Shutting the lid on beverage container deposit fraud

Container deposit fraud is more than just buddies transporting some empty soda bottles across state lines. We’re talking about multimillion-dollar tax fraud schemes. Here’s how to prevent them.

As a grade-school-aged boy growing up in southwest lower-Michigan, I remember helping load up the car with emptied glass pop bottles that we’d take to our neighborhood grocery store in exchange for a few dollars. In the Midwest U.S., “pop” is the vernacular term for soft drinks made by such producers as Coca-Cola, PepsiCo, Dr Pepper and National Beverage. If you’re from the Northeast U.S., it’s simply “soda.” Southerners often call them all “Coke” even if they’re not brown. I still remember the clinking and clanking of those bottles in the car as we drove to the grocery store.

Michigan passed a bottle bill, or beverage container deposit law, in 1976. Even though it wasn’t the first state to do so (Oregon passed the first in 1971) at the time Michigan had the highest deposit — ten cents on airtight containers under one gallon composed of metal, glass, paper or plastic. Today, 10 states and one U.S. territory have container deposit laws.

Like any well-intentioned laws, some fraudsters will exploit them for nefarious purposes. Here I’ll explore the general mechanics of beverage container deposit laws, perpetrators’ fraudulent schemes and the greatest risk factors associated with these programs.

Purpose of beverage container deposit laws

The primary purpose for beverage container deposit laws is to prevent littering. Requiring deposits provides an economic incentive for consumers to properly dispose of containers for recycling rather than dispose of them in trash receptacles that will then end up in a landfill or, worse, dumped on the side of roads to pollute the environment.

Beverage container deposit refund scenario

Here’s how most common beverage container deposit law processes work. A distributor sells beverage products to a retailer. As part of this transaction, the distributor collects a deposit payment for each beverage container — let’s say 10 cents for each container. For example, a distributor sells 5,000 container units at $1 each for a total of $5,000. The distributor will also charge a 10-cent deposit on the 5,000 container units totaling an additional $500. So, the total payment the retailer pays to the distributor is $5,500.

The retailer then passes along the 10-cent deposit on top of the retail mark-up to each end customer. For example, the retail will charge each end customer a retail price of $1.50 for each container unit purchased plus 10 cents per container unit for a total of $1.60. The customer can then return the empty container to a collection center — typically a retailer — for redemption and retrieve their 10-cent deposit. Finally, the retailer will ship the empty container to the distributor for their return of the 10-cent deposit. This is how it should work every time in a perfect world.

However, we must consider what happens when a customer doesn’t redeem their container deposit but throws it in the trash or on the side of the road, or takes it to an alternate recycling center. Depending on state law, the distributor will keep that ten-cent deposit, return it  to the state authority or a hybrid of both. (See “General flow-chart of beverage container deposit process” below.)

Even though the underlying process seems simple, the flow of transactions associated with the return of containers and deposits can become complex. Further adding to the complexity is that states regulate beverage container deposit laws. Each jurisdiction has unique program implementation and accounting regulations, so it’s important to research states’ specific requirements. (See “Unwrapping the Pros and Cons of a Bottle Deposit Program,” The Abell Report, March 2012, Volume 25, Number 2.)

‘The Bottle Deposit’ episode on ‘Seinfeld’

This column’s title might conjure up images of a famous two-part “Seinfeld” episode. The story arc tells the saga of Kramer and Newman conspiring to collect beverage containers in New York, transport them to Michigan and collect the 10-cent refunds.

Newman performs a thorough cost/benefit analysis to determine how to best transport the containers interstate — by far the greatest cost associated with the scheme. Newman, a U.S. mail postal carrier, learns of the extra Mother’s Day mail that has to be shipped from New York to Michigan for sorting. He excitedly volunteers to take the delivery route. They can’t complete the scheme because of other shenanigans that occur on the drive to Michigan. While their machinations are indeed fraudulent, they pale in comparison to some of the more organized schemes.

