Business

Fraud Finds Its Footing on Construction Jobsites

Given the right conditions, opportunities and motive for fraud can thrive amid the construction landscape. This is how you prevent it.
By Salvatore Schibell
September 7, 2023
Topics
Business

Fraud is an ongoing concern in the construction industry. It's a harsh reality where opportunities and motivations often converge, creating problems in a field that's already fraught with challenges. Contractors face a more frequent occurrence of substantial financial losses compared to nearly all other industries, trailing only behind real estate. As per the Association of Certified Fraud Examiners’ report “Occupational Fraud 2022: A Report to the Nations,” the construction sector reported a median loss of $203,000, surpassing the median loss of $117,000 prevalent in most other industries, except for real estate, where the median loss soared to $435,000.

While the median signifies the midpoint between higher and lower values, exploring the average fraud costs reveals an even more alarming scenario. On a global scale, organizations endure an annual revenue loss of 5% due to fraud. The ACFE's research uncovered that 21% of cases scrutinized reported losses exceeding $1 million, contributing to an overall average loss of $1.8 million per case.

Fortunately, implementing programs for fraud prevention and detection yields a substantial impact. A clear example lies in the contrast between median losses for companies with hotlines—$100,000—and those without—$200,000. Construction companies must take proactive steps to confront fraud, allocating the necessary resources for both prevention and detection. Given the substantial financial consequences of fraud, it is necessary to establish strong internal controls, conduct regular risk assessments and foster a culture that actively promotes reporting.

Anyone Can Commit Fraud

Fraud knows no bounds, spanning from C-suite executives to lower-tier employees, making continuous monitoring necessary. Behavioral indicators of potential fraudsters include living beyond their means, financial distress, unusually close ties to vendors or customers, irritability, intimidation, relationship issues and a wheeler-dealer attitude. 

Anyone from your most trusted employee to the company’s owner can commit fraud if they have the opportunity. Fraudsters typically work in operations (15%), accounting (12%) and sales (11%). Even though less than a quarter of occupational fraud originates from owners and executives (23%), their cases tend to yield higher losses: $337,000 per owner, $125,000 per manager and $50,000 per employee. A mere 6% of perpetrators had prior fraud convictions.

Common Fraud Schemes

Over half of construction-related fraud cases stem from situations involving corruption, bribery, kickbacks, conflicts of interest, collusion, bid rigging and similar practices. The complicated dynamics of construction contracts, coupled with the substantial roles played by regulatory bodies and government officials, amplify the likelihood of corruption. Corruption can lead to increased project expenses, reduced work quality and an erosion of trust within the construction sector.

Bid rigging encompasses various tactics, including bid suppression, complementary bidding, bid rotation and offering assurances of subcontractor participation in exchange for bid coordination. Bidders are often coerced into inflating their bids, adding unreasonable terms or refraining from submitting bids through bribes or threats, creating the illusion of a competitive bidding process.

Billing fraud poses another significant challenge, with 24% of cases involving contractors or suppliers exaggerating invoices or submitting falsified bills. Given the complex nature of construction contracts and the numerous subcontractors and suppliers involved, it is imperative to exercise vigilance when monitoring and validating invoices to prevent fraudulent billing.

Payroll fraud, which also accounts for 24% of construction fraud cases, involves employees receiving payments for work not completed or for hours not worked. Detecting payroll fraud can be difficult; it often involves the falsification of time records, collaboration among colleagues in clocking in or out, the creation of fictitious employees or the manipulation of pay rates.

Fraud Prevention and Detection

Effective strategies for detecting and preventing fraud encompass a spectrum of policies and procedures, ranging from the segregation of financial responsibilities to rigorous background checks. The bolstering of defense mechanisms is further reinforced through the implementation of a whistleblower policy, scrutiny of financial and operational data for irregularities and the strengthening of internal controls.

Key revelations often emerge from various sources, including anonymous tips, internal audits, management reviews, serendipitous discoveries and external audits. Surprisingly, seemingly straightforward measures such as job rotation and unannounced audits have a significant impact on reducing both the median loss and the duration of fraudulent schemes. Nonetheless, their adoption remains somewhat limited.

Construction companies can prevent payroll fraud by implementing measures such as identity verification, multi-level approval for payroll adjustments, electronic timekeeping systems and rigorous monitoring of payroll records.

In the United States and Canada, the most effective method for detecting fraud is through the presence of a tip hotline. According to ACFE's study, 32% of all cases were exposed through anonymous tips. Other effective fraud detection measures include internal audits (18%), management reviews (16%), surveillance, document examination and transaction/data monitoring (each at 5%), as well as external audits (4%). There is a relatively low incidence of either law enforcement (2%) alerting owners or the perpetrator (1%) confessing to committing fraud.

Fraud Prevention Checklist

The ACFE equips contractors with a comprehensive fraud prevention checklist, available in "Occupational Fraud 2022," designed to fortify jobsite security. This tailored checklist empowers contractors to assess the effectiveness of their anti-fraud strategies, focusing on four vital areas: training, reporting, awareness and control.

To foster a culture of vigilance, continuous fraud prevention training should be extended to all individuals involved in jobsite activities, regardless of their roles or employment status—whether subcontractor, permanent or temporary employee. Management should communicate a resolute stance against fraud, ensuring that employees fully comprehend the concept and its far-reaching consequences, including profit loss, negative publicity, potential job insecurity, reduced morale and productivity. It's crucial that employees know the proper channels for reporting suspicions and feel assured that their input is valued, without fear of reprisal.

Clear and accessible reporting methods must be established, including anonymous and confidential tip lines, dedicated email inboxes or web-based forms. This approach should extend to vendors, customers and external parties, ensuring that all stakeholders know how to report fraud.

Vigorous fraud-detection measures are imperative. Immediate action should be taken upon suspicion and reporting of fraud. Surprise audits act as a deterrent, while data analytics and other monitoring techniques help detect fraud. Encourage employees to take periodic breaks from work. Demonstrate a commitment to ethics, gather employee feedback on management integrity, set realistic performance expectations, and ensure the company has established, implemented and tested a robust fraud-oversight process.

In the realm of payroll-fraud prevention, construction companies can implement identity verification, multilevel approval for payroll adjustments, electronic timekeeping systems and rigorous monitoring of payroll records to safeguard against deceptive practices.

The pervasive threat of construction fraud casts a shadow over the industry, impacting not only individual organizations but also the broader public. With its multifaceted manifestations, from bid rigging to payroll deception, construction fraud requires a proactive and multifaceted approach to prevention and detection. Using comprehensive checklists, promoting a culture of vigilance and leveraging whistleblowing policies are essential steps in fortifying the sector's defenses.

The consequences of inaction are far-reaching, encompassing inflated project costs, diminished quality of work and an erosion of trust. By embracing transparency, rigorous internal controls and a commitment to ethical conduct, the construction industry can safeguard its interests and create a more reliable and accountable environment. In this collective effort, stakeholders, regulators and organizations must unite to turn the tide against construction fraud, ensuring a brighter and more trustworthy future for the industry.

by Salvatore Schibell
Salvatore Schibell, CPA, CFP®, CGMA, MS Taxation, MBA, is the tax partner at Lawson, Rescinio, Schibell & Associates, P.C. One of his specialties is working with contractors to maximize profitability utilizing his certified global management, financial planning, and tax planning specialties. Sal is considered a leader in construction accounting and can be contacted at (732) 539-7328 or salschibell@lrscpa.com.

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