Construction Fraud 2

In its second article on fraud in the construction sector,  Haymarket Risk Management Ltd highlights red flags and proposes defensive measures

Versions of these articles previously appeared in the RICS journal and on Fraud Intelligence. 

In recent years, there has been an upsurge in construction companies defrauded by their own staff. In these cases, the companies may be the primary victim but their clients can often end up footing the bill if appropriate controls and cross-checks are not in place. It is impossible to publish a statistic on the amount of such fraud when so much of it must go undiscovered, but we do know the types of fraud that regularly crop up; these include:

• theft and diversion of materials by internal staff – this is a straightforward control (or lack of proper control) issue that to a great degree can be rectified simply by putting proper checks in place and making sure there is a segregation of duties policy in operation;
• construction company managers/Quantity Surveyors signing off overpayments to sub-contractors in return for kickbacks – this is far more common than would be believed. Often this type of fraud is conducted with the collusive cooperation of the client’s project manager, who agrees to sign off the ultimate cost as long as he is also benefiting through overpayment to the sub-contractor;
• a construction company staff member setting up a shell company to invoice a sub-contractor for non-existent services, which is in turn ultimately billed on to his employer company for sign-off, sometimes by himself.

Other staff cases we have dealt with are:

• suppressing low bids to direct a contract toward a favoured supplier in return for kickback;
• creating inflated phantom bids to direct a contract toward a favoured supplier;
• imperceptible variation of tender specification to cause certain tenderers to bid high;
• over-ordering and diversion of excess materials.

Kickbacks against invoice

In my first article [1], I made reference to payment of kickbacks against invoice. This has become more commonplace in recent years and is a product of the difficulty for the company paying the kickback to find a way of extracting money to pay off their collusive partners. The way around it is to pay against invoice.

Of course, the auditor at the company paying the kickback will be unaware of what is going on; all they will see in the accounts is a purchase order and corresponding invoice from a supplier for some vaguely worded consultancy services, and payment against same. The auditor will invariably accept it as bona fide, as would any visiting tax inspector unless there was specific reason to suspect otherwise.

This type of fraudulent payment is often best made by an offshore subsidiary to a front company that is also offshore. From the recipient’s viewpoint, it is the ideal scenario insofar as his kickback is paid to an offshore entity and bank account that is fronted by nominees but over which he has control. If retirement is on the horizon, this can be the pot of gold that pays for his holiday home in the sun and so often no-one is any the wiser.

Combating construction fraud

While I have discussed a selection of examples of fraud, there are many more variations that could fall under this category. The simple fact is that the term ‘construction fraud’ covers an extremely wide range of fraudulent malpractice by a wide range of people in a wide range of victim companies. The problem for companies is how to recognise and prevent it.

We know that there is no requirement for auditors to be trained in fraud detection and, equally worryingly, there is no requirement for staff to undergo routine fraud awareness training. On the basis that it is always better to prevent a fraud than to have to recover from it, preventive controls, segregation of duties, detection trip wires and so on are all-important. It is vital that organisations know with whom they are contracting (ie, their contractors and their sub-contractors). Proper pre-vendor vetting of prospective suppliers and pre-employment screening of job candidates are logical, indeed vital, controls that are so often overlooked. Purchase from a crooked supplier or recruit a crooked employee and you will be defrauded. It is as simple as that and yet many organisations continue to deal with suppliers and recruit staff with their fingers crossed and no proper checks. These are risks that are unnecessary and simply should not be taken as professional vetting of suppliers and job candidates is inexpensive yet highly effective.

In general, companies should also have:

• a well constructed internal policy document with a clear code of ethics, which sets out precisely what is acceptable practice regarding entertainment, gifts, etc (the bar should always be set deliberately low – we suggest no personal gifts and with only lunches allowed). The code of ethics should also set out the disciplinary consequences of breaching the policy so there are no doubts and no surprises when action is taken against anyone who steps over the line. We also recommend that the code of ethics should be copied to suppliers and contractors so that they are fully aware of your policy. In short, a clear code of ethics is a must-have for all businesses but particularly those in construction where fraud is endemic;
• a fraud response plan, ie, what to do and what not to do when fraud is first suspected – this should really be put together by an experienced corporate fraud consultant working alongside a forensic Quantity Surveyor;
• a policy of running detection reviews to detect fraud when one is suspected – using analytical software to supplement manual tests can have dramatic results;
• a hotline to encourage reporting, anonymously if necessary;
• a policy of having an independent Quantity Surveyor vet all tenders to identify any cartels or other corrupt collusion well in advance of contract award.

When fraud is suspected, the first steps taken are absolutely crucial in their bearing on the chances of recovery. They will invariably include a full covert investigation with suspects still in place and unaware that they are under suspicion. That is the only way the information or allegation can be properly tested and evidence gathered or, most importantly, that the allegations may be proved untrue and the subjects exonerated without reputational damage.

There are schools of thought (usually ultra-cautious HR managers or internal audit staff who are not familiar with fraud investigations) which argue against the covert investigation policy on the grounds that it is underhand or unfair, and that the allegations should simply be put to the suspects to hear what they have to say; this, however, is a disastrous way to proceed. In reality, if you have not investigated and do not have evidence to put to the suspect, the answer will always be an outright denial of any allegations, regardless of whether they are true or false, and when it is the former, the suspect is then on notice to destroy evidence, cover tracks, warn co-conspirators, etc. This way you are no further forward and will never know for sure whether there was substance to the allegation or whether it was indeed spurious and the denials are genuine. Also, how can this be fair to an honest employee who will forever after have a cloud of suspicious unjustifiably hanging over them?

In my view, the covert investigation, aimed at assimilating the maximum amount of evidence, followed by simultaneous, unannounced interviews of all suspects (internal and external) is the only proper away to proceed when suspicions of fraud arise, in fairness to the company and to those against whom allegations have been made.

It is also most important in the investigation of construction fraud (or any other fraud for that matter), that the investigators remember to follow the money trail. Ultimately, fraud is about theft of money and it has to be extracted in some way for the fraud to be committed. Investigations into public works contracts have consistently failed to heed this principle, hence the nicely bound, voluminous reports that contain the “no-one was to blame” platitudes rather than a clear explanation of where money paid to sub-contractors via the main contractor actually ended up. Until that principle is applied in investigating major construction fraud we shall see more highly expensive and meaningless blurb produced as so-called investigation reports.

Notes

[1] http://www.counter-fraud.com/fraud-types-a-m/bribery-and-corruption/building-blocks-96391.htm