Fraud in Capital Projects and Construction Denise ... › uploadedFiles › ... · Fraud in Capital...

Fraud in Capital Projects and Construction

Denise Cicchella, CFE, CIA, CCA, PMP

Fraud in Capital

Projects and

Construction

2015 ACFE

Annual

Conference

Auspicium, CEO

Agenda

• Phases of Projects

• Risks at each phase

• Opportunities to commit fraud

• Fraud Prevention Controls – Need for

Governance

• Investigation Strategies and Tips

Capital Projects Defined

• Delivers specific objective

• Often specialized in nature (may not be a

core competency)

• Long-term consequences and impact

• Material investment of capital

• Often high risk

– Impact

– Likelihood

Examples

• New IT System

– ERP

– Customer Fulfillment

• Development of New Product or Service

• M&A

• New Building or Facility

– Corporate HQ

– Warehouse / shipping facility

Risky Business

• Project Risk

– $$$$$$

– Probability of Failure

– Reputational

• Vendor Risk

• Technology Risk

• Sabotage Risk

• Fraud Risk

Risk Mitigation

Phases of a Project

Decide Design Vendor

Selection Project

Execution Done

Project Life Cycle Activities

• The least is known about the project near its beginning

– Plans to be developed

– Concept that has to develop

• The level of uncertainty and risk is highest at the beginning of the project

– Feasibility

Decisions…

• New activity (service / product) • New system • New building • New market • Replacement system / building • Acquisition / Merger • Divestiture / Closure

ANY one of which could result in multiple

projects!

Decide

• Business decision to go ahead with a

project:

– Aligned with corporate strategy?

• Project approval process followed

– Are risks acceptable?

• Is there a trend to how projects are

approved?

– Bias

Bias in Decision Making

• Projects chosen not in organization’s best

interest

• Promote self interest

• Poor tone at the top

• Incompetence or fraud?

• Loss of employee morale

• Reputational damage

Decision Techniques

Payback

Pros/Cons

…besides Techniques • Is decision based on:

– Accurate information

– Information from reliable source

– Detailed information

• Are constraints realistic?

– Time

– Cost

– Technical feasibility

• Transparency of decision making

Identifying Bias & Favoritism

• One: • Project manager always picked

• Type of project always chosen

• Vendor always selected

• Projects chosen against corporate strategy

• Failure to comply with policy

• Decisions overridden

• “Pet Projects” — even if not prime focus of

business

Actionable Findings

• Failure to comply with policy

– Disciplinary Action

• Trends may trigger further investigations

– COI

– Kickbacks

• Enhance processes

Project Sabotage

• Purposely harming a project to make it fail:

– Vandalism

– Theft

– Picketing

– Withholding information

– Misleading information

– Friend in front, knife wielder in back

• Proving the wrong project was picked

Sabotage Happens

• Damaging IT equipment to prevent a new

system from going live

• Planting endangered species on a

proposed site

• Leaking proprietary project information

– To public

– To competitor

• Likelihood increases for sensitive projects

Sabotage Motives

• Fear of Change

– Unemployment

• Conscience

– Environment

– Government or Corporate Policy

• Financial

– Steer toward alternative action

Decision-Making Red Flags

COI, Bribes, Kickbacks, and Corruption:

• Costs / Revenue Assumptions • Unsupported

• Skewed

• Ignoring good projects and selecting bad

projects

• Project selection and approval policies not

followed

Opportunity

• Decisions taken by single individual:

– Site Identification

– Site Selection

– Vendor Identification

– Vendor Selection

• Executive override

• “Bully”

• Trusted Advisor

Hidden Personal Agendas

• Is it Rose Colored Glasses or Personal

• Miscalculations (error or intentional

“mistake”)

• Motive

– Personal gain

• Kickback

• Contracts to related parties

• Future employment

• Property owner

Design

What Who

When How

• What will the project:

– Cost

– Do

– Be used for

• Expectations

• Key deliverables

• Expertise will be needed

• Will run the project

– Internal

– External

– Executive Sponsor

• Will govern the project

• Will fund the project

• Will the project finish?

• Are the milestones? • SMART

• Will progress reports be issued?

Dates may be calendar and/or event driven

• Do you see it getting done?

• Does the organization plan on using it?

– Initial purpose

– Re-purposes

– Expansion

• Can we maximize stakeholder

expectations?

Fraud in Design

• Overly restrictive criteria

• Overstating the probability that a design

will work

• Ignoring risks and barriers to success

• Designing more than is needed

– Gold plating

– Personal agenda

– Expanding project scope

Key Players

• Design often involves specialists

– Architects

– Lawyer (should be but often done by in-house

counsel)

– Project Manager

– Programmers/Systems Analysts

– Strategic Consultants

Issues

• “Up Sell” services

– “Extras”

• Inflate work

– >24 hours in day!

