How To Use Internal Procedures to Protect Your Company From Discount Fraud


When discount fraud happens, it hurts not only the vendor, but the solution provider and the end customer. It's a crime that subscribes to the trickle-down theory. Here, Nelson and Portnoy expand on their initial post about discount fraud. Nelson, is a partner at Sideman & Bancroft, specializing in litigation, with a focus on white collar criminal defense and complex commercial litigation. Portnoy is an associate at the firm, focusing on business crimes defense and complex commercial litigation.—Jennifer D. Bosavage, editor

Last month, we explained why your company should be concerned about discount fraud, the practice of sophisticated fraudsters taking advantage of companies that offer highly discounted products under certain circumstances. The typical scenario involves a customer who asks for deep discounts on your products based upon an articulated need; for example, asking for discounted products to build a new data center.

For many companies, it is a business necessity to provide such discounts to address particular end customers’ unique circumstances. In fact, the vast majority of those opportunities are genuine, and lead to additional sales and long-term customer relations.

But sometimes the representations made concerning the end use of the specially discounted products are false, and those products wind up not with the purported end user, but somewhere else. Such schemes cause lasting damage. Your company has received less than it otherwise should have for those products, and those same products are then sold by the fraudsters into the marketplace where they undercut established sales channels.

Your company may already have been a victim of this type of fraud, or perhaps your company has identified discount fraud as a potential problem. Regardless of your situation, there are concrete steps you can take to defend your company from this type of abuse. Putting your company in the best position to protect against such fraud begins with strengthening your internal processes.

While the steps outlined below, designed to combat discount fraud, do not represent a one size fits all solution, your company can mitigate against these fraud risks by designing controls and protocols into your company’s internal system. How your company does this will likely depend on your sales operation, structure and many other factors.

Following are the general principles of what some successful companies are doing to address this issue, and what we think works.

1. Don’t take people’s word for it – Engage in end-user verification

Your company wants to authorize the additional discounts to a specific end user, either through a partner or directly, when legitimate business reasons justify those discounts. That said - you will need processes in place to verify the legitimacy of the information being provided. The level of due diligence your company takes should depend on the level of the risk – often dictated by the quantity of the products sought and the amount of the requested discount. For example, one factor a company could examine when assessing the risk of the deal is whether there are large disparities between the requested components and the equipment necessary to operate the components.

When the risk appears low, it may be sufficient to verify the end user’s information via Dun & Bradstreet, the internet, or other publicly available resources. However, as the risk escalates, so should the precautions your company takes to ensure the end user is legitimate. That could entail ensuring that the sales team have vetted the proposed deal (by, for example, meeting the end user in person), receiving clarification from the proposed end user of exactly how the products are to be used, or even making a site visit to where the products will be housed.

Every deal needs to be evaluated across a protocol that intensifies the level of review required for approval based the risk associated with deal. The thoroughness of your investigation is the key first step to thwart potential abuses.

2. Get it down on paper – Ensure the deal is well documented

Here, “less” is certainly not more. Capturing the communications confirming the details of the deal is crucial to protecting yourself. In fact, the more written information documenting the specifics of the deal, the better. Documentation certainly begins with basic end user details such as company name and contact information. However, the requirements for a deal could also include D&B numbers and other indicia of legitimacy. If a deal goes bad, and it appears that fraud was used to obtain discounted product, you will want the documentation setting up the deal to make perfectly clear (1) your due diligence in asking the right questions, and (2) the misrepresentations by the fraudsters, so that you can prove that the deal was fraudulent at the inception. The more clear the documentation, the better position your company will be in to address the abuse.

3. Educate your employees

Educating your employees about how these schemes work and how to recognize them is key to prevention. You want your employees to understand your company’s processes, why they are critical, and the unsavory consequences of failing to identify fraudulent deals. You also need your internal sales team to recognize that today’s large “blue bird” deal leads to tomorrow’s lost sales opportunity.

You should consider periodic training on these issues. The frequency of training sessions can depend on how serious this issue is to your company. Some companies facing discount fraud schemes on a large scale ensure that their employees are retrained annually on the company’s screening and verification procedures.

4. Clearly establish the expectations and policies of your channel partners

It is often the case that a channel partner approaches your company requesting that you sell specified products at steeper discounts so that the partner can meet a pricing requirement of a customer. Whose responsibility is it to vet the deal? If you haven’t ironed out your expectations with your partners, then potential fraud looms.

You should consider developing documentation for your partners, similar to the documentation your own internal procedures should now require. This should include written verification of the end user’s intent not to resell the products, but to use them solely for internal use, and the collected reasons why the partner believes that the end user is genuinely purchasing the discounted products for its own use.

Additionally, it is important to communicate your company’s policies and protocols with regard to end-user verification. Educate your partners on the reasons your company is aggressively taking measures to prevent this fraud from occurring. Explain that discount fraud hurts honest channel partners when discounted products end up at a broker and are used to defeat a competing bid from an honest channel partner. Explain that you are taking action to prevent fraudulent deals, but that a successful program requires a joint commitment by the company and the channel partners. Importantly, provide corresponding training on how your program works.

Next month we will provide guidance on how to develop intelligence on the perpetrators of these frauds—staying ahead of the fraud is often your best defense.