© 2015 Association of Certified Fraud Examiners, Inc.

Fraud in Capital Projects and Construction

Denise Cicchella, CFE, CIA, CCA, PMP

Fraud in Capital

Projects and

Construction

2015 ACFE

Annual

Conference

Denise Cicchella, CFE, CIA, CCA, PMP

Auspicium, CEO

Agenda

• Phases of Projects

• Risks at each phase

• Opportunities to commit fraud

• Fraud Prevention Controls – Need for

Governance

• Investigation Strategies and Tips

(c) 2015 Auspicium

Capital Projects Defined

• Delivers specific objective

• Often specialized in nature (may not be a

core competency)

• Long-term consequences and impact

• Material investment of capital

• Often high risk

– Impact

– Likelihood

(c) 2015 Auspicium

Examples

• New IT System

– ERP

– Customer Fulfillment

• Development of New Product or Service

• M&A

• New Building or Facility

– Corporate HQ

– Warehouse / shipping facility

– Data Center (c) 2015 Auspicium

Risky Business

• Project Risk

– $$$$$$

– Probability of Failure

– Reputational

• Vendor Risk

• Technology Risk

• Sabotage Risk

• Fraud Risk

(c) 2015 Auspicium

Risk Mitigation

(c) 2015 Auspicium

Phases of a Project

(c) 2015 Auspicium

Decide Design Vendor

Selection Project

Execution Done

Project Life Cycle Activities

• The least is known about the project near its beginning

– Plans to be developed

– Concept that has to develop

• The level of uncertainty and risk is highest at the beginning of the project

– Feasibility

© Auspicium 2015

Decisions…

• New activity (service / product) • New system • New building • New market • Replacement system / building • Acquisition / Merger • Divestiture / Closure

ANY one of which could result in multiple

projects!

© Auspicium 2015

Decide

• Business decision to go ahead with a

project:

– Aligned with corporate strategy?

• Project approval process followed

– Are risks acceptable?

• Is there a trend to how projects are

approved?

– Bias

– Motive (c) 2015 Auspicium

Bias in Decision Making

• Projects chosen not in organization’s best

interest

• Promote self interest

• Poor tone at the top

• Incompetence or fraud?

• Loss of employee morale

• Reputational damage

(c) 2015 Auspicium

Decision Techniques

SWOT

Payback

NPV

IRR

Pros/Cons

(c) 2015 Auspicium

…besides Techniques • Is decision based on:

– Accurate information

– Information from reliable source

– Detailed information

• Are constraints realistic?

– Time

– Cost

– Technical feasibility

• Transparency of decision making

(c) 2015 Auspicium

Identifying Bias & Favoritism

• One: • Project manager always picked

• Type of project always chosen

• Vendor always selected

• Projects chosen against corporate strategy

• Failure to comply with policy

• Decisions overridden

• “Pet Projects” — even if not prime focus of

business

(c) 2015 Auspicium

Actionable Findings

• Failure to comply with policy

– Disciplinary Action

• Trends may trigger further investigations

– COI

– Kickbacks

• Enhance processes

(c) 2015 Auspicium

Project Sabotage

• Purposely harming a project to make it fail:

– Vandalism

– Theft

– Picketing

– Withholding information

– Misleading information

– Friend in front, knife wielder in back

• Proving the wrong project was picked

(c) 2015 Auspicium

Sabotage Happens

• Damaging IT equipment to prevent a new

system from going live

• Planting endangered species on a

proposed site

• Leaking proprietary project information

– To public

– To competitor

• Likelihood increases for sensitive projects

(c) 2015 Auspicium

Sabotage Motives

• Fear of Change

– Unemployment

• Conscience

– Environment

– Government or Corporate Policy

• Financial

– Steer toward alternative action

(c) 2015 Auspicium

Decision-Making Red Flags

COI, Bribes, Kickbacks, and Corruption:

• Costs / Revenue Assumptions • Unsupported

• Skewed

• Ignoring good projects and selecting bad

projects

• Project selection and approval policies not

followed

• Risks understated (c) 2015 Auspicium

Opportunity

• Decisions taken by single individual:

– Site Identification

– Site Selection

– Vendor Identification

– Vendor Selection

• Executive override

• “Bully”

• Trusted Advisor

(c) 2015 Auspicium

Hidden Personal Agendas

• Is it Rose Colored Glasses or Personal

Gain?

