Fraud in the United States Factoring Industry

From industry expert Mark S. Mandula

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As long as there has been factoring, there has been fraud in our industry. There are many different variations of the way fraud can occur; but the common denominator is that these schemes attempt to obtain money from a factor using false invoices. Of course, the party attempting to defraud the factor also attempts to cover up the fraud for as long as possible to ensure that they steal a much as possible from the funding source.

How is fraud usually done in the factoring industry?

The most common approach is when the client of a factoring company creates a false or inflated invoice. In this day and age of at-home printers, this is a very easy thing to do. The invoices appear to be real and issued by a legitimate debtor similar to others previously factored by the client. The fake invoices are added to the pile of valid accounts receivables (invoices) to be factored in the hope that the factor is not either paying attention or not verifying each unique invoice. If the factor does not verify each individual invoice, this instance of fraud is amazingly easy to pull off. Other common frauds include the collection of false invoices, using lapping schemes and collusion between debtor and the client providing fraudulent verification to the factor.

How often does fraud occur in the United States factoring industry?

There has not been a lot of published research that leads us to a clear answer to this question. I have spent some time doing detailed research using a variety of industry sources to come up with an answer to this question. I hope that the information I have uncovered and the conclusions drawn are interesting and informative.

The logical spot to start our discussion and come up with an answer would be to quickly look at to the overall size of the factoring industry in the United States. The leading source for comprehensive data for the factoring industry worldwide can be found at on the Factors Chain International, www.fci.nl Factors Chain International, commonly known as FCI is the world’s most important factoring network. FCI publishes comprehensive data annually on the size and growth of the global factoring industry. I strongly encourage you to look at their website for detailed data and excellent articles about the ways factoring is used to promote trade and economic growth on a global basis.

The most recent data from FCI on the size of the factoring industry is presented below. As can be seen below, the estimated size of the factoring industry is about $3.052 trillion USD.

The second piece of data I did some research one is this: what percentage of the factored accounts receivables are written off as a percentage of gross invoices purchased by factoring firms in the United States on an annual basis?

The best source for comprehensive information on the United States factoring industry is the results of a survey [complied and published every 2 years] by the IFA, or the International Factoring Association. The IFA is the leading trade association for the factoring industry in the United States. The 2013 IFA Business Profile & Performance was complied by Industry Insights, Inc. Surveys were distributed to approximately 1,500 factors primarily based in the United States and Canada in January 2013 and were collected through late March. Industry Insights is a professional research and consulting firm that specializes in operating surveys, compensation studies, opinion analysis and customized research services located in Dublin, Ohio.

According to the data calculated by Industry Insights, the average total write off during the year 2012 [as a % of gross invoices purchased] was 1.1%. This was the percentage of all factoring firms combined. The smaller factoring firms [defined as those that purchased less than $5,000,000 of invoices for the year 2012] that responded to this question recorded a 1.3% total write off as a % of gross invoices purchased. The largest peer group [factors that purchased over $100,000,000 in Accounts Receivables] had only a 0.4% of total gross invoices purchased in 2012. As a percentage of net funds employed, the overall industry average for total write offs during 2012 as a percentage was 1.7%.

So let’s do the math on an estimate of the total dollars of bad invoices factored in 2012 in the United States. Assuming that the total write offs were equal to nonpaid invoices for the year 2012, the gross dollar amount of nonpaid factored accounts receivables would be in the neighborhood of about $1 billion. [total United States factoring volume of factored AR times assumed 1% nonpayment equals $1 billion].

So if the total amount of unpaid factored accounts receivables for 2012 was approximately $1 billion, is it possible to then determine the amount of fraud in this figure? With the understanding that the data below is a “best or most accurate estimate possible”, I think the answer to this question is yes.

There were several questions that were asked in the 2013 IFA Business Profile & Performance Survey that could help us draw this conclusion. All of the factoring firms surveyed were asked to respond to this question; “What was the primary reason for account debtor nonpayment during 2012?”

As presented in the survey, fraud was the third highest reason for Account Debtor Nonpayment for the factors that responded in 2012. Disputes were the #1 reason, accounting for 37% of the total nonpaid amount. The inability to pay or insolvency was the #2 noted reason equaling 32% of the total. Fraud was the #3 most mentioned reasons for nonpayment at 23% of the total.

