Business

Trust Is Not a Strategy When It Comes to Finding Fraud

Occupational fraud is more common than you think—especially in construction, where during every job a lot of people interact on a lot of different levels. Protecting yourself means implementing proper internal controls.
By Jennifer Walton
December 4, 2023
Topics
Business

While the punch list to complete a construction project may seem long, the truth of the matter is that the punch list for protecting that project from fraud may be much longer and more complex. According to the Association of Certified Fraud Examiners’ “Occupational Fraud 2022: A Report to the Nations,” real estate and construction experience the first- and fourth-highest median losses, respectively, among all industries—at $435,000 and $203,000.

Even a fraction of that amount will impact your cash flow and possibly your ability to bid on other projects, considering the skilled-labor crunch and the volatile cost of materials. To mitigate your exposure to fraud, you must first recognize what it looks like in the construction industry.

WHAT IS FRAUD?

Some people imagine fraud as an elaborate scheme executed by professional criminals who would never consider your business as a target. However, “Black’s Law Dictionary” defines fraud as “a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment.”

There are a variety of ways that individuals can perpetrate fraud throughout the construction industry. Due to the nature of the work, contractors, trades professionals and vendors interact daily and at a level that can make fraud easier to perpetrate and disguise through missing or manipulated paperwork.

Here are some ways fraud is perpetrated in construction:

1. Falsified payments
2. Bid rigging and/or bribery
3. Skimming
4. Embezzlement
5. Manipulation of payroll records
6. Billing schemes (including billing for personnel on one job when they are actually working and being billed on another project, and/or billing personnel at higher qualification rates)
7. Document manipulation
8. Misappropriation of tools and materials
9. Substituting materials with components of lower quality

Both small and large businesses are at risk for fraud. A large organization could be thought of as a group of smaller organizations—divisions, service lines, etc.—working together to form one large unit. As an enterprise becomes larger and more complex, there are more individuals with access to company resources, creating more opportunities to commit fraud.

ANYONE CAN COMMIT FRAUD

While your team members and colleagues may have great people skills, get the job done right or be well connected in the industry and community, anyone can be tempted to commit fraud under certain pressures and when the right opportunity is presented. So, how can you detect fraud? Since 2008, every ACFE “Report to the Nations” study has found that a perpetrator living beyond their means was the No. 1 behavioral red flag identified by someone at the organization before the fraud was detected. This can even apply to well-compensated leaders.

Here are seven other behavioral red flags you should watch for, according to ACFE:

1. Financial difficulties
2. Unusually close association with a vendor or customer
3. Control issues and/or unwillingness to share duties
4. Irritability, suspiciousness or defensiveness
5. Bullying or intimidation
6. Divorce and/or family problems
7. “Wheeler-dealer” attitude

If you notice such behavior, it could be a sign that you need to monitor and review a team member’s scope of responsibilities.

PROPER INTERNAL CONTROLS

In our experience working with contractors, there can be some hesitation when it comes to implementing proper internal controls to prevent fraud. The arguments against such measures often include “We trust our people” and “If we implement all of these controls, nothing will ever get done at the jobsite.” But over the years we have witnessed firsthand several instances of fraud due to lack of proper internal controls and oversight because the individual was “trusted.”

When helping to prevent fraud in your organization, a proactive approach is necessary. You simply cannot trust team members to do the right thing. It is important to establish a culture that values continual oversight to encourage team members not to risk a scheme. Steps for establishing the right culture include:

1. Create and communicate a company fraud policy.
2. Establish a fraud-reporting mechanism, so employees can report suspicious activities.
3. Conduct regular fraud-awareness training and include that in any onboarding programs for new employees.
4. Conduct background checks.
5. Create and communicate a conflict-of-interest policy.
6. Conduct a regular fraud risk assessment with unannounced surprise testing.
7. Also communicate these policies to subcontractors, vendors and suppliers as a way to inform them and discourage collusive activity.

According to the ACFE’s research, 42% of frauds are detected by tips, which is nearly three times as many instances as the next most common method. Implementing a hotline can be an effective and efficient method to help reduce the magnitude of a loss and the duration of a fraud, should one occur. Indeed, ACFE reports that the median loss for organizations without a hotline is $200,000 occurring over a period of 18 months compared to $100,000 occurring over a period of 12 months for organizations with a hotline.

RECOVERING FROM FRAUD

Fraud can occur even with the right policies and monitoring in place. If you discover a scheme within your organization, you should act immediately to prevent further damage. Follow these steps:

1. Contact your legal counsel for guidance.
2. Document and preserve as much evidence as you can, including digital files, physical office records, public records and the suspect’s social media.
3. When appropriate, hire a forensic accountant or an investigative team to help assess the full scope of the fraud along with the gaps in controls that allowed it to happen.
4. Follow up with conversations with your insurance and regulatory representatives.

It is our experience that fraud is more prevalent than contractors realize because many businesses do not want to admit to being a victim. But there is no shame in being a victim of fraud. There is only shame in not taking all necessary action to prevent it—or, if it happens, recover from it.

This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced professionals at FORVIS, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult a professional before acting on any matter covered in this update.

by Jennifer Walton
Senior Manager, Forvis

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