• Miscalculations (error or intentional

“mistake”)

• Motive

– Personal gain

• Kickback

• Contracts to related parties

• Future employment

• Property owner

(c) 2015 Auspicium

Design

(c) 2015 Auspicium

What Who

When How

What

• What will the project:

– Cost

– Do

– Be used for

• Expectations

• Key deliverables

• Expertise will be needed

(c) 2015 Auspicium

Who

• Will run the project

– Internal

– External

– Executive Sponsor

• Will govern the project

• Will fund the project

(c) 2015 Auspicium

When

• Will the project finish?

• Are the milestones? • SMART

• Will progress reports be issued?

Dates may be calendar and/or event driven

(c) 2015 Auspicium

How

• Do you see it getting done?

• Does the organization plan on using it?

– Initial purpose

– Re-purposes

– Expansion

• Can we maximize stakeholder

expectations?

(c) 2015 Auspicium

Fraud in Design

• Overly restrictive criteria

• Overstating the probability that a design

will work

• Ignoring risks and barriers to success

• Designing more than is needed

– Gold plating

– Personal agenda

– Expanding project scope

(c) 2015 Auspicium

Key Players

• Design often involves specialists

– Architects

– Lawyer (should be but often done by in-house

counsel)

– Project Manager

– Programmers/Systems Analysts

– Strategic Consultants

(c) 2015 Auspicium

Issues

• “Up Sell” services

– “Extras”

• Inflate work

– >24 hours in day!

• Extreme promises

– “We can install a new system bug free in

three hours”

• Recommending Related Parties

(c) 2015 Auspicium

Vendor Selection Phase • Know expertise of vendors – don’t assume

– Creative Resume Writing

– Bid to find out strategies

– Unqualified but bid anyway

• Results in errors in execution

• Results in change orders

• Identify if vendors are related

• Ensure scope is clear

– If not – here come the change orders

• Do not over rely on contractor (c) 2015 Auspicium

Considerations

• What information/assets does vendor have access to: – What records is the vendor keeping?

– Where is the vendor storing records?

– How are the records being destroyed?

• How is the vendor accessing the site or system?

• How is site/system access monitored and controlled – consider: – New employees?

– Terminated employees?

– Impaired employees?

© Auspicium 2015

Vendor Bidding Frauds

• Collusion

• Bid Rigging

• Price Fixing

• Bidding to Unqualified Vendors

– Under-specializing the specialists

• Overspecializing the Specialists

• Bait and Switch

(c) 2015 Auspicium

Corruption

© Auspicium 2015

Bid Rigging

• Cover pricing: submit a higher price or unacceptable terms, possibly for sub contract

• Bid suppression: agree not to bid or withdraw

• Bid rotation: taking it in turns to win

• Splitting the market: carve out segments of the market or geographic locations

© Auspicium 2015

Preventing Bid Rigging

• Level Playing Field – Defined selection criteria – More then one set of eyes – No single voice – No conflicts of interest

• Approved Contractor’s List – Review – Refresh

• Banned Lists – www.epls.gov

• May be a banned site

© Auspicium 2015

Loose Lips Sink Ships

– Don’t allow the bidding process to be compromised by disclosing bids or insider information

– Policy not to disclose rival bids before opening

– All communication to bidders should be done SIMULTANEOUSLY

– Use of NDAs for internal and external stakeholders

© Auspicium 2015

Know Your Vendor

• Pending Litigation

• Bankruptcies

• Citations – Health

– Safety

– Labor

• Past Performance – Delays?

– Cost Overruns?

© Auspicium 2015

Up-Billing

• “Bait and Switch” personnel

• Promise the President deliver an intern

• Qualifications

• Licensing

• Rates (?)

