Saturday, June 27, 2009

Negotiated, Willful Blindness Scam

This is a commercial finance scam designed to either create a fall guy for an intentional default, or a fall guy for an exhorbitant amount of risk.

A retail lender seeks an investor to purchase or expand its business. The value of any retail lender depends on the its own credit. The more money the lender is able to move, the more valuable it is.

The retail lender locates a wholesale line of credit provider. This wholesale lender wants to issue the line of credit, as its value is determined by the amount of "assets" it has. Since each issued line of credit is considered an "asset" they are anxious to get the line of credit on the books. This is especially the case in hot market scenarios.

The wholesale lender requires that the retail lender provide audited financials from a CPA firm. These of course transfer liability to the CPA firm if the financial information provided is not accurate. However, most applicants can not provide financials substantial enough to qualify for the wholesale line of credit. This leads to a notorious game of willful blindness.

CPA firms make the bulk of their income by charging the fees for audited financial statements in situations like these. The younger, newer accountants are hungry for the new accounts of smaller companies getting their first sets of audited financials.

With all three parties motivated toward exactly the same result, the situation is ripe for a classic case of willful blindness. The result causes the CPA firm and the wholesale lender to begin direct communications. The result is negotiated financials and other qualifications, in which all three parties negotiate directly with eachother to produce qualifying documents, despite the lack of real qualification of the retail mortgage company.

Each party to the negotiation seeks to interject what it sees as necessary to provide for plausible deniability later. The CPA wants bank statements to read as they need them to read. The wholesale lender wants the CPA to produce audited financials which they can point to later as proof that the retail lender is financially qualified. The retail lender desperately wants the line of credit, and may create false documents to fulfill the requirements set forth by the CPA.

Finally, the retail lender produces false statements, so that the CPA can produce blindly audited financial statements, so that the wholesale line of credit provider can issue its line of credit to the unqualified retail lender.

When the line of credit goes into default, the wholesale lender attempts to collect from the retail lender, which often declares bankruptcy. This brings the audited financials into question, and the CPA firm. This brings into the arena the errors and omissions insurance of the CPA firm itself.

In some cases, even the institutions providing the bank or other statements used in the preparation of the audited financials, are accused by the wholesale lender of collusion.

The entire objective is to get an outside party to cover the debt. Either the errors & omissions insurance of the retail lender or the CPA firm, or the financial institution which provided statements, will have to pay up for the scam of the three in collusion.

Once the line of credit is provided by the wholesale lender to the retail lender, there is a great increase in market value of the retail lender. They then attempt to obtain an investor or sale of the firm before the resulting default takes place.

This is a method of conspiracy to defraud a lender or an investor, but it is seldom caught or prosecuted.

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