Why it’s so hard to detect small business fraud (and what you can do about it)

Even the most discerning eye can miss small business fraud. According to recent statistics, small business fraud makes up 42% of cases worldwide. One reason is companies don’t have enough time or resources to perform due diligence on every business customer. But it’s possible to stay a step ahead of malicious entities—even with a busy schedule and limited resources.

In this article, we look at the challenges companies commonly face when identifying small business fraud, the risks involved in the small business verification process, and some best practices you can start implementing today to reduce the chances of falling victim to fraud.

The challenges of small business fraud detection

Detecting small business fraud can be difficult. Some of the most significant challenges include:

• Modern, fast transactions: The modern transaction environment emphasizes speed and convenience, enabling customersto execute complicated transactions, such as loan applications, faster than ever before. The volume of transactions and a lack of thorough verification can make it easy for scammers to defraud a business and then vanish.
• Fewer face-to-face transactions: Remote transactions make it easier and quicker for customersto do business, but they also make it easier for fraudsters to hide behind fake identities.
• The cost of detecting fraud: Fraud detection often takes time and human resources. And when companies attempt to automate their systems, they may end up investing in multiple tools, each of which comes with a cost.
• Accurate fraud detection: Due to overly stringent verification measures, it's easy to mistakenly identify a legitimate business as fraudulent, especially as you try to be as diligent as possible. But getting this wrong can lead to lost customers and a damaged reputation.

The intersection of small business fraud detection and AML laws

Complying with anti-money laundering (AML) laws and performing small business fraud detection often involve similar principles.

For example, you have to perform due diligence on each of your customers to accurately identify a company's beneficial owners. In addition to understanding who you’re transacting with, AML requirements mandate that you assess the level of risk each customer may present. Catching small business fraud involves some of the same checks and balances. Some risks to watch out for include:

• Large or frequent transactions that don’t align with a small business’s financial profile. These may be a sign the entity is a shell designed to manage illegally earned funds
• Strange transaction patterns, such as transactions at odd hours, higher business expenses without corresponding increases in revenue, or repeated payments to the same vendor. These can mean someone is using a business to disguise sources of income
• Transactions with businesses in areas of high geographic risk, such as terrorist states
• Significant cash transactions, which can include many small cash transactions or a few large ones. These can indicate laundering money earned through illegal means.
• Complicated ownership structures, such as a company being one of many subsidiaries of an international organization. Each one can be a front for criminal operations
• Politically exposed persons (PEPs), including anyone who may be likely to engage in bribery, such as a government official

One AML failure captured headlines is the money laundering scandal British bank Standard Chartered found itself in. Because it failed to follow Know Your Business (KYB) requirements, the fines it had to pay amounted to over $1 billion. Branches provided services to companies associated with terrorism and weapons trafficking. The bank also came under fire for violating sanctions imposed by the US and UK.

Best practices for effective fraud detection

By leveraging the following best practices, you can reduce the risk of falling prey to fraud while also complying with AML requirements.

Implementing robust KYB processes

KYB principles require you to understand the nature of the business you’re transacting with and recognize any red flags that can indicate criminal behavior. For example, you should understand a business’s:

• Legal status, such as its registration details and certificates of incorporation. Fraudulent business may have expired or inaccurate registration information
• Owneship structure. Illegal sheel companies can be hidden within a complicated web of businesses and subsidiaries
• Status regarding santions or whether it's on a government watchlist. Businesses impacted by sanctions may try to fund their operations by partnering with lenders and other companies.
• Enhanced due diligence (EDD) for high-risk customers

Performing enhanced due diligence may involve determining whether any of the business owners is a PEP. EDD can also include digging deeper once you discover an unusual transaction or an inconsistency in a business document.

For example, suppose a company’s financial records indicate several transactions less than $2,000 a month and then they suddenly had one for over $25,000. EDD principles include checking where that money came from and what the business provided in exchange.

Ongoing monitoring

Ongoing monitoring includes performing periodic reviews of customer profiles to see if any transactions or adjustments to business information raises concern. By monitoring the kinds and amounts of transactions a company enters into, you can flag fraud early on in its lifecycle.

Employee training

Your employees can be the first line of defense if you train them to recognize business fraud and provide them with the tools they need to do so. Employees should understand:

• The fraud tactics most common in your industry, such as making or accepting payment using a shell company
• Who to report to, including the appropriate authorities, and what to do if they suspect fraud
• Their due diligence responsibilities, such as validating documents of incorporation and checking the kind of business a potential or customer is engaged in
• How to use fraud detection technologies

Using advanced technology

Fortunately, there are tools you can use to avoid tedious, time-consuming fraud detection processes.

For example, with Markaaz Verification, you get a centralized dashboard that lets you check the legitimacy of new and potential business customers, even businesses other verification solutions have trouble verifying. You can also use our Enrichment solution to validate and correct the data you have on your clients and potential customers.

Then, there's the Markaz Directory, which includes over 300 million global small business records sourced from public and non-public databases, making it easy to onboard new business customers and conduct ongoing monitoring.

Start detecting and preventing small business fraud with the right technology today

Detecting small business fraud can be challenging, but if you know the signs to look for, you can avoid becoming a victim. In many situations, the steps you take to prevent small business fraud also help you stay in compliance with AML laws. With the right KYB platform, you can avoid AML issues and prevent fraud at the same time.

Connect with Markaaz today to learn how we can help you prevent unscrupulous actors from taking advantage of your company.