This is the sixth article in a series on discount and warranty fraud. Read parts one, two, three, four and five.

Throughout this series, you have learned that if your company’s products are in high demand, you are an inviting target for sophisticated fraud schemes aimed at finding and exploiting weaknesses in your discount and warranty programs. Even companies with a watchful eye towards spotting these crimes have become victims. 

What is discount fraud? Typically, in a discount fraud scheme a “customer” or corrupt channel partner asks for deep discounts on your products based on unique circumstances. However, the representations are false and those products end up with a broker, competing with your honest channel partners for business.

What is warranty fraud? Warranty fraud schemes frequently involve a customer misrepresenting to your company that a product is in need of service or replacement. The customer, however, does not have a failed product, but obtains a new product from your return program and sells it to third parties for profit.  

Although the vast majority of new sales opportunities and customer warranty claims are genuine, and lead to or support long-term customer relations, there are situations in which your company has been lied to—and lost valuable product and profit as a result. These practices are against the law and your company has legal rights against the perpetrators of these frauds.

If it is clear that your company is, or may be, the target of these frauds, what next?

Fast forward to the civil or criminal trial against one of the perpetrators of these schemes. The defendants argue that your company knew about their fraudulent practices, did nothing to stop the activity and thus implicitly condoned the fraudulent deal or warranty replacement. This defense, sometimes called the “condonation defense,” is playing out in a number of recent fraud cases. Whether a company knew of and condoned the defendant’s activities may now bear on the issue of whether the defendant had formed the required intent to commit the crimes with which he was charged.

Your company must be prepared to refute accusations that it looked the other way or did not put processes in place to protect itself. A clear first step in tackling the “condonation defense” is building a program dedicated to detect these frauds:

1. Discount fraud: Institute end user verification and document the deal

A key element in defeating the “condonation defense” in a discount fraud case is demonstrating that your company was serious in vetting the proposed deal and relied on the misrepresentations in approving the deal. Your company thus needs processes in place to verify the legitimacy of the information the customer provides. Every deal needs to be evaluated with a level of scrutiny appropriate to the size of the deal and the amount of extra discount involved.  

Precautions some companies take to ensure the end user is legitimate include reviewing public data on the end user (such as D&B reports, websites, etc.), clarifying exactly how the products are to be used or even making a site visit to where the end users will house the products. Companies should consider formalizing the process by requiring written verification of the end user’s intent not to resell the products, but to use them solely for internal use.

Ensuring that the details of the deal are well-documented with a clear and strong paper trail is crucial to protecting your company. If a deal goes sour and it appears that fraud was used to obtain discounted product, you will want the documentation setting up the deal to make perfectly clear:

  1. Your due diligence in asking the right questions
  2. The misrepresentations by the fraudsters, so that you can prove that the deal was fraudulent at the inception

The clearer the documentation, the better position your company will be in to deflect a claim that your sales team condoned the deal.

2. Warranty fraud: Dig into your data

Warranty fraud schemes are geared at finding and exploiting the loopholes in your warranty programs to deceive your company out of new product. Your company needs a portfolio of controls that work together to reduce the vulnerabilities of your post-sale services.

To start, tighten the controls in your warranty return process. When allegedly defective product is returned, it should be verified against the original request for warranty service and the product should be examined for authenticity. Where discrepancies exist, your company should not only follow up with the claimant, but it should also begin an internal investigation into the customer’s warranty history. Mine through your company’s data—the evidence of fraud is likely waiting for you there. Your company should also proactively monitor if possible whether replacement product is appearing on broker boards and in warranty requests by other customers. If there is a mismatch in the data (for example: a product sent out as a replacement is later the subject of another end user’s service claim), then it identifies a potential warranty fraud scheme that you can further investigate. Putting steps like these in place will help establish that your company takes reasonable steps to prevent fraud.

3. Expand your team through training

Once your company develops a program, communicate that plan to your employees and partners. Educate your employees, including sales, customer service representatives and technical assistance staff, about how these fraud schemes work and how to recognize them. Arm them with the skills to halt future fraudulent activity and appreciate the business impact of failing to identify fraudulent deals or returns.

Formalize the training that takes place. Keep the training materials and records of attendance. Some companies facing discount fraud schemes or warranty fraud abuse on a large scale ensure that their employees are retrained annually.  

It is also important to convey your company’s policies and expectations to your channel partners through training or communications such as newsletters or partner summits. Inform your partners about the reasons your company is aggressively taking measures to prevent fraud from occurring, including that these frauds hurt honest partners when discounted or stolen products end up at a broker and are used to defeat a competing bid from an honest channel partner.  

4. Work closely with outside counsel

Creating a team that includes both inside and outside counsel, and inside and outside investigators, often provides the best results in preparing a fraud case for possible civil action or criminal referral to law enforcement. As your company uncovers the fraud, including experienced outside counsel in these communications, discussions and strategy decisions helps to ensure that the investigation is privileged. If your outside counsel is familiar with these fraud schemes and your industry, they may already have intelligence about the perpetrators and the scheme that was committed.

Once the case becomes ripe for a potential referral to law enforcement, experienced outside counsel will strategize with you about whether the matter is best addressed civilly or by criminal referral. If a criminal referral is desirable, counsel experienced in criminal matters can advise you about the best fit, both with regards to venue (should you be looking federal or state? New York or California?) and the right investigatory agency (Federal Bureau of Investigation? Secret Service? Department of Homeland Security?) for the particular matter.

An effective collaboration with law enforcement is often guided by your counsel. As the victim, your company must realize that while it is perfectly appropriate to assist law enforcement, the victim can actually provide too much assistance at times. Working with counsel who understand where those boundary lines are (and they are not necessarily bright lines) will benefit your company as the case proceeds criminally.

Complex and sophisticated fraud schemes aimed at discount sales programs and warranty replacement programs are on the rise. Make certain that your company has the program and team in place to identify, stop and pursue the perpetrators.