By: Stephen Crowe


A high-risk fraud environment is typified by heightened pressure and opportunity. When these factors are considered on an industry basis, the Construction sector rates highly, particularly in the procurement cycle. From award to execution, employees and external parties (agents, suppliers, and competitors) have significant opportunities to commit procurement fraud.

In the Middle East, these risks are heightened by region-wide growth, an influx of government funded infrastructure projects, and the prevalence of cash dealings.

The absence of properly structured and executed fraud controls in high margin construction projects acts as a vacuum into which fraud opportunity, and persons susceptible to the temptations that these opportunities present, are drawn together. In the below case studies, you will see that the simplest of controls would have prevented the fraud, or at the very least detected it much earlier.

 

Case Study #1

“A major power plant project was victim to a significant fraud comprising of a number of managers who received large cash payments and gifts from colluding vendors to award lucrative supply contracts. Some of these same Managers went on to establish companies through proxies to act as agents in the supply of a wide range of materials to the Plant. The syndicated nature of this scheme meant that the cross-check mechanisms in their processes were circumvented. The fraud took place progressively over a period of years. By the time a whistle-blower came forward, the quantified leakage exceeded 2m. USD, and involved 285 material item types. The investigation discovered that there was no active price checking outside of provided bids or existing supply contracts, and that an examination of vendor registrations and human resource files would have identified the suspicious links between suppliers and employees.”

 

Case Study #2

“Following allegations of misconduct involving the General Manager of a regionally-based Construction company, an investigation revealed a significant discrepancy between the quantity of high-value scrap materials that were removed from a number of construction sites, and the payments received by the construction company for the scrap volumes. The General Manager was found to have directed the sale of these materials for his own personal benefit. The schemes employed included the allocation of usable materials as scrap; sale of scrap below market value; and general theft and diversion of scrap and consumable materials. The position of the individual allowed for the circumvention of internal controls, including diversion of staff from their normal role; and placing undue pressure on site security personnel to effect the movement of materials from the sites without documentation, or with documentation that was not verified to the contents of the trucks. Calculated losses exceeded 1m. USD, however the true impact is likely to have been significantly larger.“

 

Numbers do not tell the full story

That last point in the above study is something that readers will see in many cases of procurement fraud. Quite understandable, as these activities are mostly identified ‘after the fact’ through investigations and post-construction audits. Full quantification of loss is a significant exercise, and rarely do companies wish to invest further funds to put a true number to the loss when they have already weeded out the offending people and practices. Only in circumstances where there is a reasonable chance of recovery from the offending parties would such a detailed quantification be palatable.

 

Procurement Integrity Awareness

Regionally, much is being done to address the specter of fraud, bribery, and corruption. Recent efforts in Oman, Saudi Arabia, and the UAE have placed companies on notice that the ‘old’ ways of cornering business through under the-table inducements are no longer acceptable. The recent spotlight has been on tendering and awarding. There are of course many other areas throughout the four stage procurement cycle where fraud and misconduct can occur. The below table (Table 1) lists some of the fraud risks at each stage of the cycle, aligned against where that risk resides.

Fraud, in all its guises, has at its center a breach of trust. In a project environment, trust is essential due to the segmented expertise that each party brings to the table. Accordingly, it is critical to ensure that the trust awarded is based on substance, and subjected to some level of verification and cross checking.

 

Table 1: Construction Procurement Integrity Risk Matrix

SC2 - Procurement Integrity Risk Matrix - TRIMMED v3

 

Prevention is better than the cure

The most common of sayings, it is however a resounding truth with procurement fraud. Too often construction companies have been caught out with an ‘eyes on the prize’ mentality, and neglect the core planning processes that may identify questions that need asking of other parties in the project; and ensuring that the supply chain policies and procedures clear, transparent, and properly segregated.

Whilst the risk of procurement fraud can never be fully eliminated, companies can implement controls to mitigate the likelihood of such risks occurring, and help detect them earlier to reduce the impact to the project, and to the company. Consider the following checklist for preventing procurement fraud:

1. Due Diligence and background checks on partners / master contractors / sub-contractors. At a minimum, you should have confidence on the following factors:-

  • Capabilities to contracted tasks.
  • Financial stability and ultimate beneficiaries of payments.
  • Reputation in the market.

2. Overt stance on fraud, bribery & corruption: –

  • Fraud Risk Management framework.
  • No bribes’ policy.
  • Business Code of Conduct, with specific conflict of interest and gifts & entertainment provisions.
  • Whistle-blowing facility.
  • Fraud Response Plan.
  • Ethics and Fraud Awareness training for your staff.
  • Supplier Code of Conduct for your suppliers, and their sub-contractors.
  • Rotation policy on high risk parties (eg, buyers).
  • ‘No Bribery’ clause in all supplier agreements.
  • Right to audit clauses in all supplier agreements.
  • Debarment policy to exclude suppliers and contractors that have participated in any illegal or unethical activities.

3. Independent oversight to test and challenge your supply chain procedures and processes:

  • Internal audit reviews
  • Data mining to look for hidden red flags.

The dynamic nature of construction projects should compel continual vigilance throughout the life of the project to procurement fraud risk. Never lose sight of the fact that efficiency and performance issues can at times be indicators that a party is not being true and trustworthy in their responsibilities to the project. If your processes and challenge points to your processes are robust, your chances of weeding out the fraudsters from the merely incompetent are greatly enhanced.

 

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STEPHEN CROWE is a Director in the forensic division for the Middle East region of Deloitte Corporate Finance Limited.