PRESENTED BY: RACHEL VILLICAÑA, CFE

Construction Industry Fraud

Professional Background

Certified Fraud ExaminerLEED AP; Certified Associate Project

Manager6 years of Industry-Related ExperiencePresident of Radii Consulting

www.radiiconsulting.com Speaker at UCB 2012 Leadership Symposium:

“Entrepreneurship” Panel MA- Forensic Psychology; UC Berkeley

Alumna

INDUSTRY BACKGROUND

COMMON FRAUD SCHEMES IN THE INDUSTRY

FRAUD RISKS SPECIFIC TO CONSTRUCTION

FRAUD RISK ASSESSMENTS

CAREERS IN THE F IELD

Overview

Construction Industry Statistics

Nationwide Annual Revenue:

$1.731 Trillion Active Companies:

729,345 Number of Employees:

7,316,240

(April 2012, US Census Bureau)

Statewide Annual Revenue:

$171.369 Billion* Active Companies:

72,173 (9.9%) Number of Employees:

723,978*

*Based on 9.9% rate

Estimated Annual Fraud Loss in Industry

Based on the ACFE’s 2012 Report to the Nations, CFE’s nationwide estimate a 5% annual loss in revenue due to fraud.

5% of $1.731 Trillion: $86.55 Billion in potential projected annual losses;

5% of $171.369 Billion: $8.57 Billion in potential projected annual losses in California.

Financial Statement Fraud

Timing Differences

Unauthorized Expenditures

Misclassified Expenditures

Timing Difference Scenario:

Harry Johnson of ABC Builders altered the date

of transactions to adjust financial statements to

ABC’s advantage.

Tax purposes- lower annual net profit.

Lending/Banking purposes- increase assets; decrease liabilities.

Contract Fraud

Defective Pricing

Product Substitution

Defective Pricing Scenario:

Georgia Sanders from 123 Construction submitted low bids to obtain jobs.

She knew her company would lose money if they performed these projects.

Expected to recover losses through forced change orders.

Investigating the Scenario:

Original contract value was $1,000,000. Final costs to client were billed at $1,500,000, with no significant change of scope. Review of correspondence with client to determine

whether change orders were approved. Review of project costs- invoices from suppliers, field

labor, and overhead charges. Review contractor’s financial statements and current

credit situation, determine whether there’s motivation to defraud the client.

Conduct interviews with field foremen- were these additional costs due to significant changes in field conditions/availability of materials.

Bid Rigging

Bid Rotation

Bid Suppression

Complementary Bidding

Collusion

Case Study: At UC Berkeley:

3 mechanical subcontractors have blanket work authorizations

These subs are directly awarded jobs on a rotational, yet bid-based cycle

Subs are known to engage in bid rotation and suppression, since they are all friendly.

However, they want to maintain a positive, long-term relationship with the owner.

Payroll and Labor Fraud

Undocumented Employees

Ghost Employees

Labor Mischarges

Case Study:

John Smith, owner of Construction, Inc., anticipated a large profit from a $1,500,000 contract.

He purchased materials with company funds and sent two employees to perform construction work on his home during weekend hours.

The employees were directed to bill this time to the contract mentioned above.

Financial Statement Fraud- Resources

Utilize in-house software reports Ex. Quickbooks reports:

“Audit Trail” “Voided/Deleted Transactions Detail”

Audit tax returns Corporate returns Personal returns of shareholders/officers

Review bank and credit card statements Examine credit account applications Compare printed copies of financial statement reports Third Party Information- CPA, Enrolled Agents Employee Interviews

Contract Fraud- Resources

Project file audits Compare contract drafts Research available correspondence

Emails Voicemails

Employee interviews Customer interviews Third party information

Suppliers Subs Competitors

Bid Rigging- Resources

Employee Interviews Third-party interviews Review bid documentation Audit original project (bid) file Research correspondence

Emails Voicemails

Gather related bids Subcontractor bids Competing contractors.

Obtain bid results from public agencies.

