You will never be able to completely protect your company from fraud. Unfortunately, fraud is and has always been a reality of doing business. If, however, you are aware of the common risks and red flags related to occupational fraud, and implement proper controls within your business, you can significantly reduce your risk.

According to a recent study published by the Association of Certified Fraud Examiners (the ACFE), it is estimated that the typical organization loses 5% of its annual revenues to occupational fraud each year. Applied to the estimated 2013 Gross World Product, this figure translates to a potential projected global fraud loss of more than $3.7 trillion.

The reported frauds lasted a median of 18 months before being detected. The median occupational fraud case cost companies $145,000, and more than one-fifth of these cases caused losses of at least $1 million.

Red Flags Signaling Fraud in the Construction Industry

According to the ACFE, the median loss in the construction industry was $245,000. The top three prevalent fraud risks in construction are billing fraud, corruption schemes, and cheque tampering.

Billing Fraud

Billing fraud is a misappropriation of a company’s cash by way of a fraudulent disbursement. There are primarily three specific types of billing fraud schemes: shell companies, non-accomplice vendors and personal purchases.

Billing fraud can be combatted by adhering to – and not deviating from – the approved vendor list, as well as management review and verification of vendors before payments are issued. Project managers must investigate budget overruns and unexplained increases in purchased quantities. A manual or computer software-assisted review for suspicious mailing addresses, PO box numbers, out-of-sequence invoice numbers and duplicate invoice numbers should be conducted on a periodic basis.

For example, if an analysis of excessive expenses uncovers invoices from one or more vendors for vague or non-descript products or services, then you might be the victim of billing fraud. Watch for entries like “consulting fee” or “special commission” on the invoices, particularly if they are not easily explained.

Corruption Schemes

In a corruption scheme, an employee misuses his or her influence in a business transaction in a manner that violates their duty to the employer, resulting in a direct or indirect benefit.

Forms of corruption fraud include conflicts of interest (purchasing and sales schemes), bribery (invoice kickbacks and bid rigging), illegal gratuities and economic extortion.

Controls should include reference checks for new vendors, and an established (and never-deviated-from) process to review bids. For example, competitors in the same market could potentially collude to defeat competition or artificially raise the prices of goods and services. A winning bidder sub-contracting work to a losing bidder may be an indicator of bid-rigging.

Cheque Tampering

The third most prevalent fraud risk in the construction industry is cheque tampering. It can take the following forms:

• Forged maker: the cheque signature is forged;
• Forged endorsement: the perpetrator intercepts the cheque and forges an endorsement;
• An altered payee: the fraudster intercepts the cheque and converts the payee to self, another company, relative, etc.;
• An authorized maker: an authorized employee fraudulently writes a company cheque out to him or herself; and
• Concealed cheques: fraudulent cheques are submitted for signing and included with legitimate cheques.

Smaller organizations can protect themselves from cheque tampering by implementing basic controls, such as never signing blank cheques, as well as carefully reviewing invoices and original supporting documents. In addition, blank cheques should be locked away when they are not in use by your company’s designated cheque issuers. If the bank statements are sent to the office, and you suspect fraud, you could have the bank statements sent to your home address for a few months to ensure they are not intercepted at the office by fraudsters.

If you are part of a larger organization, you will want to ensure appropriate segregation of duties, as well as proper controls and a review process to monitor inconsistencies.

How Can You Help Catch Fraud?

In the ACFE study, the lack of internal controls was rated the most important contributing factor for fraud, followed by fraudsters overriding existing internal controls, and a lack of management review.

Providing individuals a means to report suspicious activity is a critical part of a successful anti-fraud program. For larger organizations, fraud reporting mechanisms such as hotlines can be set up to receive tips from both internal and external sources. To be successful resources in combatting fraud, reporting mechanisms must preserve the anonymity of tipsters and the confidentiality of reported information. Management should actively encourage employees to report suspicious activity, as well as enact and emphasize an anti-retaliation policy.

Occupational fraud is more likely to be detected by a tip than by any other method. The majority of tips reporting fraud come from employees. Therefore, even the most subtly expressed tip should be taken seriously and followed up. If employees are aware that there are processes in place to investigate and reduce fraud, they are more likely to report suspicious activity.

Look Out For Red Flags

In 92% of cases examined by the ACFE, the fraudster displayed one or more behavioral red flags that are often associated with fraudulent conduct. Some warning signs of the most commonly observed behaviours include living beyond their means, financial difficulties, unusually close association with vendors or customers, excessive control issues and an unwillingness to share duties.

In summary, proactively monitoring and analyzing data (including bank statements, reconciliations and budgets-to-actuals), detecting red flags and following up on tips will reduce fraud and the resulting financial losses that could occur within your company.