Construction Financial
Management Association
MANAGING FRAUD RISK:
Identifying and Preventing Corruption
Schemes in Construction Companies
Edward Opall and Tim Van Noy
Amper, Politziner & Mattia
Certified Public Accountants and Consultants
“Seeing Beyond the Numbers…”
Fraud in the Construction
Industry
Attributed to ACFE – Association of Certified Fraud
Examiners – 2008 Report to the Nation
About the ACFE Survey
• Report done every 2 years, initially done in 1996.
• Based on surveys of CFE’s on cases investigated and
resolved.
• 2008 report based on 959 cases across the country.
• Most authoritative survey of its type.
CFMA – Fraud in Construction
Occupational Fraud
• Definition
“The use of one's occupation for personal enrichment through the
deliberate misuse or application of the employing organization's
resources or assets”
Association of Certified Fraud Examiners –
2006 Report on Occupational Fraud and Abuse
Summary of Findings
• Occupational fraud schemes frequently continue for
years before they are detected.
• Corruption is most common form of occupational
fraud (27%), fraudulent billing schemes (24%)
second.
• Data shows that fraud is more likely to be detected by
a tip than by audits, controls, or any other means.
• Implementing major controls appears to reduce the
median loss.
Summary of Findings
• Industries most vulnerable - Banking and Financial
Services (15%), government (12%) and healthcare
(8%).
• Small businesses are especially vulnerable to
occupational fraud. Same for 2006 survey. Check
tampering and fraudulent billing were the most
common small business fraud schemes.
• Lack of adequate internal controls was most
commonly cited
Summary of Findings
• Most victim companies modified their internal
controls AFTER discovering they have been
defrauded.
• Occupational frauds were most often committed by
the accounting department or upper management.
• Fraudsters are generally first-time offenders. Triangle
of Opportunity, Incentive, Rationalization.
CFMA – Fraud in Construction
Occupational Fraud
Corruption
Conflicts of Interest
•Purchasing Schemes
•Sales Schemes
Bribery
•Invoice Kickbacks
•Bid Rigging
Illegal Gratuities
Economic Extortion
Asset
Misappropriation
Cash
•Larceny
•Fraudulent
Disbursements
•Skimming
Non Cash
•Misuse
•Asset Requisitions/
Transfers
•False Sales / Shipping
•Purchases / Receiving
Fraudulent Statements
Financial
•Asset / Revenue
overstatement /
understatement
•Timing differences
•Fictitious Revenues
•Concealed liabilities and
expenses
•Improper Disclosures
•Improper Asset
Valuations
Non Financial
•Employment
Credentials
•Internal and External
Documents
Detection of Fraud
Schemes
• TIP or COMPLAINT - Nearly half of cases in 2008
study were uncovered by a tip or a complaint from an
employee, customer, vendor, or other source.
• INTERNAL CONTROLS AND INTERNAL AUDITS
Most helpful in government and public
companies
• DISCOVERY BY ACCIDENT
Most common in private companies
• EXTERNAL AUDIT
Most helpful for private companies
TIPS
• Greatest source of tips is from other employees
– Employees should be trained to understand fraud and how it
harms the organization
– Encourage employees to report illegal or suspicious behavior
– Reassure employees that reports may be made confidentially
and the organization prohibits retaliation against
whistleblowers
•
30% of Tips came from external sources –
encourage customers / vendors / stakeholders
to report improper conduct
Small Businesses
• Business with less than 100 employees generally have
fewer or weaker controls in place, primarily due to
lack of personnel
• Small business frauds are more likely to be detected
by tip or accident
• Room for improvement in their proactive detection
efforts.
CFMA – Fraud in Construction
Occupational Fraud
• Definition
“The use of one's occupation for personal enrichment through the
deliberate misuse or application of the employing organization's
resources or assets”
Association of Certified Fraud Examiners –
2006 Report on Occupational Fraud and Abuse
CFMA – Fraud in Construction
Occupational Fraud
• Possible perpetrators
– Clerks
– Managers
– Executives
– Owners/Principals
• Conclusion: Anyone in the company
CFMA – Fraud in Construction
Occupational Fraud
• Categories
– Misappropriating assets
– Corruption
– Falsifying financial statements
CFMA – Fraud in Construction
Occupational Fraud
• Is it fraud or abuse?
– Clandestine
– Fiduciary violation
– Committed to obtain financial benefit
– Costs company assets, revenues, or reserves
CFMA – Fraud in Construction
Occupational Fraud
• Why do employees commit fraud?
– Cressy’s Fraud Triangle
Opportunity
Incentive
Rationalization
CFMA – Fraud in Construction
Occupational Fraud
• Why do employees commit fraud?
