Documentary letter of credit fraud risk management課件

1、Documentary letter of credit fraud risk managementYanan ZhangDepartment of Law, University of Eastern Finland, Joensuu, FinlandAbstractPurpose The purpose of this paper is to explore and examine, in a systematic manner, possible preventive measures that commercial parties can take in order to preven

2、t or reduce documentary letter of credit (L/C) fraud in international transactions.Design/methodology/approach In the context of international transactions, considering documentary L/C fraud as a risk, the paper searched preventive measures that different parties involved can adopt, from both busine

3、ss perspective and legal perspective.Findings The paper provides a number of specific measures which buyers, sellers, and banks in international L/C transactions can take in business to reduce L/C fraud. The option of banks providing additional services of checking further the validity or authentici

4、ty of some documents under the L/C, by charging additional prices, has reflected the needs of some business parties. However, this is proposed to be optional rather than compulsory for banks. The lawyers can also play an important role by adopting preventive legal mentality to help and provide advic

5、e to different parties in applying the preventive and proactive approach. More importantly, the author recommends that buyers or sellers maintain close cooperation with their banks and lawyers in implementing preventive and proactive measures.Practical implications The paper can be a helpful source

6、of advice for business enterprises likely to be involved in international documentary L/C transactions.Originality/value This paper fulfils the gap of a holistic study on how to prevent international documentary letter of credit fraud.Keywords International trade, International finance, Documentary

7、letter of credit, Fraud,Risk management, Prevention, Buyer, Seller, Banks, Lawyers1. Introduction Neil (1980) points out that risk basically means uncertainty. According to Gregory (2008) enterprise risk management (ERM) can be defined as managing risks associated with the business objectives of an

8、organisation; risk refers to “the potential for loss caused by an event (or series of events) that can adversely affect the achievement of a companys objectives”. Pickett (2006) argues that in practice many enterprises fail to put the fraud inside in the ERM frame; thus, Spencer suggests that fraud

9、should be put in the centre stage, considering fraud as a risk. Besides taking fraud seriously, having a sound and effective anti-fraud policy (four key elements: prevention, detection, deterrence and response) in place is important (AICPA, 2009). In combating fraud, fraud prevention and detection m

10、ust operate hand in hand(AICPA, 2009). To prevent fraud measures to reduce motivation, limit chances andrestrict the ability of offenders to commit fraud have to be taken (AICPA, 2009). Proactive fraud prevention has to be conducted, and it covers good division of responsibilities, supervision of st

11、aff, monitoring work performance, and all those measures intended to ensure dishonest people cannot access the system, or even if the systemis accessed that a proper control is in place (COSO, 2004). Further factors that help to prevent fraud can be anti-fraud policies, procedures, training and frau

12、d awareness (Naill, 2006).Nevertheless, preventive measures may require some investment in advance and cannot provide complete protection. However, even dedicated controls can be abused by fraudsters. Thus, a frauddetection strategy (designed to detect fraud), including noticing or analysing strange

13、trends or inconsistencies, looking out for red flags that indicate something may be going wrong and a reporting system need to be adopted (AICPA, 2009). In addition, managers also need to assess internal controls regularly, and know the latest fraud issues and what new scams exist (Pickett, 2006). F

14、raud deterrence, deterring potential fraudsters from attempting fraudulent activity,is linked closely with the response of an enterprise to fraud (AICPA, 2009). It is significant if a consistent and comprehensive response to suspected and detected events of fraud is in place. A few response methods

15、have been proved to be effective, such as conducting thorough investigations, allocating individual personnel liable through internal, civil or criminal action, preserving evidence for prosecution and reviewing existing systems to investigate system gaps (AICPA, 2009). Therefore, in fraud risk manag

16、ement, essentially preventive measures against fraud are required so that the harmful consequences can be controlled or prevented before fraud actually happens; and a good response plan is helpful so that people know what to do. Letter of credit (also documentary credit, or more formally documentary

17、 letter ofcredit, hereinafter L/C) is a well-known payment method in international trade. Thisinstrument has two fundamental principles: the autonomy or independence principleand the doctrine of strict compliance. Such principles intending to facilitate international transactions make L/C easy to be

18、 abused by fraudsters. Traders from developing countries who are lack of sufficient experience and knowledge in L/C transactions are often the targets of L/C fraud (Xiaorong and Ruiping, 2005). The Executive Director of the ICC Commercial Crime Services, Pottengal (2009) emphasised that L/C fraud in

19、 international transactions has become increasingly complex and new schemes have developed. Each year traders or banks lose huge amounts of money due to international L/C fraud. In the LONECO case, it was discovered that US$400 million were lost due to a L/C fraud scheme involving forged documents;

20、26 international banks in the Middle East and Europe (some even had sophisticated trade finance operations) were victims (Pottengal, 2008). However, how to prevent fraud in international L/C transactions is anunderdeveloped and unsystematic area, which deserves a holistic study. The paperwill consid