So assuming that non-paid factored accounts receivables are assumed to be about the same as write-offs in a given year, the amount of fraud in the United States factoring industry in 2012 would be in the range of $230 million. [23% of $1 billion]. By any measurement stick, that’s a lot of money.

The next area of analysis that I decided to look at was to see if I could determine if the amount of fraud in the factoring industry in the United States has been increasing, decreasing or has been relatively the same over the past couple of years. It would seem to be a logical conclusion that the amount of fraud should be counter cyclical to the overall state of the United States economy; in that as the economy tanked, the amount of fraud would be increase. And conversely, as the United States economy improved, the amount of fraud would lessen.

One of the many questions that were posed in the 2013 IFA Business Profile & Performance Survey to Factoring firms in the United States and Canada was this: what was the length of time since the most recent case of fraud had occurred in your operation?

As can be seen below, the results were very interesting. Of the Factoring firms that responded, 83% of the factors had some form of fraud in their operation in the past 5 years. Put another way, only 17% of the entire factoring firms asked never had any fraud reported in the past 5 years.

Of the factors that responded, more than 50% had experienced some type of fraud in their operations in the past 12 months, and 66% of the factors surveyed had some form of fraud in the past 2 years. So whatever way one looks at the data, the obvious conclusion that can be drawn is the lion&rsrsquo;s share of all factoring firms have had to deal with the bitter taste of fraud in the recent past.

Has the amount of reported fraud increased or decreased over the past couple of years? I was actually quite surprised by the results of the survey results in the 2013 IFA Business Profile & Performance Survey. The data form the IFA study reveals that of the factoring firms that replied, only 16% of them had seen an increase of fraud in the last 12 months. I honestly thought this would have been a higher number than 16%. 56% of the survey respondents said there had been no major change in the number of fraud cases and 28% reported a decrease.

Given the anemic recovery that has occurred over the past 12 months in the United States economy, I would have guessed that the percentage increase in frauds [only 185] would have been much higher.

I also decided to take a look at the same data/responses to this question from the identical IFA Survey completed in 2011. The United States economy was in materially worse shape in the 2010/2011 time frame when compared to its current state. So what did the factors who responded have to say about the change in the amount of frauds that occurred?

The results of the 2011 survey are presented above and again, I was surprised by the data. Of the factoring firms that responded, 38% of them said that the number of fraud cases had declined over the past 12 months [compared to 28% in the most recent survey]. 46% of the firms that responded said that the number of fraud cases was unchanged and only 16% [identical to the current results] said that the number of fraud cases had increased.

As an aside, the sample size of the factoring firms that responded was nearly identical for both surveys.

So even though the economy was weaker in the 2010/2011, the overall percentage of factors that reported any increase in the number of cases of fraud was unchanged. I would have thought it would have shown an increase.

There are so many other areas of research related to fraud in the factoring industry that don’t appear to have been studied or commented on to this point. For example, I went seeking data to determine if fraud is more common in certain industries when compared to others. There isn’t much, if any data available to begin to answer this question.

Logic tells me that the probability of fraud increases exponentially when there is a higher percentage of debtor [the clients’ client] concentration. In these cases, when something goes bad, the factor has little or no room to recover. It is interesting to note that this was one of the questions asked in the IFA Survey referenced above. Of the factoring firms that responded, nearly 75% of the factor said that they have clients that have a 100% concentration in the AR. This is a very risky but obviously very common structure in the United States factoring industry.

Another area of analysis that lacks credible research is what factoring firms are doing [or are doing different] to help reduce fraud in their portfolios. The IFA surveys factoring as part of the Business Profile and Performance Survey about what sources are used to underwriter a debtor’s credit worthiness. The usual sources are most commonly cited: Dun & Bradstreet, Public filings, Credit applications, Experian, Ansonia and others. No real similar question is asked on how factoring firms attempt to protect against fraud.

This would be an interesting area that additional, detailed research would be valuable to the global factoring industry. Much work and research needs to be done to try to help reduce the exposure of fraud to all factoring firms and to identify the “best of breed” benchmarks to combat this global plague.