How to Guard Against Fraudulent Misrepresentation in Business

Unless your business is 100 percent vertically integrated, there’s a good chance you work with other companies from time to time to produce your product or sell your service. Just think about all of the suppliers, vendors, distributors, contractors, freelancers, consultants, agencies, and other companies that help keep the wheels of your business turning, often playing essential roles you can’t (or would prefer not to) perform in-house.

But without adequate processes to screen these potential partners, you open yourself up to various risks and threats — including fraudulent misrepresentation.

Below, we explain what misrepresentation is in a business setting and the different types of misrepresentation you should be aware of. We then take a closer look at fraudulent misrepresentation in particular and walk through some steps you can take to protect your business from this abuse.

What is misrepresentation in business?

Typically, in order for one business to partner with another, they first need to agree to terms of engagement. This often results in a contract between both parties that outlines the scope of the engagement as well as timelines, costs, deliverables, and more.

Business misrepresentation occurs when one business makes a false statement (i.e., misrepresentation) that affects the other business’s decision as to whether or not they should agree to a proposed contract. Such misrepresentations might cause a business to engage or partner with a business that, for various reasons, they would not have engaged with without the misrepresentation.

Types of business misrepresentation

Admittedly, the definition above is a little vague. That’s because there are actually different types of business misrepresentation, each of which works a little differently and carries different levels of intent.

Innocent misrepresentation

Innocent misrepresentation occurs when one business unknowingly makes a false statement during contract negotiations. In other words, the business didn’t realize they were saying something untrue, even if that statement impacted your decision to work with them.

Imagine that you’re looking to purchase office space for your business. During the property search, you find a piece of property that seemingly fits the bill. You ask the owner if they’ve had any structural issues and they truthfully tell you that they haven’t, so you close the deal without a proper inspection. Later, you uncover extensive termite damage that, had you known about it, would have caused you to pass on the property. Because the property owner truly believed that there was nothing wrong with the property, this counts as innocent misrepresentation.

Negligent misrepresentation

Negligent misrepresentation occurs when one business makes a false statement without verifying whether it is true, which causes the second business to agree to a contract that they otherwise would not agree to.

Consider a data storage company selling its services to another business that is required to keep its customer data within a certain jurisdiction. During the sales process, a member of the data storage company’s sales team assures the other business that all data is stored domestically, leading the business to enter a contract for storage services. However, it’s later revealed that the salesperson was mistaken — the data is stored in international data centers. Even though the salesperson didn’t mean to mislead their customer, they also didn’t verify the information, making this a case of negligent misrepresentation.

Fraudulent misrepresentation

Fraudulent misrepresentation occurs when one business knowingly makes false statements, causing the other business to sign a contract or enter an agreement they otherwise would not have entered.

Imagine that you run an online marketplace that connects food vendors with potential customers. Your company policy prohibits cannabis or alcohol merchants from onboarding to your platform. In an effort to skirt your policy and join the platform, a vendor that sells a mix of cannabis-laced snacks lies about their offerings. Because the vendor knew that their product line included cannabis-laced products and chose to lie about it, this would be a case of fraudulent misrepresentation.

The dangers of fraudulent misrepresentation for your business

While all three types of misrepresentation can be damaging to your business, fraudulent misrepresentation is perhaps the most nefarious.

Fraudulent misrepresentation is, at its heart, fraud. It’s right there in the name, and it opens your business up to a host of different risks. These can include everything from non-delivery of goods and services to subpar quality of deliverables, reputational damage, cybersecurity threats, and even regulatory action — all depending on how, exactly, the business misrepresented itself.

Further, a business that knowingly misrepresents itself is a business that’s only looking out for itself — even if that means disregarding your requirements for entering into an agreement with them. And that means they’re a bad partner, even if they deliver on the terms of your agreement in every other way.

How to protect your business against fraudulent misrepresentation

It’s important to note that no single solution can prevent or identify all cases of fraudulent misrepresentation. But a comprehensive Know Your Business (KYB) program can help you evaluate how much fraud risk each potential business partner poses to your organization and empower you to avoid the businesses that are most likely to engage in fraudulent misrepresentation.

As you build your KYB program, it’s important to consider a variety of different risk factors, including:

General business risk signals

Before engaging with any business, you’ll want to verify that the business is real — not a shell company that exists solely on paper. This can help you avoid working with a company that is misrepresenting its legal status — for example, a supplier that is lying about being registered or a distributor that is on a sanctions list and not eligible for your business. Try to answer questions like:

Does the business have a valid TIN?
Does the business have a valid business registration number?
If operating in the EU, does the business have a valid VAT number?
Has the business registered with the Secretary of State (SOS) in each jurisdiction it operates in?
Can the business provide any official documents, such as articles of incorporation or a partnership agreement?
Does the business operate out of a commercial address?
Is the business included on any sanctions lists or watchlists?

Financial history risk signals

Some companies may fraudulently misrepresent how established they are, how much business they do (i.e., the volume of transactions they process), how many customers or clients they have, or their ability to reliably meet a deadline or pay a bill. Looking at the company’s financial history can help you avoid working with a business lying about these factors. Try to answer questions like:

Does the business have a record of engaging in legitimate third-party transactions?
Does the business currently have any liens filed against it?
Does the business have a healthy credit report?
What is the company’s Better Business Bureau (BBB) rating?
Does the company have any complaints filed against it with the Consumer Finance Protection Board (CFPB)?
Does an adverse media screening turn up any negative mentions of the business?

Ownership risk signals

In order to truly understand the different risks posed by a business, it’s important to also evaluate the people behind the business: the owners and key stakeholders in charge of making business decisions that could ultimately affect your working relationship. Try to answer questions like:

What does the business’s ownership structure look like?
Who are the business’s ultimate beneficial owners (UBOs)?
Can the identities of these individuals be verified?
Do any of the business’s owners appear on a sanctions list or watchlist?
Does an adverse media screening turn up any negative mentions of the owners?

Other risk signals

There are, of course, countless other questions you may want to answer about a business partner before you agree to work with them. These can vary significantly depending on the industry your business operates within, the regulations you’re subject to, and the products or services you create and deliver. Some questions that may fall into this category include:

Does the business operate within a “risky” industry — for example, a cash-intensive business that may increase the risk of money laundering?
Does the business or its owners share suspicious links to other businesses or bad actors that may indicate an organized fraud ring?
Does the business have an online presence, including a legitimate business website, social media profiles, and a business email address?

Armed with these different risk signals, you can cross-reference them and look for discrepancies that might point to misrepresentation. It’s generally considered best practice, for example, to verify that the same information appears on multiple documents and sources. Ideally, this includes self-attested information (for example, business documents or the company website) as well as official sources (like the Secretary of State registry or other government databases).

Build a custom, flexible KYB program with Persona

Implementing a comprehensive KYB program customized to your business and the specific types of fraud you face is an effective way to reduce the risk of falling victim to fraudulent misrepresentation.

With Persona, you’re not stuck with a one-size-fits-all solution. Instead, you’re empowered to decide which risk factors matter most to your business and choose the verifications and screenings best suited to evaluating them, including:

Ready to see how Persona can help protect your business against fraudulent misrepresentation and other forms of fraud? Request a custom demo today or get in touch with any questions.

Fraudulent misrepresentation in business: How to protect your organization