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Cracking Down on Project Fraud

9/26/17 – Kerri Richardson & Dan Kraft

Going into a job, every contractor’s objective should be to arrange everything to maximize the chances of turning a healthy profit. But the sad fact is that you can do that and still lose money if just one unscrupulous employee commits fraud. And you can probably imagine the damage of multiple parties conspiring to defraud you.

For this reason, you’ve got to stay cognizant and proactive about how construction project fraud can happen. According to Donald Cressey, the creator of the fraud triangle, all three factors must be present at the same time for an ordinary person to commit fraud: 1) Financial Pressure 2) Rationalization and 3) Opportunity. As an employer you cannot control financial pressure or rationalization. You DO have control over Opportunity. Let’s review some of the most common points of opportunity, how to recognize, and ways to prevent.

Know what everyone’s up to

Historically, the construction industry’s reputation has struggled because of the prevalence of fraud schemes involving kickbacks and bid rigging. These schemes, which are hardly extinct, usually involve payments to employees to secure a bid or, later in the process, get a change order approved.

If your company is suddenly winning bids that you’ve typically had trouble securing, make sure this success isn’t too good to be true. Verify that all of your usual bid processes have been followed and the appropriate documentation is present.
Remember that kickbacks and bid-rig payouts don’t always involve cash. As mentioned, a corrupt employee might be disguising them as change orders. So limit the number of staff members authorized to approve change orders and, if possible, validate each one yourself. Specifically, check to make sure the costs of a given change order weren’t included in the original bid, so you don’t pay multiple times for the same item.

Beyond that, be afraid of ghosts. It’s not unusual for a construction company employee to create a ghost employee whose paycheck is directed to an address or bank account where the fraudster can get to it. An employee could also “punch in” his pal on the time clock when the friend isn’t there to do it himself.

Scrutinize vendor payouts

As materials move from storage locations to projects, bad things can happen. For example, a dishonest employee may order more materials than are necessary for the project. He or she can then report the excess as scrap and sell it — or use it on another, “privately arranged” job. An employee also might steal equipment or report it as broken and then sell it or use it personally.

Another common scheme is for an employee to make duplicate payments to a legitimate supplier for a legitimate invoice related to the project. One check goes to the supplier, but the employee cashes the other check. Sometimes the employee is in collusion with the supplier and they share the duplicate payment. Require several levels of verification to set up a new vendor.

Do your office work

The job site may seem like a natural place to catch project-related fraud. But your office may actually be the better setting for establishing your defenses.

For starters, gather your financial statements and sit down with your CPA to reconcile items such as estimated vs. actual costs for labor, materials and equipment. Consider both the number of hours on the job and the unit rates applied to those hours. Your construction-savvy accountant also can perform regular reconciliations of material requisitions and deliveries, tying them to the estimate for the job and investigating any significant differences.

Next, meet with your HR staff or advisor to perhaps recast some of your job descriptions. For instance, ensure accounting-related duties are properly segregated. Different individuals should be charged with reviewing invoices and issuing payments. Ordering, receiving, delivery and payment duties also should be segregated.

Additionally, run regular background checks, credit worthiness and request current financial statements on subcontractors, suppliers and others involved in your project. Beware of any personal relationships between employees and subcontractors or suppliers. Cross-check your employees’ respective home addresses with those of subcontractors, vendors and co-workers.

Take a positive approach

Above all, create a construction company culture that not only conveys zero tolerance for unethical behavior, but also promotes principled business practices. Although punitive measures are important, so are positive actions demonstrating good behavior.