Schemes, Scams and the Cost of Occupational Fraud

Fraud affects an organization’s bottom line in many ways, and few companies know why it occurs, what to look for or how to stop it.
By Joshua Levy
January 27, 2020

According to the Association of Certified Fraud Examiners’ 2018 Report to the Nations on Occupational Fraud and Abuse, the construction industry is the ninth industry most often impacted by fraud with the fourth-highest in median loss at $227,000. Fraud affects an organization’s bottom line in many ways, and few companies know why it occurs, what to look for or how to stop it. Savvy contractors should recognize the most common types of construction company fraud and adopt strategies for preventing and detecting fraudsters’ misdeeds.

There is a High Cost of Fraud

Five percent of revenue is lost to internal fraud and abuse each year. The median for construction industry is $227,000, significantly higher than the median for all industries of $130,000. There is also the cost of external assistance and the looming potential for higher insurance cots in subsequent years. Additionally, there is the non-monetary loss to reputation and opportunity costs, which can oftentimes be more damaging.

Recovering Funds is the Exception

In 53% of the reported frauds, there was no recovery—money was often gambled away. For 15% of reported frauds where there was a full recovery, the source of recovery was usually an insurance policy.

Insurance Applications Provide Self-Evaluation Check

Look closely at the Management Liability and Cyber Insurance Applications. They not only speak to the different types of coverages available, but also provide an outline of good thoughts to self-evaluate an internal program. Also, make sure that actual business practices track representations on the insurance applications, as inconsistencies could result in coverage denials at the time a claim is made.

“Cybercrime” Combines Two Distinct Insurance Product Lines

Cyber coverage traditionally covers risks with privacy and loss or theft of personally identifiable information, while crime coverage usually covers theft of money and certain property. Policy wording and exclusions are designed to keep one policy line from covering risks intended to be covered by another.

Fidelity Bonds Could be a Useful Insurance Tool

Fidelity Bonds are insurance products which specifically target deceitful acts, not mistakes or oversights. They are commonly designed on a “claims made” basis. There are numerous different types of fidelity bonds—e.g., Business Services Bonds (protects customers from dishonest acts by employees) and Employee Dishonesty Bonds (protects employers from their own employees’ dishonest acts like theft, embezzlement and forgery). Specific costs will vary, but a general guideline is that fidelity bonds typically cost anywhere from .5% to 1% of the coverage amount.

There is no Specific Fraudster Profile, but there are some Perpetrator Characteristics

For good or bad, the United States is not alone in dealing with occupational fraud. According to the Association of Certified Fraud Examiners’ 2018 Global Study on Occupational Fraud and Abuse, data gathered showed occupational fraud occurring in 125 different countries and in 23 different industries. Among the characteristics of perpetrators noted in the study were:

  • a direct correlation between the level of authority and fraud loss;
  • the length of time an employee works for an organization can relate to the likelihood of fraud;
  • the majority of fraudsters were men; and
  • the highest number of fraud acts are committed by those aged 36-45, but the highest dollar amount of loss from fraud acts were committed by those aged 56 or over.

Anti-Fraud Controls for Billing Fraud

Any scheme in which a person causes his or her employer to issue an irregular payment for goods or services (whether through an inflated or false pay application, change order abuse, billing for costs associated with another project, etc.) is billing fraud. Scrutinizing pay applications helps to not only safeguard against errors, but also helps to address potential fraud. The same is true for change orders, which should include appropriate justification. For example, be mindful of numerous, unusual or unexplained change orders for a specific subcontractor, which are approved by the same employee.

Red Flags for Expense Reimbursement Credit Card Schemes

Look for things such as:

  • purchases that do not appear to be business related;
  • original documents supporting expenses are missing;
  • receipts are altered;
  • expenses in round dollar amounts;
  • expenses are just below the receipt submission threshold; and
  • expensive meal expenses lack information as to names/organizations.

Cost-Effective Methods to Help Prevent Fraud

Among the most effective methods to help prevent fraud is to involve numerous employees in the accounting process. Examples include having two staff members review and sign checks over a set amount, and having one employee periodically conduct an independent review of payments to vendors. Also, put in place appropriate segregations of duties.

Hot Lines are the Top Method of Fraud Detection

The ACFE’s 2018 Global Study on Occupational Fraud and Abuse stated that tips from hotlines were the biggest means of fraud detection. More than 40% of all fraud is detected by a tip. Fraud losses are estimated to be 50% smaller for organizations with hotlines than those without.

by Joshua Levy

Joshua Levy is a Partner in the Milwaukee, WI office of the law firm, Husch Blackwell. He is the leader of the firm’s Construction & Design Group and serves as an AAA Arbitrator on the Construction Industry Panel. Josh’s past experience as in-house counsel for a national construction firm has given Josh an in-depth understanding of the concerns of owners, developers, architects and contractors.

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