• Extreme promises

– “We can install a new system bug free in

three hours”

• Recommending Related Parties

Vendor Selection Phase • Know expertise of vendors – don’t assume

– Creative Resume Writing

– Bid to find out strategies

– Unqualified but bid anyway

• Results in errors in execution

• Results in change orders

• Identify if vendors are related

• Ensure scope is clear

– If not – here come the change orders

Considerations

• What information/assets does vendor have access to: – What records is the vendor keeping?

– Where is the vendor storing records?

– How are the records being destroyed?

• How is the vendor accessing the site or system?

• How is site/system access monitored and controlled – consider: – New employees?

– Terminated employees?

– Impaired employees?

Vendor Bidding Frauds

• Collusion

• Bid Rigging

• Price Fixing

• Bidding to Unqualified Vendors

– Under-specializing the specialists

• Overspecializing the Specialists

• Bait and Switch

Corruption

Bid Rigging

• Cover pricing: submit a higher price or unacceptable terms, possibly for sub contract

• Bid suppression: agree not to bid or withdraw

• Bid rotation: taking it in turns to win

• Splitting the market: carve out segments of the market or geographic locations

Preventing Bid Rigging

• Level Playing Field – Defined selection criteria – More then one set of eyes – No single voice – No conflicts of interest

• Approved Contractor’s List – Review – Refresh

• Banned Lists – www.epls.gov

• May be a banned site

Loose Lips Sink Ships

– Don’t allow the bidding process to be compromised by disclosing bids or insider information

– Policy not to disclose rival bids before opening

– All communication to bidders should be done SIMULTANEOUSLY

– Use of NDAs for internal and external stakeholders

Know Your Vendor

• Pending Litigation

• Bankruptcies

• Citations – Health

– Safety

– Labor

• Past Performance – Delays?

– Cost Overruns?

Up-Billing

• “Bait and Switch” personnel

• Promise the President deliver an intern

• Qualifications

• Licensing

• Rates (?)

Digging up the Dirt

• The Internet has made it easier to uncover background information about people and companies

– Pay to Access Databases

• D&B

• Lexis / Nexis

– Accurent/Relavent

• Hoover’s

• Kroll’s

More Dirt

• Government Records – Licenses

– Complaints

• Blogs – Current and former employees

– Advocacy groups

• Social Media

• Traditional Media – Newspapers

Detecting Vendor Problems

• Bid analysis

• Patterns of bidding

• Trends

• Price comparisons

– Benchmarking

– Independent appraisals

• Quick response

Contract as a Control

• Who writes the contract has the advantage • Don’t accept vendor contracts without challenge

• Make sure contract works for you

• Terms and conditions are added or edited

• Contract matches proposal

• Reviewed by expert

• Keep relationship but stand ground

• Make sure contract terms don’t contradict

Requirements Not

(Clearly) Defined

• The BIGGEST pitfall

• If the requirement isn’t clearly articulated:

– Undue reliance on vendor to “understand”

– Contract difficult to enforce

– Escalated costs

– Monitoring not possible or difficult

– “Objectives” not met

Legal Advice

• Internal counsel may not have expertise in

the contract subject matter

– IT

– Construction

• Contract may contain domain-specific

terminology (Lingo/Jargon)

– Hard / soft costs

Right to Audit

• What records will owners have the right to review

• When does audit right expire

• Where will audit be done

• Who pays for the audit

• Does the right to audit pass to subcontractors

• What will happen in the event of overcharges

• Can you audit records not directly related to the project

– Personnel files

– Administrative records

• OFTEN MISSING!!!!!

Specific Costs or Calculations

• Labor

• Material

• Equipment (rental)

• Indirect costs

• Unit costs

• Specific calculations

• Profit margins

• Payment to inter-related companies

• Change orders

• Exchange rates © Auspicium 2015

Other Cost Considerations

• Pre-assignment of supplier

• Owner reimbursed items

• Industry inflation

• Trade discounts

• Discount prices

• Hard vs. Soft !!

Liabilities

• Right of refusal to allow employee / vendor on project

• Confidentiality – IT Security

• Expected behavior protocols & consequences

• Premise rules

• Drug/Alcohol Policy – Testing

– Monitoring

– Screening

– Suspicions

Substitution Clauses

• “The contractor shall have the right to substitute any materials with a substitute of equal value and quality” – Define value

– Define quality

– Define grade

• Material is not available

• Material is more costly

• Construction requirements

• Changes to building code

• Pricing differentials

Salvage

• Who owns money collected on sale?

