Construction Fraud Can Hurt Your Bottom Line

In its 2012 Report to the Nations on Occupational Fraud and Abuse, the Association of Certified Fraud Examiners (ACFE) estimated that a typical organization loses 5% of its revenues to occupational fraud each year. When it comes to construction, the ACFE found that the median loss suffered due to fraud schemes was in the neighborhood of $300,000. It’s not just contractors who are victims of such fraud; project owners, investors and creditors also risk losses. That’s why it’s critical to understand common schemes and take steps to prevent and help detect fraud if it occurs. There’s a Thief among Us Construction projects are particularly vulnerable to the following occupational fraud schemes: Kickbacks and bid rigging. These schemes usually involve payments to the employees of the project owner in order to secure a contract or, later in the process, approval of change orders. The payment isn’t necessarily in cash — the contractor might provide services to your employee in exchange for the employee’s aid. In such cases, the contractor could even end up billing you for those services, disguising the charge in a change order. Ghost employees. Project owners can easily be billed for nonexistent employees or hours that weren’t worked. How? An employee of the contractor creates a ghost employee and then diverts the ghost’s paycheck to an address where he/she can pick up the check and later cash it. An employee could also “punch in” his pal on the time clock when the friend isn’t there to do it himself. Similarly, fraudsters may falsify invoices from bogus or “dead” vendors and subs. Materials waste. Here, a contractor’s employee may order more materials than are necessary for the project. He or she then reports the excess as scrap and sells it — or uses it on another job. An employee also might steal equipment or report it as broken and then sell it — or use it personally. Duplicate payments. A contractor’s employee makes duplicate payments to a legitimate supplier for a legitimate invoice related to the project. One check goes to the supplier, but the other check is cashed by the employee. Sometimes the employee is in collusion with the supplier, and they share the duplicate payment. Combating Fraud Fortunately, project owners can take some measures to protect themselves from these and other schemes. Start at the beginning: During the bid management stage, implement internal controls for the solicitation, receipt and evaluation of bids and proposals. For example, require that more than one of your employees be involved in the bid-opening process and establish an evaluation team to award the contract. Once you’ve selected a contractor, include a right-to-audit clause in the contract — and then use it. The clause grants you and your representatives access to the contractor’s accounting records to validate costs and look for irregularities. Surprise audits often are more effective than regularly scheduled visits.

About William H. Jennings