21、er the following question: how can the theory of fraud risk management beapplied combining the principal ideas of preventive and proactive approaches to the area of L/C fraud risk management? Theoretically, L/C fraud risk management essentially includes L/C fraud prevention and response. In this pap

22、er, we will first examine L/C fraud prevention by exploring possible preventive measures commercial parties in L/C transactions (buyers, sellers, banks and lawyers) can take. Then we will briefly look at how enterprises can respond to L/C fraud.2. L/C fraud prevention This part will discuss the prev

23、entive and proactive methods in international L/Ctransactions. If systematic preventive methods were applied, the possibilities for L/Cfraud would be reduced. Examining past and predicting potential L/C fraud types (UNCTAD Report, 2003) will help the trading parties consider vulnerable aspectswhere

24、they are likely to be defrauded and accordingly seek preventive measures. Incurrent international L/C frauds, most of the victims are buyers. Thus, we will start toexamine the measures that buyers can take in order to prevent L/C fraud risk.2.1 What preventive and proactive measures can buyers take?

25、Check credibility of seller. Before a buyer concludes a sales contract with the other party,the buyer needs to collect as much information as possible about the credibility of the seller (Yuantao, 2007). More importantly, contacting local banks in the sellers place of business to learn the credit hi

26、story and current state of the sellers business can be of great help to the buyer (Huanhuan, 2006). From an economic point of view, it is true that checking credibility involves some information costs. However, compared to the potential cost that would be involved if fraud were to occur, it would de

27、finitely be worthwhile carrying out thorough search. It is significant for the buyer to choose a trustworthy partner in international sales transactions. Check capacity and location of contractual ship. Apart from carefully checking thecredibility of the seller beforehand, the buyer must cautiously

28、choose suitable trade terms which allocate the risk of goods, cost and liability between buyer and seller indifferent ways (Xiaorong and Ruiping, 2005). It is particularly advantageous to graspthe knowledge of shipping (Jingsheng et al., 2007) and to choose the FOB term ratherthan the CIF term in a

29、sales contract to ensure that the buyer has control over theshipped goods (King Tak, 2008). It is also recommended that in an underlying sales contract buyers are required toinclude terms concerning name of ship and time of shipment (Liwei and Jie, 2008). Such clauses give the buyer a chance to conf

30、irm the availability of the ship. The standard Lloyds information can tell whether a vessel is able to take the contractual quantity of goods; and Lloyds Shipping Intelligence can show the current location of the ship and thus it is possible to estimate when the ship will arrive at the specified por

31、t (Yuqun and Zhenying, 1999). Use independent inspectors. In international trade, different methods of paymentallocate different risks to different parties. The L/C payment instrument places therisk mainly on the buyer. The payment will be made merely against the documents from the seller; and this

32、provides a seller the opportunity to engage in fraudulent conduct. In order to seek added security, it is suggested that a buyer gets an independentjudgment from a third party on inspection certificates in L/C transactions (Tianping, 2006). Independent inspectors, as a third party, would employ thei

33、r resources to determine the quality and quantity of goods, to inspect whether the goods have been loaded and so forth (Zhuilin, 2006). In such a way the risk of fraud, to some extent, could be alleviated. Use time drafts rather than sight drafts. In order to collect the proceeds of the documentary

34、L/C from the paying bank through forged documents, the fraudsters have to do that before the goods are inspected so that their fraud is not detected beforeobtaining payment. Thus, it is recommended that a buyer chooses to use time drafts(usance drafts) instead of sight drafts (payable when presented

35、) concerning L/C payment method in international trade (Daniel, 1993). Where a sight draft is used in the L/C mechanism, payment shall be done immediately when the draft is presented. However, where a time draft is used, payment can be made some days after acceptance. Thus, it is possible to discove

36、r fraud after the goods arrive but before the date of payment.Asimilar suggestion is to insert a provision that allows payment in a certain period after the beneficiarys presentation and the purpose of such provision is also to allow a period for verifying some facts (Ying, 2003). Use law: sale of g

37、oods “on approval”. A further proposal is to insert a term of sale of goods on approval (Daniel, 1993). Under the sales on approval, the property in the goods does not pass to the buyer until the buyer approves of the goods (Guest, 2002). Originally the term of sales on approval was created so as to

38、 ensure the quality of goods. However, if such terms are included and used, the condition of the goods, including the situation where no goods exist at all, would be found out during the examination of goods for approval. Then the buyer may have valid ground for preventing the bank from payment unde

39、r L/C. Such terms would run against the purpose of L/C, which is independent from the underlying sales contract. However, from the buyers viewpoint, it would be an effective strategy for defeating fraud in L/C transactions. Confirm issuance of bill of lading. It is recommended that buyers ask for co