– Cressy’s Fraud Triangle
1. Ability to commit fraud
Opportunity
Incentive
2. Get away with it
Rationalization
CFMA – Fraud in Construction
Occupational Fraud
• Why do employees commit fraud?
– Cressy’s Fraud Triangle
1. Greed/desire
Opportunity
2. Pressure/need
Incentive
Rationalization
CFMA – Fraud in Construction
Occupational Fraud
• Why do employees commit fraud?
– Cressy’s Fraud Triangle
Opportunity
1. Crucial element
2. Justifies act
Incentive
Rationalization
CFMA – Fraud in Construction
Occupational Fraud
• Why do employees commit fraud?
– Observations
• Opportunity – Area where the employer has the most control
• Incentive – Employer cannot control but may be observable
• Rationalization – Grayest area; hardest for employer to discern
CFMA – Fraud in Construction
Occupational Fraud
• Categories
– Misappropriating assets
– Corruption
– Falsifying financial statements
CFMA – Fraud in Construction
Frequency of Fraud Schemes
Corruption
Billing
Skimming
Non-Cash
Check Tampering
Expense Reimbursement
Cash on Hand
Fraudulent Statements
Cash Larceny
Payroll
Register Disbursement
26.90%
23.90%
16.60%
16.30%
14.70%
13.20%
12.60%
10.30%
10.30%
9.30%
2.80%
Source: ACFE 2008 Report to the Nation
CFMA – Fraud in Construction
Occupational Fraud - Median Loss
Corruption
Check Tampering
Billing
Non-Cash
Skimming
Cash Larceny
Payroll
Cash on Hand
Expense Reimbursement
Register Disbursements
$375,000
$138,000
$100,000
$100,000
$80,000
$75,000
$49,000
$35,000
$25,000
$25,000
Source: ACFE 2008 Report to the Nation
(excludes Fraudulent Financial Statements)
CFMA – Fraud in Construction
Corruption
• Definition
Employee wrongfully influences a business
transaction in order to procure some benefit
for themselves or another person.
CFMA – Fraud in Construction
Corruption
• Categories
– Bribes
– Economic extortion
– Illegal gratuities
– Conflict of interest
CFMA – Fraud in Construction
Corruption - Bribes
• Definition
– Commercial Bribery
A business transaction where something of
value is offered to influence a business
decision.
– Differs from traditional bribery only in relation to what is
being influenced.
CFMA – Fraud in Construction
Corruption - Bribes
• Categories
– Kickbacks – Undisclosed payments made by vendors to
employees of purchasing companies
– Bid rigging – Employee fraudulently assists a vendor in
winning a contract
CFMA – Fraud in Construction
Corruption - Bribes
• Kickback scheme commonalities
– Involve collusion between an employee and an outside party
(vendor)
– Normally attack the purchasing function
– Consequently, purchasing employees are usually involved
CFMA – Fraud in Construction
Corruption - Bribes
• Kickback scheme examples
– Diverting additional business to a vendor
• Market pricing (where’s the harm?)
– No market incentive re: price and quality
– Incentive to recoup kickback
– Usually turn into overbilling scheme
CFMA – Fraud in Construction
Corruption - Bribes
• Kickback scheme examples
– Overbilling
• Vendor submits inflated invoice
– Higher than market pricing
– Shipped less product or lower quality product
– Fictitious invoice
• Employee may or may not have approval authority
CFMA – Fraud in Construction
Corruption - Bribes
• Kickback payments
– Always a two-sided transaction
– Cash for kickbacks usually diverted to “slush fund”
• Non-company account
• Company checks to fictitious entity
• Paying false invoices
• Payments often charged as “fees” for consulting or other services
CFMA – Fraud in Construction
Corruption - Bribes
• Bid rigging
In the context of bribes, bid rigging
involves and illegal payment to an
employee to assist a vendor in
winning a contract.
CFMA – Fraud in Construction
Corruption - Bribes
• Bid rigging
– Employee fraudulently assists a vendor in winning a contract
– Subverts the bidding process
– Victim company’s employee tends to have influence in or access to
bidding process
– High stakes in construction market (particularly in bad economic
times)
CFMA – Fraud in Construction
Corruption - Bribes
• Bid rigging categories
– Presolicitation phase
• Needs recognition schemes
• Specification schemes
– Tailoring/narrowing
– Prequalification requirements
– Vague specifications
– Bid splitting
– Advance look
CFMA – Fraud in Construction
Corruption - Bribes
• Bid rigging categories
– Solicitation phase
• Bid rotation
• Fictitious suppliers
• Restricted bid period
CFMA – Fraud in Construction
Corruption - Bribes
• Bid rigging categories
– Submission phase
• Abuse of sealed bid process
• Advance or inside information
CFMA – Fraud in Construction
Corruption – Economic Extortion
• Flip side of bribery scheme
• Employee demands payment to select vendor
• Pay up or else
• Transactionally the same as a bribe
CFMA – Fraud in Construction
Corruption – Illegal Gratuity
A gift given by a party who
benefitted from a decision
to the person who made
the decision.