© Auspicium 2015

Digging up the Dirt

• The Internet has made it easier to uncover background information about people and companies

– Pay to Access Databases

• D&B

• Lexis / Nexis

– Accurent/Relavent

• Hoover’s

• Kroll’s

© Auspicium 2015

More Dirt

• Government Records – Licenses

– Complaints

• Blogs – Current and former employees

– Advocacy groups

• Social Media

• Traditional Media – Newspapers

© Auspicium 2015

Detecting Vendor Problems

• Bid analysis

• Patterns of bidding

• Trends

• Price comparisons

– Benchmarking

– Independent appraisals

• Quick response

© Auspicium 2015

Contract as a Control

• Who writes the contract has the advantage • Don’t accept vendor contracts without challenge

• Make sure contract works for you

• Terms and conditions are added or edited

• Contract matches proposal

• Reviewed by expert

• Keep relationship but stand ground

• Make sure contract terms don’t contradict

(c) 2015 Auspicium

Requirements Not

(Clearly) Defined

• The BIGGEST pitfall

• If the requirement isn’t clearly articulated:

– Undue reliance on vendor to “understand”

– Contract difficult to enforce

– Escalated costs

– Monitoring not possible or difficult

– “Objectives” not met

© Auspicium 2015

Legal Advice

• Internal counsel may not have expertise in

the contract subject matter

– IT

– Construction

• Contract may contain domain-specific

terminology (Lingo/Jargon)

– Hard / soft costs

© Auspicium 2015

Right to Audit

• What records will owners have the right to review

• When does audit right expire

• Where will audit be done

• Who pays for the audit

• Does the right to audit pass to subcontractors

• What will happen in the event of overcharges

• Can you audit records not directly related to the project

– Personnel files

– Administrative records

• OFTEN MISSING!!!!!

© Auspicium 2015

Specific Costs or Calculations

• Labor

• Material

• Equipment (rental)

• Indirect costs

• Unit costs

• Specific calculations

• Profit margins

• Payment to inter-related companies

• Change orders

• Exchange rates © Auspicium 2015

Other Cost Considerations

• Pre-assignment of supplier

• Owner reimbursed items

• Industry inflation

• Trade discounts

• Discount prices

• Hard vs. Soft !!

© Auspicium 2015

Liabilities

• Right of refusal to allow employee / vendor on project

• Confidentiality – IT Security

• Expected behavior protocols & consequences

• Premise rules

• Drug/Alcohol Policy – Testing

– Monitoring

– Screening

– Suspicions

© Auspicium 2015

Substitution Clauses

• “The contractor shall have the right to substitute any materials with a substitute of equal value and quality” – Define value

– Define quality

– Define grade

• Material is not available

• Material is more costly

• Construction requirements

• Changes to building code

• Pricing differentials

© Auspicium 2015

Salvage

• Who owns money collected on sale?

• Who will it be sold to?

• Who does it belong to?

• Disposal (especially IT)

• Retainage of scrap

– Same criteria apply

– What does owner get for routine maintenance

– The more intricate the design, the more scrap

© Auspicium 2015

Early Termination

• For Cause

– Disciplinary

– Performance

• Financial reasons

• Destruction beyond a certain

point

• Sale to another party

• “Just Because”

• Force majeure

© Auspicium 2015

Breach of Contract

• Damages

– Performance

– Team

– Liquidated

• Can contractor cancel?

– With or without cause

• Vendor dismissal

• Finance charge reimbursement

– Delayed start or finish

© Auspicium 2015

Guarantees

• Performance

• Quality of work

• Material

• Equipment

• Extended warranties

• Who pays

© Auspicium 2015

Dispute-Resolution Agreements

• Arbitration

• Litigation

• Mediation

– Who mediates

– Jurisdiction

– Binding versus Non-Binding

– Pre-assigned mediator

• Resolution Protocol © Auspicium 2015

Project Execution

• Most project time

• Most project expenditure

• Anything can go wrong

• MUST BE MONITORED

– Deliverables

– Performance

– Changes

– Key Performance Indicators

– Security (c) 2015 Auspicium

Important Deliverables

• Cost/Budget

• Time

• Scope

• Quality

• Safety

• Other

• Defined and monitored

(c) 2015 Auspicium

Other

Cost

Time

Scope Safe

Quality

Professional Service Frauds

• Working more then 24 hours a day

• “Raises”