$80.3 million recycling fraud

On April 19, 2018, California Attorney General Xavier Becerra announced criminal charges against five individuals for defrauding the state’s beverage container recycling program. (See the state release.)

The 166-count indictment alleges that the defendants conspired to manufacture fraudulent weight tickets (printed records of large amounts of bottles for redemption) through a certified redemption center to obtain California Redemption Value (CRV) refunds. In California, consumers can redeem their beverage container deposit from certified redemption centers. Under state regulation, these redemption centers are responsible for ensuring that only eligible beverage containers sold in California where the CRV deposits were paid can be redeemed.

In this case, the state alleged that the defendants received out-of-state material from various recycling centers and engaged in illegal activity to claim CRV refunds to the tune of $80.3 million. They perpetrated the scheme by submitting CRV claims containing fraudulent information. The collected documentary evidence collected included inaccurate, altered and falsified weight ticket claims.

Various players would’ve been involved in collecting, transporting and dropping off of containers at the redemption center; falsifying of documents; submission of false claims; and collection of CRV refunds.

$4.3 million settlement

On May 24, 2018, New York State Attorney General Barbara D. Underwood and Rockland County District Attorney Thomas Zugibe announced a $4.3 million settlement with Oak Beverages Inc. for falsely inflating the number of empty beverage container returns it received, which resulted in the company’s failure to turn over approximately $1,859,000 in unpaid deposits to New York State — a violation of New York’s bottle bill. (See the New York state release.)

Per the New York state beverage container deposit program, distributors each quarter must turn over 80% of any unredeemed deposits to the state, which Oak Beverages failed to do. Distributors are allowed to keep the remaining 20% of any unredeemed deposits.

Oak Beverages systematically and falsely inflated the amount of empty containers it received and reported those falsely inflated numbers in quarterly reports to the state. The company’s general manager, who initiated and directed the scheme, would modify customer invoices from drivers’ daily route records to exaggerate the number of empty containers they collected.

In one instance, the general manager indicated on an invoice that a store in Queens returned 80 bags of assorted empty cans and bottles — although drivers hadn’t picked up any empty containers. Oak Beverages retained the $1,264.80 adjustment to the invoice. The general manager also instructed lower-level employees to modify sales records to reflect these alterations and not inform anyone else at the company about the adjustments.

Greatest risk factor: self-reporting

An audit of the state of Hawaii’s deposit beverage container program has analyzed the risks of self-reporting. The primary audit findings center around the program’s reliance on self-reported data from distributors and certified redemption centers and lack of adequate controls to monitor the accuracy and completeness of the information they provide.

They simply file inaccurate information to receive increased refunds or not remit taxes due similar to how individuals or organizations might evade other tax payments. Distributors and certified redemption centers committing beverage container deposit frauds might file false or fictitious documentation with state regulatory authorities to receive increased container deposit refunds. Or they might understate the amount of unreturned containers to reduce deposits they pay to state coffers.

The greatest risk for malfeasance exists at the distributor’s stage because they might have the incentive to under-report sales/distributions of deposit beverage containers to retailers plus collected container deposit refunds from retailers and not remit them to state authorities by falsifying paperwork.

Bottling up these fraudsters

Beverage container deposit fraud is a real concern within jurisdictions that require such programs. The cases here involve more than just a couple of buddies hauling a garbage bag of containers over state lines. The most logical answer to this issue is for state authorities to develop vigorous enforcement components to ensure compliance with beverage container deposit programs policies and procedures. This might be a tall task for officials to implement because of state jurisdictions facing shrinking revenues and cost-cutting budgets. The overall integrity and future of beverage container deposit programs could be in jeopardy because of fraud.

L. Christopher Knight, CFE, CPA, is a forensic accountant in Indianapolis, Indiana, and an adjunct faculty member at Indiana University’s Kelley School of Business in Bloomington and Indiana University-East in Richmond. The views expressed in this article are his own. Contact him at lchristopherknight@yahoo.com.