CFMA – Fraud in Construction
Corruption – Illegal Gratuity
• Similar to bribe, but usually occurs after decision
• Often morph into bribery schemes
• May be a way to determine openness to a bribe
CFMA – Fraud in Construction
Corruption – Illegal Gratuity
• Generally follow a pattern
– Gifts, travel & entertainment
• Construction work, new windows, finished basement
CFMA – Fraud in Construction
Corruption – Illegal Gratuity
• Generally follow a pattern
– Gifts, travel & entertainment
– Cash
– Checks/financial instruments
– Hidden interests
– Loans
– Asset leases/sales below market
– Promises of favorable treatment
CFMA – Fraud in Construction
Corruption – Conflicts of Interest
• Definition
Situations where an employee, manager,
executive or partial owner has an
undisclosed economic or personal interest
in a transaction that adversely affects the
company.
CFMA – Fraud in Construction
Corruption – Conflicts of Interest
• May violate employee’s fiduciary duty owed to employer
• May violate terms of partnership, ownership or joint
venture agreement terms
• Not all conflicts are economic
• Conflict vs bribery
– Approving fraudulent invoice for:
• Kickback, then its is bribery
• Fraudster’s company, then conflict of interest
– Transaction mechanics are the same
CFMA – Fraud in Construction
Corruption – Conflicts of Interest
• Schemes
– Purchase schemes
• Inflated prices
• Rig bids
• False invoices
– Sales schemes
• Under-market pricing
• Write-off A/R
– Compete with employer
• Divert employer’s clients to employee’s company
CFMA – Fraud in Construction
Corruption – Conflicts of Interest
• Schemes
– Unique assets transactions
• Usually involves land, buildings or large equipment
• Fraudster owns an interest in the asset
• Fraudster impacts negotiations in his favor
– Land flips
– Resource diversions
• Fraudster uses employer’s materials, equipment, or labor to assist his
own company
CFMA – Fraud in Construction
Corruption – Detection
• Most corruption schemes detected through:
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Tips from honest employees
Tips from disgruntled co-workers
Tips from disgruntled outsiders
Tips from disgruntled co-conspirators
• Tip allegations need to be validated through investigation
CFMA – Fraud in Construction
Corruption – Detection
• Red flags
– People
– Transactions
CFMA – Fraud in Construction
Corruption – Detection
• Red flags related to fraudsters
– Bribe takers/embezzlers
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Big spender
Gift taker
Odd couple
Rule breaker
Complainer
Genuine need
CFMA – Fraud in Construction
Corruption – Detection
• Red flags related to fraudsters
– Bribe givers
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Gift bearer
Sleaze factor
Too-successful bidder
Poor products or services
One person operation
CFMA – Fraud in Construction
Corruption – Detection
• Red flags related to transactions
– Purchasing
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Material reorder points routinely missed
Use of same vendor(s)
Purchasing policies not followed or consistently bent
Analytics
– Pricing trends year to year or project to project
– Trends relative to market pricing
CFMA – Fraud in Construction
Corruption – Detection
• Red flags related to transactions
– Bidding
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False statements in bid docs
Sign-offs by unauthorized individuals
Shortcutting or bypassing review procedures
Bidders involved in developing bid docs
Unusual variations in specification or contracts
Short bid periods
Vague terms in solicitation package
Improper contact (business or social) with a bidder
Acceptance of late bids/back dating of bids
Changes to bid after all bids received (intentional errors)
Patterns in bid awards
CFMA – Fraud in Construction
Corruption – Detection
• Analytics and corruption indicators
– Develop a body of historical data
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For each bid received
For each bid awarded
Actual costs for each contract
By CIS number
Cost/SQFT (installed)
Unit prices
Material prices by purchase unit
CFMA – Fraud in Construction
Corruption – Detection
• Analytics and corruption indicators
– Trend and compare historic data
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Year to year
Project to project
By sub/vendor
By market
By work (new, rehab, repair)
By purchasing person
Against competitors or industry metric
Versus market pricing
– Look for departures from trends and anomalies
CFMA – Fraud in Construction
Corruption – Detection
• Conflicts of Interest
– Very difficult to uncover
– Discovery methods
• Tips
• Observation
• Analysis
CFMA – Fraud in Construction
Corruption – Detection
• Conflicts of Interest
– Tips
• Other vendor complaints
• Employee complaints re: service or quality
– Observation
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Lifestyles
Financial problems
Personal problems (divorce, addictions, relationships)
Work habits (it takes time to run a side business)
Involvement in areas of company outside of job duties
CFMA – Fraud in Construction
Corruption – Detection
• Conflicts of Interest
– Analysis
• Periodic comparison of:
