Top 10 ways to lose money to fraud
August 1, 2012 by Chris Eagles and Ross McGowan
The construction industry could be described as perfectly constituted for commission of fraud.
The contracts are typically unique and large value, the job sites are busy and sometimes chaotic and the opportunity for monitoring and controls are always challenging. Relationships between those that hand out the contracts and those that receive the work are sometimes opaque and poorly documented. Integrity amongst leaders in the construction industry is paramount to public confidence and ultimately, critical to the long-term financial health for all participants. Fraud losses erode profits in the short term, and ultimately lead to a loss of the open, competitive bid process that underpins the industry.
We look at the leading issues and a few ways to fight back against fraud on the construction site:
The Top 10
1. Accounting/bookkeeping frauds
2. Secret commissions and collusion
3. Billing for work/materials not performed or delivered
4. False applications for payment
5. Manipulating change orders
6. Manipulating schedule of values and contingency accounts
7. Substituting material from specifications
8. Diverting lump sum charges to time and material cost
9. Diverting purchases and theft of equipment/tools
10. Intentional non-payment of subcontractors and material suppliers
The impact of these schemes can be mitigated through appropriate controls, development and implementation of well-considered hiring, tendering and anti-corruption policies, a zero tolerance approach to participation in such schemes and a standard known policy that seeks to disgorge profits by careful use of litigation.
The pen is mightier than the shovel when it comes to fraud. Most common schemes take place back at the office, through skimming receipts, double invoicing for expenses, false supplier invoices and interception of payments. Threats are external and internal and require an awareness of: the job site, material and supply contracts, timely reconciliation of invoices to contract, review of change orders, and close monitoring and reconciliation of banking deposits.
The single most critical prevention/detection method is to ensure there is a well trained accounting staff with an appropriate segregation and rotation of job duties. Those that do invoicing must not handle collections, those that handle receipts must not do the banking reconciliation, etc; and all must know that there is real and effective oversight of their work.
Commissions and collusion
Sometimes it is not better to give than to receive. Both are bad when it comes to kickbacks, bribes, secret discounts and secret commissions. These have a devastating effect on the construction industry, both locally and internationally, such that Canadian firms must be vigilant of their obligations under Canadian law as well as an array of foreign legislation that applies to Canadian firms working here or abroad.
Collusion comes in many forms, from bid rigging amongst ‘competitors’ to tipping confidential information to selected tender contestants. The effect is the loss of open, fair, competitive bids in favour of cronyism, creeping costs and loss of the open market.
Individuals in a position of trust that are obliged to be loyal to another, are subject to duties to protect the beneficiary of the relationship, including the duties to avoid conflicts of interest, keep trade secrets confidential, and fully disclose to the beneficiary all material circumstances that might influence the individual’s decision making. The duty of loyalty is summed up by the stipulation that one must not make a secret profit or secret commission.
Protection and pursuit
Companies can protect against losses due to fraud and collusion through robust anti-corruption/anti-conflict of interest policies, zero tolerance for requests for secret payments, rebates or discounts, and transparency in all material contracts, including audit rights provisions for major sub-contracts and material supply contracts.
If a party has reason to believe that they have been victimized, a targeted civil litigation investigation strategy can be used to obtain necessary court orders to disclose banking and other third-party records. The key is to act quickly and aim carefully in the pursuit of your civil remedies.
This column is provided for general information only and may not be relied upon as legal advice. Send comments to email@example.com.