By James Marasco, CPA, CIA, CFE Fraud Matters, Summer 2010

Procurement fraud extends across various industries, and the types vary in sophistication. It arises from contract management and the outsourcing of goods and services. Identifying the risks of procurement fraud will aid in safeguarding your organization from falling victim.

Types of procurement fraud

Procurement fraud can be perpetrated through a variety of schemes. The types of procurement fraud, and the definition of each, are as follows:

Bribery – Offering and/or soliciting something of value for the purpose of influencing the action of an official in the discharge of their public or legal duty.

Bid Rigging – Collusion among competitors to artificially increase the prices of goods and/or services offered in bids to potential customers.

Embezzlement – Stealing money for one’s own use by individuals to whom assets were entrusted.

Money Laundering – Legitimizing illegally obtained money to hide its true nature or source.

False Claims – Filing false claims for reimbursement, usually against the government (i.e., health care, military, etc.)

Cost/Labor Mischarging (Defective Pricing) – Charging rates or costs to customers at prices that exceed contractual terms.

Defective Parts or Supplies – Items that were built or delivered below the acceptable standard or level.

Product Substitutions – Delivering inferior or substandard products.

Safeguarding against procurement fraud

A variety of safeguards are available to thwart the threat of procurement fraud. In addition to a strong internal control framework, specific controls include:

• A centralized procurement department that routinely rotates purchasing managers across different vendor relationships.
• A strong contracting process that includes robust, well-written contracts and a code of ethics for vendors to acknowledge and by which to abide.
• A thorough review and disclosure process to investigate all new vendors and any association they may have with existing vendors or employees of the organization.
• A well-organized and efficient process of accepting/acknowledging that goods and services are adequately delivered in accordance with the terms of their contract(s).
• Routine auditing of your vendors to ensure that pricing is in accordance with your agreements and other contractual terms are being met.
• Routine auditing of your accounts payable to look for duplicate disbursements and verify that credits and discounts are being properly administered.
• Routine bidding process for contractual items to determine if the pricing is at market rates. These bids should be reviewed by the procurement department, independent of those requesting the goods or services.

The biggest victim

Here in the United States, the federal government is the largest single purchaser of goods and services. It goes without saying, the federal government has also become the most widely abused victim of procurement fraud. The federal government has experienced all aspects of procurement fraud and has built aggressive defenses against it. The Iraq and Afghanistan wars have exposed the vulnerabilities of the government to procurement schemes by contractors. A BBC investigation in 2008 reported that approximately $23 billion may have been lost, stolen or not accounted for in Iraq since the start of the war. At that time, Henry Waxman, who chaired the House committee on oversight and government reform, said, “The money that’s gone into waste, fraud and abuse under these contracts is just so outrageous, it’s egregious. It may well turn out to be the largest war profiteering in history.” In 2006, the National Procurement Fraud Task Force was created to provide the government with a group specifically focused on detecting and prosecuting procurement fraud. The task force includes members from the FBI, Department of Justice and others. It has been estimated that, since its inception, the task force has prosecuted more than 400 cases, resulting in more than 300 criminal convictions and millions of dollars in civil judgments and settlements.

Punishment

Procurement fraud is punishable through a number of federal legislative acts, which include:

• The False Claims Act
• The Sherman Antitrust Act
• The Contract Dispute Act
• Truth in Negotiations Act

The most publicized of these acts is the False Claims Act, or Qui Tam Provision. It was passed during the Civil War to prosecute parties who were selling the government decrepit horses and mules. This law allows citizens to sue on behalf of the government and be paid a percentage of the recovery. Thus, in many cases, people are usually referred to as whistleblowers. These cases have helped the government recover billions of dollars over the years. One of the largest cases involved hospital conglomerate Columbia/HCA, which ended up paying the government nearly $2 billion in false claims suits. These types of fraud can affect any organization. Even nonprofits are vulnerable. Strong controls, diligent procedures and a vigilant audit process will help safeguard against procurement fraud.

Jim Marasco, CPA, CIA, CFE, is a partner in the Business Valuation, Forensic & Litigation Services Department at EFPR Group, LLP, Certified Public Accountants and Business Consultants. He practices exclusively in the forensic and litigation support areas and travels around the U.S. helping safeguard various types of businesses. He may be reached at 585.427.8900 or by e-mail at jmarasco AT efprgroup.com