ComplianceLegalFebruary 12, 2021

Guarding against external threats of fraud to your business

External frauds commonly originate with or involve customers and vendors. Common frauds include check and credit card frauds, shoplifting, vendor and telemarketing frauds, and fraud perpetuated by ID theft.

Like frauds committed internally in a business by its employees, external frauds can cause serious damage to your bottom line. These types of frauds are abundant, to say the least. Only by staying alert 24/7/365 can a business owner recognize and nip these scams in the bud.

As varied as they are common, external frauds that pose a threat to your business include:

  • Check frauds: It has been estimated that check fraud in our nation exceeds $60 billion a year . . . not just bounced checks, but every sort of creative tampering using ever-improving laser and color technologies.
  • Credit card frauds: Issuers of credit cards have been actively working to protect their product lines from abuse, but this remains an area of intense concern.
  • Shoplifting: Shoplifters range from opportunistic amateurs to kleptomaniacs to professionals who do this for a living.
  • Vendor frauds: Bribes and kickbacks are the most common vendor frauds, easy to commit and off the books. But others abound as well, including bid rigging, over-billing, and frequent involvement of employee accomplices.
  • ID theft: ID theft is rarely a stand-alone crime. It's almost always a component of two or more crimes, such as bank fraud, credit card fraud, access device fraud or the use of counterfeit financial instruments
  • Franchise scams: Franchise scams aren't as prevalent as they once were. But for those wannabee entrepreneurs who impulsively dive into things that sound too good to be true, a bad franchise deal can be ruinous.
  • Tax scams: Tax scams range all over the place, from frivolous returns to willful understatement of income to false statements and returns. Some tax cases read like a novel.
  • Telemarketing scams: How often do you get unsolicited, high pressure phone calls with exotic vacation offers, or fantastic merchandise or cash sweepstakes prizes . . . but only good if you act right now?

Insurance, bankuptcy, mail and wire, false statement and mortgage fraud, as well as money laundering, investment and internet scams, and cybercrime are all also external frauds that affect businesses both big and small.

Credit card and check frauds can impact small businesses

Check and credit card fraud are a serious problem for businesses of many types. Identifying these types of frauds and stopping them is critical for your business.

Check fraud continues to plague small business

The Fraud: Losses due to the fast growing crime of check fraud now exceeds $60 billion a year. The major perpetrators of check frauds in the U.S. are foreign crime organizations, mainly from Nigeria and Russia, as a sideline to drug trafficking. They have been known to use all the common tricks of check tampering , such as washing, altered payees, forged maker, and forged endorsements using stolen canceled or uncanceled checks.

And speaking of canceled checks, they make fine templates for creating new check forgeries, right down to a company logo, precise routing numbers, font matching, colors and watermarks. With the advent of the Check 21 system it was thought that these problems would be minimized but, due to the innovative nature of crooks and the rapid evolution of technology, check image fraud is still rampant.....simply in a different form.


The Check 21 system was developed to take advantage of the provisions of the Check Clearing for the 21st Century Act (Check 21 Act). The Check 21 Act allows the recipient to create a digital image of a paper check, which eliminates the need to continue to handle the paper version.

The Flaw: You need only visit your friendly neighborhood office supply store to find the cause of many check frauds. For a small investment, one can buy a nice laser printer/scanner/copier, some good check stock paper, magnetic ink cartridges, an encoder and high quality MICR fonts. Voila! You are in the check-forging business.

Don't permit a new customer (most likely with false ID) to open an account by depositing a third-party check and then drawing a portion of it in cash immediately. . . or tap the balance with an ATM card before the phony deposit is uncovered. This is an inherent payment system fraud threat in remote deposit capture and wire transfer transactions.

The permutations are endless.

The Fix: Educate employees on how to recognize phony checks, how to insist on valid IDs, and how to examine and verify them. Know your customers! Have strict policies and strictly enforce them. Keep your technology tools up to date. If you scrimp on this facet of operations you leave yourself open to exploitation by better equipped fraudsters.

Numerous instances of fraudulent activity external to a business are also grouped under the term credit card fraud.

Credit card fraud remains rampant

Credit card fraud is rampant because the sheer number of transactions daily make credit card fraud inevitable.

The Fraud: Credit card fraud includes counterfeit cards, fraudulent or unauthorized use of legitimate cards, stolen and lost cards, re-embossed cards, and "skimmed" cards."