40、pies ofthe documents presented under the L/C to be e-mailed, couriered or faxed to them before presentations to banks, which will allow them time to make independent investigations to verify whether some key documents such as bill of lading are authentic (Pottengal, 2008).Acommon-sense approach can

41、be to call the issuer to check the authenticity of the key document BL. Require carrier to send bill of lading to banks. Normally in a L/C transaction, thecarrier will send the original bill of lading to the seller (shipper) of the goods and the seller then presents the original bill of lading or ac

42、companying copies as required to the paying bank. Such a way of delivering bill of lading from sellers to banks opens the door for forgery. Therefore, Daniel (1993) proposed that a buyer may require thatcarriers deliver the original bill of lading to paying banks, which may reduce the opportunities

43、for forgery. However, this is not an absolute safeguard, as it is still difficult for the buyer to prevent fraud where the seller conspires with the carrier and delivers a false bill of lading to the bank. Use performance guarantees. Using a performance guarantee might be the bestmethod for the buye

44、r to be protected from fraud by the seller (Yeliz, 2002). By issuingsuch a performance guarantee with the buyer as beneficiary, the seller provides aguarantee to carry out their contractual obligations. Deficient behaviour might obligate the issuing bank to pay the stipulated amount to the buyer, so

45、lely upon a demand by the buyer. The use of performance guarantees might make the transactions more complex and increase costs due to a service charge at the bank. However, such a guarantee provided by a seller with an unconditional undertaking by a bank could reduce the likelihood of fraud to the l

46、owest level. Take export credit insurance. Export credit insurance plays a basic and vital rolein international trade and it essentially supports both the buyer and the seller. Usuallyexport credit insurance covers the risks as follows: first, commercial and business risk, such as buyers insolvency,

47、 unwillingness to pay, failure of adequately performingcontract; second, political and related risks; and third, financial and currency risks(Hans, 2002). Covering the risk on failure to adequately perform a contract is important for our subject matter. If the non-existence of goods paid by L/C is d

48、ue to the sellers failure to fulfil the contract, then it can be covered by an export credit insurance contract. However, as for the understanding of the failure of adequately performing a contract, it most probably depends on the scope defined by the export credit insurance agency and may vary from

49、 one to another.2.2 What preventive and proactive measures can sellers take? Choose a credible partner. Choosing a credible trading partner is the best wayof avoiding fraud or falling into a harmful situation. A well-known L/C expert pointedout that the buyerwho employs L/C to pay should be very car

50、eful and must clearly know who the trading party is (Liangyi, 1998). This suggestion is also relevant to the seller. A common channel by which to investigate the credibility of new customers is through the bank and those professional institutions that provide credibility investigation (Qinghua, 2001

51、). If the trading partner is a middleman, then it is much more important to find out its credibility including its economic strength and its past record of implementing contracts (Dingjie, 1999). Draft international sales contract carefully. Usually L/C clauses in a L/C agreement are essentially bas

52、ed on an underlying international sales contract. Therefore, the whole sales contract, especially contracting clauses on the various documents should be drafted as clearly as possible (Tao, 2009). It would be preferable if the various required documents including bill of lading, insurance policy, co

53、mmercial invoice, inspection certification, certificate of origin and other possible documents are stipulated clearly in the sales contract. If contingent conditions in the future are possible to predict and are stipulated in the sales contracts, then the possibility of inserting soft clauses into L

54、/C agreements would be reduced. Check L/C after it is received. The seller needs to carefully and promptly check the L/C after it is received, so as to leave sufficient time if any amendment is necessary and to avoid the failure of not having the conforming documents (Xiaoyong, 1998). There are two

55、main aspects requiring attention when the L/C is checked. First, the seller needs to check the validity of the L/C itself, including the credibility of the issuing bank, the terms of honouring payment and the appropriateness of period of validity (Haizhi and Youxin, 2000). Second, Yuexiu (2007) sugg

56、ests that the seller needs to check whether the L/C terms comply with the clauses of the sales contract. Once the seller identifies soft clauses in the L/C, the seller must immediately require the applicant to amend; at the same time, the seller sets forth the time limit for the buyer to amend or pr

57、ovide other guarantees and clearly points out that the buyer should extend the validity of the L/C due to the delay of amendment (Zhenhang, 2007). Preventing soft clause becomes feasible, if the seller is aware of possible L/C soft clauses in each stage (such as inspecting goods, shipping goods and

58、accepting goods) of a L/C transaction (Renbo, 2009). Before solving the problem of L/C soft clauses in a L/C, the seller must not impatiently ship the goods in order to avoid more loss.Concerning problematic soft clauses in a L/C, on the one hand,we emphasise preventing the inclusion of such clauses

59、; on the other hand, we recommend the sellers make use of contractual provisions to protect themselves. Cooperate with internal units and banks. It is important for the seller to make efforts to cooperate between different units inside the company and cooperate with banks. L/C is in itself complicated and risky, thus once a L/C transaction is involved, it is essential not o