Capital Improvement Programs: Where is the Fraud, Waste and Abuse

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2 Capital Improvement Programs: Where is the Fraud, Waste and Abuse 1

3 Agenda: Definition and Statistics Internal Fraud Construction Risks Types of Contracts and Red Flags Take-Aways 2

4 Definition The use of one s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization s resources or assets. Occupational Fraud and Abuse, Joseph Wells, Obsidian Publishing Company,

5 Fraud Triangle: Opportunity Rationalization Construction Triangle Pressure 4

6 Pressure Pressure 6 5

7 Statistics ACFE Statistics: Median Fraud loss in construction is 245,000* Seventh highest fraud loss amount by industry* ACFE Common Construction Fraud Schemes: Corruption 40 percent* Billings 20 percent* *Per the ACFE S 2014 Report to the Nations on Occupational Fraud and Abuse 6

8 Behavioral Red Flags Behavior Red Flags Close Association with Vendors ($410,000) Wheeler Dealer Attitude ($405,000) Excessive Pressure ($388,000) Control Issues ($250,000) Per the ACFE s 2010 Report to The Nations On Occupational Fraud and Abuse 7

9 Corruption Negotiation Billings Workmanship Fraud Waste and Abuse 8

10 Corruption East Coast Mafia: Lumpy, Mush, The Claw, Jack the Wack, Meatball controlled illegal activities through legitimate industry It was such a major as construction remodel. New The York: contractor s Six building job inspectors cost records taking bribes, reflected three the associated cost invoiced with Luchese to the family owner, (previously showing 19 payments or 24 inspectors American charged) Express for approximately $8,000 Dallas: and $6,000. Mayor pressured developers to hire minority firms and received kickbacks Oakland: The contractor City council stated, members I was alleged afraid to have you sole would source see this; construction I will provide work for support. preferred contractor San Later Francisco: the contractor Pacific Cement stated a minority that he contractor talked to used his recycled attorney concrete and would on Bay remove Bride, Golden that State amount Bridge from parking lot. Pleaded guilty to environmental charge 10 Case Study the job cost and billings. The charges were for resorts in Hawaii. 9

11 Internal Fraud Procurement No procurement department or poor controls Bids received by facilities Change orders Related parties (conflict of interest) 10

12 Case Study The manager of facilities received all bids. After receipt, the manager of facilities called his favorite contractor and had that contractor submit a lower bid. The favorite contractor was awarded all competitive bid projects. The favorite contractor did free work at the home of the manager of facilities. 11

13 Internal Fraud: Kickbacks Forms of Kickbacks Cash payments Home improvements Travel and entertainment 12

14 Case Study Papa Bear was the project manager for the owner. Papa Bear received a proposal for $6.8 million from drywall contractor. Papa Bear increased the price of the proposal from $6.8 million to $8.2 million. Papa Bear received $800,000 of the $1.4 million in the price increase in the form of a kickback from the drywall contractor. 13

15 Negotiations Fraud not identified Truth in Negotiations Act Won t lie, won t tell the truth 14

16 Internal Fraud Red Flags Close relationship with vendors Vendor new to business Living beyond means Poor segregation of duties Numerous complaints Conflict of interest 15

17 Fraud Risk based on Contract Type Contract type Lump sum, fixed price, stipulated sum Competitively bid Negotiated Cost reimbursable or cost plus Cost plus with fixed or percentage fee Guaranteed maximum price Time and material 16

18 Stipulated Sum Risks Procurement process Specifications Change orders Front-end or top-loading Allowances 17

19 Change Orders 18

20 Stored Material $2,000, Stored Materials Invoiced $1,800, $1,600, $1,400, $1,200, $1,000, $800, Delivered After Invoiced Invoiced $600, $400, $200, $0.00 January February March April May June 19

21 Workmanship 20

22 Stipulated Sum Red Flags Unsuccessful bidder doing subcontract work Same firm winning bids Excessive change orders Lack of competition Numerous bidders Stored materials Poor workmanship (rework) 21

23 Cost Reimbursable Issues 60% 50% 40% 30% CY CY % 10% 0% Labor Overbilled Cost Fee Other Insurance Subcontracts 22

24 Movie Theatre Case Study There was concern for ABC s financial position and their ability to pay subcontractors. The subcontractor s agreement included the requirement to maintain a clean worksite. ABC gave change orders to the subcontractors for clean-up work. The subcontractors awarded the work to XYZ to clean up the site. 23

25 Cost Reimbursable Red Flags Low fee Self-performed work Two trades performing subcontract work CCIP and subcontractor default insurance Related parties Contractor turnover No audits Close relationship 24

26 Case Study Owner s Rep was a new firm Owner Rep: Until the time of the award worked for the hospital Change order executed where Owner s Rep who do clean-up in lieu of contractor for $250,000 Owner s Rep billed $500,000 to the project for cleanup Owner s Rep president lived next door to the hospital CEO Owner s Rep did work at the CEO s house Contractor filed claim for $250,000 for clean-up they did in lieu of Owner s Rep 25

27 Other Indicators Change in management for contractor Contractor is newly formed entities Related parties Unusual transactions 26

28 Take-Aways How did we get to the price: Stipulated Sum Competitive Bid Bid Spread Adequate segregation of duties Cost Type Contract negotiations Changes to the contract Change Orders Determine cause and examine Hotline Internal and External Walk the project site Audit 27

29 Contact Information John M. Croy, CPA, CIA, CFE, CCA RSM US LLP Phone: Cell:

30 Questions & Answers 29