• Who will it be sold to?

• Who does it belong to?

• Disposal (especially IT)

• Retainage of scrap

– Same criteria apply

– What does owner get for routine maintenance

– The more intricate the design, the more scrap

Early Termination

• For Cause

– Disciplinary

– Performance

• Financial reasons

• Destruction beyond a certain

• Sale to another party

• “Just Because”

• Force majeure

Breach of Contract

• Damages

– Performance

– Team

– Liquidated

• Can contractor cancel?

– With or without cause

• Vendor dismissal

• Finance charge reimbursement

– Delayed start or finish

Guarantees

• Performance

• Quality of work

• Material

• Equipment

• Extended warranties

• Who pays

Dispute-Resolution Agreements

• Arbitration

• Litigation

• Mediation

– Who mediates

– Jurisdiction

– Binding versus Non-Binding

– Pre-assigned mediator

Project Execution

• Most project time

• Most project expenditure

• Anything can go wrong

• MUST BE MONITORED

– Deliverables

– Performance

– Changes

– Key Performance Indicators

Important Deliverables

• Cost/Budget

• Time

• Scope

• Quality

• Safety

• Other

• Defined and monitored

Scope Safe

Quality

Professional Service Frauds

• Working more then 24 hours a day

• “Raises”

• Raises with underpayments

• Everyone appointed as lead

• Highest paid employee does clerical work

• Working without license

– “Borrowing” of licenses

Inflated Labor

• Overstated hours

• Ghost Employees

– Not there

– On other sites

– Undocumented

• Overtime “mis”calculations

• Equipment operators without equipment

• Pay for training or vacation

Material & Equipment Fraud

• Ordering for other projects

• Material never shipped to site

• “Nice to have” material

– iPads

– Otter boxes

– Tablets

• Obtaining excess materials

• “Stolen” from site

Overpayments on Equipment

• Equipment that is idle more then it is used

• Equipment used without operator

• Charging piece by piece

• Charging at wrong rate

• Charging same equipment multiple times

• No credit for returns

Change Order Abuse

• Execute change and then get approval

– Sometimes OK

• Foundation work

• Stop catastrophe

• Split change orders

• Change order for work in scope

• Fraudulent site conditions

• Price inconsistent with normal work

The Investigation

• Investigation triggers

– Budget

– Executive Concerns

– Tip

– Observation

– Audit

• Document concerns about the project

• Map key players and relationships

Investigative Team

• Subject matter expertise

• Determine if experts need to be called in

– What capacity will they serve?

• Investigate and negotiate

• Investigate and litigate

• Investigate only

• Quality (e.g. materials used)

• Legal

– Attorney Client Privilege

Establish Facts

• Obtain contracts and project charter

• Obtain original investment decision

– Highlight any objectives

– Highlight constraints

• Time

• Money

• Scope

– Compare to actual

– Calculate/ID deviations from constraints

Interview Key Players

• Executive Sponsor

• Project Manager and Team

• End Users (if at that stage)

• Key Vendors and Subcontractors

– (Should have the right to do so in your

contracts)

• Depending on suspicion, interview most

“innocent” first

Follow the Money

• Obtain project financials from project

manager and accounting!

• Graph data to identify unusual trends

• Look for money spent “out of order”

– Painting before masonry

• Obtain change order log

• Trends in change orders

• Inappropriate vendors or charges

Useful Graphs

• Budget to actual

• Timing of expenses

• Expense by:

– Vendor

– Trade / Specialty

– Clusters (Location / Employee / Phases)

• Change Orders

– Root Causes

Determine Progress…

• What stage of the project life cycle are you

• If work is completed – does it work?

– Quality of deliverables

• Progress to date

– Project Management reports

– Incident reports

– Minute meetings (if kept)

Suspects • For vendor(s): similar issues elsewhere?

– May need to assess vendor vetting

– Re-perform (Kroll)

• For employee(s): employment history

• Has organization had similar issues on

other projects?

– Commonalities

• Are there related issues?

Cost & Invoicing Issues

• Trace invoices:

– Is amount invoiced reimbursable per

contract?

– Is amount invoiced accurate per documented

backup?

– Are invoices submitted in a logical order?

– For reimbursable, is there proof money has

been paid?

– Are invoices submitted timely?

Investigation Results

• Is it fraud?

– Incompetence

– Errors

– Rush

• Cost Recovery

• Litigation / Disciplinary Action

• Were policies/methodologies followed?

– Possible Improvements

Questions/Comments

Denise Cicchella

Denise.cicchella@auspiciumco.com

1-877-550-6802

(201) 835 – 4069

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