Letter of Credit Fraud
This fraud is a bit unusual in that it deals with letters of credit. It’s a bit more sophisticated than what we’ve seen before and we don’t have the company name. This is a case from the Association of Certified Fraud Examiners so the company and perpetrator are not named. First though, a little background.
From Wikipedia:
A letter of credit (LC) … is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an exporter of goods. Letters of credit are used extensively in the financing of international trade, when the reliability of contracting parties cannot be readily and easily determined. Its economic effect is to introduce a bank as an underwriter that assumes the counterparty risk of the buyer paying the seller for goods.
When I worked for Darden Restaurants they used LCs extensively when buying seafood from all over the world. An LC mitigates the risk of not receiving payment for the exporter and simplifies the process for the importer because a bank is guaranteeing the payment.
In our case study, a company defaulted on a loan tied to a letter of credit. The bank hired an auditor to figure out why the loan had really gone unpaid. One thing about an LC, since it’s tied to the international shipping of goods, they typically generate a lot of paperwork for someone to trace. There are the LC and related documents, customs forms, bills of lading, and other shipping documents, etc.
The auditor dug in and compared submitted paperwork with public records data, loan documents, and statements about the LC’s purpose, and boy did they find a mess. Specifically:
- There were inconsistencies between disbursements and the stated purpose. For example, the borrower dealt in plastics while the supplier specialized in metal rods.
- The supplier (payee) appeared to be a related party to the borrower.
- The supplier’s office and the borrower’s warehouse had the same address.
- During the previous year, 135 draws were made on the letter of credit totaling $73 million.
Further investigation revealed that the borrowing company had not held a business license for three years and the transportation company listed as a shipper in the documents did not exist at the address on the paperwork.
Ultimately this was straight-up loan fraud, but more sophisticated than a simple take the money and run. There were also allegations of money laundering and that certainly could have been part of this scheme, but nothing beyond the allegation was detailed in the article. Despite the sophistication, the bank missed a lot of red flags. Anti-money laundering efforts like “know your customer” should have helped prevent this. A simple check of business licenses and addresses should have raised red flags.
For businesses that are not banks, it’s still important to know your customer before providing significant credit. It’s not unusual for independent partners of very large firms to try to leverage the credit of their partner inappropriately. One more note, $73 million is a lot of money over the course of a year.