Contract Performance Fraud

Contract Performance Fraud
February 2016
Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA
314.983.1238
rsteinkamp@bswLLP.com

Elements of a Contract
Methods of Procurement
Procurement Phases
Contract Performance Fraud Schemes
Red Flags
Preventing Contract Performance Fraud
Detecting Contract Performance Fraud
© 2016 All Rights Reserved Brown
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Table of Contents

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A contract is a mutual oral or written agreement
between two or more parties that must contain the
following elements:
– Competent parties
– Lawful subject matter or objective
– Mutual consent
– Legal consideration
– Form permitted by law
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• Competitive bidding using sealed bids.
• Contracting by negotiation:
– Competitive negotiation.
– Sole-source contracting.
• Simplified acquisition procedures:
– Charge accounts.
– Purchase cards.
– Purchase orders.
– Petty cash funds.
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Procurement Phases

• Identify needs.
• Develop bid specifications.
• Determine method of procurement.
• Develop criteria to award the contract.
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Pre-solicitation Phase

• Prepare solicitation document (RFI, RFQ, RFP, etc.).
• Provide notice of solicitation.
• Issue solicitation document.
• Receive bids and proposals.
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Solicitation Phase

• Evaluates bids/proposals.
• May conduct discussions/negotiations.
• May provide opportunity to revise bids/proposals.
• Select winning bid/proposal.
• Execute contract and terms.
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Bid Evaluation & Award Phase

• Performance of contractual obligations.
• Contract modifications/change orders.
• Review of completed portions and release of funds.
• Assessment of deliverables for compliance with
contracts terms and quality.
Post Award & Administration Phase

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Contract Performance
Fraud Schemes

• Non-conforming goods or services.
• Change order abuse.
• Cost mischarging.
Performance Fraud Schemes

• Contractor knowingly delivers goods or services that do not conform to the
underlying contract specifications and bills and receives payment without
informing purchaser of the deficiency.
• Examples:
– Delivering/using products/materials or lesser quality than specified in contract.
– Substituting products/items different than what is specified in the contract.
– Delivering/using using lower quality staff than specified in the contract.
– Delivering/using counterfeit, defective, reworked, or used parts.
– Delivering/using materials that have not been tested.
– Falsifying the test results of materials, products, or goods.
– Making false certifications for example:
• New materials
• Domestically manufactured.
• Meet contract specifications concerning quality or quantity
• Company minority owned
Non-Conforming Goods or Services

• Contractor submits a low bid to ensure they win the contract, but increases the
price with subsequent change orders.
–OR-
• Contractor uses change order process to improperly extend or expand contracts
and avoid rebidding.
• Usually involves collusion with employee.
• Change orders receive less scrutiny than the original bid selection process, making
them a popular way to fraudulently access funds or generate funds for kickbacks.
Change Order Abuse

• Contractor charges the procuring entity for costs (material and labor) that are not
allowable, not reasonable, or cannot be allocated to the contract.
• Three types:
– Accounting Mischarge: Contractor knowingly charges unallowable costs to the buyer, concealing or
misrepresenting them as allowable costs, or hiding them in accounts that are not closely
monitored/audited.
– Material Mischarge: Contractor charges higher price for materials than agreed or substitutes inferior
materials.
– Labor Mischarge: Contractor charges for work that was not actually performed or overcharges for
labor.
Cost Mischarging

• Examples:
– Charging the same cost to more than one contract.
– Charging non-existent costs or costs at inflated amounts.
– Charging unallowable costs (e.g. entertainment, advertising, etc.) to the contract.
– Charging costs to the wrong cost category or contract.
– Failing to disclose discounts and credits.
– Using outdated standard costs.
– Colluding with contractors directly to charge high process and rebating part of the price
increase without disclosure.
– Using phantom suppliers to inflate costs.
– Falsifying support documentation.
Cost Mischarging (Cont.)

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Red Flags

• High percentage of returns for noncompliance with specifications.
• Product compliance certificate missing or appears altered or modified.
• Compliance certificates signed by low-level employee with no quality assurance
responsibilities.
• Materials testing done by supplier.
• Evidence that tests or inspection results were falsified.
• Highest profit product lines have highest number of returns or reshipments.
• Discrepancy between product description and appearance.
• Offers by contractors to select the sample and prepare it for testing.
• Delivery of look-alike goods.
• Unusually high number of early replacements.
• Contractor restricts or avoids inspections of goods or services upon delivery.
Non-Conforming Goods or Services

• Poor contractor internal controls over determining the need for change orders.
• Procurement employee acts outside normal scope of duties.
• Numerous change orders justified on a variety of grounds, for example:
– Change in prices.
– Inflation.
– Unavailability of specific materials/equipment.
– Need to substitute more expensive alternatives.
• Employee of procuring entity approves numerous unexplained or unjustified
change orders for same contractor.
• Repeated pattern of change orders that increases price, scope, or period of
agreement.
• Questionable, undocumented, or frequent change orders awarded to a particular
contractor.
• After contract award, bid specifications that lack detail are clarified through
change order.
Change Order Abuse

• Poorly drafted requests for change orders.
• Pattern of change orders just below threshold limit.
• Employee of procuring entity that is directly involved in both determining
requirements and procuring the item.
• Period of agreement extended by change order instead of re-bidding.
Change Order Abuse (Cont.)

