How to Identify Vendor Fraud and Protect Your Organization

Vendor fraud covers a broad spectrum of schemes. To catch the perpetrators and limit financial damage, you’ll need to understand how they operate, what red flags to look for, and when to consult a fraud professional. 

Vendor fraud schemes can be divided into two groups: 1) fraud committed by vendors acting alone and 2) fraud that involves collusion between vendors and the defrauded organization’s employees. These schemes can be simple, such as when employees invent fictitious vendors and submit bills from the “vendor” to their employer for payment, or they can be complex. For example, a long-time supplier might submit unwarranted charges over many years — sometimes operating with the help of an insider accepting kickbacks. 

Common Vendor Fraud Schemes  

When using a third-party vendor, it is much more challenging to stay vigilant, but potential risks are everywhere. If a fraudster sees an opening or opportunity for fraud, your organization is at risk. It’s crucial to understand what to look out for. The most common types of vendor fraud schemes include:  

Inflated Invoices and Overbilling 

Vendors submit inflated invoices for their goods and services. For instance, the invoice might reflect charges for more goods than the customer received. This type of procurement fraud can significantly impact an organization’s finances.  

Bid Rigging 

Vendors conspire to steer a company’s purchase of goods or services to a specific bidder, undermining the competitive bidding process. 

Price Fixing and Kickbacks 

This is an agreement among competitors to set the same price for goods or services by either jointly establishing a price range or minimum price. In contrast, a kickback is a scheme where employees accept misappropriated funds from vendors to facilitate fraud. 

 How Fraud Trends Are Impacting Organizations 

Surveys show that fraud continues to increase around the world — both in dollar amounts and frequency. According to the Association of Certified Fraud Examiners (ACFE) Occupational Fraud 2024: A Report to the Nations, a typical organization loses 5% of its annual revenue to fraud. Applied to the estimated gross world product, this figure translates to a potential worldwide fraud loss of more than $5 trillion annually, with a reported median fraud loss of $145,000. 

About 22% of the frauds in the report involved losses of at least $1 million, and 75% of the frauds were committed by individuals in one of these eight departments:  

• Accounting 
• Operations 
• Sales 
• Executive/upper management
• Customer service 
• Finance 
• Administrative support 
• Purchasing 

An even more troubling fact is that the typical fraud scheme lasted a median of 18 months before being detected. The longer a fraud goes undetected, the more financial damage it can cause. 

Preventing Vendor Fraud in Your Organization 

The best way to combat the threat of fraud is for your organization to be proactive rather than reactive. Below, we cover a few best practices to consider. 

Educating Employees and Encouraging Tips 

The ACFE report concluded that employee education is the foundation for preventing and detecting vendor fraud. Most fraud schemes are discovered via employee tips. In addition, organizations that provide anti-fraud training for employees experience fewer fraud losses. Organizations should make sure that employees understand what constitutes fraud, how it hurts the entire organization, and how they can report questionable activity. 

Establishing Internal Controls 

In addition to educating employees, organizations can help prevent and detect vendor fraud by establishing internal controls through: 

• Establishing an anonymous fraud hotline for employees and other stakeholders to report irregularities. 

• Establishing and reviewing internal controls duties and functions regularly. 

• Performing background screens on all new hires. 

• Enforcing appropriate segregation of duties and review procedures periodically. 

• Establishing a dual review process for master vendor file management. 

• Performing a vendor validation process that reviews and verifies each vendor’s business name, W-9, tax identification number (TIN), phone number, P.O. Box and street address, bank account, and internal contact or salesperson name. 

Validating Vendors  

Because dishonest employees often set up fake vendors using their personal information, your organization should have a vendor verification process in place to cross-check vendor and employee addresses and tax identification numbers. You should also perform regular vendor file maintenance by removing duplicates and any files for vendors that have gone out of business. Regularly review accounts payable records to identify and prevent duplicate payments. 

Consulting with Forensic Accounting Professionals  

Vendor fraud can cost your organization a significant amount of money and even impact its reputation. Time spent implementing, reviewing, revising, and updating policies and due diligence procedures now is well spent if it prevents a single fraud scheme. 

If you suspect vendor fraud or another scheme, a fraud professional’s involvement is critical. Forensic accountants can investigate suspicions and help you build a case to recover the perpetrator’s ill-gotten gains. They can also help organizations prevent fraud from happening again in the future. EisnerAmper professionals have extensive experience investigating fraud and implementing controls. Contact us below if you have questions about your organization’s fraud risk.