Beware the shell company

Scams can go unnoticed

Shell companies or shell corporations are legal vehicles for certain types of legitimate business activity, such as for seeking financing before business is off the ground. Unfortunately, they can also be convenient mechanisms to conceal large-scale financial fraud, and should be a concern for all individuals, non-profits and businesses.

While they have been used by drug cartels, corrupt government officials, cyber criminals and scammers, shell companies can also be set up on a smaller scale by employees, vendors and customers to conceal garden-variety frauds in your company's accounts payable and billing functions.

Shell companies can be used to conceal the nature, origin or destination of misappropriated funds and the identities of their true owners. Once a shell company is successfully established as an approved vendor or customer in your company's accounts payable and billing system, its legitimacy is often no longer questioned.

If your employee who has the authority to make or approve purchases and disbursements to vendors controls a shell company and is able to get this entity on the approved vendor list, your organization can sustain significant losses through its accounts payable.

Unfortunately, shell companies can be easily created by fraudsters. It is easy to incorporate and register a shell company with a state, thereby establishing the appearance of legitimacy. Illegitimate nominal directors and shareholders can easily be designated in the filings with the state to conceal the true identities of the individuals in control. Undisclosed co-conspirators, friends and relatives are easily recruited to fill these positions. Bank accounts, web pages and emails are easily created by the fraudsters using the registration information to support and further the deception.

One key to avoid being a victim of fraud through the use of a shell company is strong internal controls and segregation of duties in your company. In regard to purchasing goods and services, one employee should never be given the authority to requisition goods or services, approve the purchase, select the vendor, verify receipt of the goods or services and initiate payment. Granting this much authority to one individual creates the opportunity for a fraud. If the employee is experiencing financial difficulties and lacks integrity, you have all the ingredients for a significant fraud loss.

Another mechanism to prevent shell company fraud is to scrutinize thoroughly all approved vendors before they are put on the vendor list. Prior to becoming an approved vendor, a company or individual should be thoroughly investigated by someone who is not directly involved with the approval of cash disbursements.

The investigation should include interviewing the vendor's management and review of its filings with the state, web page, email accounts and credit (e.g., Dunn & Bradstreet) rating. The employee assigned the responsibility for investigating vendors should be provided with some training and a list of required inquiries.

Post office boxes should not be accepted in the absence of a verified business street address. Online presence is critical to most active organizations. The lack of a web page, online content about the company's goods and services and management profiles is a red flag. Any questionable information, discrepancies or inconsistencies need to be pursued, thoroughly investigated and resolved.

Once a vendor is on the approved list, most employees and managers do not normally question the vendor's bona fides. Your vendors need be actively reviewed and the list updated regularly to eliminate inactive vendors.

Most significant accounts payable fraud schemes involve some use of a shell company and a breakdown in the internal controls of the victimized entity. Proper segregation of duties and a thorough and regular investigation of your company's vendors are the key mechanisms to preventing fraud losses.

—Richard G. Witkowski
witkowski@nicola.com