• Contractor refuses, delays, or is unable to provide complete supporting data.
• Contractor’s supporting data is missing or unavailable for review.
• Contractor’s supporting documents are of poor quality.
• Contractor provides different supporting documents for the same item and unit
prices vary widely.
• Evidence of falsifications or alterations to supporting data.
• Contractor fails to submit cost data that is current, accurate, and complete.
• Contractor fails to disclose internal documents on vendor discounts.
• Cost estimates are not consistent with contractor’s prices.
• Repeated non-compliance with the contractor’s disclosed bidding or estimating
practices.
• Old, outdated standards used to support proposals.
• Contractor fails to disclose information regarding significant cost issues that will
reduce proposal costs.
Cost Mischarging Abuse

• Contractor uses unqualified personnel to develop cost or pricing data used in the
estimating process.
• Contractor uses vendors or subcontractors other than those listed in the proposal.
• Contractor repeatedly fails to comply with their disclosed bidding/estimating
practices.
Cost Mischarging Abuse (Cont.)

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Preventing Contract
Performance Fraud

A program designed to prevent and detect contract
procurement fraud should include the following
elements:
– Employee Education
– Internal Controls
– Monitoring Activities
– Vendor Due Diligence
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Elements of Fraud Prevention

Organizations should:
– Educate employees about procurement fraud.
– Focus education efforts on employees in best
position to identify vulnerabilities or red flags.
Employee Education

Key internal controls include:
– Documented policies and procedures.
– Selection committees and criteria.
– Segregation of duties.
– Supervisory controls.
– Receiving controls.
– Authorization/approval controls.
– Reconciliation controls.
– Recording controls.
Internal Controls

Implement programs to measure the performance of
procurement activities:
– Continuous monitoring using data analytics.
– Regular internal audits.
Monitoring Activities

A vendor due diligence program should include:
– Vendor background checks.
– Controls for vendor master file management.
– Vendor monitoring.
Vendor Due Diligence

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Detecting Contract
Performance Fraud

• Examine the following documents for red flags:
– Contract or purchase order specifications.
– Contractor’s statements, claims, invoices and supporting documents.
– Received products.
– Test and inspection results.
• Review correspondence and contract files for indications of non-compliance.
• Request assistance from outside technical experts to conduct after the fact tests.
• Inspect or test questioned goods or materials.
• Segregate and identify the source of suspect goods and materials.
• Review inspection reports to determine whether the work performed and
materials used were inspected and considered acceptable.
• Review the contractor’s books, payroll, and expense records to see if they incurred
necessary costs to comply with contract specifications.
• Review the inspection and testing reports of questioned goods/materials.
Non-Conforming Goods Or Services

• Conduct routine and unannounced inspections and tests of goods/materials.
• Examine the contractor’s books and manufacturing or purchase records for
discrepancies between claimed and actual costs, contractors, etc.
• Interview procurement personnel about the presence of any red flags or other
indications of noncompliance.
• Search and review external records (e.g. court records, prior complaints, audit
reports, investigative reports, media sources, etc.) to determine if history of
misconduct.
Non-Conforming Goods Or Services (Cont.)

• Examine change orders that add new items.
• Examine change orders that increase scope, quantity, or price of contract.
• Analyze change orders for red flags.
• Interview complaining contractors, unsuccessful bidders, and procurement
personnel about the presence of red flags.
misconduct.
Change Order Abuse

• Examine contract , material and labor cost files for red flags.
• Review for unallowable costs.
• Examine material cost transfers.
• Examine contract charges to determine if materials properly charged to the job.
• Examine materials ordered and charged in excess of contract requirements.
• Compare material and labor costs over a specific period to identify any unusual
changes and determine reason for the change.
• Review standard vs. actual material and labor costs to determine any variances.
• Investigate contractor to determine ownership and search for signs of corruption.
• Scan the general ledger for unusual adjusting entries.
• Review audit reports, reimbursement requests, construction reports, etc.
• Examine time cards and hours expended on the contract and compare to hours
billed.
Cost Mischarging

• Conduct site visits to verify labor.
• Compare direct and indirect labor account totals between years and investigate
significant changes.
• Analyze labor charges to determine any shifts in charging patterns.
• Prepare a schedule of salary/wage changes and compare to rates at contract
award date.
• Look for terminated employees charged to contract.
• Compare employee personnel records to contract position qualification
requirements.
misconduct.
Cost Mischarging (Cont.)

Questions?

Ron Steinkamp
rsteinkamp@bswLLP.com
314-983-1238
37
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