Despite new risk mitigation methods in place to reduce fraud in factoring, it continues to thrive in the industry and factoring companies face a growing threat each year. Not only do factors face the traditional forms of fraud that have always plagued the industry, but several converging trends have increased the scale and sophistication of fraud in recent years. The growth of online commercial lenders, a robust economy with greater access to capital, more availability of information on businesses and individuals, the Dark Web, and the increased speed of lending are just some of the trends contributing to newer and more sophisticated fraudulent schemes. The good news is that new methods of detection can be used to prevent new as well as traditional types of fraud schemes from the outset. Below are 4 types of fraud schemes and how to prevent them right from the start.
- Business Identity Fraud — This occurs when prospects act as business owners or representatives of legitimate companies by using real company information obtained via the Dark Web or by accessing readily available information online. Unfortunately, business and personal identity information can be easily obtained and while you may think you are dealing with a real prospect, the person and/or business may be misrepresenting themselves. What can be done to detect prospects that are willing to present personal identification, financial statements and bank statements that are purchased and are real but just not theirs? Offer all digital onboarding mechanisms and consider adding Two-Factor Authentication during the application process to confirm your prospect’s phone number as well as gather other types of revealing data from the point of application. Go a step further by asking for address verification in the form of utility bills, lease agreements, etc. and use social media to verify companies and the individuals that work there. Look for phony email addresses and consider incorporating cutting edge services now available that analyze social media, email addresses, and corporate domains, and give you results quickly.
- Misdirected Funds/Wire Fraud — Much of the time this type of fraud is unintentional, but it does happen frequently that payments are incorrectly misdirected to the client as opposed to the factor and by the time the factoring company realizes and the client’s receivables starts to age, it’s too late because the money is gone leaving the factor in a bind. To detect misdirected funds early on, connect to prospect’s bank accounts at the point of application and then pull the bank data at consistent time intervals to monitor large deposits or ones coming in from a specific payee to quickly detect unintended mistakes and redirect the payments back to the factor or detect intentional fraud and stop it right in its tracks.
- Invoice Fraud — This type of fraud involves misrepresenting accounts receivable and/or modifying invoices and is common in factoring. Typically, when applying for a factoring facility prospects want their accounts receivable to look better so they can be approved even though their AR might be aged and so they modify invoices. Factoring staff may call/email to verify if the invoices and amounts are real and may even obtain copies. In this scenario, the invoices and amounts may be correct, but how can the factor be sure that the invoices submitted have not been modified, especially the date? Factors spend quite a lot of time and money underwriting a prospect in order to approve them and during spot verification might be able to catch that some of the dates were changed in the accounting system data. Depending on their methods, they may or may not be able to catch this type of fraud since it depends on the quality of the information coming back from the debtor and how thorough the person is who is verifying on behalf of the debtor. In this scenario, the factor often must wait to get paid but even if they do get paid on the invoices sooner or later, the factor didn’t discover a character issue with the client from the beginning and is now in a situation that could have been avoided. So how can a factor be sure that invoices weren’t changed in the accounting system? Factors can connect directly to client’s accounting systems at the point of application, lenders can detect whether or not an invoice was modified before or close to the time of application and not after funding which often becomes a ticking time bomb. How does connecting directly to accounting systems help? Connecting directly enables lenders to extract “metadata” that regular users cannot see. This metadata tells when the invoice was created, when it was last modified in their accounting system, who modified it and other information that internal users of their accounting system will not be able to see.
- Shell Companies — These are characterized by fictitious entities created for the sole purpose of committing fraud. These businesses may appear real, have a physical address, a state license, a local telephone listing and even a receptionist answering calls but are not real companies. How can factors detect a fake company? Use multiple third-party data services to cross reference information. Frequently, factoring companies are too cost conscious and rely only on one or two particular data services. Best practice is to cross reference information from multiple data sources and ensure that the data services being used tell you the source of their information. Take the time to understand each data service, ask what the source of their information is and don’t accept vague answers like “multiple sources”. Demand that data service providers tell you exactly where their information is coming from in order to cover all your bases and if one data service doesn’t completely look at every data point you need, use another to help you cross reference information.
- Loan Stacking — This has become a major issue in recent years. With the growth of online lenders giving fast approvals, multiple business loans are taken out by borrowers who present themselves to factoring companies and attempt to hide other loans. The ease of access to online loans and loopholes in online lending can result in multiple lenders making loans to the same borrowers, often within a short period, without the full picture of their rising obligations and declining ability to pay. What can be done? Encourage prospects to embrace technology. In an era of open baking, prospects can now allow lenders to connect directly to their bank accounts to extract information that is very difficult to be altered. This is becoming more and more mainstream and businesses are more open than ever to provide information in order to secure working capital. Don’t just rely on PDF documents or information sent by prospects but insist that they connect their bank accounts directly. By having direct read-only access to their bank account data, factors can monitor dates and amounts of transactions in order to detect loan stacking.
Combining the latest methods in fraud detection with traditional risk mitigation practices can help factoring companies reduce costly fraud from the beginning.
Published in IFA’s Commercial Factor Magazine Aug 2019 issue.
Access the full article: Commercial Factor Magazine Aug 2019