Construction contracts are especially vulnerable to fraud. According to a global study from the Association of Certified Fraud Examiners, the median loss in over 40 construction fraud cases was about $245,000. For small or mid-sized companies, that amount is staggering. What’s more, small organizations report more instances of fraud than their larger counterparts. Here’s a look at some types of fraud controls.
Construction involves dealing with multiple vendors, managing large orders, and hiring subcontractors to help with several projects at one time.
With all these moving parts, construction companies are the perfect target for theft, as con artists are well aware of the challenges that come with juggling all of these small details.
With that in mind, business owners, managers, and other leaders must keep a close eye on bad actors, looking out for signs of fraud or unfortunately, employee theft.
Here are some of the most common types of construction fraud, and how to avoid it down the line.
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Materials and Expense Reimbursement Fraud
Construction contractors and employees often bill companies for the materials used to complete a project.
Inflating business expenses usually comes into play when employees claim things like meals and entertainment reimbursement that go beyond your established per diems. Or, they might include things like fictitious expenses for items like gas, food, and accommodations for personal use.
How to watch out for expense and materials fraud
With expense reimbursements, look for original receipts. All expenses must be backed up and match what’s included on the report. Internally, this process is made much easier by adding the right controls into the ordering and purchasing process. All expenses must require approval from a supervisor before a transaction is completed.
Our software, for example, allows you to set tight controls within the system, so if an employee submits an order, it’s automatically routed to a manager with approving privileges.
These added protections make it much easier to stay on top of all orders—big and small—that might slip through the cracks otherwise.
Purchasing Controls to Consider:
- Maintain a travel reimbursement policy
- Require original documentation for all expensed items
- Establish a formal review process
- Conduct expense and purchasing audits on an annual basis
- Order supplies as needed–when there’s an excess of materials, there’s an increased risk of theft
- Process all orders in a digital system rather than paying employees for purchases
Change Order Fraud
Change orders are modifications to the original quote—this might include a change in pricing or revised scope of work. Most established construction companies have a change order process in place. While change orders are not subject to the level of scrutiny you’ll apply during the bidding process or initial vendor review, relevant parties must sign off on the change and document the updated expenses.
Change order fraud is relatively common. Often a corrupt contractor submits fraudulent change orders to increase the price (and pocket the difference), improperly extend a contract, or avoid rebidding.
Red flags include a high number of change orders, a repeated pattern of change orders—changes in scope, billing for additional parts and labor not included in the original contract, or employees repeatedly approving unjustified change orders.
To combat change order fraud, procurement must closely examine contracts. Look for contract changes like new items, extended contracts, increases in the scope or price of project/service, or vague contracts.
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False representation can involve a whole host of instances of misrepresentation—from falsifying contracts, faking compliance with environmental regulations, using undocumented workers, and so on. In short, false representation means you’re getting something that differs from what you’ve paid for.
How to prevent false representation
Obtain written documents that have recorded everything that the subcontractor has claimed you’ll get with the service you’re paying for.
This means contracts, photos, video recordings, expense reports, and the associated receipts, and any copies of any required certifications if you can contact references in advance of kicking off a new relationship that can mitigate the risk of hiring a faker.
This checklist from SBP offers a thorough approach to vetting vendors before awarding the bid. In it, they emphasize the importance of doing your research from background checks to looking closely at proposal details.
Subcontractor collusion takes place when two or more parties join forces to control who wins a bid for a particular project. This specific type of fraud can involve things like bid rigging, price fixing, or allocation schemes. The idea is that the conspiracy results in the pricing to be set higher than it would be if the bidding process were genuinely competitive.
This agreement typically means that some potential bidders refrain from submitting a bid or they might withdraw their submission.
You’ll come across collusion in areas like building construction, road construction, and other large-scale projects. It’s more likely to occur if there are few qualified suppliers in an area and those suppliers know each other well.
There are a few different forms of collusion you often see in the construction industry. One example is complementary bidding, which is designed to look like competitive billing. Instead, fraudsters are working behind the scenes to raise prices and control the outcome.
To prevent subcontractor collusion, ask the right questions during the bidding process, including some that address collusive bidding head on. Look out for bids that appear to be identical or evidence that suppliers are dividing projects by territory or making deals behind the scenes.
Unfortunately, theft can come from within. In this example, a trusted employee, in charge of accounts payable and receivable, set themselves up as a fake vendor. From there, they were able to issue checks in small amounts, to not raise any flags. But, over time, those small deposits eat into profits.
Employees might falsify a bill for work or expenses or work with an outside vendor.
One solution is working with an outside party. A third-party bookkeeper that reviews the bank statements each month can provide some checks and balances that can help companies get ahead of internal fraud. Additionally, you’ll need to keep a close eye on the budget and ordering process.
Again, internal controls over who gets to approve an order, what was ordered, and a small list of trusted vendors can help ensure all relevant parties are operating above board 24/7.
Unfortunately, there are countless ways that you can be defrauded in the construction industry. And with advancing technology, teams need to be ever more diligent as they navigate vendor relationships and suspicious client relations.
While it might be overwhelming to think about becoming a victim of construction fraud, there are several methods to protect yourself.
Internally, keep tight controls over your ordering process, your vendor management process, and your subcontractors. You should always have a clear understanding of where your money is going and what it’s for.