A US Treasury Department unit that investigates financial crimes has directed banks to send alerts when they come across suspicious activity that indicates a business is using check cashing companies to avoid payroll taxes and reduce workers’ compensation premiums.
Such “check-cashing schemes” by construction companies have long been a target for state insurance fraud investigators. The Aug. 15 notice by the Financial Crime Enforcement Network signals that the federal government is preparing to add its resources to the fight.
The agency, known as FinCEN, said it has observed a “concerning increase” in payroll tax evasion and workers’ compensation insurance fraud by residential and commercial construction contractors. FinCEN said it is collaborating with the Internal Revenue Service’s criminal investigations unit to crack down on construction companies that use shell companies with few employees to purchase workers’ compensation policies and then pay workers in cash to avoid payroll taxes and insurance premiums.
“By enlisting the help of financial institutions, we hope to crack down on fraudsters and level the playing field for legitimate business owners,” IRS Criminal Investigations Chief Jim Lee said in a press release.
The federal government has required financial institutions to report suspicious financial activities since 1992. The FinCEN notice adds the use of check cashing companies to commit payroll tax and workers’ compensation fraud to a list of red flags that financial institutions should be alert for and directs them to send suspicious activity reports if they detect key indicators.
FinCen said fraudsters typically register what appears to be a legitimate construction company and then purchase a workers’ compensation policy that covers a minimal number of workers. A contractor makes payments to the shell company, which deposits the funds or takes the checks to a check casher. The shell company deducts a fee, generally 4 to 10%, and returns the money to the contractor, who uses the cash to pay his workers without withholding payroll taxes or paying appropriate workers’ compensation premiums.
The notice says typically the shell company will be dissolved before a full year passes in order to avoid a premium audit by the insurer. The owners will then create a new shell company to continue the scheme.
The notice lists 11 red flags that financial institutions should look for. Among them:
- A customer who opens an account has no known prior involvement in the construction industry, or uses a passport from a foreign country as identification.
- A company’s recently acquired workers’ compensation insurance policy, which can usually be verified through an official state website, was issued within the past year and covers only a small number of employees.
- The customer receives weekly deposits that exceed normal account activity from several construction contractors involved in multiple trades.
- A construction company makes large cash withdrawals or negotiates checks for cash when accompanied by another person, or uses an armored car service to deliver bulk cash.
According to the Bank Policy Institute, financial institutions submitted 640,000 suspicious activity reports (SARs) in 2017 and received feedback from law enforcement on only 4% of those referrals. But that doesn’t mean the reports are being ignored. The institute said law enforcement mines the SARs database for leads and uses the data to gather evidence or find other suspects.
Dominic Dugo, a retired San Diego County insurance fraud prosecutor who now acts as outreach coordinator for the Coalition Against Insurance Fraud, said he is not aware of any previous involvement by federal law enforcement in investigating workers’ compensation premium fraud. He said federal agents have assisted the District Attorney’s Office in investigations of fraud by medical providers, but premium fraud up to now had generally been left to local law enforcement.
Dugo said the federal government’s involvement will help the fraud fight.
“In general, the more government agencies that are interested in premium fraud and tax evasion and the more partners that we have in this battle, the more successful we will be,” he said.
Dugo said the FinCEN notice by itself may help prevent fraud. He said in his experience, people are far less likely to attempt premium fraud if they are reminded that it is a crime. Dugo said when he was in charge of insurance fraud investigations for San Diego County, he oversaw a successful fraud-prevention campaign that used billboards and radio and television advertisements that spread the word that workers’ compensation fraud is a serious crime.
Some are skeptical, however. In a blog post, Ballard Spahr attorneys Siana Danch and Peter Hardy said banks will find it difficult to assess the red flags listed in the FinCEN notice.
For one thing, the red flags repeated use the term “shell company,” a pejorative term that reflects a value judgment, they said. The lawyers said “the fact remains that tens of millions of ‘shell’ LLCs and other entities in the United States exist for entirely legitimate purposes.” They said financial institutions, unlike federal law enforcement, do not have grand jury subpoena and search warrant powers and do not enjoy the luxury of conducting multi-year investigations.
“Having said that, the bottom line import of the notice appears to be that (financial institutions) should be wary of construction companies and, perhaps, should subject many of them to enhanced due diligence simply because of their status as construction companies,” the blog post says. “This may not have been the intent of the notice, but it may be the practical consequence.”
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