Many a deal is concluded with a firm handshake, a smile and a few scuffles of a boot in the dirt on farms and ranches across the country — but that level of trust may soon be as rare as handwritten letters.
A “gentlemen’s agreement” is often all that’s required to conduct business in rural America, but that may not be enough anymore, says Jason Thomas, CPA, JD, and senior tax manager at Frost PLLC, certified public accountants in Little Rock, Ark.
“Is the gentlemen’s agreement obsolete?” he asked at a Beef Financial Management Conference in Amarillo, Texas. “That may be a little too strong, but business is becoming less personal, and farmers and ranchers are making fewer one-on-one deals.”
A bankruptcy case about a year ago involving the Eastern Livestock Company, LLC, proves the point, Thomas says. In that case, the company drew on a $32 million letter of credit and created “artificial balances in other accounts,” using an illegal scheme called check kiting to defraud clients.
“The bank was asleep at the wheel,” he says. Checks issued to producers who had sold cattle were returned because of insufficient funds.
“They were left holding worthless checks,” he says. “The company filed bankruptcy and the producers were left with nothing.”
The fraud amounted to a kind of Ponzi scheme, he notes. While some funds have been recovered, significant amounts remain unsecured.
Ranchers should take this cautionary tale to heart, Thomas says, and think carefully about how they conduct business. Preventing fraud, he says, should be part of any producer’s risk management strategy.
“Managing risk requires an integrated approach to balance conflicting objectives,” he says, and both personal objectives and business objectives come into play. Personal goals include building relationships and trust, while business objectives include profit, business security and the farm or ranch’s longevity.
He said fraud includes three parts — motive (or pressure), opportunity and rationalization.
“Don’t provide an opportunity for fraud,” he advises. That may mean doing business in a different way than usual.
“Think about managing risk every day. That’s hard to do in daily practice — producers tend to do things the same way for a long time. But we’re in changing conditions. We deal with new buyers, for instance.”
He says producers should enter into new relationships cautiously, “with someone you can trust. But trust is a two-way street — you have to build a trust history.”
In the absence of that history, producers still have options to reduce the chances of fraud. Obtaining information about a trading partner is critical for a cattle producer, he says. Keeping good records is also important; he recommends requiring binding contracts, letters of credit and getting everything in writing.
State and federal laws also help. Following the case from last year several states have initiated regulations that require security liens from cattle buyers, Thomas notes. The liens are in effect “until the check clears the bank. This is a minimal and a useful approach.”
He says a letter of credit should “guarantee that the obligation is paid.”
Responding to a question from the audience, Thomas said auction houses offer special circumstances for sellers.
“The buyer may be unknown, so the auction house itself may need to put in safeguards. That may be tedious to do. Also, state legislation may come into play.”
He says auction houses face both a challenge and an opportunity to “protect customers and to increase the customer base” with increased safeguards.