Fraud is prevalent in the financial services industry and no matter what checks and balances are put into place to prevent it, there always seems to be a latest and greatest creative fraud. Recently, Equipment Acquisition Resources (EAR) was involved in a fraud on various lenders including First National Bank of McHenry, Libertyville Bank & Trust, Millennium Bank, Waukegan Bank, First Chicago Bank and IBM Global Finance, among others. EAR ostensibly was obtaining financing to purchase equipment from Machine Tools Direct (MTD) and arranged sham sales transactions between the two companies, knowing there were no actual sales.

The principals of these companies falsely represented to multiple lenders that EAR and MTD were separate companies engaged in arms-length sales transactions, according to a 10-count indictment in the United States District Court in Chicago. Further, after MTD received payments for the alleged financing from lenders, payments were sent to EAR so that EAR could use the money to make payments on other loans — a typical Ponzi scheme. This case is just another example in a long line of historical fraud cases in the financial services industry. It is difficult to forget companies like NorVergence, Allserve, and Cyberco — just to name a few of the infamous fraudsters.

Some of the more common types of frauds in the financial services industries, especially with respect to equipment leasing and financing, include:

• Forgery of documents
• No equipment (this often occurs when a supplier of the equipment works with the lessee; instead of an equipment purchase, the two parties split the cash proceeds from the lessor)
• Overstatement of equipment value (this was the main argument in the NorVergence fraud)
• Double or triple financing of the same equipment (this is often perpetrated not only by the lessee but by the supplier or a broker)
• Fraudulent financial statements (this is done either by the supplier to obtain the proceeds or by the lessee to qualify for the lease and obtain the equipment)
• Kickbacks (usually occurs when the supplier pays a portion of the proceeds to the lessee for overvalued equipment)
• A fake or affiliated vendor or supplier — and the money is actually going to the lessee or borrower
• Identity theft
• Unknown agreements to the lessor or lender (this fraud involves side letters and undisclosed purchase options)
• Representations that the equipment is new when in fact it is used
• Fraudulent delivery date for the equipment and unknown sales/leaseback transactions (the vendor or supplier is usually involved in this with phony invoices)

Some fraud warning signs or red flags are:

• When there are departures from the normal course of business. For example, when a lessee or borrower requests favors, exceptions, waivers and other departures.
• When the lessor or lender cannot verify the authority of the document signer because the officer of the company is not available.
• When the vendor or broker does not want the lessor or lender’s salesperson to visit the vendor’s office; likewise, when the vendor, broker or lessee does not want the lessor or lender to visit the lessee or borrower’s offices.
• Although it may not be prevalent as it once was, the use of a cell phone rather than a land line phone is a red flag. If the lessee is hard to reach by phone it may also be a problem. If a lessor is not permitted to communicate directly with principals, guarantors or other creditors.
• Where there are last-minute changes to the structure or terms of a transaction. Where there is a greater-than-usual sense of urgency by the vendor or broker.
• Where a credit bureau report reveals numerous recent inquiries on an applicant.
• Where it is difficult to verify a business address or the business address is a P.O. box.
• Where checking account numbers reference a new account. Where a business name, address or phone number are not on a check. Where the lessee or borrower is making a payment by a cashier’s check or money order not revealing a business address.
• Where the broker, vendor and lessee are located in different parts of the U.S. with no explanation of commonality.
• Where an application is incomplete in some material respect.
• Where credit references reflect many closed accounts. Where the phone number and area code do not coincide with the business address.
• Where the years of employment do not correlate with the age of principals. Where a business answers a telephone “hello” rather than with a business name. Where guarantors are unrelated to the business.
• Where there is a financial statement that is not signed, in an unusual format, or not audited. If audited, then the auditor should be called to verify that the lessee is a client. Where there is no business plan for a recently formed company.
• Where there is receipt of a generic invoice that is not numbered or dated. Where serial numbers are not listed on an invoice. Where equipment is sent to a location other than the lessee’s place of business. Where the “shipped to” address on the invoice is a P.O. box. Where the equipment is not suitable for a particular business.
• With respect to vendors, watch out if there is a new vendor involved. If the vendor does not want the leasing company or lender to contact the lessee. The lessee owns or has a vested interest in the vendor from whom they are getting the equipment. If the vendor has no resale number, an invalid number or a number belonging to another business. Any vendor payment that is required to go to some other address than on the invoice. Any invoice date that is over 30 days. That the vendor is extraordinarily pushy for payment. Where the invoice has a payee other than the vendor of the equipment. Where a vendor is a corporation or limited liability company not listed with the Secretary of State or not in good standing. Where a vendor is not an authorized dealer for equipment that is usually sold only by an authorized dealer. Where the vendor answers the phone with a different name than that on the invoice. When the vendor check is returned due to a wrong or incomplete address. Where a vendor presents only an 800 number and does not have a local listing. Where a vendor is physically with the lessee when funding occurs or on a three-way call.

The best methods to protect against fraud are:

• Know the parties in the transaction and, when possible, visit the places of business.
• Avoiding cold calls from vendors or brokers.
• Avoid one off deals with vendors.
• Avoid last-minute changes and desperate pleas for exception to your leasing and lending policies.
• Insist on direct access to all parties.
• Use a template or checklist with criteria that must meet credit and documentation approval prior to funding.
• Be thorough in all of your screening processes through UCC searches, Dun & Bradstreet reports, CBR reports, checking litigation and tax records; obtaining good standing and certificates to verify through public filings and the existence and history of a company; checking the Internet to see if there is any other information about a company. Further, if there is nothing about a company or the vendor on the Internet, then this may in and of itself create a red flag. Where appropriate, check social media sites of the company or the individuals involved with the company.
• There are websites that will produce fake documents. There are also websites that allow the sale of a name of a corporation or LLC that is a valid entity in order to create a new company. If you are smelling a fraud, you want to check these websites to see if one of the companies you are doing business with recently bought a name or may have faked documents.
• You can now use geotagging to actually locate the address of equipment when it is delivered. Therefore, in transactions where you may not want to use an inspection service to inspect the equipment, you can use geotagging.

No matter how many checklists and controls you put in place, they may not prevent a creative fraud. As the old saying goes, the best transaction a lender or lessor enters into is the one it never enters into because there is something fishy about it. It is therefore suggested that a lender or lessor do as much due diligence as possible before making a loan or entering into a lease in all phases of a transaction – sales, credit and documentation – in a concerted effort to prevent a fraudulent transaction.

Andrew K. Alper is a partner with the law firm of Frandzel Robins Bloom & Csato, L.C. in Los Angeles.