Skimming cards is a favorite of waiters who can skim a customer's card into a small device in his pocket and later sell all the skimmed numbers to an accomplice. 

It has been estimated that 70 percent of all credit card fraud can be attributed to skimming.

In addition, credit card fraud is committed online. And stealing cards out of mailboxes is a favorite means of acquiring them.

Prepaid credit card products are used for fradulent activity as well. They can be bought everywhere from pharmacies to delicatessens to banks to websites. However, these cards serve many legitimate needs, from travel to payroll to gifts. And banks and other issuers of the cards have been actively working to protect their product lines from abuse.

The Flaw: Each industry has its particular vulnerabilities. Your trade journals would be a good source of specific red flags to watch for in your line of work. Prepaid credit cards are a whole separate fertile field of fraud which often involves money laundering.

The Fix: Processors such as Visa, MasterCard and American Express have elaborate security systems to stem most varieties of credit card fraud. These measures are too numerous and complex to detail here, but if you go to their respective websites, you'll be able to see the astounding breadth of frauds and how these firms are grappling with them.

What can you do? Merchants need to educate employees on the various tricks common to their particular industries, as well as the geographic regions where the most frauds originate. These days you'd want to be alert for transactions from Russia, Romania, Bulgaria, Egypt, and Malaysia. The least troublesome countries include Austria, Australia, Hong Kong, Norway, Switzerland, Spain and Taiwan.

And it can't be repeated often enough, where possible, the Know Your Customer rule applies.

Shoplifting and vendor fraud costs small businesses billions

Shoplifting and vendor fraud cause alarming losses for businesses. The National Retail Foundation recently had the University of Florida do a study on data regarding theft and shoplifting losses of $40+ billion in a specific period. The results broke down this way:

  • Employee theft = 47%
  • Shoplifting = 32%
  • Administrative errors (pricing, etc.)= 14%
  • Vendor fraud = 4%
  • Unknown sources = 3%


Based on the above study, we might estimate the cost of shoplifting to retailers at perhaps around $13+ billion a year!

The Fraud: Shoplifters can be freelance amateurs, kleptomaniacs, or members of sophisticated professional bands who shoplift for a living. Some pros even take orders from local "fences" for specific items.


While employee theft is an internal rather than external fraud, be aware that a form of "shoplifting" occurs when by working with an accomplice employees in the context of grocery stores or large discount retail operations steal by "sweethearting."

That term refers to a checkout clerk, when processing an order for a friend, relative or accomplice, holding a hand over the bar code on a product being scanned so that no amount is rung up on the register. This sleight of hand fools any security cameras into thinking the item was scanned properly.

The Flaw: The lack of security controls allows shoplifters to get away with their crime.

The Fix: The following steps can go along way towards preventing and dealing with shoplifting:

  • Closed circuit TV surveillance
  • Employee training and supervision
  • Alarm devices attached to products (to be disarmed by cashiers)
  • Security personnel (in uniform or plain clothes)
  • Intelligent hiring practices
  • Vigorous prosecution


If possible, your best bet is to check "all of the above!"

Frauds involving bribes, kickbacks, and other forms of corruption are another threat your business may encounter.

Vendor fraud often involves employee kickbacks

The most common vendor fraud is bribery . . . giving kickbacks or gratuities to an employee of a firm to influence the choice of vendor, unbeknownst to the owner or management of the firm.

The Fraud: The employee owes loyalty to the employer, not the vendor. Accepting cash or favors to choose the bribing vendor over other competitors is illegal. Travel and entertainment rewards are a common way to incent crooked employees. 

Once an employee is affiliated with the crooked vendor, the vendor need no longer be concerned with competition and can often raise prices to cover the costs of paying off the employee.

In larger firms, the transgressions will be found in bid-rigging and contract fraud.

Bribery schemes can work backward as well. Rather than a vendor bribing an employee, an employee can demand payment from a vendor to assure selection as a preferred provider. This is called extortion.

The Flaw: Some warning signs of vendor fraud can include:

  • Conflicts of interest
  • Fraud in the bidding process
  • False statements and claims
  • False, inflated and duplicate invoices
  • Phantom vendors
  • Product substitution
  • Unnecessary purchases
  • Purchases for personal use or resale
  • Overcharging

The Fix: The correct hiring, training and supervision of employees in a position of power over purchasing is imperative. Also, your business policy should be that management (only) qualifies and approves vendors.

