9 Common Fraud Schemes in Construction and How to Mitigate Them
- Mar 22, 2023
- Craig Mann
By Craig Mann
Construction fraud is a significant problem that can cause financial loss and damage to a company's reputation. It is crucial to remain vigilant and implement proper controls to detect, mitigate damage, and prevent fraud from affecting your organization. Understanding common fraud schemes and implementing best practices is a great first step.
1. Bid Rigging:
What It Is: Multiple contractors conspire to rig the bidding process so that one wins the project at an inflated price.
How To Mitigate: Implement a formal process to identify and request products and/or services the owner needs so that qualified potential service providers can review those requests and submit bids for them as part of efforts to keep bid evaluations fair and objective. Rotate the selection committee and provide training on ethical procurement practices.
2. Change Order Fraud:
What It Is: Contractors inflate the costs of change orders or create false change orders to increase their profits.
How To Mitigate: Establish transparent change order processes and require multiple parties, such as the project manager and owner, to review and approve change orders. Also, require that cost estimates be provided for any proposed changes.
3. False Invoicing:
What It Is: Contractors submit false or inflated invoices for work that was not performed or for materials that were not used on the project.
How to Mitigate: Verify all invoices against work performed; require supporting documentation for all expenses. Conduct periodic audits of invoices and payments.
What It Is: Contractors or employees receive payments or other benefits from vendors or subcontractors in exchange for awarding them work.
How to Mitigate: Mandate that all vendor and subcontractor relationships be disclosed and approved in advance. Also, vendors and subcontractors must sign contracts prohibiting kickbacks and other unethical practices.
5. Substitution of Materials:
What It Is: Contractors use inferior or cheaper materials than those ordered by the client to save money on costs.
How to Mitigate: Establish precise specifications in the contract. Mandate that all material substitutions be approved in advance. Also, once you have the materials, conduct routine testing to verify that the ones purchased are being used, particularly from new vendors.
6. Phony Claims and Double Billing:
What It Is: Contractors submit claims for additional payments for work that was already included in the original contract, or multiple invoices for the same work order or materials.
How to Mitigate: Maintain copies of all original receipts or invoices for all expenses, as well as orders and subsequent payments. If there are any changes to the scope of work, they must be documented and approved in advance.
7. Overbilling for Labor:
What It Is: Contractors bill for more hours than their employees worked on the project.
How to Mitigate: All employees must submit timesheets that a supervisor verifies. Conduct periodic audits of time sheets and compare them to payroll records.
8. Collusion with Inspectors:
What It Is: Contractors collude with inspectors to ensure the project passes inspection, even if the work was not done correctly.
How to Mitigate: Establish clear inspection protocols and require that multiple parties inspect all work. Also, inspectors must disclose any conflicts of interest or relationships with contractors.
9. False Certification:
What It Is: This happens when contractors falsify certification documents, such as safety certifications, DBE certifications, or quality certifications, to win a project or receive payment.
How to Mitigate: Verify the authenticity of certifications and require that reputable organizations issue all certifications. Conduct periodic audits of certifications to verify that they are valid.
A comprehensive anti-fraud program that includes training audits and ongoing monitoring of construction projects is vital to protecting your business's operations. Fraud prevention is an iterative process, and all fraud prevention programs should be modified at least annually to keep up with the changing fraud risks associated with the scope of work your firm performs.
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Craig Mann is a Manager in the Forensic, Litigation & Valuation Group with extensive experience in construction progress billing and accounting for large-scale projects.
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