Shippers should scrutinize their relationships with outside payment and auditing firms.
By Eric Johnson
When the news came in early spring that the third-party freight payment and audit vendor Trendset was embroiled in a fraud and embezzlement case, it might have ordinarily sent shockwaves through the shipping industry.
Here was a vendor admitting to its customers that it had lost track of potentially millions of dollars in which it was entrusted to pay carriers on those customers’ behalf.
But the reality is this was merely the latest cautionary tale for shippers that use outsourced freight payment providers. More than a decade ago, it was names like Stategic Technologies, Inc. (STI) and Computrex that were taken down by misuse of funds.
And mere weeks after the Trendset case came to light, another provider, TransVantage Solutions, was taken to U.S. District Court over an alleged systematic failure to make payment on behalf of the automotive supplier division of the U.S. conglomerate Johnson Controls.
Trendset has landed in U.S. bankruptcy court after several of its customers filed petitions.
In both cases, a breakdown in internal controls at the freight payment vendor led to the misuse of funds. And in both cases, it can be argued that shippers didn’t do enough to confirm the soundness of their partners.
For some reason, shippers often fail to hold their freight payment vendors to the same standards as they would a bank. Shippers would never entrust a multimillion cash deposit with an entity other than a regulated financial institution, but they often willingly do so with millions of dollars in carrier payments.
For Cecil Bryan, a longtime veteran of the freight payment industry and now a consultant, it’s not clear why companies aren’t more diligent in vetting and checking their freight payment vendors.
“I wish I knew the answer and it’s still puzzling,” he said. “It’s not chump change. I don’t know why they view it as a minimal risk.”
One factor is clear: the vendor landscape in freight payment and audit is vast and confusing. There are bank-backed vendors and non-bank vendors. Among the non-bank vendors, there are small vendors and large vendors. There are non-bank vendors that go to extra lengths to insure their customers’ payments, and those that clearly don’t.
There is one unifying theme, though: all vendors have a legal requirement to safeguard the funds with which they are entrusted. While it is true that bank-backed vendors have certain regulatory mandates that non-bank vendors don’t, many non-bank vendors realize this and provide extra safeguards that approximate the benefits of the bank-backed peace of mind.
Roxane Kramer, chief financial officer for the non-bank payment vendor Data2Logistics, told American Shipper
that it pays for insurance with the Federal Deposit Insurance Corp. (FDIC) in excess of 100 percent of the payments it manages to assure clients they would recoup all of their money in the event of a problem.
Incidents like that at Trendset can have the effect of tarnishing the reputation of the entire freight payment industry, and particularly those vendors not perceived to have the advantage of being a bank. That’s a tough hurdle to overcome. Kramer noted while Data2Logistics places a premium on financial safeguards, she suspects not all of its competitors do.
And therein lays a problem. While the gamut of specialized vendors is quite interested in differentiating themselves from one another — in essence, portraying their solution as the best and most trustworthy out there — the reality is that all vendors are hurt when something goes wrong at one vendor.
Shippers can easily retreat to paying bills through their broader enterprise resource planning (ERP) platforms, or even doing it in-house. The financial gains of paying through a vendor can quickly be forgotten if there’s trepidation about the safety of vast sums earmarked for carrier payment.
In March, days before the Trendset incident came to light, the freight payment consultancy Quetica and law firm Balch & Bingham released a white paper, Getting It Right: Due Diligence and the Outsourcing of Freight Audit and Payment
, that encourages shippers to perform due diligence when it comes to selecting an external freight payment and audit services provider.
The authors of the report — Quetica managing director Richard Langer (who created the industry’s pioneering PowerTrack network) and Dean Calloway, a partner in Balch & Bingham’s Atlanta office — emphasized shippers should also ensure controls are implemented to safeguard the funds they are entrusting to these third parties.
It’s also interesting that freight payment, for many companies, remains a process apart from normal invoicing. A mining shipper American Shipper
spoke to in April said it uses a procurement and invoicing platform for freight, while the rest of the company’s invoices are handled through a shared services division. Freight payment is a unique process. As such, it requires due diligence and a lot of homework.
The Quetica/Balch & Bingham white paper suggests companies need to begin the vendor selection process with a rigorous study of each vendor they shortlist. The process is important regardless of the reputation of the entity.
Two key points from a section in the report about knowing your provider advised shippers to make sure the vendor “is financially stable; and pays its other customers’ carriers promptly, and is not using funds advanced by one shipper to pay another shipper’s carriers.”
This gets to the heart of the issue when it comes to freight payment. When a company outsources its payment process, it is not only paying a fee for that service, it is entrusting potentially large sums in regular payments to carriers to an outside entity. Best practice dictates a shipper should contractually stipulate that the money it moves to the provider will be used specifically to pay its carriers. It should not be used to pay other shippers’ carriers or for working capital.
There’s a simple solution to this: escrow.
“Few shippers require providers to establish formal escrow accounts for their funds even when the amounts advanced by the shipper to the provider run into the millions,” the white paper said. “Common sense and logic dictate that funds advanced by a shipper to a provider for the purpose of paying carriers belong to the shipper and that the provider is merely a disbursing agent. However, securing the return of funds in the event a provider declares bankruptcy or defrauds a shipper can be an uncertain and expensive proposition in the absence of an escrow account.”
The white paper alludes specifically to the STI case.
