5 ways to protect your company from discount fraud

If you have a discount program, you may have a problem that needs to be addressed

This is the third installment in a series on warranty and discount fraud. Read parts one and two.

If your company’s products are in high demand, it can be highly profitable for others to obtain your products at steep discounts by making fraudulent misrepresentations, only to turn around and resell the products into the marketplace. Sophisticated fraud schemes like this, aimed at finding the weaknesses in your company’s discount sales programs, are hitting organizations in industries from software, to pharmaceuticals, to consumer products. The bottom line is this: If you have a discount program, you may have a problem that needs to be addressed.

For many companies, it is a business necessity to authorize special discounts to certain customers who can demonstrate a particular project or business that would justify forfeiting profits on their products. And while many of these opportunities are genuine—and lead to additional revenue—one-off cases exist where the statements made to obtain the discounts are false. Not surprisingly, most of those heavily discounted products do not wind up with the supposed end user, but are sold elsewhere for a profit. 

These schemes mean lost profits to you and your channel partners, increased costs and marketplace disruption. What can your company do about it? 

Once uncovered, discount fraud schemes can lead to serious consequences for the perpetrators. Consider these recent prosecutions:

  • U.S. v. Mirza Ali: Defendants were sent to prison for 60 months each and ordered to pay $20 million in restitution to Microsoft, for a scheme where they made false statements to obtain $30 million in products on which they received about $20 million in special discounts available to educational institutions. The defendants falsely pledged to sell the discounted products only to “educational users,” but instead sold 90 percent of the software to commercial entities. 
  • Dina Wein-Reis, a well-known New York socialite, pleaded guilty and now must serve 31 months in prison and pay $7 million in restitution for a fraud scheme in which she tricked well-known manufacturers and distributors of consumer products into selling her merchandise at incredibly discounted prices by falsely promising them that her company would distribute those products as samples to non-profit organizations. In reality, Wein-Reis actually sold the goods at substantial profit to wholesalers, retail stores and others.  
  • Joseph Monahan pleaded guilty and was recently sentenced to 18 months in prison and ordered to pay $1,845,128.70 in restitution for a fraud scheme in which he and a business partner deceived a large technology company into providing substantial discounts on products that were allegedly being sold to particular end users. Instead, the products were being ordered by, and sold to, a large unauthorized reseller of products, which then sold the discounted goods in competition with honest channel partners.

Even the most vigilant of companies have fallen victim to these deceptions. Many are now proactively tackling prevention of these crimes. Whether your company has already been hit by these schemes or has merely identified them as a potential problem, there are steps you can take to mitigate fraud risks. 

Here are a number of tactics we think work.

1. Secure internal support

Educate your key executives about how these fraud schemes work and the consequences of failing to identify fraudulent deals. They need to recognize that “a sale is not a sale,” and that deals rooted in discount fraud schemes distort revenue, harm honest partners, inequitably distribute sales commission credit to the internal sales team and undermine the integrity of point-of-sale data. With executive support, you will be able to take steps to tackle this problem.

2. Employ end user verification

Protecting your company from fraud often simply means “not taking people’s word for it.” When business reasons justify authorizing additional discounts on your products, you need processes in place to verify the legitimacy of the information the end user is providing. The thoroughness of your investigation is the key first step to thwarting potential abuses. Your sales teams need to vet the proposed deal according to a protocol that intensifies the level of review based on the level of risk. 

Precautions some companies take to ensure the end user is legitimate include meeting that end user in person, clarifying exactly how the products are to be used, or even making a site visit to where the products will be housed. 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 purposes.

3. Identify your company’s internal tools

Ensure the deal is well-documented. Capturing the communications confirming the details of the deal is crucial to protecting your company. A clear and strong paper trail begins with attaining basic end user information. However, you should chronicle, in writing, all of the specifics of the deal, so that if it goes bad, you can prove that it was fraudulent at the inception.

Pay attention to sales data, such as point-of-sale data and warranty returns. Critical information about discount fraud deals is often at your fingertips. You may already know who is supposed to have particular products, which are identified by serial number.  A mismatch in data between the purported end user of a product and the entity that ended up with it could mean a potential diversion deal requiring further investigation.

4. Train your sales team

You want your sales team to understand your company’s internal processes and the reasons your company is aggressively taking measures to prevent this fraud from occurring. By educating your employees about how these schemes work, how to recognize them and the significant financial impact fraud has on the business, you can arm them with the tools to identify fraudulent deals. 

Depending on the size of your sales team and the scope of potential fraudulent activity, you should consider requiring training sessions on your company’s screening and verification procedures. 

5. Engage with your channel partners

Discount fraud hurts honest channel partners  when discounted products end up at a broker and are used to defeat a competing bid from a partner. These partners can’t compete against the low prices that can be offered on products procured through such fraud.

In all likelihood, your company’s partners have already been vocal about these issues. Tap into them as a resource because they are a valuable source of information regarding partner harm. There may be deals they have lost or other word-of-mouth information that can provide leads for investigating these crimes. 

Contributing Author

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Richard Nelson

Richard J. Nelson is a partner at Sideman & Bancroft LLP in San Francisco, where he specializes in litigation and government investigations. Mr. Nelson often...

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Contributing Author

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Erica Brand Portnoy

Erica Brand Portnoy is an associate at Sideman & Bancroft LLP in San Francisco where she focuses on the representation of corporate crime victims and...

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