in Procurement & Contacting · Managing Fraud Risks in Procurement & Contacting The IIA Los Angeles Chapter October 2, 2017 John J. Hall, CPA (970) 926-0355 [email protected]

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Managing Fraud Risksin

Procurement & Contacting

The IIA Los Angeles ChapterOctober 2, 2017

John J. Hall, CPA(970) 926-0355

[email protected]

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Four Categories

1. Theft

2. Results

Manipulation

3. Corruption=============================================

4. Technology

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Wrongdoingand

Bad PracticesOften LookThe Same

Procurement & Contracting

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10 Fraud Exposure Points1. Determination of need

2. Documenting deliverables

3. Develop internal budget

4. Identify potential suppliers / contractors

5. Solicit bids

6. Negotiate and finalize terms

7. Award the work

8. The work itself

9. Administration, billing and payment review

10. Closeout and final settlement

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1. Conflict of interest

2. Phantom vendor or contractor

3. Purchases for personal use

4. Information theft by suppliers

5. Split purchases

6. Secret commissions and kickbacks

7. Tailored specs

8. Time limitations

9. Unnecessary purchases

17 Fraud Risks

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10. Collusive bidding

11. Bid rigging

12. Change order abuse

13. Duplicate payments

14. Defective pricing

15. False representations / documents

16. Front end loading / advance payments

17. Product / equipment substitution

17 Fraud Risks

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Exposuresin

Procurement

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Unauthorized Payments

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Dallas ISD Purchasing Cards

“Secretarycharges

$383,788,has no receipts”

Dallas MorningNews

July 2, 2006

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Fake

Vendor

My Favorite

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The

Controller

Case

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Lessons for Auditors

805 ??

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Lessons for Management

• Highest threat from inside

• Need for real oversight

• True variance analysis

• True performance analysis

• Monitor related parties

• Monitor spend levels

• Use “How Do I Know”

• When in doubt, DOUBT

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Valid business license and TIN

Sent one low value item

UPS receipt – False security

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Exposuresin

Contracting

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1. Bids and tendersa) Bid rigging, collusion, price fixing

b) Assumption of integrity in the process

2. Negotiationa) Sole source

b) Bidding that appears to be competitive

c) Related parties or other noncompetitive sources

3. Change ordersa) Misrepresentation

b) Defective pricing

4. Type of contract (compensation basis)

Exposures in Contracting

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5. Cost of the Work Issuesa) Self-performed work

b) Cost shifting / mischarging

c) Inaccurate / inappropriate cost accounting

d) Inaccurate / inappropriate billing methodologies

6. Specific Fraud Exposuresa) Material and source supplier substitution

b) Defective pricing (including multi-level pricing risk)

c) Buyouts of subcontracted work

d) Non-reimbursable costs

e) General conditions

f) Falsification of records


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6. Specific Fraud Exposures (continued)g) Labor and related labor burden

i. Rate and hour variances

ii. Burden Payroll taxes Insurance Benefits

iii. Fully loaded rates

h) “Errors” in methodologies

i. Allocation of indirect costs to direct cost pool

ii. Application of correct rates to incorrect base

iii. Incorrect application of method (overhead rates)


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Inflated

Labor

Hours

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BovisLend Lease

8 Plus 2

InflatedLaborHours

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Inflated

Labor and

Burden Rates

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InflatedLaborRates

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DuplicateChargesBuried inJob Costs

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SOURCE: Contractor Job Cost Report

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Sort by Cost Code

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Sort by Cost Code then by Vendor

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Duplicate Charges Surface

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Billed and

Paid CostsActual Costs

Total

Overcharge

A - $10,110,000 $8,660,000 $1,450,000

B - $4,410,000 $2,825,000 $1,585,000

Total - $14,520,000 $11,485,000 $3,035,000

Summary of Losses

Plus:30% Penalty $910,000Audit and legal costs $250,000

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Case Details1. Overbilling through real and fictitious sub-

contractors

a) Internal project budget

b) Contract value

c) Schedule of values

2. $250,000 kickback paid to owner executive

3. Fabricated Change Orders (relocate water line)

4. Architect knowingly approved inflated costs

5. Insurance claim for activities of ownercompany executive

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Corruption

and

“Shadow

Deals”