Labor Fraud- Resources

Audit employee files I-9; W-4 Background investigations

Audit payroll summaries Review cancelled checks Review Worker’s Comp insurance reports Audit insurance files Compare certified payroll reports against in-house

payroll summaries Employee Interviews

Why Assessing Risk Matters

Fraud Prevention

Realize Larger Profit Margins

Maintain Positive Reputation Maintain Business

RelationshipsImprove Company EfficiencyAvoid Legal Repercussions

Why Assessing Risk Matters

Fraud Detection

Mitigate further lossesRecover some lossesImprove company relations

Problem Solving Conflict Resolution

Involve law enforcement Lessen corporate responsibility Accountability for the

blameworthyRegain control of company

Fraud Risk Assessment Modules (ACFE)

Employee AssessmentManagement

AssessmentPhysical Controls-

DeterrenceSkimming SchemesCash Larceny Check TamperingCash Register

SchemesPurchasing/Billing

Schemes

Payroll SchemesExpense SchemesInventory/Equipment

TheftTheft of Proprietary

InfoCorruptionConflicts of InterestFraudulent Financial

Reports

Fraud Risk Assessment- Case Study

Fraud Risk Assessment- Assessing whether fraud may be occurring and what vulnerabilities do exist.

Case Study: Orange River Construction

VulnerabilitiesShop KeysKey Lockbox- client keysSignature StampCheckbook and Drawers Employee Opportunities & Motivations

Identified Fraudulent Activities

Financial Statement FraudUndocumented LaborersDefective PricingForgery

Skills Utilized Tools and Techniques

Observation SkillsCFE Knowledge Critical AnalysisIndustry KnowledgeAdministrative

BackgroundInterpersonal Skills

Basic Computer Forensic Techniques

InterviewsChecklistsHistorical DataThird Party

InformationPublic Records

Assessing Orange River Construction

Orange River: Identified Risks and Frauds

Employee AssessmentManagement

AssessmentPhysical Controls-

DeterrenceSkimming SchemesCash Larceny Check TamperingCash Register SchemesPurchasing/Billing

Schemes

Payroll SchemesExpense SchemesInventory/Equipment

TheftTheft of Proprietary

InfoCorruptionConflicts of InterestFraudulent Financial

Reports

Orange River, Specific Examples

Employee Assessment- majority of employees are unhappy at this company.

Management Assessment- President has history of ‘burned bridges’, unaccommodating personality.

Physical Controls- lack of security at shop.Payroll Schemes- overtime not paid to particular

employees; ghost employees receiving health insurance.Conflicts of Interest- President’s landlord is company’s

tenant and landlord’s company is contractor’s subcontractor.

Fraudulent Financial Statements- Timing Differences. Signs of Contract Fraud- excessive proportion of clients on

payment plans due to overbudgets.

Preventive Measures

Know current and pending regulations.Company policies

Code of Ethics Fraud Prevention and Detection Policies Whistleblower Protection Policy

Social modeling- strong values of senior management.

Legal counsel, external advisors (including a CFE).

A) Regular and B) unplanned audits.Mandatory vacations.

Career Opportunities

Work within the Industry: Become a Project Risk Management Professional (PMI

Certification) Join a Large Company

Legal Division Financial Counsel VP

Join a third-party service company: Consulting firm Forensic accounting firm Construction litigation firm, etc...

Or….Be Your Own Boss

Become an independent consultant: Your value-added:

Stronger credibility when defending against litigation or criminal accusations.

Higher degree of trustworthiness when banking and lending are involved.

Few industry competitors.

Consulting Tip

Develop relationships Networking:

Industry Events Conferences Chapter Meetings

Board positions on large companies External advisor for small companies Volunteer to Lead Workshops

Fraud Risk Awareness Trainings

One More Tip…

Offer (free) Fraud Risk Assessments! A Fraud Risk Assessment can reveal multiple areas of

vulnerability in a construction company. Offering an Assessment can lead to obtaining a

contract to provide risk mitigation services. These services allow you to better network within the

industry: Provide great service to a general contractor- you may

obtain access to its industry network of clients, suppliers, and subcontractors.

Resources

Fraud Examiners Manual- 2011 edition: www.ACFE.com Managing the Business Risk of Fraud: http://

www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/managing-business-risk.pdf

Sample Fraud Risk Assessment from ACFE website: http://www.acfe.com/fraud-risk-assessment.aspx

California Infrastructure Projects-A Guide to Successful Contracting and Dispute Resolution: http://constructionlawyers.com/CM/book/table_of_contents.html

Bid Rigging (from California Contractor magazine): http://www.agc-ca.org/uploadedFiles/Publications-Products/Constructor-Mag-PDFs/March2010.pdf