Establish and enforce strict receiving procedures, as well as separating accounts payable duties.

Profile purchasing employees and vendors for living beyond their means, signs of financial difficulties, etc.

Small businesses need to join the fight against identity theft

The Federal Trade Commission (FTC) reports that identity theft was the number one cause of consumer fraud complaints for the past seven years. The FTC received 813,899 complaints (out of an estimated total of 10 million U.S. victims) in 2007, and consumers reported over $680 million (out of an estimated total of $5 billion) in losses from fraud.

ID theft is a complex crime in that it works in conjunction with other crimes such as credit card fraud or the use of counterfeit financial instruments to acheive the goal of ripping you off. Preventing ID theft is much more preferably than dealing with the mess created if your identity is stolen.

Identity theft fraud takes many forms

ID thieves have a long menu of methods for stealing your ID, including:

  • Dumpster diving: They dig through your trash for bills or other items with personal information on it.
  • Traditional stealing: They steal mail, wallets, and bank and credit card statements, or they steal personnel records by bribing employees who have access to them.
  • Skimming: They steal credit/debit card numbers by using a pocket-sized storage device when processing your card.
  • Phishing: They mock up websites identical to financial institutions or companies, and then send spam messages to lure you into revealing personal information.
  • Pharming: Similar to phishing, but no spam involved here. The fraudster illegally acquires the domain of a legitimate financial institution and gets the victim to enter passwords and other vital information.
  • Address changing: They divert your bills to another location by completing a change of address form.
  • Pretexting: They get financial institutions, telephone companies or other utilities to reveal your personal info by pretending to be you.

The Flaw: Our information-age society relies on electronic data storage in large measure, and security vulnerabilities in these technologies continue to be exploited by fraudsters. And low-tech opportunities also exist for crooks, such as unlocked mailboxes holding pre-approved credit card mailings and dumpsters holding all kinds of other sensitive information!

The Fix: As a small business person, you know that it's hard to be in business and not collect or hold personally identifying information -- names and addresses, Social Security numbers, credit card numbers, or other account numbers -- about your customers, employees, business partners, etc. 

If this information falls into the wrong hands, it could put these individuals or other businesses at risk for identity theft. Therefore, you must institute ID protection strategies for your business.

Adopt ID protection strategies

The following are steps you can take to protect your business from identity theft:

  • If your business suffers a computer breach or information theft or in some other manner customer info is compromised, the FTC recommends calling your local police first. They can decide if they or you will contact the FBI about the incident. You must also notify those individuals or businesses who you think may be affected.
  • If you discover that information has been misused, you should file a online complaint with the FTC or phone them at 1-877-ID-THEFT (877-438-4338). Information entered into the Identity Theft Data Clearinghouse, the FTC's database, is made available to law enforcement.
  • And if the criminal is caught, be sure to prosecute. Not doing so lets the person continue criminal activities in the belief that there are no consequences.
  • The Federal Trade Commission website will give you very specific rules for safeguarding customer and employee information from ID theft.

Due to the nature of running a small business, the theft of a small business owner's identity can have an especially severe effect on his or her business operations. For the good of your business, (as well as your own, of course) be vigilant about protecting your identity.

ID theft protection strategies for individuals

The following measures can help you guard your personal identity information:

  • To protect against the unauthorized use of your personal information, you may want to consider placing a security/fraud alert with these credit bureaus.
  • Get your free annual credit report online at the site sponsored by the three credit bureaus listed above. If you see any suspicious activity on your credit report, contact your local law enforcement agency and file a police report. And be sure to always closely review any Explanation of Benefits form that you receive from your health or casualty insurance carriers.
  • Photocopy everything in your wallet, especially the back of credit cards, so you have the emergency number to call in case of theft.
  • Shred everything to defeat dumpster divers.
  • Think about having an unpublished phone number.
  • Be sure you have a locked mail box (or a door slot . . . better your dog should eat your financial information than it fall into the hands of a fraudster!)
  • Don't base passwords on your birthday, address, pet's name, or a spouse or kid's name.