“STI had actually been operating a decade-long Ponzi scheme, using more recent shipper deposits to cover earlier obligations, with prior deposits having been diverted by former STI CEO Marc Cooper to other pursuits,” the report said.
“How did STI avoid discovery? STI was able to perpetuate its scheme because it maintained a single account into which its customers’ funds were deposited alongside each other and the transaction fees they paid to STI. The single account structure allowed STI to disregard the purpose for which any particular client funds had been advanced so long as STI maintained sufficient funds in the account to cover any present obligation it found necessary to satisfy. The comingling of STI’s clients’ funds and STI’s own fees made detecting the fraud virtually impossible,” the paper’s authors said.
The white paper advises that shippers demand their prospective vendors produce audited and certified financial statements, submit multiple references from similarly situated shippers, and disclose whether the provider has ever been involved in a lawsuit with a customer or part of any criminal proceeding.
Lastly, the paper contends that shippers ought to retain outside counsel.
“Shippers should never enter into any contract without the assistance of experienced legal counsel,” the white paper said. “A failure to engage counsel beforehand is an open invitation to costly, time-consuming and unnecessary litigation at a later date.”
Bryan, meanwhile, said the recent cases should serve as a wake up call to shippers.
“Get up and do this,” he said. “It doesn’t take much time to do some checks and balances. Spot check to make sure they’re doing what they say they’re doing. If a company doesn’t have audited financials, end of story. When you’re doing internal audits, do a test of cash, so you know how much you’re funding them and how much is going to carriers. It’s easy for a freight payment company to send you a payment lag report. Run those weekly, and if anything looks out of kilter, call them on it.”
Bryan said there is a difference between bank-backed vendors and non-bank vendors. Vendors like U.S. Bank and Citi use the Syncada payment network, which functions much like a credit card company does. Shippers can use Syncada to pay their carriers early and pay the freight pay vendor later.
“In terms of having your funds safe, certainly the Syncada model is completely safe there,” Bryan said. “It’s like a credit card model — they’re paying upfront and you’re paying on the back end. Even Cass (another major bank-backed vendor), all the rigors they’re subject to. But there are certainly non-bank providers that are very safe.”
Bryan’s experience includes stints with non-bank vendors AIMS Logistics, before it was acquired by U.S. Bank, and nVision Global. It should be noted that nVision had its own problems in recent years, being sued by its customer Cardinal Health for overcharging fees related to its freight invoice payment.
“AIMS went overboard in terms of internal controls and audit, just for the fact that U.S. Bank bought them,” Bryan said. “If you’re going to sell your freight payment company, you’ve got to be clean.”
Bryan noted another way shippers can maintain control of the funds they dedicate to pay their carriers — keep control of their own checkbook.
“That’s the easiest first control,” he said. “If the vendor has a float price and no float price, it’s kind of a shell game. There are fewer steps to manage if the provider pays the bills for you. So you’ve got to do more to make it work, but we have technology today that we didn’t have five years ago. There ought to be a way to make it work.”
Three freight payment funding processes
The freight audit and pay company requests funds from their shipper customers
for all carrier invoices due the following week. The shipper customer
electronically transfers the money for all invoices due the following week
to the freight audit and pay company. The freight audit and pay company
consolidates invoice payments owed to each carrier on each day across all
of their shipper customers. Lastly, the freight audit and payment company
makes a single check or ACH payment to each carrier on each due date for
all shipper payments. The carrier payment is accompanied with a detailed
remittance advice for the carrier’s AR department to apply the payments to
each customer’s outstanding accounts receivable in their accounting system.
Freight audit and payment companies are able to earn interest income
on the float interest from the prefunded carrier obligations and reduce either
check or ACH payment costs by grouping payments across shippers. This
interest and payment cost reduction should help lower invoice processing
fees charged to the shipper.
Post funded or early payment
The freight audit and payment company pays the carriers immediately
after they finish auditing and approving payment on a carrier invoice. For
the early reimbursement the carrier is charged a percentage fee (e.g. 1.2
percent) based on how many days before the carrier’s invoice trade term
due date. The shipper repays the freight audit and payment company at the
carrier due date. In effect, the carrier is paid early for a fee and the shipper
still pays on the due date. All payments are grouped across all shippers for
each carrier for each day of payment to reduce settlement costs. All carriers
are incented to have electronic payment (ACH) because an early repayment
program would not make as much sense with check, thus lowering
the payment costs. The freight audit and payment company’s early payment
revenue and reduced settlement cost should help lower invoice processing
fees charged to the shipper.
Audit and invoice processing only
The freight audit and payment company still audits and approves invoices
but sends a payment file back to the shipper. The shipper then disburses
payment through its commercial bank. Although this may seem the safest
model it doesn’t prevent a shipper’s employee or freight audit and payment
company from committing fraud. This creates the most expensive invoice
processing fees charged to the shipper because the freight audit and payment
vendor cannot take advantage of float interest, early payment carrier
fees or settlement efficiencies to lower overall pricing to the shipper.
- Thoroughly vet any potential freight payment vendor and retain outside
counsel before signing any contract.
- Implicitly state that your carrier payment funds be held in escrow, and
not in a joint account comingled with funds from other customers.
- Decide whether you want to handle paying the checks internally or let
the vendor do it — there are benefits and drawbacks to both options.
- Bank-backed vendors have a safer pedigree, but there are non-bank
vendors who go the extra mile to protect your funds.