Occupational Fraud Prevention in Construction

There is a saying in the construction litigation arena that “no one has clean hands,” meaning that rarely is one party completely at fault in a dispute. The same can often be said for fraud in the construction industry. Although the perpetrators of fraud are always completely responsible for their actions, contractors often open the door to fraudsters by not taking the basic steps necessary to protect themselves. What are these basic steps?

Contractors need to protect themselves from the same occupational frauds as any other business, including for example:

• Billing schemes, where employees submit and process fictitious invoices from accomplice vendors or through their own shell companies;
• Payroll schemes, where ghost employees are set up in the payroll system, terminated employees stay on the payroll or employees claim overtime hours not actually worked; 
• Bidding schemes, where an employee colludes with a subcontractor or material provider to inflate bids and/or control who wins a bid; or
• Expense reimbursement schemes, where an employee submits a request for reimbursement for fictitious or inflated business expenses.

However, due to the nature of the industry, construction contractors are more susceptible to these frauds than other businesses. The construction industry is highly competitive and very risky, and margins can be small. These conditions often lead to small back office staffs and inadequate cost accounting and reporting systems. Compounding these problems is the distributed nature of contracting. Very often labor cost recording and entry, as well as purchasing, takes place at the project site where controls are typically weaker than at the home office. Even in large contracting organizations, the ability to control multiple projects in multiple locations is a challenge.

When contractors do not adequately address these challenges, they leave the door open for employees to commit fraud. So how do you start closing the door? Make sure your employees know that someone is paying attention. The owner(s) of smaller contractors should consider the following type of actions.

• Receiving the business bank statements at home and reviewing the cancelled check images to see which vendors are being paid and how much. If you do not recognize a vendor or an amount, go ask your accounts payable person and/or foreman about the vendor or the charge.
• Assuring that bank reconciliations are done every month by someone who is not involved with purchasing or paying vendors and reviewing the bank reconciliations to make sure they are done timely.
• Reviewing subcontractor invoices periodically for reasonableness and questioning your foreman about the subcontractors work and/or charges.
• Reviewing employee expense reports on a regular basis and questioning items periodically.

None of these actions have a dollar cost, but they all let your employees know that you are paying attention. 

Larger contractors with more complex operations may not be able to rely solely on the no cost actions above, but that does not mean complex and expensive actions are required. Making employees aware that the company is watching can be accomplished with a focused approach to identifying and addressing risk. Options to consider include the following activities.

• Having a fraud risk assessment performed of both the home office and a typical field office. A proper fraud risk assessment will evaluate which fraud schemes your company is most vulnerable to given your existing internal control environment and staffing structure. Based on the findings of the fraud risk assessment, enhance controls and reporting to address the identified fraud risks. 
• Implementing an ethics policy that establishes how the company expects its employees to conduct themselves relative to the company, customers and vendors. Train employees every 2 years on the ethics policy and on how to recognize and report fraud. Have employees sign an annual certification that they will comply with the ethics policy.
• Establishing and monitoring a hotline for employees and vendors to report suspected fraud.
• Expanding vendor due diligence activities to assure the ownership of subcontractors and material suppliers is identified.
• Performing periodic cross contract and trend analysis of subcontractor and material costs per unit to identify cost anomalies for investigation.
• Requiring monthly detailed cost reporting from project managers addressing, at a minimum, progress against schedule, cost against budget, explanations of variances, and upcoming schedule and cost challenges.

Finally, owners of both small and large contractors need to be aware of and watch for the red flags associated with occupational fraud. A simple search on the internet will provide long lists of fraud red flags, but most of them can be addressed by observing the people who work for you. Watch for employees who:

• Have unusual relationships with vendors;
• Will not follow the rules;
• Exhibit marked behavior changes;
• Appear to live beyond their means;
• Are dealing with personal or family financial, medical or substance abuse problems; or
• Are constantly complaining.

Occupational fraud prevention is mostly about convincing employees that the company is watching. By increasing employees’ perception of detection, they are much less likely to attempt a fraud in the first place. 

FRAUD WEEK ARTICLES

• Preventative and Detective Fraud Controls in Accounting Software
• Fraud in the Workplace
• Do You Know Your Employee
• Important Considerations when Conducting an Effective Fraud Risk Assessment
• Expense Reimbursement Fraud
• Recognizing Vendor Fraud
• Occupational Fraud Prevention in Construction
• Excess Benefit Transactions and Their Impact on Not-for-Profit
• Health Care Fraud 
• Ponzi Schemes
• Occupational Fraud and Abuse Statistics