11/22/2012 Meeting - Fraud In The Construction Industry


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11/22/2012 Meeting - Fraud In The Construction Industry

  1. 1. P R E S E N T E D B Y : R A C H E L V I L L I C A Ñ A , C F E Construction Industry Fraud
  2. 2. Professional Background  Certified Fraud Examiner  LEED AP; Certified Associate Project Manager  6 years of Industry-Related Experience  President of Radii Consulting  www.radiiconsulting.com  Speaker at UCB 2012 Leadership Symposium: “Entrepreneurship” Panel  MA- Forensic Psychology; UC Berkeley Alumna
  3. 3. I N D U S T R Y B A C K G R O U N D C O M M O N F R A U D S C H E M E S I N T H E I N D U S T R Y F R A U D R I S K S S P E C I F I C T O C O N S T R U C T I O N F R A U D R I S K A S S E S S M E N T S C A R E E R S I N T H E F I E L D Overview
  4. 4. Construction Industry Statistics  Nationwide  Annual Revenue:  $1.731 Trillion  Active Companies:  729,345  Number of Employees:  7,316,240  (April 2012, US Census Bureau)  Statewide  Annual Revenue:  $171.369 Billion*  Active Companies:  72,173 (9.9%)  Number of Employees:  723,978*  *Based on 9.9% rate
  5. 5. Estimated Annual Fraud Loss in Industry  Based on the ACFE‟s 2012 Report to the Nations, CFE‟s nationwide estimate a 5% annual loss in revenue due to fraud.  5% of $1.731 Trillion: $86.55 Billion in potential projected annual losses;  5% of $171.369 Billion: $8.57 Billion in potential projected annual losses in California.
  6. 6. Financial Statement Fraud Timing Differences Unauthorized Expenditures Misclassified Expenditures  Timing Difference Scenario: Harry Johnson of ABC Builders altered the date of transactions to adjust financial statements to ABC‟s advantage.  Tax purposes- lower annual net profit.  Lending/Banking purposes- increase assets; decrease liabilities.
  7. 7. Contract Fraud Defective Pricing Product Substitution  Defective Pricing Scenario: Georgia Sanders from 123 Construction submitted low bids to obtain jobs.  She knew her company would lose money if they performed these projects.  Expected to recover losses through forced change orders.
  8. 8. Investigating the Scenario:  Original contract value was $1,000,000. Final costs to client were billed at $1,500,000, with no significant change of scope.  Review of correspondence with client to determine whether change orders were approved.  Review of project costs- invoices from suppliers, field labor, and overhead charges.  Review contractor‟s financial statements and current credit situation, determine whether there‟s motivation to defraud the client.  Conduct interviews with field foremen- were these additional costs due to significant changes in field conditions/availability of materials.
  9. 9. Bid Rigging Bid Rotation Bid Suppression Complementary Bidding Collusion  Case Study:  At UC Berkeley:  3 mechanical subcontractors have blanket work authorizations  These subs are directly awarded jobs on a rotational, yet bid-based cycle  Subs are known to engage in bid rotation and suppression, since they are all friendly.  However, they want to maintain a positive, long-term relationship with the owner.
  10. 10. Payroll and Labor Fraud Undocumented Employees Ghost Employees Labor Mischarges  Case Study:  John Smith, owner of Construction, Inc., anticipated a large profit from a $1,500,000 contract.  He purchased materials with company funds and sent two employees to perform construction work on his home during weekend hours.  The employees were directed to bill this time to the contract mentioned above.
  11. 11. Financial Statement Fraud- Resources  Utilize in-house software reports  Ex. Quickbooks reports:  “Audit Trail”  “Voided/Deleted Transactions Detail”  Audit tax returns  Corporate returns  Personal returns of shareholders/officers  Review bank and credit card statements  Examine credit account applications  Compare printed copies of financial statement reports  Third Party Information- CPA, Enrolled Agents  Employee Interviews
  12. 12. Contract Fraud- Resources  Project file audits  Compare contract drafts  Research available correspondence  Emails  Voicemails  Employee interviews  Customer interviews  Third party information  Suppliers  Subs  Competitors
  13. 13. Bid Rigging- Resources  Employee Interviews  Third-party interviews  Review bid documentation  Audit original project (bid) file  Research correspondence  Emails  Voicemails  Gather related bids  Subcontractor bids  Competing contractors.  Obtain bid results from public agencies.
