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A Little Something About Fraud and Identity Theft

Dispatches from the Trenches

Identity theft is becoming an increasingly common occurrence and more and more creditors find themselves receiving notices from guarantors or other obligors who are individuals claiming that those individuals have been the victim of identify theft and are not obligated under their respective contracts.  This is particularly true in a small ticket arena due to the increased volume and pressure to close transactions quickly and without as much due diligence as in other market segments.

Sometimes creditors are contacted by distraught individuals who seem deserving of some sympathy. Other times, those individuals are angry and combative.  It is increasingly common for first contact to be made by an attorney who represents the alleged victim and claims that the creditor cannot take collection action, report negative credit information to consumer reporting agencies or otherwise take further action with respect to the debt without being subject to penalties under the Fair Credit Reporting Act.

This issue of Dispatches from the Trenches focuses on two areas. The first section discusses fraud prevention methods and red flags which can help creditors from funding transactions tainted by identity theft.  The second section discusses creditor rights when contacted by legal counsel with a claim that an individual obligor’s identity has been stolen.

Detecting Fraud on the Front-End

There are a variety of precautions that parties can take to help detect identity theft prior to funding a given transaction. Of course it is important to balance protection with the need to process transactions quickly and efficiently and even cautious lawyers are hesitant to recommend preventive tactics which are too burdensome.

One of the simplest preventative measures that can be taken by creditors is to require driver’s licenses for all signatories. This step provides some protection against forged signatures, particularly in states where a copy of the driver's signature is included on the license. Note, because of privacy concerns, some funders elect to shred the copies after verification rather than keeping them in the deal file.

Other types of due diligence can be more burdensome but are worth considering if there is any indication of fraudulent activity or other "Red Flags" discussed below are present. The additional due diligence boils down to the obtaining of independently verifiable financial information from (and business and credit references for) each of the parties to the transaction – especially vendors, lessees and other obligors – since any one of them can potentially be the starting point of a fraudulent transaction. For example, creditors can spot check addresses in consumer reports for consistency or contact other creditors. In addition, to the extent financial statements are provided, creditors could contact the accountants rendering those statements. Misappropriation of the letterhead of reputable accounting firms is a common type of fraud.

The follow Red Flags should spur additional investigation.

  1. Restricted Communications Being restricted from communicating directly with lessees and guarantors, or from visiting the premises where the equipment will be located, should place lessors and lenders on notice of the potential for fraud.  It should be noted with respect to syndicated transactions, however, that some originators jealously protect their relationships with the lessee and that there is an understandable and legitimate business reason for such actions.
  2. Restricted Access to Equipment Being prohibited from inspecting the equipment at the time and on the terms lessors and lenders wish to impose may also be a potential sign of fraud. Lessees may desire to deny or delay access to (or inspection of) the equipment.  Such delays may offer lessees the opportunity to switch equipment or put fake identification numbers on other equipment.  Even if creditors don’t routinely inspect equipment involved in transactions of that size, inquiring about inspecting in suspect transaction may provide reveal an additional red flag.
  3. Unusual Time Pressures – Unusual or unexplained time pressure should be considered a warning signal in a lease financing transaction.  Parties may seek to make last minute changes in the structure or terms of the transaction or may seek waivers of standard documentation or procedures that, while appearing innocent, may go to the very core of the enforceability or financial viability of the transaction.  All parties in the transaction should be wary of changes that happen in a time span that prevents them from being able to conduct appropriate due diligence. 
  4. Third-Party Payments Any payments in a transaction made by a party that is not directly involved in the transaction should be viewed with skepticism by a lessor or funding source.  These payments may be used to make down payments or security deposits that the lessee/borrower should itself be able to make if it were in the proper financial condition. 
  5. Unknown Vendors As noted earlier, its best for lessors and lenders to know the vendors.  The lack of independent verifiable financial information (as well as business and character references) regarding a vendor should be regarded as a serious potential for fraud.  Since the vendor is the one that winds up with the bulk of the money in a leasing transaction, it is usually the "weakest link" in a chain of leasing fraud.  Non-existent and "phony" vendors have been at the center of several notorious equipment leasing schemes.
  6. Bogus and Inconsistent Financial Information – It helps to determine whether the information furnished to lessors and lenders is trustworthy and consistent.  Lessees and borrowers may overstate assets or income using false CPA certifications, or provide business descriptions that exaggerate the scope and nature of their operations that, upon closer examination of the lessee’s/borrower’s financial statements, would appear inconsistent.  For example, the obligor may claim that it needs to lease equipment for 15 business locations where its financial statements do not show sufficient assets to support that number of locations.
  7. Inappropriate Equipment – Lessors and lenders should attempt to understand whether the equipment sought to be acquired is appropriate for the obligor’s existing or proposed operations.  As an example, the obligor may have leased or otherwise financed 50 machines for a location that can only support 10 machines.  The additional machines may turn out to be non-existent or may have been sold to third parties, with the proceeds retained by the obligor or a co-conspiring vendor.  Sometimes a routine, inexpensive search of the UCC financing statement records showing multiple financings can yield surprising results indicating widespread fraud by obligors.

Requiring Proof of Identity Theft

What happens if, despite exercising the protective measures referenced above, a creditor funds a transaction and later receives the dreaded call from counsel for an individual obligor which claims that the individual has been the victim of identify theft and is not obligated under its agreements with the creditor.

Before writing off the debt completely it is important to understand the verification rights that creditors under the Fair Credit Reporting Act.  The most important of these rights is the right to request proof from the alleged victim.  This right stems from the fact that a creditor’s duties under the FCRA do not begin until the occurrence of certain conditions.

One obligation of the creditor is to provide the alleged victim with a copy of all transaction records, such as applications for credit and other transaction documents.  This also includes information like invoices, credit applications, account statement and all other documentation.  This obligation is found in §609(e) of the Fair Credit Reporting Act (the "FCRA").  However, the obligations of creditors under this section are not triggered until the creditor receives proof of identity like a government issued  ID card, the same type of information that the thief used to open the account or the type of information currently requested from applicants and two.  In addition, the creditor must receive a police report with respect to the identity theft and completed affidavit.  Upon receipt of this information, the lessor must provide all the requested records within 30 days.

A second obligation imposed on creditors by the FCRA with respect to identity theft is a restriction on the creditor from pursuing a victim of identity theft.  That obligation is found in §623(a)(6)(b) of the FCRA which states: 

"If a consumer submits an identity theft report to a person who furnishes information to a consumer reporting agency at the address specified by that person for receiving such reports stating that information maintained by such person that purports to relate to the consumer resulted from identity theft, the person may not furnish such information that purports to relate to the consumer to any consumer reporting agency, unless the person subsequently knows or is informed by the consumer that the information is correct."

In other words, upon receipt of an identity theft report, a lessor can no longer report negative information regarding the transaction to a consumer reporting agency.  There are further restrictions in §615(f) of the FCRA which also prevents the lessor from selling, transferring or placing the transaction for collection.

However, the magical language in these sections is the term "identity theft reporting".  Under §603(q)(4) of the FCRA that term essentially requires a police report.  The exact language is that it is "at a minimum, a report (a) that alleges identity theft; (b) that is a copy of an official, valid report filed by consumer with an appropriate federal, state, or local enforcement agency, including the United States Postal Inspection Service, or such other government agency deemed appropriate by the Commission; and (c) the filing of which subjects the person filing the report to criminal penalties relating to the filing of false information if, in fact, information in the report is false."

Article appeared in the September, 2007 issue of the Monitor.
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