In auto retail, selling cars out of trust is an old story. A dealership sells a vehicle but doesn't report the sale right away or pay off the corresponding floorplan debt immediately, as required.
Often, the money is diverted to other purposes, which could include improperly using it to pay off older floorplan debt.
The practice is a form of bank fraud. But it's becoming less common than it used to be, some industry experts say. That's in part a function of tighter controls at dealerships and lenders and faster communication in the age of the Internet. When it could take days for a lender to learn of a sale, even via express mail or shipping, there were more opportunities to fudge exactly when a car was sold without the lender getting suspicious.
Also reining in out-of-trust sales is that dealerships tend to do it only when they're in dire financial straits, a situation less likely today, amid robust industry sales, than it would have been, say, during the Great Recession.
"I believe this type of fraud is almost unheard of, more so today than in the past," said Gil Van Over, president of consulting firm gvo3 & Associates in Crown Point, Ind.
Selling out of trust hasn't gone away entirely. Prosecutors said it played a role in a case in which the former general manager of a Berlin, N.J., dealership pleaded guilty to bank fraud and filing a false tax return, for offenses dating to 2004-08. The dealership, Chevrolet 73, later closed. The defendant in the case, Richard T. Pepe, pleaded guilty and in June was sentenced to five years in prison. He was ordered to forfeit almost $3 million, according to the U.S. District Attorney's office in Camden, N.J.
Besides falsely reporting to M&T Bank that vehicles were present when they had been sold, court documents say, Pepe used other schemes, such as misuse of company credit cards, to divert money that had been loaned to the dealership for legitimate operating expenses to his own personal use.
Tom Hudson, a partner at Hudson Cook law firm in Hanover, Md., said a search of the firm's CarLaw case summaries since 1997 turned up 76 hits on the word duo "trust" and "floor." He said that doesn't include what's probably a much higher number of cases that were settled out of court. It also includes some false positives that turned up based on the same search terms.
An informal look at the case summaries turned up at least 35 cases from 2000-13 involving dealerships that sold vehicles out of trust, including franchised new-car dealerships and independent sellers. About half of those cases involved dealerships that also filed for bankruptcy. Most of the rest cited financial difficulties for the dealership but didn't mention bankruptcy. Other cases came to light when a new owner bought or invested in a distressed dealership.
Hudson said selling out of trust will probably never fully disappear. "The case summaries seem to be saying that even careful floorplanners can get burned by inventive dealers," he said.
• Perform background checks, update insurance: “Thorough background checks before employment would help. It's [also] possible that the dealer's insurance policies might cover that sort of employee fraud, or that such coverage could be added, so the dealer principal ought to be talking to his insurance agent (and lawyer) about the extent of insurance coverage.” — Tom Hudson, partner, Hudson Cook, Hanover, Md.
• Double-check inventory vs. floorplan: “One simple thing the dealer should be doing when they review the financial statements is to take a look at the inventory balance and compare that to what's in their floorplan balance. In an ideal world, the only difference would be holdback. The totals should be very close, let's say within 3 percent or so.” — Ron Sompels, managing partner of retail dealer services, Crowe Horwath, Tampa, Fla.
• Divide responsibilities, use checks and balances: “Dealers need to compartmentalize. Asking a general manager to do approvals on floorplan payoffs is asking the GM to do too much. Their strength, generally, is sales and service. Also, there's a conflict of interest for a GM who's highly paid and who has the obligation to pay off the floorplan. If things aren't going so well, he might not be so inclined to tell the boss. If he's less than honest, he might sell cars to pay himself, instead of paying off the floorplan.” — Leonard Bellavia, founding partner, Bellavia Blatt & Crossett, Mineola, N.Y.