Did you know the average monetary loss from a typical fraud case in the construction industry is $245,000, which is $90,000 more than the average loss across all industries according to the 2014 Report to the Nations issued by the Association of Certified Fraud Examiners (ACFE.com)? This means that not only construction business owners but those who hire construction companies are at risk for construction-related fraud This type of loss have a significant impact on the bottom line of your business, it can lead to reputational loss as well. Preventing and detecting construction fraud is a necessity for your business. Knowing what to look for and how to protect your company is paramount when dealing with construction fraud risk. Following are the most common construction fraud scenarios along with tips for preventing fraud and the red flags that can alert you that something is amiss.
The Most Common Types of Construction Fraud
The first step in preventing construction fraud is understanding what types of fraud may be involved. Below are the most common types of fraud perpetrated in construction.
- Billing Schemes – Schemes such as false payment applications, billings for work not performed, change order manipulation, payments to non-existent vendors, employees and subcontractors, overpayments to vendors and purchasing personal items with company funds, make up over 35 percent of fraudulent activity within the construction industry, according to the ACFE.
- Theft –Don’t just be on the lookout for big ticket items to disappear. Small items, such as tools, lumber, copper pipe, wiring, and other building materials are hard to trace and easy to remove from job sites so they make easy targets for thieves.
- Bid Rigging and Corruption – According to the ACFE study, almost 47% of construction fraud cases had an element of corruption, usually in the form of bribery, kickbacks or instances of quid pro quo.
Who to watch for…
In addition to knowing the types of construction fraud, it’s important to be able to identify the people who are most likely to become perpetrators. That way, you can stop fraud before it happens. Unfortunately, your employees are the most likely perpetrators, and they may be working with your customers, contractors, subcontractors or suppliers to commit these frauds
Most perpetrators have no prior fraud convictions. Of those ACFE studied, only 5% had a prior fraud-related offense employees who have been with your company for more than one year are more likely to commit fraud than new hires.
While background checks are still useful and necessary to weed out bad employees, but they aren’t a fool-proof defense against fraud.
Watch for Individuals with the following characteristics:
- living beyond their means (unusually expensive houses, cars, recreational
vehicles, trips, amounts of cash) - High Personal Debt
- Wheeler-dealer attitude along with overwhelming desire for personal gain.
- Wants to “beat the system”, challenges authority or rules/laws
- Addictive behaviors such as gambling, drinking, drug use.
- Undue Family or Peer pressure.
Keep a watchful eye out for these red flags:
• Atypical application for payment form
• Missing or disorganized billing backup
• Use of contingency funds without adequate/timely explanation
• Changes in the schedule of values without adequate/timely explanation
• Subcontractor complaints regarding delayed payment
• Missing subcontractor lien waivers
• Unusual bid patterns
• Unsuccessful bidders hired as subcontractors
• Unauthorized changes in time records or missing time records
• Missing weight tickets for debris removal or soil removal
• Use of related parties and subcontractors with common ownership
• Resistance to audit or to providing back up for billings.
• Close relationship between customers, employees, suppliers, subcontractors or
contractors.
Internal controls can prevent fraud and also allows for quick recovery should fraud occur.
- Internal controls can give business owners a sense of security, as they decrease opportunities for fraud. Some of these controls, like proper division of duties, can set a solid foundation for other implemented controls on site and in the office.
Ensure every contract has a right-to-audit clause for the entire scope of the project including fixed fee and time and materials work, change orders, and addendums along with requirements for the audited party to provide supporting documentation such as timesheets, employee data, billing records, and purchasing records for all materials purchased and options for recovery of amounts billed outside of the contract terms. Construction contract compliance audits are your best friend in detecting fraud and overbillings. - Have every contractor on the job site sign in and out. Be sure this includes a requirement for all employees of the contractor.
- Require a list of employees from the contractor including job classifications and rates of pay.
- Check estimates for accuracy. Make sure labor rates, calculations and correspondence with drawings are correct.
- Compare job-cost estimates with actual costs. Review any discrepancies.
- Get quotes from 2 or more vendors for material estimates above a specified amount.
- Make purchases with pre-numbered purchase orders. Match them with invoices and reports before making payments.
- Use specific job numbers, phase codes and work order numbers in any on-site communications.
- Always obtain signatures–either electronic or ink–before work begins.
- Let customers, suppliers, employees, contractors and subcontractors know how they can report something that does not seem right. Fraud is discovered by tips from individuals more than any other detection method. (ACFE.com)
- Have a contract compliance audit done at the end of the project by an individual who specializes in fraud and contract compliance audits. Professionals can determine which suppliers/contractors are the best candidates for an audit and will work with you to strengthen controls to prevent further issues.
Knowing how to keep your business safe and acting proactively is half the battle when it comes to fraud. Please feel free to contact me for more information on how I can partner with you to guard against fraud, to start a Contract Compliance program or Fraud Risk Assessment for your business or if you think you have become a victim of fraud.
Melissa Goddard is a certified fraud examiner and an Oregon Licensed Private Investigator who holds an MBA in Economic Crime and Fraud Management. Melissa is the owner of FACT Financial Investigations, LLC, based in Bend, offers fraud deterrence, detection and investigation services to individuals, corporations and lawyers throughout Central Oregon. Melissa is passionate about her objective to reduce fraud and financial crimes in our Central Oregon communities as well as around the globe and to inform, train and assist those who have been victimized or who are at risk for being victims of fraud and financial crimes. FACT Financial Investigations, LLC also offers notary, bookkeeping and compliance services and will be adding tax resolutions services in the near future.
Melissa Goddard, CFE PI
FACT Financial Investigations, LLC
factfinancialinvestigations@gmail.com
541-241-6250
