Not all shell companies are dishonest. Despite their often-sinister reputation, these paper-only companies may be used legitimately to hold another business’s assets. Or they may be the “empty container” left after a company downsizes or is acquired. That said, some fraud perpetrators use shell companies to embezzle funds, evade taxes, dodge debts and commit other illegal acts.

For many businesses, the biggest threat posed by illegitimate shell companies is that unscrupulous employees will use them to perpetrate billing fraud. Here’s how to spot a shell scheme in your midst.

Under cover

Employee-perpetrated shell company schemes take one of two forms. In the first, an employee sets up a shell company to send out — and collect on — fictitious bills. Perpetrators don’t have to send the bills for nonexistent goods and services to the company for which they work. But it’s easier, and can help them evade detection, if they do.

Consider, for example, an accounting staffer who knows that his company rarely scrutinizes invoices for less than $3,000. He applies for a “doing business as” (DBA) certificate from his state for a fictitious business and opens a business account at a local bank. Now he can bill his employer for services that cost less than $3,000 per invoice.

In the second type of scheme, an employee sets up a shell company to sell products to his or her employer at a marked-up price. Because the employee’s shell company has no overhead or expenses, the employee can pocket the proceeds.

Invoices contain clues

Shell company schemes can go undetected for a long time, particularly if the fraudsters are savvy enough to attempt to cover their tracks and don’t get too greedy. Most perpetrators, however, leave a paper trail of invoices that, when scrutinized, is suspicious.

For example, invoices may vaguely define their products or services, arrive more than once a month and show an increased number of purchases over time. Addresses are important. Fake companies usually use a post office box as a return address. But less clever (or more arrogant) thieves may use their actual home address.

Shell company scams work only if the crooked employee can pay the invoices or get the shell company authorized as a legitimate vendor. A quick credit check on a new vendor will reveal whether it has an operating history and deserves greater scrutiny. Job rotation, mandatory vacations and a strict separation of duties in critical areas, such as your accounting department, can help prevent financial losses from shell company schemes. 

(This is Blog Post #918)