Three Types of Construction Fraud – How to Prevent Falling Victim
Updated: Apr 27, 2022
With the economy in its current state, fraud is on the rise even in the construction industry. Fraudsters are everywhere. One may even be on your payroll.
1. Falsifying Payment Applications – According to the ACFE's 2022 Report on Occupational Fraud, billing fraud accounts for more than 24% of the reported cases in the construction industry. Receiving falsified applications for payment happens a lot, due to the time-consuming nature of having one of your employees verify every detail of an invoice. Just maybe, one of your employees is collaborating with the fraudster. City employees have been caught doing so. Why not one of yours? Be sure to understand how this happens:
a. Material costs appear inflated compared to their market value – One of your internal controls should include asking the applicant to include receipts or copies thereof for items that you’re being billed for. Contacting the source may provide an answer other than you expected.
b. Payment applications that fall outside the scope of work – Requests for payment should match the negotiated scope of work. It’s not uncommon for project managers, even others within a company like yours to have submitted false pay applications for work, made up or otherwise. Don’t pay an invoice or application for payment just because it came in the mail. Both invoices and payment applications should be matched to work orders.
c. Improper wage rates and categories – Other examples of construction fraud includes subcontractors who charge a journeyman rate for work performed by an apprentice, or charge for rental of a piece of equipment that they already own. Requesting receipts for any expenses that the subcontractor is forwarding to you along with their payment application is not only smart but a means to reduce the opportunity for fraud. You might not catch everything, but you’ll gain the attention of those who seek to do you harm by stealing from you.
2. False Representations – What are they? A false representation happens anytime you receive a product or service different than what you’ve paid for. Most often materials or equipment, but a misrepresentation can apply to services as well. False representations can occur in many ways:
a. The subcontractor overbills for labor when the job involved fewer hours to complete. Example: You’re being billed for 24 hours when the actual amount of labor needed to complete the task was 16.
b. A “no-brainer” here. The subcontractor claims they are supervising a skilled team of laborers but are found to be employing unskilled day workers or using undocumented foreign workers paid at a much lower rate.
c. The subcontractor bills you for materials he claims to be top grade, when in fact the material is of a lessor grade. Preventable by asking for receipts.
d. The subcontractor claims to comply with environmental regulations but is caught engaging in illegal and harmful practices at your job site. It’s a real possibility that you could be held responsible.
3. Theft, Diversion, Substitution or Removal – When contractors are allowed to bill for their expenses, some may use the opportunity to steal or even substitute materials of a lessor grade. Here are a couple of things to keep an eye out for:
a. The subcontractor who substitutes (and maybe even steals) materials, billing you for Class A material but purchases and installs materials of a lessor grade to complete the project is committing fraud. Remember, you’ve paid top dollar for a product that your now left with that doesn’t even meet the specifications of the project! On-site material inspections could’ve prevented this from happening.
b. This happens all the time. The subcontractor bills for a piece of equipment which is being used on another job site or is using the same piece of equipment without authorization for their own project. Remember, equipment that you pay for becomes your property and should only be used for your job! Make it part of your routine to double-check purchased materials or equipment against the application for payment.
Ipsen Due Diligence recommends that you obtain written documents confirming all claims and representations that the subcontractor makes to you. Always remember, an honest subcontractor would have no problem providing professional licenses, references and evidence that they’re doing things the proper and legal way.