Business: Construction Fraud

The growing prevalence of construction fraud is not a myth or the product of hype — it’s happening, and the stakes are high. Companies in all sectors of the construction industry are losing money to fraud perpetrated by employees, contractors, subcontractors and venture partners. A recent study showed the loss from fraud for Canadian companies was higher than the global average, and this held true in construction, where the average loss was $628,500. That’s not small change.

What factors can create the right environment for construction fraud to take place? Things like economic pressures, a lack of internal controls, increased opportunity for collusion, vaguely-worded contracts, using large amounts of cash, cost-based contracting, not clearly defining the scope of work, and risky joint ventures.

Whether they are acting on behalf of an owner, a design build contractor or another party, consulting engineers need to be aware of the problems in order to prevent and detect fraudulent activity. Below are 10 of the most common fraud schemes in the construction industry.

1. Non-payment of subcontractors and material suppliers by delaying lien waivers, falsifying lien waivers or using project cash receipts to pay bills for other projects.

2. Billing for unperformed work by overstating the units of production, the equipment actually used, or time spent.

3. Manipulating the schedule of values and contingency accounts. This can be done in several ways, including: failing to update schedule of values line items as buyouts or changes are made, or failing to associate subcontractors or vendors with specific SOV line items.

4. Diverting a lump-sum cost to time and material cost by initially budgeting expenses as a lump-sum, then billing for time and materials related to change orders.

5. Substituting or removing material, including using lower-grade material that requires subsequent repairing or replacing or that leads to a structural or system failure.

6. Change order manipulation, including altering work scope, removing scope descriptions, adding charges, omitting design specifications in the original scope of work, and improper price reductions for work substitution. Some of these activities can be a major concern for engineering companies since they could compromise the long-term integrity of the building.

7. Falsifying payment applications by covering up the purchase of personal items or funneling money to a phantom company controlled by an employee. Other examples include inflating invoices beyond actual costs by using profit or mark-up formulas.

8. Subcontractor collusion, including bid rigging, bribes, kickbacks, false or inflated change orders, undervalued deductive change orders, or phantom subcontractors.

9. Diverting purchases and stealing equipment and tools, or billing for tools not required by job specifications.

10. False representations, which could involve using undocumented workers; falsifying minority content reports, test results or insurance certificates; non-compliance with environmental regulations; misrepresentation as as a small business.

The benefits of understanding construction fraud risks and taking proactive measures to combat them are many. Of course, engineers are also bound by their professional licensing organizations to abide by a Code of Ethics.

At the same time, a strong fraud strategy can help you avoid project delays or cancellations, maintain costs at stable and predictable levels, and control risks to your reputation.

Given current levels of construction activity and investment in Canada, the industry needs to implement proactive, preventive measures. Individuals and organizations need to invest the time and money to put a fraud prevention and detection plan into action – before they become a victim. And it’s going to require strong governance and leadership – in other words, the push for fraud prevention has to start at the top of the organization. CEOs may balk at the time and cost involved in implementing a substantive fraud prevention program, saying “It won’t happen to me.”

Unfortunately, fraud exists, and it is becoming more prevalent and sophisticated. Take action before it happens.cce

Kelly Kolke is a Chartered Accountant and partner with Grant Thornton LLP in Nova Scotia. E-mail Kelly.kolke@ca.gt.com