10 most common construction fraud schemes
Diverted funds. Materials misuse. Padded bills. Hidden cost overruns. Every day, construction firms lose money to fraud perpetrated by employees, contractors, subcontractors and venture partners. In fact, a global study by the Association of Certified Fraud Examiners (ACFE) ranked real estate and construction fraud as the second and third most costly frauds in terms of median loss, and estimated that the average loss was a startling $628,500. Despite media headlines and stereotypes, construction companies are often the victims of fraud rather than the perpetrators.
Construction numbers remain strong in Canada, and particularly in Toronto, which is estimated to have more skyscrapers and high rises under construction than any other North American city. From businesses in commercial construction to individuals involved in residential construction, it’s critical to understand fraud.
Grant Thornton LLP has released a new white paper, Construction fraud in Canada—Understand it, prevent it, detect it, which outlines the severity of fraud, lists the most common types of fraud schemes, and shows how to prevent and detect fraud.
The report provides details of the 10 most common construction fraud-related schemes:
1. Non-payment of subcontractors and material suppliers.
2. Billing for unperformed work.
3. Manipulating the schedule of values (SOV) and contingency accounts.
4. Diverting lump-sum cost to time-and-material costs.
5. Substituting or removing materials.
6. Change order manipulation.
7. Falsifying payment applications.
8. Subcontractor collusion.
9. Diverting purchases and stealing equipment or tools.
10. False representations.
The report also highlights red flags that may be helpful in identifying fraudulent activities, allowing companies to take action or implement controls to prevent fraud. For example, does one person dominate or control an entire process? Are subcontractors complaining of delayed payments? Are there unusual bid patterns? For these and other examples, Construction fraud in Canada suggests preventative measures to improve operations, reporting and governance, and help lower the risk.
“A strong fraud strategy can help companies reduce the risk of fraud loss, of course, but the benefits extend far beyond,” says David Malamed, Senior Partner, Fraud and Investigative Services, Grant Thornton LLP. “Fraud has a host of additional costs, such as penalties for violating industry standards or regulatory requirements, project delays or cancellations, escalating costs and reputational risk. A good fraud prevention program may even prevent injury or loss of life if the fraud involves the use of substandard or unsafe materials.”
Given current levels of construction activity and investment in Canada, the construction industry needs to implement proactive, preventive measures for fraud. “Individuals and organizations need to invest the time and money to put a fraud prevention and detection plan into action before they become a victim,” says Bo Mocherniak, National Leader, Construction, Real Estate and Hospitality, Grant Thornton LLP. “The push for fraud prevention requires strong governance and leadership, and must start at the very top of the organization.”
And it’s not just construction companies. The issue extends to a broad range of individuals and businesses involved in commercial construction, including lawyers, real estate companies, property development companies, property management companies and, of course, investors.
The growing prevalence of construction fraud is not a myth or the product of hype—it’s happening, and the stakes are high.