time, have a "going-out-of-business sale," and skip with the profits or go under. "An electronics retailer did this recently," she says. "They purchased extra inventory for the Christmas season, had a huge discounted sale, and filed for bankruptcy protection shortly afterwards. Their suppliers, in essence, paid for the sale."
Thorpe stresses that there is really no better way of guarding yourself against these kinds of problems than by staying abreast of customer activity. "It's very important to communicate frequently with salespeople who will be able to notice any changes or activities of a suspicious nature," she says. "The moment you identify any problems, seriously consider a credit hold and shipment hold." Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.
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