Contractors face daunting fraud risks

Employee-perpetrated fraud can be devastating: According to the Association of Certified Fraud Examiners’ 2006 Report to the Nation, the median loss for construction companies victimized by employee fraud is $500,000. Of the 19 industries the report profiles, only mining and wholesale trade suffer heavier losses than the construction field.

Who might steal?

Never assume an employee won’t steal from you. Of those who perpetrate fraud and are caught, only 10 percent have criminal backgrounds; most have never received anything more serious than a speeding ticket. The typical “fraudster” is generally a long-term employee who has built trust through years of service to the company and is often the kind of person colleagues go to for advice.

Such employees may be allowed to make unquestioned decisions and often have access to company assets. An alarming finding of the 2006 Report to the Nation shows a direct correlation between fraud loss amounts and the fraudster’s length of employment: Longer lengths of employment equal higher fraud loss amounts. Here are a few types of fraud to keep an eye on.

Bonuses and incentives. Carefully monitor employee bonuses or incentive arrangements. Shifting costs away from projects that start to look less profitable (or even falsifying job profitability reports) can be very tempting for some employees, particularly if their compensation is strongly tied to project profitability. Don’t allow project employees to assign costs to jobs if their compensation depends on meeting project profitability targets.

Kickbacks. Long-term employees often develop friendly relations with materials suppliers and subcontractors. Some project managers may agree to artificially inflate pricing in exchange for gifts or cash under the table. Require project managers to obtain competitive bids for materials or subcontractors for more than a specified amount, then periodically verify bids were obtained. A knowledgeable employee other than the project manager also should review supplier and subcontractor invoices.

Fictitious suppliers and subcontractors. These are common, often in the form of suspicious-looking services. For example, an employee might create fictitious invoices at home for “project consulting” services and submit them for payment to an unsuspecting bookkeeper. Checks are cut and mailed to a post office box (or home address) that the fraud perpetrator controls.

If you are an owner or manager, sign all checks, and review supporting invoices for suspicious suppliers or subcontractors.

Searching for symptoms

Fraud often has symptoms that are noticed long before it’s ultimately uncovered and exposed. Many companies could have uncovered fraud had they noticed the warning signs along the way:

• Employees who refuse to take vacations or are very protective over their work;

• Long delays in receiving regular financial reports or job profitability reports;

• Bank accounts that go unreconciled for several months;

• Employees who begin to work odd hours when fewer co-workers will be around; and

• Employees who improve or maintain their lifestyle despite personal hardships.

There are things you can do to reduce the company’s chances of being victimized by fraud:

Establish an ethical culture. The foundation of fraud prevention is a company culture where ethics and integrity are highly valued. Without it, few other fraud prevention strategies will work.

Use anonymous reporting hotlines. Provide employees, suppliers and subcontractors an anonymous hotline to report fraud and abuse. This has proved to be one of the most effective methods of combating fraud, and a number of companies now offer hotline services.

Separate duties. No single employee should perform every accounting-related duty. Many frauds involve longtime bookkeepers whose work is rarely reviewed or questioned.

Make vacations mandatory. Because fraud is often discovered during an employee’s absence, require employees to take at least one full week of vacation and have another employee perform their duties.

Receive bank statements at home. Owners of smaller companies should consider having company bank statements sent to their home address. Review the statements and ask your accounting staff questions about various transactions. Potential fraudsters are less likely to commit fraud if they believe an owner or manager reviews their activities.

No one strategy is foolproof, but the more fraud prevention elements you introduce into your company, the better your chances are of stopping fraud before it starts.

Jeffrey R. Roberts is a certified fraud examiner and senior managing consultant and member of the forensic and dispute consulting division of BKD LLP. He can be reached at jroberts@bkd.com. [[In-content Ad]]