Sarah Hofmann | Construction Executive | June 14, 2019
The word fraud might conjure up images of Wall Street executives led out to police cars in cuffs, or sleazy conmen with slicked-back hair. While these ideas might be popular in movies and TV, and often in the news, many small and large businesses fall victim to fraud. Whether it’s a trusted site manager who needed a little extra cash to cover an unexpected bill or the accountant who’s been on board for years and has been slowly siphoning an extra paycheck through a ghost employee each month, fraud might be hitting businesses without them even knowing it.
The construction industry is hardly immune to such schemes. According to the ACFE’s 2018 Report to the Nations on Occupational Fraud and Abuse, organizations lose an estimated 5% of their revenue each year to fraud. The median amount lost per instance of fraud was $130,000 across all industries, but fraud cases in the construction industry cost almost twice that much at $227,000 per fraud. They also last longer on average: fraud schemes in the construction industry continue for 24 months before being detected versus the overall median average of 16 months. The more time a scheme continues, the more money is lost for organizations.
WHAT TYPES OF FRAUD SCHEMES ARE MOST COMMON IN THE CONSTRUCTION INDUSTRY?
The construction industry is more susceptible to certain types of fraud than other industries due to the nature of the work. The companies may be smaller in size leading to fewer resources to combat fraud and more trust among employees. Also, construction companies inherently deal with many vendors, subcontractors, bidding organizations and other various third parties, which can all pose fraud risks.
Here’s how the two most common umbrella schemes of corruption and asset misappropriation affect the construction industry.
Corruption
The most common fraud scheme that affected the construction industry was corruption, representing 42% of all fraud cases. Corruption is defined as the wrongful use of influence to procure a benefit. With all those third parties involved in construction projects, there are many opportunities for corruption. At different points in a construction project, certain individuals may have more influence, such as inspectors or estimators. If they apply their influence unethically, they can be susceptible to bribery or kickbacks.
Asset Misappropriation
Asset misappropriation is a blanket term for someone either misusing or stealing an asset that does not belong to them. For construction companies, the most common schemes in this category are billing fraud and expense reimbursement fraud, representing 37% and 23% of the fraud cases, respectively.
Billing fraud schemes can include using shell companies, using company assets to make personal purchases or colluding with vendors. Expense reimbursement can include billing for fictitious expenses, mischaracterizing expenses or submitting multiple requests for reimbursement.
WHY DO PEOPLE COMMIT FRAUD?
The Fraud Triangle is a model for explaining the factors that cause someone to commit occupational fraud. It consists of three components that, together, lead to fraudulent behavior:
- Perceived financial need;
- Perceived opportunity; and
- Rationalization.
Financial need may come in the form of a gambling or drug addiction, or perhaps mounting medical bills for a family member. Perceived opportunity can be when they realize they have the power to sign and approve checks. Rationalization is the thought that they’ll pay the money back as soon as they can or that the organization is taking advantage of them and won’t miss that money. If these three factors are present, it does not necessarily mean a person will commit fraud; it’s just that these three factors tend to need to be present for a person to act.
DEMOGRAPHICS OF FRAUDSTERS IN THE CONSTRUCTION INDUSTRY
For fraud schemes in the construction industry, the perpetrators tended to work in the accounting or purchasing department, representing 31% and 11% of cases. Forty-five percent of them were employees, rather than managers (29%) or owners/executives (23%). The largest red flag they displayed was living beyond their means (42%), followed by experiencing financial difficulties (31%), or having an unusually close association with a vendor or customer (22%).
One thing that set the construction industry apart was that younger employees who committed fraud stole more than older employees. Data from other industries almost always show older employees stealing more money, as they tend to be in higher positions of power in the organization and have more tenure. This may point to construction companies needing to keep a closer eye on newer, or younger, employees.
HOW CAN CONSTRUCTION COMPANIES PROTECT THEMSELVES AGAINST FRAUD?
One of the easiest and cost-effective ways to prevent fraud in any organization is to implement an anti-fraud policy and set an ethical tone at the top. When organizations discuss fraud and teach their employees, and clients/customers, about fraud prevention or detection tools, they are more likely to prevent fraud before it happens.
Another great way to prevent fraud is to institute a hotline or similar anonymous reporting method. Only 34% of construction organizations in the Report to the Nations used a hotline, versus 63% of organizations across all industries. The most common way fraud was detected overall in the larger study was through a tip (40). Construction organizations only had tips account for 19% of fraud detected. Even establishing a simple anonymous online form, or email address, and telling employees, vendors and clients about it can greatly cut down on fraud.