Have You Been a Victim of Fraud?

By Jim Jordan

Jim Jordan is director of construction services for Dallas/Fort Worth-based Weaver and Tidwell LLP.

Although fraud occurs at all business types, the construction industry should be particularly vigilant. The most important step a contracting firm can take, Jordan writes, is to make it clear that unethical behavior will not be tolerated..

For the past several years, corporate fraud has been one of the most reported crimes in America. In a way, that's good because owners and shareholders of private and public companies are now aware that fraud is expensive and must be prevented.

The bad news, of course, is that corporate fraud is too common. In fact, it's all around us - particularly in the construction industry. Across the globe, corruption consumed 10 percent of the world's total construction in 2004, a year in which contracts totaled $3.9 trillion, according to Transparency International. That means $390 billion was pilfered. A 2004 report by the Association of Certified Fraud Examiners states that the typical U.S. organization loses 6 percent of its annual revenue to fraud and 40 percent of those organizations never recover any of their losses.

In terms of domestic corruption, a top Justice Department official said last year that the construction industry generates the most corruption cases in America. These cases may involve bribery, theft of money or property, theft of trade secrets, misrepresentation or concealment of material facts or breach of fiduciary duty. It also can come from various directions: Contractors can defraud owners; employees can steal from their own companies.

Even employees of construction firms can use their companies to steal from the project owner. That is what occurred between 2000 and 2005 at Tampa, Fla.-based PBS&J, according to the U.S. Justice Department. Earlier this year it was disclosed that three PBS&J company executives embezzled $36 million by overstating expenses billed to transportation departments in Texas, Florida, Georgia and Nevada. The executives currently are negotiating a plea deal with federal prosecutors. But the company is left with the financial burden of making restitution.

Fraud, however, most often occurs at small- and mid-sized firms. These firms by necessity often allow employees to wear many hats whether qualified or not. The most common forms of fraud include:

Cash Schemes Without the proper internal controls, those with access to a company's cash can misappropriate funds in various ways including skimming, altering cash receipts, creating fictitious refunds and discounts and kiting. Inventing expenses is particularly common. In a study conducted by Ipsos Reid, 7 percent of respondents said they knew people who inflated expense accounts. While the study showed that employees under age 35 are most likely to commit this fraud, managers inflated their expense accounts by larger amounts.

Inventory Schemes More than a few company owners have learned the hard way that unprotected inventory is a treasure trove for the larceny-minded. The two most common forms of fraud are embezzlement of scrap proceeds and the appropriation of inventory for personal use.

Purchasing Schemes Without formal controls and safeguards, purchasing functions can be manipulated for fraudulent purposes. Acts of deception may include fictitious invoices, unapproved paychecks made out to employees, over billing and excess purchasing of property and services.

Fixed Assets Many contractors fail to pay close attention to fixed assets such as trucks and equipment. Unscrupulous employees many find it easy to steal or make personal use of company assets.

Although fraud occurs at all businesses, the construction industry needs to be particularly vigilant. Our business is inordinately dynamic, with projects spread across a wide geographical area. It's a difficult process even for large contractors, who are more likely to employ trained auditors and have formal internal controls. In Texas, however, the majority of contracting operations are relatively small and few have anything other than rudimentary financial checks and balances. Many of these companies fail to even obtain employee dishonesty bonds on company personnel.

One major problem at smaller companies is that a single employee - a bookkeeper, office manager or even administrative assistant - often is assigned multiple responsibilities. When one of those disparate responsibilities is financial oversight, an environment for fraud is created. When financial responsibilities are segregated, it's harder for an employee to cover up pilfering. Although smaller contractors may not have the resources to hire full-time forensic accountants or even CPAs, there are inexpensive ways to reduce fraud. Again, one of the most important steps is to segregate banking responsibilities from accounts receivable and accounts payable functions. At the same time, owners should require dual signatures on all checks, including theirs. Owners can request that they receive all bank statements before they are opened.

Another precautionary step an owner can take is to mandate a week of vacation for all employees. This allows the company to temporarily hand bookkeeping responsibilities to someone else. That person may notice something odd about the accounting. And outside accountants should be retained periodically to review the work of those making financial decisions.

Company owners should create a hotline or similar system that allows employees to anonymously report evidence of wrongdoing. Owners should do more than merely threaten. They should demonstrate by their actions a strong commitment to ethical behavior and remind employees that fraud is not just unethical it is criminal.