Construction Audit Fraud

Presented by: Denise Cicchella, Director

Altran Control Solutions

November 3, 2009

ACFE - Charlotte, NC

Director, Altran Control Solutions International - Construction Audit Practice

Author:

• IIA Handbook Series: Construction Audit Guide: Overview, Monitoring and Auditing

• Essentials of Construction Management (co-author)

IIA Speaker/Instructor

(201) 835-4069

Denise Cicchella, MBA, CIA, CFE, CCA

© Altran Control Solutions', October 2009

Construction Life Cycle

CO

Finishing

Site Work

Foundation

Site Preparation

Demolition

Types of Contracts

Lump SumGMAX

(Guaranteed Max)

Design-Build

Cost Plus Percentage of Completion

Lump Sum

One price (by trade) to encompass all costs and to complete the project as specified.

Great in theory but there are frequently too many unknowns. Contractors’ protection = change orders, owner’s protection = change management controls

Other names

Stipulated Sum

Fixed Price

May or may not include “General Conditions’

Cost Plus

Similar to having work done with a mechanic.

Parts = Material Equipment and Labor

Percentage for other costs – called “Overhead and Profit” or general and administrative (G&A).

Also called Time and Material

No incentive to reduce cost – more costs means more G&A.

More Cost=More G&A

Project Cost 2 Million with 4% G&A

• $2,000,000 * .04 = $80,000

Project Cost 3 Million with 4% G&A

• $3,000,000 * .04 = $120,000

Is the difference really labor and other costs or is it overinflated buying?

GMAX

Cost plus with a limit on spending.

Cost is capped at a MAX called an upset price or price cap.

May be capped by individual trade or total project cost.

Creates a use it or lose it scenario, charge costs to Max.

Savings Incentive may be included in contract. (False control). [Only known to be have done once at WSU]

Savings Incentive ClausePromise to share in any amounts “under budget”

• 60% Owner

• 40% Construction Manager

Assume under budget by $1,000,000

• Which would you rather?

• $1,000,000 or $400,000

• Contractors choose to “try” the fraud and if they get caught claim it was nothing more then an error.

Design – Build

Also called turnkey

Less bidding as the contractor and builder are one in the same.

Maximum acceptance cost is given at bidding.

Builder is the designer and the owner has little say in what goes in.

Reduces the number of cooks stirring the pot, but do you have the right chef?

Gated community homes usually are design-build.

Franchises are generally design-build.

Percentage of Completion

Payment is made based on lump sum ibut apportioned based on “amount completed”.

Difficult to define percentage of completion

Even more difficult to calculate.

Is it by trade or by entire project?

Includes an estimate of included materials.

True Up full completed projects.

The Fraud Triangle

Motive

OpportunityRationalizationHow Can I?How Can I?Why Should I?Why Should I?

Why Me?Why Me?

Rationalization

Why would the contractor thinks he deserves to commit fraud?

He lowered prices as a “favor”.

With all the money going out no one would miss it anyway.

Payment on invoices has been slow so – this is payback.

He knows that the project is so time sensitive that even if he gets caught he will not lose the project.

Opportunity

Why can the contractor conceal his fraud?

No one reviews invoices.

Rubber stamping (Radar O’Reilly principle).

Too much paperwork.

Reviewer does not understand construction like the contractor does. (Mechanic’s theory).

Everything is done with an air of haste.

Bills are not audited.

He has gotten away with it before.

Motivation

What would motivate a contractor to commit fraud?

Need it to meet capital demands.

Declining trends in construction.

Low balling original bid to win job.

When to conduct a Construction Audit

During After

Time

Fix ongoing problems

Implement controls

Not getting in the way

Safety – location

Get to the contractor before he is gone

More effective

Memory recall

Right to Audit Clause may expire

Concentrate risks when you can see the overall picture

Quicker

More efficient

When to conduct a Construction Audit

NOW!!!

Benefits of Early Intervention

MULTI DISCIPLINED APPROACH

Conventional Audit Skills

Knowledge of Construction and

Construction Terms

Ability to read and understand contract

languageData Analytics

SOME THOUGHTS

During the Big Dig in Boston claims had to be forfeited when it was discovered because no one tested to ensure that insurance policies paid for were actually inactive. Amount lost $80 million.

A recent audit revealed that equipment rates were off by nominal amounts, amortized over the whole project this amounted to $800,000.00

A project was recently reported to the press, a loss of $27,000 was incurred because no one ensured that prevailing wages were being paid.

In a recent audit we tested conversion rates between the GC in Japan and the Client in the US. An agreed upon rate was contracted for and not used. It took us 40 minutes to recover $1.8 million.

