Mitigating Fraud Risk in Real Estate During the Pandemic
October 12, 2020
A pandemic offers a huge opportunity for fraud in business. Due to changes in operations, priorities, and security, we’re seeing heightened fraud activity. Carol Surowiec and Nelson Luis discuss the increased vulnerabilities, and offer ways to mitigate these risks.
My experience is around advising law firms and corporate clients on complex domestic and cross border forensic and litigation support matters. These could relate to issues dealing with disputes or forensic accounting, fraud investigations that might involve allegations of bribery and corruption, financial reporting irregularities, or other occupational fraud areas. I've managed over 150 cross border investigations, Latin America, Asia Pacific, Africa, and led in country investigations and compliance assessments in over 40 countries around the world.
CS: And Nelson, why is there such an increase in fraud in this current market during the pandemic? Any statistics that you could include?
NL: The reality is that the COVID-19 pandemic that we're all living through here has really created an environment that's ripe for fraudulent activity. You hear a lot of the terms of it's creating the perfect storm in comparison to what's been observed and in previous economic crises. So the current pandemic is changing the way organizations are operating, how management's priorities are being put in play.
So, you have kind of three factors here. You have the combination of adverse conditions where companies are cutting expenses, they're working remotely, you have employee furloughs, layoffs; all these things are increasing the vulnerability and increasing the risk of corporate fraud. Secondly, you have, the risk of fraud typically is not considered a top priority by management when there's a crisis or there's an economic recession. There's other areas around company's survival that are taking play.
And then thirdly, the current crisis certainly increases the amount of pressure on management to obtain financial results. And that further increases that heightened fraud in a risk. So from a statistic perspective, while it's still early, I'm going to comment later about a paper that I authored, I did some studies and interestingly after the 2008-2009 financial crisis, 84% of companies mentioned some level of fraudulent activity at their organizations. So it'll be interesting to see as we come out of this pandemic and people start to go back to the office, how those statistics might stack up.
CS: Nelson, can you please share with us what red flags you were seeing within the real estate industry respective to fraud?
NL:So within the real estate industry, the top fraud scheme, that's typically cited on surveys is around corruption. Management should really look at are property managers, for example, always using the same contractors and vendors without going out to bid? Is there a possible kickback arrangement there? Tons of funding coming from the government right now, as part of the Cares Act. Many companies that have taken PPP loans and how recipients of those loans are going to be submitting documentation to the lenders.
So there's a lot of discussion right now around that level of fraud that might be seen in the industry. Other areas would be potential money laundering between buyer and or sellers. So are there shell companies and higher risk geographies involved? Kind of that KYC, know your clients. Are funds coming from overseas? Are prices significantly more or less than comparable properties? Are there are sudden changes and instructions in terms of wiring of funds? So be on the lookout for some of those areas.
CS: And Nelson, what are the top mitigation procedures that an operator or owner should consider implementing within their organization?
NL:So the most heavily regulated industries out there are normally in the kind of financial, pharma, healthcare space, or they have proactive anti-fraud monitoring procedures. Interestingly, the real estate industry is on the opposite end of the spectrum, right? So according to the ACFE where they put out a survey each year, the real estate industry is ranked as the, as having the second highest median fraud loss of any industry.
And that's likely due to the fact that they may not have these robust anti-fraud programs in place. They may not have well developed code of conduct policies. Companies’ management should make sure that they have those code of ethics policies in place if they're getting annual confirmations from employees. Another mechanism is that, the number one source for uncovering fraud is through having a kind of whistleblower hotline to receive tips. Companies that may not have those processes in place are really putting themselves at a disadvantage. Because if that's the number one way to uncover fraud and they don't have that mechanism, they're really potentially missing out on identifying a lot of those fraud risks.
So they should put a program in place to do that. And of course, management needs to exude the proper tone at the top on their stance on fraud and having a zero tolerance policy. And if tips come in the door, they shouldn't ignore them. They should have a process in place of how they're going to triage them, how they're going to pursue them, how they're going to investigate them.
CS: How would that process begin once that decision is made to implement?
NL: There's what I like to call kind of low-hanging fruit, right? What should companies should be doing now? And I will break it up into three different steps. The first is companies should be assessing where their most vulnerable to fraud. Two is they should be instituting some level of fraud mitigation procedures. And three, they should then be actively monitoring for these fraud red flags. So I'll quickly break down these three and shed a little more light and color on them.
So for the first one, they need to assess where they're most vulnerable to fraud. This pandemic is affecting employee morale and sentiment. There's a well-known fraud detection, a model out there that's called the fraud triangle and that talks about how there's normally three elements involved when there's fraud. You have pressure, opportunity, and rationalization. So pressure right now, obviously very high, right? You have to meet your financial targets. How do you do that under this current market and environment? So that increases one of those elements.
The second one, opportunity, clearly people working from home, there's limited management oversight, there's impact on company's internal controls, there's reduced budgets, so the opportunity is now sky high.
And then lastly, you have rationalization. So employee psyche may perceive improper behavior differently under this environment. They might justify their actions for committing some level of fraud. So you'd take those three elements into account. And then after you've done that, you try to prioritize those fraud risks, right, or the second step, which is, instituting fraud mitigation procedures.
So you need to adapt to the current market conditions. Where do you have those big gaps? Where are you most susceptible to your internal control environment? Or do you need to update some of those controls? Do you need to reinforce the hotline? Do you even need a hotline? So I would say making sure that you are prioritizing where you are most vulnerable within your organization and then adapting accordingly.
And then the third and final one that I mentioned is actively monitoring for those fraud red flags. You're going to have issues that might present itself in areas around corruption that I talked about, potential bribes, asset misappropriation, and then the third and biggest one is around potential fictitious financial statements. Are you increasing your revenues? Are you creating potential fictitious documentation all along and correlated with those pressures that management is feeling to meet the numbers?
CS: A lot of great information, Nelson. Can you give us a brief client example without mentioning any names of course, of the problem, the solution you prescribed, and the outcome?
NL:Yeah. So one example would be that we recently assisted counsel to a leading real estate investment and development company, where we were gathering evidence for a fraud suit against a construction company that development company had hired. And our team was performing a closeout assessment into the project costs by analyzing project contracts, change orders, labor rates, material costs, indirect costs for potential inflation. Over-billing right, essentially.
Our team was also investigating anomalies identified during the analysis of the payment applications, correspondence supporting documentation. It's an ongoing fraud suit, but it's an example of a one where construction company perhaps was feeling pressure under their current environment and was inflating its bills. And our client is having us help them investigate those allegations.
CS: And for listeners who want to learn more about fraud prevention and detection. What can they do?
NL:Well, there's many wonderful resources out there. I'll give a few examples. One would be the Association of Certified Fraud Examiners, the ACFE, that they put on great surveys on fraud prevention and detection that you can look at their website. Due to the pandemic the FBI created a dedicated website around COVID fraud prevention considerations, so you can look at that.
On our own website, Carol, on our eisneramper.com website or on my LinkedIn page, you'll see a white paper that I authored with the Institute of Internal Auditors that's around this topic that we're covering here and it's called a Blueprint to Managing Corporate Fraud Risk During a Pandemic. People have access to that if they want to take a look. And then of course, feel free to reach out if you have any questions. I'd be happy to have a discussion with you around what we're seeing other organizations doing to mitigate its fraud risks right now during the pandemic.
CS: Nelson, thanks for sharing your perspectives on preventing fraud in real estate companies and thank you for listening to Breaking Ground, real estate insights from EisnerAmper. Join us for our next podcast and visit EisnerAmper.com/RE for more real estate news.