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Deal Documents

Purchase OrdersContracts

Engagement LettersCapital Requests

Account AgreementsSales Agreements

Bids/TendersVendor Arrangements

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1. Bribery

2. Kickbacks

3. Payoffs

4. Excessive gifts / entertainment

5. Bid-rigging

6. Extortion / blackmail

Examples:Corruption & Shadow Deals

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1. Design errors, discrepancies, omissions

2. Undisclosed or unknown existingconditions

3. Owner initiated changes in scope

4. Change in designer preference

5. Value engineering

6. Change in external requirements

• Building code, zoning, fire, ADA

7. Change in market conditions

Why Change Orders Occur

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1. Not priced in accordance with contract

2. Markups for fee billed incorrectly

3. Material prices do not reflect actual cost

due to trade discounts & other issues

4. Material quantity estimates not accurate

5. Labor hours overstated due to poor

estimating techniques

10 Change Order Exposures

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6. Labor rate and/or burden exceeds actual

7. Improper charges for overtime versus

premium time

8. Buyouts of lower-tiered subcontractors

not disclosed

9. Change orders for work already included

in the base contract

10. Fabricated change orders

• Move water line

10 Change Order Exposures

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Inadequate Change Support

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Indicators,

Symptoms

and

Red Flags

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1. Unclear or unreasonable specifications

2. No audit terms in contact

3. Atypical ‘application of payment’ forms

4. Missing or disorganized backup

5. Failure to track or report use ofallowances and contingencies

6. Sloppy safety, testing & controlprocedures

Indicators, Symptoms, Red Flags

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7. Unexplained ‘schedule of values’ changes

8. Missing lien waivers

9. Unusual bid patterns

10. Missing documents

11. Undisclosed related parties

12. Subcontractor complaints regardingpayments from general contractor


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13. Material substitutions without approval

14. Excess material purchases

15. Change order manipulation

16. Front end loading in billing

17. Undervalued deductive change orders

18. Diverting lump sum work to T&M projects


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1. Pre-contract audits

2. Interim contract audits

3. Project close out audits

4. Pricing reviews (change orders & claims)

5. Financial reviews

6. Procurement process reviews

Opportunities for Auditors

Vendor AssuranceAudit Services

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Simple Executive Summary

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1. Analyze bids looking for patterns byvendor or purchasing agent

2. Confirm losing bids

3. Confirm failure to respond to bids & RFQs

4. Audit vendors - transactions, T&Es, 1099s

5. Surprise inspect at receiving points

6. Match PO, proof or receipt, & invoice

7. Observe inventory held by others

8. Observe highly tempting items

24 Detection Suggestions

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9. For sole source suppliers, confirmexistence, prove ownership, test prices,find other sources, analyze usage volume

10. Verify sole source justification

11. Reconcile inventory, purchases andusage of items subject to pilferage

12. Audit rental of equipment (includingequipment used by contractors)

13. Verify accuracy of items stored incontainers (gas, liquids, other)


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14. Audit areas where vendors come in, takestock, and replenish on their own

15. Audit purchases that do not go throughnormal purchasing procedures

16. Audit maintenance agreements

17. Audit property management agreements

18. Audit leases with cost pass-throughprovisions

19. Confirm delivery locations


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20. Audit costs on cost-plus agreements tooriginal documentation. Look for creativeinterpretations of the term ‘cost’

21. Pull D&B and similar reports onsupplierts and contractors

22. Enter vendor and contractor names inpress databases

23. Look for multiple PO and bill splits

24. Verify address and other master filechanges by vendors


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John J. Hall

[email protected]

www.JohnHallSpeaker.com

(970) 926 0355

Questions, Comments,Further Info on How We Can Help

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www.JohnHallSpeaker.com