DC

Performing a Site Walk Through

Supervised - Are workers properly supervised.

Idle – Are workers or equipment sitting there with nothing to do.

Recognize – do you recognize workers from the last walk-through.

Check for obvious safety violations.

Look for risks to your client.

Organized – Does the site and the workers appear to be flowing.

Count the number of employees to use later when verifying payroll for the period of your visit.

Kept – Is the site kept clean and broom swept?

Audit Costs Summary

RADIO TestR – REIMBURSABLEA – ACCURATED – DOCUMENTEDI – INCURREDO - ORDER

Auditing Lump Sum

Change Orders

Substitution

Permitting

Insurance

Correct Price

Everything New?

Auditing Cost Plus

Hours

Overtime

Rates

Supervision

Employees

Cost Plus

Rates for blueprints / copies

Travel Expenses

Audit charges from subs

Audit payroll taxes

Audit applied rates for G&A or profit.

Audit labor burden

Auditing GMAX

Costs

Rebates

Allocations

Max

Scrap

Contract Incentives

If the contract has incentives or damages consider these in your audit:

Cost Incentive (coming in less then GMP)

Quality Incentive

Delivery Incentive

Time Incentive

Safety Incentive

Target Price

These same incentives may also be damages.

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About 10% of all project costs are fraudulent. The National Audit Office in the UK states that this can climb as high as 20%!

FRAUD!

Project Costs Wasted on Fraud

5–10 % of all Time & Material project costs are due to fraud, error, or mistakes.

The 2008 Association of Certified Fraud Examiners (ACFE) “Report to the Nation on Occupational Fraud & Abuse” says that construction ranks as the fifth highest industry in median losses per scheme, with a median loss per scheme of $330,000.

Think About This……

Cost of Fraud

$$+

Safety

Rep

Employees

Punitive

Common Areas of Fraud and Abuse

Pre –Bid Schemes

Corruption

Kickbacks

Bribes

Conflicts of Interest

Fraudulent Bonds

Post-Bid Schemes

Collusion

Signature Fraud

Unbalanced Bidding

Exclusion of Qualified Bidders

Leaking Bid Data

Unjustified Sole Source Awards

Change Order Abuse

Co-Mingling Contracts

Unpaid or Fraudulent Insurance

Contract Fraud

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What is a contract?

Five Elements

1. Competent Parties

2. Lawful Subject Matter

3. Legal Consideration

4. Mutual Promises

5. Mutual Obligations

Other Considerations

• Legally Enfoceable

• Oral or Written

• Certain and Definite Terms

• Revocable

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Corruption

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Do Vendors pay to play?

Vendor Due Diligence

How long have they been in business?

How many other jobs are they currently involved in?

Do references believe that they can provide a quality service or material?

Have they worked with you before?

Were they successful in the work they did for you?

What does Dunn and Bradstreet, Hoover’s, or Kroll say?

Are they subject to any pending litigation?

When was the last time they were asked to bid for your services? How did their prices vary after the last bid?

Are they related to anyone in your company!

Bribes and Kickbacks

The giving or receiving of a “thing of value” to influence a business decision or official act.

Takes Multiple Forms

• Refunds after the fact

• “Facility Tours”

• Gifts

• Service Favors

• Loans

Conflicts of Interest

A person with procurement decision making ability has an undisclosed (financial) relationship in the recipient of the contract or bid.

• Title or ownership of acquired property.

• Stock Ownership

• Employment offers or prior employer – Are they still “on the payroll?”

Bribes, Kickbacks and Conflicts of Interest

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Unusually high prices

Price Increases

Purchases above and beyond

Repeated use of the same supplier

Acceptance of poor performance

Close relationships with vendors

High commissions

Reputation or debarrment

Procurement official living beyond means

Use of liaisons or middleman

Change orders unusually high or for “normal reasons”

Failure to disclose key information about key stakeholers

Public Records search shows financial interest with high level or procurement. personnel

Red Flags

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Fraudulent Bonds

Surety bonds have consecutive numbers.

Surety bond outdated

Surety bond offered by same sureties

Sureties of unknown or poor reputation

Collusion

Bid Rotation

Purpose submission of high bids to allow a lower bidder to win, at inflated price – share in profits.