– Vendor and employee addresses
– Vendor TIN’s and employee SSN’s (including listed relatives
– Vendor phone numbers to all employee phone numbers
• Full investigation of vendor ownership done and filed with periodic
reviews/updates
• Periodically interview purchasing employees to identify vendors
receiving favorable treatment
• Credit and background checks
– Must have signed employee permission form on hand
– State laws vary, so review with counsel
Source: ACFE 2008 Report to the Nation
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• ARRA – American Recovery and Reinvestment
Act of 2009
• Purpose
– Stimulate economy by accelerating “shovel ready” projects
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Issues
– Applies FAR to Stimulus projects
– Applies other Federal requirements to Stimulus projects
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NEPA compliance
Buy American
Whistleblower
Federal fraud and false claims
Contractor reporting
Federal oversight
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• NEPA Compliance
– National Environmental Policy Act
– Required even if project has completed an environmental review
– NEPA compliance issues could create delays to construction start
• Adjust your schedules, budgets and/or estimates
– ARRA requires reviews to be “completed on an expeditious basis”
• Fed will likely use a streamlined process
• Even so, delay impacts should be planned for
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Buy American
– Generally:
• All steel, iron and manufactured goods produced or manufactured in
U.S.
• “Unmanufactured” construction material must be domestic (e.g.
sand)
• All components or subcomponents of manufactured construction
materials can be foreign
– Normally 50% must be domestic
• Contracting Officer must mark-up non-compliant bids by 25%
• Any waiver should (must) be obtained prior to submitting offer
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Whistleblower Protection
– Applies to all “non-Federal” employees
• State & local governments, contractors and subs
– Offenses expanded from fraud to also include:
• Mismanagement, waste, abuse, substantial danger to public health, or
violation of law or regulation
– Whistleblower must have only “reasonable belief”
– Employee has low burden to prove reprisal
– Employer must show “clear and convincing evidence” that action
against employee would have occurred regardless of whistleblower
status
– Economic times may cause employees blow whistle to avoid firing
or layoff
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Fraud and False Claims
– Legislation
• Passed into law
– Fraud Enforcement and Recovery Act (5/09) (“FERA”)
• Pending
– H.R. 1788 False Claims Correction Act
– S. 458 False Claims Clarification Act
– H.R. 1667 War Profiteering Prevention Act
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Fraud and False Claims
– FERA
• Protects TARP and other stimulus monies
• Authorizes funding to hire fraud prosecutors and investigators
• Extends False Claims Act to any false or fraudulent claim for
government money or property whether or not:
1.
2.
3.
Claim is presented to government employee
Government has physical custody of money
Claimant intended to defraud the government
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Fraud and False Claims
– Pending House and Senate bills
• Essentially apply FERA expansion of the FCA to all federal contracting
– War Profiteering Prevention Act
• Bill is still in Committee
• Aimed at U.S. companies with government contracts to provide goods
and services overseas
• Establish criminal penalties for bid rigging, fraud, gross overcharging,
delivery of faulty military parts, and environmental damage
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Enhanced Quarterly Reporting
– Stimulus contracts in general require more extensive reporting and
extend reporting to subs and material suppliers
– New FAR rule 52.204-11
• Applicable to any contract fully or partially ARRA funded
• Requires quarterly public on-line reporting of ARRA expenditures
• If prime or 1st tier sub, disclose names and total compensation of five
highest-paid officers
• Reporting likely to be covered by FCA provisions
• Allows competitors access to ongoing projects’ cost and status
CFMA – Fraud in Construction
Stimulus Monies - ARRA
• Enhanced Oversight
– Allows GAO access to prime and sub records
– Permits GAO to interview officers and employees of prime and
subs
– IG powers expanded only to the prime contractor
– Contractors should:
• Increase internal and document controls
• Follow FAR to the letter
• Assure that consultants (CPA’s, attorneys and claims consultants)
aware of changes to laws and regulations
• These new powers combined with new reporting means project
performance issues need to be dealt with proactively
CFMA – Fraud in Construction
• Seminar Agenda
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Backgrounds √
Fraud statistics √
Occupational fraud in construction √
Issues surrounding stimulus monies √
Q&A
“The material contained in this presentation is for general
information and should not be acted upon without prior professional
consultation.”