The Punch List for Construction Fraud

While the punch list to complete a project may seem long, the truth of the matter is that your punch list for protecting your construction enterprise from fraud is much longer and complex. According to the Association of Certified Fraud Examiners’ 2020 Report to the Nations, the median loss due to fraud in the construction and real estate industries is $200,000 and $254,000, respectively.

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Even a fraction of that amount will impact your cash flow and possibly your ability to bid on other projects with the industry’s labor crunch and the rising cost of materials. You must first recognize what fraud looks like in the construction industry to mitigate your exposure to it.

What Is Fraud?

Some people imagine fraud as an elaborate scheme executed by professional criminals that would never consider your business as a target. However, fraud is defined as “a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment.”[1] There are a variety of ways that individuals can perpetrate fraud throughout the construction industry. Due to the nature of the construction industry, there are a number of construction vendors, contractors, and employees interacting daily. The level of interaction across various parties can make fraud easier to perpetrate and disguise through missing or manipulated paperwork.

Here are some ways fraud is perpetrated in the construction industry:

  • Falsified payments
  • Bid rigging and/or bribery
  • Skimming
  • Embezzlement
  • Manipulation of payroll records
  • Billing schemes – These can include 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
  • Document manipulation
  • Misappropriation of tools and materials
  • Substituting materials with components of lower quality

Businesses both small and large are at risk for fraud. A large organization could be thought of as a group of smaller organizations (i.e. 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 in Your Organization Can Commit Fraud

While your team members and colleagues may have great people skills, get the job done right, or are 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 we help detect fraud? Since 2008, every ACFE Report to the Nations study has found that the perpetrator living beyond his or her means was the number one behavioral red flag identified by someone at the organization before the fraud was detected. This can even apply to well-compensated leaders. If you notice such behavior, it could be a sign that you need to monitor and review that team member’s scope of responsibilities. Here are some other behavioral red flags you should watch for:

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Trust Is Not an Internal Control

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:

  • Create and communicate a company fraud policy
  • Establish a fraud reporting mechanism so that co-workers can report suspicious activities
  • Conduct regular fraud awareness training and include in any onboarding activities for new employees
  • Background checks
  • Create and communicate a conflict-of-interest policy
  • Conduct a regular fraud risk assessment with unannounced, surprise testing

You can also communicate these policies to subcontractors, vendors, and suppliers as a way to inform them and discourage collusive activity.

Recovering from Fraud

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

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

DHG’s Construction team can help you safeguard your organization from the consequences of fraud. Our multidisciplinary team of professionals serves the construction industry and partners that insight with our advisory services professionals to help you conduct a fraud risk assessment, design and implement robust internal controls and, in the event fraud has occurred, conduct an investigation. Our collaboration integrates assurance, tax and advisory experience and tailors those insights to the specific needs of your business so you can continue to grow.

References:

  • 2020 Report to the Nations. Copyright 2020 by the Association of Certified Fraud Examiners, Inc.
  • [1] Black’s Law Dictionary (9th Ed. 2013)

ABOUT THE AUTHORS

Jennifer Walton
Manager
Jennifer.Walton@dhg.com

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