Be alert for franchise, tax scams and telemarketing cons

Franchise and tax scams and telemarketing cons have at least one thing in common: Each of them presents a possible external fraud threat to your business. If you think your business might be be a target of one or more of these frauds, learn how to identify and prevent them.

Don't fall for "too good to be true" franchise scams

Franchising refers to an arrangement in which a party, the franchisee, buys the right to sell a product or service from a seller, the franchisor. The right to sell a product or service IS the franchise. At the heart of any franchise is the formal franchise agreement, a critical legal document. Most franchises are on the up and up, but those that are not can ruin dreams and lives.

The Fraud: Legitimate franchises are an excellent way for a person to get into a small business with a good chance of success. The franchisor has developed the concept, suppliers, marketing and promotion strategies, site selection, and feasibility studies. The franchisee benefits from the experience of the franchisor and pays a franchise fee as well as a percentage of sales or a royalty in return.

But . . . you must investigate before you invest in any franchise!

Deceptive franchise scams are especially concentrated in "opportunities" like medical billing, work from home and make $2,000 a week, vending routes, and "be your own boss."

The Flaw: Fraudsters misrepresent everything and anything about the franchise: revenue potential, site evaluation, traffic patterns, operating costs, quality of merchandise, and their expertise. Anything it takes to get your money upfront. They rely on the fact that, as the old saying goes, "there's one born every minute."

The Fix: Investigate before you invest! There is no substitute for due diligence.

Tools to use

The Business Tools contain a checklist that gives you a laundry list of things to check when doing your due diligence on a franchise offer.

The Federal Trade Commission provides a detailed example of what you should know before you invest in any franchise.

Like franchise frauds, tax scams can have devastating results on people's professional and personal lives.

Tax scams can prove exceedingly costly

Tax scams range from frivolous returns to willful understatement of income to outrageously false statements. Some tax cases read like a novel.

The Fraud: Every year the IRS publishes a list of the "Dirty Dozen" tax scams. Some items fall off the list, but there are always new ones to take their places. Recent lists saw the decline of frauds surrounding "structured entity credits" and the telephone excise tax and the rise of scams based on the economic stimulus payments as well as fuel tax credits.

Tax preparer frauds can cost taxpayers a bundle in penalties and even carry the risk of a time-out at Club Fed.

Promoters aggressively market packages or kits claiming to show taxpayers how they can avoid paying income taxes by deducting ordinary living expenses as a "home-based business expense" when no business exists. This flagrant scheme, and a host of others, will astound you with their brazenness.

A recent IRS "Dirty Dozen" list will give you an idea of the range of scams that are out there.

The Flaw: In the words of the IRS, "American taxpayers who willfully and intentionally violate their known legal duty of voluntarily filing income tax returns and/or paying the correct amount of income, employment, or excise taxes pose a serious threat to tax administration and the American economy."

The Fix: Vigorous enforcement of the law is the prescribed cure, but that takes skilled and massive manpower, often beyond the budgetary reach of the IRS. Public education pointing out the fact that taxes are the price we pay for our liberty and civilized society would be a good start. We need to instill in each generation the idea that everyone must contribute his or her fair share.

Be smart. Using every legal provision to pay the lowest amount of tax is a shrewd business move. Crossing the line into fraud, invites disaster. Remember, as with nearly everything in life--if a "tax plan" seems too good to be true, keep in mind that it probably is!

Don't fall for telemarketing cons

Telemarketing often has a bad reputation, usually due to the bad actors in the industry more than the irritating timing of their calls.

The Fraud: How often do you get unsolicited, high pressure boiler room phone calls with exotic vacation offers, or fantastic merchandise or cash sweepstakes prizes . . . but only good if you act right now? If they call your business, perhaps they're selling fabulous advertising opportunities in fake Yellow Pages-type books or very inexpensive printer cartridges with large shipping and handling fees. And all they want is your bank information or credit card number.

The Flaw: Gullibility is often the problem here. Most of these telemarketing scams are aimed at the elderly or the busy payables clerk or secretary, all of whom are too polite to cut someone off.

Also, supposedly getting a great deal for your business is often irresistable.

The Fix: Hang up! Then get on the "Do Not Call" list, right away.

In addition, buy only from a reputable telemarketing firm. Never pay a fee to receive something "free." If you have any doubts about a particular firm, contact the Better Business Bureau and/or the Federal Trade Commission to see if complaints have been registered against the firm.

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