While fraud can be seen in all types of businesses, it is especially prevalent in construction companies due to the nature of the industry. High volume of transactions, large numbers of suppliers and subcontractors, and varying employment levels can open the doorway for fraudulent activities to occur. According to a global fraud study conducted by the Association of Certified Fraud Examiners (“ACFE”), the median loss found in construction fraud cases is approximately $227,000. Furthermore, a greater percentage of small to mid-size companies report incidents of fraud compared to larger companies.
According to the ACFE study, here are some of the most common types of fraudulent activities affecting the construction industry:
- Corruption/Collusion – Collusion between project managers and vendors/subcontractors including kickback schemes, bid rigging at the subcontractor level, conflicts of interest, bribery, etc.
- Billing – Substitution of materials while billing for higher quality, falsification of pay applications and billing for uncompleted work, incorrect labor rates, etc.
- Expense reimbursement – Falsifying invoices for expense reimbursements, inappropriate use of company credit cards and gas cards.
- Noncash misappropriation – Stealing the noncash assets of a company assets such as job site supplies, equipment, scrap metal and other materials, etc.
- Check and payment tampering – Office employees may have the opportunity to write checks to fictitious vendors or collect checks from customers and hide the activity through entries to the general ledger.
Occupational fraud is generally a result of individuals having the opportunity, rationalization, and pressure to commit the acts. While a company may have little to no control over the outside pressures that an individual might have to push them to commit fraud, controlling the opportunity afforded to employees and other third-parties can greatly reduce the likelihood of fraud in your organization. Construction companies should focus on the following in order to reduce likelihood of fraud, and increase the chance of catching fraud if it occurs:
- Establish strong internal controls and enforce them – Ensuring that the in-office internal controls include reasonable and thought out segregation of duties will greatly reduce the risk that an individual will be able to falsify expense reimbursements, manipulate checks/payments or misappropriate cash receipts. Instituting appropriate levels of approvals and oversight for bidding, selection of subcontractors and vendors, change order approval, etc. can reduce the risk of collusion between parties. Appropriate controls over the estimate and pay application process can prevent and detect issues relating to falsification of completed work, inflating labor or material costs, double dipping on billings, etc. Controls can be implemented throughout all areas of the business in order to protect it.
- Conduct regular (and sometimes unannounced) job site visits – Having unexpected visits to job sites can deter unwanted behavior from field employees and can provide valuable information on how a job is performing to compare to pay applications and estimates.
- Perform appropriate due diligence – Setting up a strong prequalification process for subcontractors and other vendors can weed out undesirable companies. In addition, due diligence performed at the appropriate level can help mitigate the risks that can arise with change orders and selection of vendors/subcontractors.
- Set up a System to Receive Anonymous Tips – Majority of fraud is detected via tips that are provided by employees or others that have knowledge of the fraud. Setting up an easy medium for individuals to communicate these tips will allow for a higher likelihood of uncovering ongoing fraud.
Although fraud is a real issue in the construction industry with significant implications, businesses can take proactive steps to prevent fraud before it happens and detect instances of fraud at an early stage in order to manage losses. TeamDKB has experience in such matters. We would be happy to discuss your business further, so we can help set up a strong system of internal controls, to protect you and your unique business needs.
Reference: 2018 ACFE Report to the Nations