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Best practices for making a referral to law enforcement on a fraud case

If the government pursues a fraud case to a successful conviction, it will send a deterrent message to would-be scammers

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

Even the most vigilant of companies have become victims of discount fraud schemes or fallen prey to warranty fraud scams. When that happens, making a referral to law enforcement may be the best approach under the right circumstances. If the government pursues the case to a successful conviction, that sends the strongest deterrent message possible. Prison gets everybody’s attention. Also, it may be possible to recoup your financial losses through court-ordered restitution. The bottom line is that a criminal referral should be an arrow in your enforcement quiver, to be used in the right circumstances.

The basis for criminal prosecution

When your company is the victim of fraud, federal and state case law support its right to recover lost revenues. You may think that the government would not spend time on a criminal warranty fraud or discount fraud case. As many people who are now in prison have found out, that is not true. 

For the most part, these fraud schemes have been prosecuted as violations of the federal mail fraud and wire fraud statutes. For example, in the discount fraud case of U.S. v. Mirza Ali, the court held that mail and wire fraud defendants took “money or property” from Microsoft Corp. by obtaining discounted software packages under false pretenses and then selling the packages for full price. The 9th Circuit upheld the fraud convictions. Similarly, in the recent Cisco Systems Inc. warranty fraud case of US. v. Iheanyi Chinasa, the 4th Circuit upheld the conviction of Chinasa, who was sentenced to seven years in prison for directing a scheme in which he returned counterfeit products after Cisco replaced “defective” products with new parts worth almost $18.8 million. The court found that the “evidence was easily sufficient to prove that Chinasa committed mail and wire fraud.”

Perpetrators of these frauds can also face charges of violating 18 U.S.C. § 2314 (“interstate transportation of stolen property”) in scenarios where the schemers obtained products through fraud and then transported those products across state or international lines. The defendants in U.S. v. Ferro violated this statute when they received substantial discounts from various pharmaceutical sellers by misrepresenting that they were purchasing the products for their “own use” in defendants’ institutional pharmacy, but instead sold the drugs to wholesalers. 

Although these prosecutions all occurred in federal court, prosecutors can certainly bring discount fraud cases in state courts. 

What to remember when preparing the case for referral

Referring these cases to law enforcement can be challenging. As a result, it is essential to make it easy for an agent and prosecutor to understand the facts of your case. Discount and warranty fraud cases involve complex schemes, often with many players and moving parts. Your company should identify, assemble and analyze the evidence first. intake time when writing the report to distill the facts into an understandable description of the essential elements of the crime. 

Here are some of the issues that companies are tackling head-on to facilitate productive cooperation with law enforcement.   

Sales and discount fraud issues:

1. Investigating internally

In our experience, companies that have invested the time and resources to identify the nitty-gritty details of the scheme and have thoroughly investigated the case internally have more success when approaching the government. Your team should know the ins and outs of the case—including whether there was internal involvement and to what degree—so there are no surprises.

2. Tackling and proving materiality

A prosecutor will need to prove the fraud beyond a reasonable doubt. A case that is a good candidate for referral has clear facts showing the company’s due diligence and the fraudulent statements. If the fraud is clear to you, then you must make it equally evident to the investigator and prosecutor. Preparation and investigation on your end can certainly have an effect on whether the case is worthy of government resources. Hone in on the misrepresentations that are the basis for the fraud. Gather all of the specifics of the deal, including emails and other communications, purchase orders, and other documents, to show that the deal was fraudulent at the inception.

3. Proving both harm to you and to competition

Be prepared to face questions about whether your company has actually been harmed, since a sale occurred and you received some payment for the discounted product, in spite of the scheme. The fact of the matter is that the perpetrators of these frauds may be making millions of dollars by selling your products, which they obtained through deception and lies. Your company, on the other hand, is losing substantial revenue and losing goodwill from your channel partners.

While you may be able to calculate your company’s lost revenue on paper, in order to increase the government’s interest in investigating and prosecuting the fraud you will need to develop the broader back story. For example, one company, which has secured multiple restitution orders, focuses on how the scheme has harmed both competition and end users. Effectively painting this picture can be crucial to your case.

Warranty fraud issues:

1. Pinpointing the perpetrators

When warranty fraud schemes become sophisticated, organized and deliberate, identifying the key players can be the most difficult hurdle. Be assured that the perpetrators of warranty abuse know how to get what they want by finding ways around your procedures, and you need to be equally smart about them. It is critical to have a dedicated team of internal personnel who receive leads, dig into your data and then follow up on them to investigate. Identifying the person or persons behind the scheme is usually the most important part of the investigation.      

2. Defending your company’s internal controls

There may be no question that the fraudulent activity occurred. But before the prosecutor will go forward with the case, additional questions will likely arise about what steps your company took to protect itself. Showing that your company has aggressive, proactive fraud detection procedures in place to address warranty abuse is an important piece of the case. Implementing warranty fraud detection tools should be the first step in preparing your company for successful collaboration with law enforcement.

3. Calculating the damages

Computing the damages from a warranty abuse scheme can be as straightforward as an Excel spreadsheet. But, depending on the sophistication of the scheme and what kinds of products (new, used, refurbished, end-of-life) your company actually sent out as replacement product, the damage calculations can be tricky to hammer down. 

Although not every case is appropriate for criminal referral, when the circumstances are right and you have done the necessary groundwork, collaboration with law enforcement can both bring tremendous return on your investment and send the important message that your company is not an easy target. 

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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