How to prevent fraud in your construction business
Unfortunately, fraud is common in the construction industry. As an owner or manager, you must always be vigilant with employees as well as vendors, contractors, and sub-contractors to avoid falling victim. Fraud not only means lost revenue, but it can also result in legal trouble for you, even if you weren’t the one responsible. In fact, claiming ignorance won’t get you off the hook, just like it doesn’t matter if you unknowingly broke a traffic law.
Here are some common types of fraud that can occur.
- Falsifying payment applications – This accounts for more than half of all fraud. It can include:
• Erroneous totals or line items.
• Roll-forward errors.
• False invoices.
• Inflated rates.
• Fraudulent wage rates and categories.
• Overhead and equipment rates.
• Profit or markup formulas and fee calculations.
- Billing for unperformed work.
- Subcontractor collusion – This can include bid rigging and price fixing.
- Manipulating change orders.
- Manipulating the schedule of values and contingency accounts.
- Substituting or removing materials.
- Diverting low-sum cost to time and material cost.
- Diverting purchases and stealing equipment/tools.
- False representations:
• This can include subcontractors who make false claims about employees, insurance, and purchases.
• Claiming the use of skilled workers when they really used undocumented workers.
• Violating “By American” requirements.
• Falsifying minority content reports, test results or insurance certifications.
6 tips that can help prevent most common types of construction fraud
1. Conduct a thorough background screening before working with anyone
Before you hire anyone, sign a contract or make a deal with another individual or company, make sure you do a background check. This includes contractors, subcontractors, and principals in your company. You want to look for things like tax liens, lawsuits, legal judgments, and violations. Start with a Google search, which can actually turn up a lot, but don’t hesitate to hire an attorney or licensed investigator to do background checks.
One red flag to watch for is subsidiary companies that mask the identity of the principals. Also, don’t overlook people you’re already working with, including long-standing business partners. Just because you’ve known someone for a long time doesn’t mean he or she is honest.
2. Have someone monitor business activities for fraud
Many construction companies hire someone called a chief compliance officer (CCO) who conducts regular reviews. This person should report directly to the owner or board of directors. Continuous monitoring can help spot fraud and ensure accountability within the organization.
- Duties should include:
- Analyzing payroll, invoices, and contracts.
- Speaking with workers in the field to ensure accurate documentation.
- Establishing relationships with all contractors and subcontractors.
- Providing anonymous ways that people can report potential fraud, waste, or illegal activity.
3. Consult with a compliance professional
Compliance professionals can help you establish protocols that will safeguard your company against fraud or illegal activities. These individuals are trained to ensure companies comply with employment laws, tax and government mandates, and more.
4. Always review invoices, pay applications and wage rates
As stated above, over half of all fraud falls under the category of false payment applications, such as inflated material costs or applications that exceed the scope of work or include made-up work. Another red flag can be improper wages or categories. A subcontractor might charge a journeyman rate for work that was done by an apprentice, for example.
5. Review itemized payment applications
Fraudulent contractors or subcontractors will sometimes charge for Class A materials when they’re really using Class D materials. In this case, it’s not enough to just inspect an invoice. You will have to conduct on-site inspections to ensure the correct materials are being used. Another common fraudulent practice employed by subcontractors is charging for a piece of equipment that ends up being used for another, unrelated job. You’ll need to double-check invoices for purchased materials and equipment to ensure you are being charged correctly.
6. Obtain written documentation regarding claims
False claims and false representation are both extremely common. False representation means you’re getting something other than what you paid for. It can take the form of overinflated units of labor, i.e., the job took 12 months, but you were charged for 16 months. It might also include subcontractors who use undocumented workers but claim them as skilled laborers. It can even include false claims regarding environmental regulations, harmful practices, or illegal activity that could get you into legal trouble or result in heavy penalties and/or fines. To protect yourself legally and financially, make sure you obtain written documentation that confirms all claims and representations.
Construction fraud is common, and it can lead to lost revenue and even legal trouble. Follow the above 6 tips to help reduce your risk and contact No Boundaries Advisors to help monitor your business for fraud.
