Managing Fraud Risks. Procurement & Contacting. John J. Hall, CPA (970)
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1 Managing Fraud Risks in Procurement & Contacting The IIA Los Angeles Chapter October 2, 2017 John J. Hall, CPA (970)
2 Four Categories 1. Theft 2. Results Manipulation 3. Corruption ============================================= 4. Technology 2
3 Procurement & Contracting Wrongdoing and Bad Practices Often Look The Same 3
4 10 Fraud Exposure Points 1. 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 4
5 17 Fraud Risks 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 5
6 17 Fraud Risks 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 6
7 Exposures in Procurement 7
8 Unauthorized Payments 8
9 9
10 Dallas ISD Purchasing Cards Secretary charges $383,788, has no receipts Dallas Morning News July 2,
11 11
12 12
13 My Favorite Fake Vendor 13
14 The Controller Case 14
15 Lessons for Auditors 805?? 15
16 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 16
17 Valid business license and TIN Sent one low value item UPS receipt False security 17
18 Exposures in Contracting 18
19 Exposures in Contracting 1. Bids and tenders a) Bid rigging, collusion, price fixing b) Assumption of integrity in the process 2. Negotiation a) Sole source b) Bidding that appears to be competitive c) Related parties or other noncompetitive sources 3. Change orders a) Misrepresentation b) Defective pricing 4. Type of contract (compensation basis) 19
20 Exposures in Contracting 5. Cost of the Work Issues a) Self-performed work b) Cost shifting / mischarging c) Inaccurate / inappropriate cost accounting d) Inaccurate / inappropriate billing methodologies 6. Specific Fraud Exposures a) 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 20
21 Exposures in Contracting 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) 21
22 Inflated Labor Hours 22
23 Inflated Labor Hours Bovis Lend Lease 8 Plus 2 23
24 24
25 Inflated Labor and Burden Rates 25
26 Inflated Labor Rates 26
27 Duplicate Charges Buried in Job Costs 27
28 SOURCE: Contractor Job Cost Report 28
29 Sort by Cost Code 29
30 Sort by Cost Code then by Vendor 30
31 Duplicate Charges Surface 31
32 Summary of Losses Billed and Paid Costs Actual 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 Plus: 30% Penalty $910,000 Audit and legal costs $250,000 32
33 Case Details 1. Overbilling through real and fictitious subcontractors 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 owner company executive 33
34 Corruption and Shadow Deals 34
35 Deal Documents Purchase Orders Contracts Engagement Letters Capital Requests Account Agreements Sales Agreements Bids/Tenders Vendor Arrangements 35
36 Examples: Corruption & Shadow Deals 1. Bribery 2. Kickbacks 3. Payoffs 4. Excessive gifts / entertainment 5. Bid-rigging 6. Extortion / blackmail 36
37 37
38 38
39 39
40 Why Change Orders Occur 1. Design errors, discrepancies, omissions 2. Undisclosed or unknown existing conditions 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 40
41 10 Change Order Exposures 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 41
42 10 Change Order Exposures 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 42
43 Inadequate Change Support 43
44 Indicators, Symptoms and Red Flags 44
45 Indicators, Symptoms, Red Flags Unclear or unreasonable specifications No audit terms in contact Atypical application of payment forms Missing or disorganized backup Failure to track or report use of allowances and contingencies Sloppy safety, testing & control procedures 45
46 Indicators, Symptoms, Red Flags Unexplained schedule of values changes Missing lien waivers Unusual bid patterns Missing documents Undisclosed related parties Subcontractor complaints regarding payments from general contractor 46
47 Indicators, Symptoms, Red Flags 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 47
48 Opportunities for Auditors Pre-contract audits Interim contract audits Project close out audits Pricing reviews (change orders & claims) Financial reviews Procurement process reviews Vendor Assurance Audit Services 48
49 Simple Executive Summary 49
50 50
51 24 Detection Suggestions Analyze bids looking for patterns by vendor or purchasing agent Confirm losing bids Confirm failure to respond to bids & RFQs Audit vendors - transactions, T&Es, 1099s Surprise inspect at receiving points Match PO, proof or receipt, & invoice Observe inventory held by others Observe highly tempting items 51
52 24 Detection Suggestions For sole source suppliers, confirm existence, prove ownership, test prices, find other sources, analyze usage volume Verify sole source justification Reconcile inventory, purchases and usage of items subject to pilferage Audit rental of equipment (including equipment used by contractors) Verify accuracy of items stored in containers (gas, liquids, other) 52
53 24 Detection Suggestions Audit areas where vendors come in, take stock, and replenish on their own Audit purchases that do not go through normal purchasing procedures Audit maintenance agreements Audit property management agreements Audit leases with cost pass-through provisions Confirm delivery locations 53
54 24 Detection Suggestions Audit costs on cost-plus agreements to original documentation. Look for creative interpretations of the term cost Pull D&B and similar reports on supplierts and contractors Enter vendor and contractor names in press databases Look for multiple PO and bill splits Verify address and other master file changes by vendors 54
55 Questions, Comments, Further Info on How We Can Help John J. Hall (970)
56 56
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