How To Protect Your Company From Theft By Discount Fraud

Discount fraud can ring up hundred of thousands—if not millions—of dollars in lost profits. Even the most vigilant of companies can fall prey to fraudsters, according to Nelson, a partner at Sideman, and Brand, an associate. Here, Brand and Nelson offer tips on what to do should your company get stung.—Jennifer Bosavage, editor

Responding to new sales opportunities for your company’s products is generally viewed as the lifeblood of a company’s sales organization and channel operation. But consider this situation: Your company steeply discounted its product for a particular new sale because unique circumstances and business justifications existed to warrant those special discounts—only those products ended up in the wrong place, not with the purported end user.

Worse yet, the discounted products were used by a broker to defeat a competing bid from an honest channel partner. That is discount fraud.

You know the bottom line: You’ve been lied to. But when the sales opportunity goes awry like this, it can mean more than lost revenues. What can you do about it?

The law considers it theft.

Discount fraud exploits the special discounts companies sometimes offer when market circumstances justify sacrificing revenue to win a particular new piece of business. Most commonly, the customer provides a description of those unique circumstances to the company and also pledges that any specially discounted products it acquires will be used only for the specified purpose, and will not be resold.

Consider the recent case of United States v. Ali, where the defendants devised a scheme through which they made false representations to Microsoft in order to obtain “authorized education resellers” status to ultimately purchase discounted academic edition software. The defendants procured roughly $30 million in Microsoft products on which they received about $20 million in special discounts. Defendants were supposed to sell the discounted products only to “educational users,” but instead sold 90 percent of the discounted software to commercial entities. They were ultimately sentenced to imprisonment and ordered to pay Microsoft $20 million in restitution, which reflected the difference for the academic edition software and the full list price Microsoft would have charged for the normally marketed version of the software.

The Court of Appeal upheld the fraud convictions, stating that “Microsoft had a right to full payment for its software and was deprived of that right when defendants fraudulently obtained the software for less than full payment.”

If your company’s products are in high demand, then you are an inviting target to the perpetrators of this fraud.

Next page: What’s at stake?

What’s at stake?
First, these frauds can cause significant harm to companies, including millions of dollars of lost revenue. Second, you have an obligation to your honest channel partners, who have lost sales to the schemers. By procuring products at unjustifiably lower prices, the schemers are actually able to steal business away from your honest channel partners and undercut your company’s efforts to promote a healthy channel or partnership system.

The good news is that whether your company has already been the victim of discount fraud or wants to take active steps to ward off this crime, there are effective ways to both protect your company from channel abuse and to legally respond when it happens.

1. Strengthen Your Internal Processes.
Companies facing discount fraud schemes head-on have adopted procedures to detect and prevent such fraud. Educating your company about how this scheme works and how to recognize them is fundamental to prevention. Your company can mitigate against these fraud risks by designing controls and protocols into your company’s internal systems. Next month our how-to post will discuss what factors companies should consider as they build a program, what works, and why.

2. Develop Intelligence.
Be assured that the fraudsters know your products and how to “package” their scheme to get what they want. You need to be equally smart about them. It is critical to have a dedicated team of internal personnel who receive leads from customers, channel partners, and others, and then follow up on them to investigate. Learning what you can about who is targeting your company, and how they are doing it, gives your company a fighting chance to stem this problem.

3. Take The Fraudster To Court
Don’t be discouraged by a mistaken belief that you don’t belong in the courtroom because your company received some payment for the discounted product, in spite of the scheme. A civil suit can often be the appropriate tactic to confront a discount fraud perpetrator directly.

There are many benefits of bringing a civil suit for causes of actions such as intentional misrepresentation or unfair business practices. One such benefit is that you are likely to obtain a faster result than to go through the criminal proceedings route. Additionally, your company can send a loud message to potential fraudsters that you treat this issue seriously. Discovery or settlement is likely to net intelligence about other fraudsters, and their involvement with the brokers who are selling the stolen products. Finally, a successful suit can recoup some or all of the losses suffered by your company.

There are, unfortunately, instances in which channel partners are involved in discount fraud activity. When that is the case, OEMs often have options short of a court proceeding, especially where the scheme involves a rogue employee. “Make Well” programs can be instituted in cooperation with the channel partner, institutionalizing protocols that strengthen a healthy partner relationship.

4. Refer A Case For Criminal Prosecution.
While it can be highly profitable to obtain specially discounted products by making fraudulent misrepresentations, only to turn around and resell the products, people engaging in such schemes can be subject to federal prosecution for mail fraud and wire fraud.

The court in Ali held that mail and wire fraud defendants took “money or property” from Microsoft by obtaining discounted software packages under false pretenses and then selling the packages indiscriminately for full price. The perpetrators were sent to prison, some as long as 60 months. Thus, making a referral to law enforcement to pursue the crime that has been committed against your company may the best approach under the right circumstances, as it sends the strongest deterrent message possible.

Don’t ignore it. If you do nothing at all, then you allow others to become the victims of fraud.

Don’t miss a more detailed discussion of each topic above in our upcoming series of follow-up posts.