• Raises with underpayments

• Everyone appointed as lead

• Highest paid employee does clerical work

• Working without license

– “Borrowing” of licenses

(c) 2015 Auspicium

Inflated Labor

• Overstated hours

• Ghost Employees

– Not there

– On other sites

– Undocumented

• Overtime “mis”calculations

• Equipment operators without equipment

• Pay for training or vacation

(c) 2015 Auspicium

Material & Equipment Fraud

• Ordering for other projects

• Material never shipped to site

• “Nice to have” material

– iPads

– Otter boxes

– Tablets

• Obtaining excess materials

• “Stolen” from site

(c) 2015 Auspicium

Overpayments on Equipment

• Equipment that is idle more then it is used

• Equipment used without operator

• Charging piece by piece

• Charging at wrong rate

• Charging same equipment multiple times

• No credit for returns

(c) 2015 Auspicium

Change Order Abuse

• Execute change and then get approval

– Sometimes OK

• Foundation work

• Stop catastrophe

• Split change orders

• Change order for work in scope

• Fraudulent site conditions

• Price inconsistent with normal work

(c) 2015 Auspicium

The Investigation

• Investigation triggers

– Budget

– Executive Concerns

– Tip

– Observation

– Audit

• Document concerns about the project

• Map key players and relationships

(c) 2015 Auspicium

Investigative Team

• Subject matter expertise

• Determine if experts need to be called in

– What capacity will they serve?

• Investigate and negotiate

• Investigate and litigate

• Investigate only

• Quality (e.g. materials used)

• Legal

– Attorney Client Privilege

(c) 2015 Auspicium

Establish Facts

• Obtain contracts and project charter

• Obtain original investment decision

– Highlight any objectives

– Highlight constraints

• Time

• Money

• Scope

– Compare to actual

– Calculate/ID deviations from constraints

(c) 2015 Auspicium

Interview Key Players

• Executive Sponsor

• Project Manager and Team

• End Users (if at that stage)

• Key Vendors and Subcontractors

– (Should have the right to do so in your

contracts)

• Depending on suspicion, interview most

“innocent” first

(c) 2015 Auspicium

Follow the Money

• Obtain project financials from project

manager and accounting!

• Graph data to identify unusual trends

• Look for money spent “out of order”

– Painting before masonry

• Obtain change order log

• Trends in change orders

• Inappropriate vendors or charges

(c) 2015 Auspicium

Useful Graphs

• Budget to actual

• Timing of expenses

• Expense by:

– Vendor

– Trade / Specialty

– Clusters (Location / Employee / Phases)

• Change Orders

– Root Causes

(c) 2015 Auspicium

Determine Progress…

• What stage of the project life cycle are you

at?

• If work is completed – does it work?

– Quality of deliverables

• Progress to date

– Project Management reports

– Incident reports

– Minute meetings (if kept)

– Test reports and other assessments (c) 2015 Auspicium

Suspects • For vendor(s): similar issues elsewhere?

– May need to assess vendor vetting

– Re-perform (Kroll)

• For employee(s): employment history

• Has organization had similar issues on

other projects?

– Commonalities

• Are there related issues?

(c) 2015 Auspicium

Cost & Invoicing Issues

• Trace invoices:

– Is amount invoiced reimbursable per

contract?

– Is amount invoiced accurate per documented

backup?

– Are invoices submitted in a logical order?

– For reimbursable, is there proof money has

been paid?

– Are invoices submitted timely?

– Do invoices flow one to the other (c) 2015 Auspicium

Investigation Results

• Is it fraud?

– Incompetence

– Errors

– Rush

• Cost Recovery

• Litigation / Disciplinary Action

• Were policies/methodologies followed?

– Possible Improvements

(c) 2015 Auspicium

Questions/Comments

(c) 2015 Auspicium

Denise Cicchella

Denise.cicchella@auspiciumco.com

1-877-550-6802

(201) 835 – 4069

Linked in

© 2015 Association of Certified Fraud Examiners, Inc.

Fraud in Capital Projects and Construction

Denise Cicchella, CFE, CIA, CCA, PMP