Pay off of “new” bidders

Hiring losing bidders as subcontractors

Similar bids

Fraudulent Bonds and Collusion,

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Labor Fraud

Unlicensed Workers

Ghosts on the Payroll

Unauthorized Workers

Time Miscalculations

Unauthorized Rate Changes

Up-billing

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Undocumented

Not on site

Worked less time

Wrong Rate

Ghosts

PAYROLL ISSUES - A GHOST STORY

Employees working 32 hours a day

100 hours @125 per hour = $12,500

Father and Son had birth years 3 years apart, led to discovery of people on payroll not paid

65 hours @ $60 per hour = $3,900

So many people, so little space = $120,000

GHOST STORY II

150 workers working on a day the site was closed. Because site was closed they were paid overtime.

$27,000

Workers working multiple projects simultaneously

$320,000

Employee paid more on paper then on paychecks

$190,000

EVEN MORE GHOSTS

Everyone’s marital status on Payroll registers were “single’s” despite their age category

Unwillingness to open their books for Audit

Up-billing

• Charging a journey as a foreman.• Charging full cost for an apprentice.• May not necessarily just be construction workers:

• Project Managers• Should be done by clerical • Clerical Costs covered in G&A

Evidence of Up-billing

• Unusual overtime charges.• Tasks that seem to take too

long to complete.• Workers working more then

usual shifts.• Workers whose “titles”

keep changing.• Workers on certified payroll

twice with different titles.• Workers paid multiple

rates.• Incorrect math on payroll.

Testing for Up-billing

• Obtain a copy of certified payroll report.• Categorize payroll by employee and include:

• Employee name• Social Security Number• Rate of Pay• Time Card

• Verify information to personnel records on file with the general contractor.

• Interview personnel:• Obtain title• Obtain Job description

• Compare to registered job records.• Compare payroll to actual time cards.

Equipment Fraud

Personal Use

Free Parking Pilfer Piece by

Piece

No operator

Material Fraud

Unauthorized Material

Substitute Material

New vs. Like New

Invoicing

Price Extensions

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Replacement Material

Three Screwson a square!

Replacements

Contract Invoice

Behind the Wall Shortcuts

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Invoicing

Invoicing for material not used

Invoicing/Ordering material for other projects

Back Dated Invoices

Invoicing for material that was returned

Reporting theft of material when no such loss incurred.

Time Schemes

Unauthorized Delay

Phantom Weather

Change order to escape liquidated damages

Intentional Failure to recover on liquidated damages

Charging for work performed on Holidays or Unauthorized OT

Ordering OT for work that should be completed in normal course of business

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Change Order Management

Work then approve

Rate Changes

Site Conditions

Time Quotes

Work then Approve

Log and Monitor

Trends by Contractor/Subcontractor

Fake

Over

RepeatOut OfScope

Stated

Billing Fraud

Duplicate Billings

Investigating Duplicate Billings

• Obtain copies of invoices and cancelled check showing proof of payment.

• Contact vendor and request copy of accounts receivable ledger for contractor.

• Interview personnel responsible for preparing monthly invoice.

• Interview project manager or general contractor who certified or did initial due diligence on the invoice.

Evidence of Duplicate Billings

• Invoice Numbers out of sequence

• Date of invoice out of order for construction done

• Invoice date inconsistent with the rest of the invoices.

• The invoice seems familiar

• An analysis of invoice numbers indicates that duplicate numbers.

• Invoice numbers are “backwards”

Invoices Out of Order:

During an audit of a construction project, I was presented with a slew of invoices for painting, amounting to almost 75% of the cost of painting indicated during billing. According to the monthly invoice only 20% of masonry (walls) had been completed.

Evidence of Fictitious Vendors/Bills

Testing for Fictitious Vendors/Bills

• Testing EIN• Verify again consumer databases• Run against Hoover’s, Dunn and Bradstreet, or Accurint or other vendor databases

available.• Interview Accounts Payable Clerk at General Contractor• Send certification letter to vendor on address given on invoice.

• Testing Website• Visit website and verify that they sell goods and services indicated on the invoices.• Search for company using Bing, Google, and Ask. Note any “headlines” found during

your searches.• Check local yellow pages to ensure existence of company.• Call company using number supplied on the invoice.

Operator Fraud

A little boy was attending his first wedding. After the service, his cousin asked him, "How many women can a man marry?" "Sixteen," the boy responded.  His cousin was amazed that he had an answer so quickly.  "How do you know that?“"Easy," the little boy said. "All  you have to do is add it up, like the Bishop said: 4  better, 4 worse, 4 richer, 4 poorer"

It’s all in the Math….

Time and Expense Fraud

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Expense Not justified for work performed.

Excessive/Elaborate expenses

Meals with Owners

Invoices not consistent with expenses submitted.

Contractors know the cost of Fraud!

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