  14. 14. Labor Fraud- Resources  Audit employee files  I-9; W-4  Background investigations  Audit payroll summaries  Review cancelled checks  Review Worker‟s Comp insurance reports  Audit insurance files  Compare certified payroll reports against in-house payroll summaries  Employee Interviews
  15. 15. Why Assessing Risk Matters Fraud Prevention  Realize Larger Profit Margins  Maintain Positive Reputation  Maintain Business Relationships  Improve Company Efficiency  Avoid Legal Repercussions
  16. 16. Why Assessing Risk Matters Fraud Detection  Mitigate further losses  Recover some losses  Improve company relations  Problem Solving  Conflict Resolution  Involve law enforcement  Lessen corporate responsibility  Accountability for the blameworthy  Regain control of company
  17. 17. Fraud Risk Assessment Modules (ACFE)  Employee Assessment  Management Assessment  Physical Controls- Deterrence  Skimming Schemes  Cash Larceny  Check Tampering  Cash Register Schemes  Purchasing/Billing Schemes  Payroll Schemes  Expense Schemes  Inventory/Equipment Theft  Theft of Proprietary Info  Corruption  Conflicts of Interest  Fraudulent Financial Reports
  18. 18. Fraud Risk Assessment- Case Study  Fraud Risk Assessment- Assessing whether fraud may be occurring and what vulnerabilities do exist.  Case Study: Orange River Construction Vulnerabilities Shop Keys Key Lockbox- client keys Signature Stamp Checkbook and Drawers Employee Opportunities & Motivations Identified Fraudulent Activities Financial Statement Fraud Undocumented Laborers Defective Pricing Forgery
  19. 19. Skills Utilized Tools and Techniques  Observation Skills  CFE Knowledge  Critical Analysis  Industry Knowledge  Administrative Background  Interpersonal Skills  Basic Computer Forensic Techniques  Interviews  Checklists  Historical Data  Third Party Information  Public Records Assessing Orange River Construction
  20. 20. Orange River: Identified Risks and Frauds  Employee Assessment  Management Assessment  Physical Controls- Deterrence  Skimming Schemes  Cash Larceny  Check Tampering  Cash Register Schemes  Purchasing/Billing Schemes  Payroll Schemes  Expense Schemes  Inventory/Equipment Theft  Theft of Proprietary Info  Corruption  Conflicts of Interest  Fraudulent Financial Reports
  21. 21. Orange River, Specific Examples  Employee Assessment- majority of employees are unhappy at this company.  Management Assessment- President has history of „burned bridges‟, unaccommodating personality.  Physical Controls- lack of security at shop.  Payroll Schemes- overtime not paid to particular employees; ghost employees receiving health insurance.  Conflicts of Interest- President‟s landlord is company‟s tenant and landlord‟s company is contractor‟s subcontractor.  Fraudulent Financial Statements- Timing Differences.  Signs of Contract Fraud- excessive proportion of clients on payment plans due to overbudgets.
  22. 22. Preventive Measures  Know current and pending regulations.  Company policies  Code of Ethics  Fraud Prevention and Detection Policies  Whistleblower Protection Policy  Social modeling- strong values of senior management.  Legal counsel, external advisors (including a CFE).  A) Regular and B) unplanned audits.  Mandatory vacations.
  23. 23. Career Opportunities  Work within the Industry:  Become a Project Risk Management Professional (PMI Certification)  Join a Large Company  Legal Division  Financial Counsel  VP  Join a third-party service company:  Consulting firm  Forensic accounting firm  Construction litigation firm, etc...
  24. 24. Or….Be Your Own Boss  Become an independent consultant:  Your value-added:  Stronger credibility when defending against litigation or criminal accusations.  Higher degree of trustworthiness when banking and lending are involved.  Few industry competitors.
  25. 25. Consulting Tip  Develop relationships  Networking:  Industry Events  Conferences  Chapter Meetings  Board positions on large companies  External advisor for small companies  Volunteer to Lead Workshops  Fraud Risk Awareness Trainings
  26. 26. One More Tip…  Offer (free) Fraud Risk Assessments!  A Fraud Risk Assessment can reveal multiple areas of vulnerability in a construction company.  Offering an Assessment can lead to obtaining a contract to provide risk mitigation services.  These services allow you to better network within the industry:  Provide great service to a general contractor- you may obtain access to its industry network of clients, suppliers, and subcontractors.
  27. 27. Resources  Fraud Examiners Manual- 2011 edition: www.ACFE.com  Managing the Business Risk of Fraud: http://www.acfe.com/uploadedFiles/ACFE_Website/Content /documents/managing-business-risk.pdf  Sample Fraud Risk Assessment from ACFE website: http://www.acfe.com/fraud-risk-assessment.aspx  California Infrastructure Projects- A Guide to Successful Contracting and Dispute Resolution: http://constructionlawyers.com/CM/book/table_of_contents .html  Bid Rigging (from California Contractor magazine): http://www.agc-ca.org/uploadedFiles/Publications- Products/Constructor-Mag-PDFs/March2010.pdf