U.S. federal prosecutors have charged two top executives of a South Florida-based company with orchestrating a fraudulent investment scheme that allegedly raised more than $150 million,
Miami Herald reports. Antonio Carlos de Godoy Buzaneli and Jose Manuel Ordoñez Jr. offered a factoring investment that would generate a high rate of return through their firm, Providence Holdings International, according to the indictment. The company advertised that it would purchase accounts receivables at a discount from Brazilian retailers, paying $820 to retailers for $1,000 in post-dated receivables from each customer and retaining $180 in returns once the checks matured. Using unlicensed brokers in the U.S., the company sold investors $64 million in promissory notes at between 12 percent and 24 percent annual interest rates. Prosecutors allege that Buzaneli and Ordoñez diverted investor funds to a series of other companies they owned. A third principal of the company pleaded guilty to one count of mail fraud in November.
Knowledge and inquisitiveness are the main keys to better prevention and detection of the type of fraud in this case — certainly sooner than the seven years and large financial losses incurred before the scheme ended in 2016. While accounts receivable, or debt, factoring has existed since the early 1400s as a way for businesses to manage uneven revenue cycles, few people outside of the factoring industry are familiar with the associated processes and fraud risks.
A blog post by investment firm United Capital Funding estimates factoring is a more than $130 billion industry in the U.S., and the size of related fraud activity totals more than $230 million. To learn more about factoring, internal auditors and investors should focus on two aspects.
Learn about factoring industry markets, sources of expected profits, and their associated risks. On the surface, the highly concentrated Brazilian banking system would appear to be promising. As credit expanded in Brazil over the past 20 years, real interest rates and lending spreads have stayed among the highest in the world. Historically, small and medium-sized companies paid 10 percent monthly for their financing.
However, factoring firms offer varying discounts depending on the duration, chosen industry segment, level of direct retail exposure, credit quality, payment history, and many other considerations. That brings the cost for the better prospective debtors down to 2 percent to 3 percent. That's just one risk factor among many for a country such as Brazil, with less stable political and economic systems compared to some other countries. In this case, investors should have been skeptical about Providence's promised 48 percent annual rate of return.
Understand the gaps and inconsistencies in the factoring industry's legal, regulatory, and structural framework. As one recent industry report notes (currently available in English and Portuguese at
www.fitchratings.com.br), "It is evident in transactions that inadequate checks and balances, with over reliance on a single, low-rated party to perform credit origination, collection, and special servicing exists. ... Proper segregation and transparency among originator and servicing responsibilities are paramount in a moment where many small-sized factoring companies have employed aggressive growth strategies, levering up their operations via securitization."
As with many industries, there are significant legal, compliance, and tax risks accentuated by the large number of widely varying applicable laws and regulations in different countries. In some cases, governments have intervened to regulate the factoring industry. In addition, the industry's International Factoring Association has addressed the need to mitigate risks related to smaller or higher risk factoring companies, such as by applying rating caps to some or all of their receivables transactions. These parties could always do more to cooperate, share knowledge and intelligence, and provide greater legal and regulatory consistency across borders to help prevent these crimes.
Equipped with more knowledge about the factoring industry, auditors should look out for two red flags:
The factoring company is reluctant to provide essential identifying information about the debtors and clients with whom it is dealing. Ask to see examples of the invoices or debt notices upon which the factoring company is basing its expected investment profits. One commonly used fraud tactic is for the factoring company and the client to create a false or inflated invoice. This is easy to do with inexpensive digital printers. Invoices appear as if they have been issued by a legitimate debtor similar to others already factored in the past by the client or the factoring company. The fake invoices are added to the pile of valid accounts receivables to be factored by the client in the hope that no one is paying attention or verifying each unique invoice. If the factoring company cannot demonstrate that it is verifying each individual invoice, this is also a red flag. Collusion between the debtor and the client providing fraudulent verification to the factoring company may also be going on at the same time.
The factoring company is unable to provide key business documents such as financial statements. These include:
- Articles of incorporation.
- Previous years' tax returns.
- Balance/profit/loss sheet.
- Previous audits of company operations and financial statements.
- Signed contracts between the debtor and client. Also, disclosure of any contractual disputes with debtors and clients.
- Proof that the factoring company deals only with licensed brokers.
- Evidence the company has a fraud insurance policy that covers investors, and potentially debtors and their clients.
- Disclosure of any Internal Revenue Service liens associated with payroll taxes.