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Defusing the Bomb: Managing Fraud Risk in Transportation Factoring

HubTran’s Vice President of Factor, Tom Durrenberger, wrote this article for the International Factoring Association’s July/August 2020 edition of Commercial Factor.


I want to describe a client of yours. Jim has been with you for a long time. He is an honest owner of a small trucking company with a history of working with your account executives, factoring a dozen loads per week with you for years. His record is solid and unremarkable — a few chargebacks here and there, but typically nothing beyond a missing lumper receipt or two.

To all outward appearances, Jim is a great client and one that makes you feel good about being a factor. What you don’t know is that Jim recently had some financial trouble and ran in with some bad folks who paid him a lot of money to use his company’s identity. These folks are experts at what they do. They know just how to evade your systems — from when to submit invoices, to the dollar-value thresholds they need to stay under, to the specific debtors they create fraudulent invoices for — all to make sure their invoices get as little review as possible.

Unfortunately for you, the result looks something like the graph below.

The details of this story are fake, but the purchases and payment data are not. As dramatic as it is, the graph understates the effect — when you consider increasingly slim factoring fees, this single loss erased months of bottom line profits.

This happened to a large, sophisticated and well-regarded factor. It survived, but others might not. There’s no need to put too fine a point on it: Whether due to stolen identities, deliberate carrier fraud, collusion between carriers and brokers, or fraudulent double-brokering, the risk of major fraud poses an existential threat to both large and small factors alike.

Unpacking the Problem

Detecting fraud is difficult but not because it is hard to spot in a vacuum. On the contrary, in many cases, fraud has several telltale signs. The trouble is transportation factoring is a high-volume business that allows little time to make sure you know what you’re buying, which increases the odds of purchasing something — and in the worst cases, a whole lot of something — that you will really wish you hadn’t.

Factoring is also a victim of its success at rooting out more straightforward fraud. “Fraud in transportation factoring used to be a 60-day scam,” David Jencks of Jencks Law, a specialist in transportation factoring and asset-based lending, says. “Now it’s a six-month scam, and it’s not a $10,000 loss, it’s six-figures.” Fraud is less routine and minor, and more episodic and severe than it used to be.

Factors also are battling the bad behavior of a few large brokerages. The pre-purchase verifications process is the one silver bullet that factors have today, but verifying loads is impossible for a small number of large and well-known debtors who simply choose not to answer the phone or respond to emails. The problem is at least partially self-inflicted; factors have tolerated this behavior by continuing to factor loads from these players. Fraudsters know how to take advantage, spoofing invoice documents on impossible-to-verify loads before they take your money and disappear.

Traditional credit and account monitoring and controls are a good start, but the situations described previously illustrate how those can fall short. The question remains: What is to be done?

Taking Advantage of All Available Data

Even with the most thorough document audit, there will be some issues that your team won’t catch. For instance, most companies do not check to make sure an invoice’s lane rate isn’t too high, which is an indicator of potential fraud. This is a tough thing to do — you have to calculate distance based on the origin and destination; consider the number of stops, equipment and freight type; and understand recent rate trends to understand an invoice’s level of abnormality. However, processing teams handle hundreds or thousands of invoices per day and simply don’t have the time or tools to complete these checks on lane rates.

This is particularly dangerous because the more abnormal the lane rate, the higher the likelihood of nonpayment.

Other invoice details also correlate to higher rates of nonpayment and fraud. Examples include incorrect debtor contact information, having the wrong clients or debtors on the BOL, missing BOL pages, and out-of-sequence load IDs.

At best, factors’ processing teams check for these types of issues sporadically because it is difficult to do this work manually. However, modern technologies such as OCR and machine learning can do this work accurately and cost effectively. By matching the details of submitted paperwork against patterns of client behavior and actual payment data, a factor can achieve detailed, invoice-by-invoice risk surveillance. This is a leap beyond traditional client and debtor risk scoring. The net effects are reduced write-offs, chargebacks and days outstanding.

Creating a Bulletproof Verifications Process

Risk management will only be as effective as the process you set up around it. A successful verification reduces average nonpayment on an invoice by a factor of three and gets paid three days faster. Clearly this is a powerful risk and fraud mitigation tool. Contacting a debtor to confirm the key details of a load prior to purchase really does work.

Unfortunately, pre-verification is managed largely based on gut feel and tribal knowledge. Three examples illustrate the point:

  • Ask a simple question, such as, “What’s the optimal number of invoices that you should verify as a factor?” and you will find a wide range of answers: 25%, 40%, 50% or 100%. Ask for justification for this number, and you already know the response — it’s how things have always been done.
  • Which invoices get selected for verification is usually determined by some combination of client newness, age of client-debtor relationship, prior client bad behavior and invoice amount. These are reasonable criteria to use if you don’t know anything else about the invoice, but modern OCR and AI technologies allow us to know much more. Not using this granular level of data to prioritize verifications is like playing with fire.
  • Lastly, the verifications method, the tools and processes used, and even how this data is recorded often vary widely even within a given factor. There is little process control and managers often must accept on faith alone that verifications are really occurring and are effectively reducing fraud and nonpayment.

This is not a scientific process, but it could be. In the same way that automation revolutionized document processing, a modern verifications workflow will help factors work smarter and faster while taking out cost. Moreover, there’s no reason why the verifications process itself can’t be automated by comparing clients’ invoice details with information in debtors’ TMS systems on a real-time basis, eliminating the need for repetitive and inconsistent phone and email verifications.

It’s Everyone’s Problem

Fraud is a problem that eventually affects every factoring organization, including yours. The good news is that you can now decide how to deal with fraud, either by choosing to do so retroactively or by taking proactive steps to make sure it doesn’t blow up in your face.

Ready for your team to work 4X faster?