The rise in contract management and the outsourcing of goods and services has created an increase in procurement fraud. Here are some red flags that can help you save millions.
The top execs at QRX Inc. were quite concerned about their contracting officials (CO). The COs had been selecting several new bidders for jobs and seemingly ignoring longtime contractors. QRX wasn't opposed to new blood, but the established contractors were beginning to grumble. QRX called me in to investigate.
I discovered the COs in one bidding round had given low ratings to all the reputable contractors. However, then they gave high ratings to a new company and awarded the contract to that company at double the price they could have paid. I later learned the bid evaluators were friends with the contractor. The winning bidder actually had offered a bid evaluator a job with the company during the bid evaluation process.
Though I've changed some of the details, this actual case shows just one of many red flags ("Awards to non-lowest bidder," see below) in procurement and contract fraud. This is one of the more complex types of frauds to investigate because there are so many ways in which the contracting process can be manipulated to exclude fair and open competition and/or to unjustly profit.
When I first starting investigating contract fraud, I was a bit overwhelmed. Not only did I have to learn the rules of contracting, then I had to figure out how the rules were or could be manipulated or circumvented. Making it more difficult were the lies of some dishonest contracting officials (CO) when I asked for explanations about procedures. However, as I kept (skeptically) asking questions and learning, I got better at catching the "bad guys" in the contract arena.
In this article, I'll describe 12 red flags that could indicate fraud and provide examples to help fraud examiners work with their bosses or others to be skeptical when examining, auditing or investigating contracts and procurements. I'll also give some examples of how I've identified wrongdoing in those areas. (This list is far from exhaustive. See the 2012 Fraud Examiners Manual, 1.1901.)
12 RED FLAGS
- Repeated awards to the same entity.
- Competitive bidder complaints and protests.
- Complaints about quality and quantity.
- Multiple contracts awarded below the competitive threshold.
- Abnormal bid patterns.
- Agent fees.
- Questionable bidder.
- Awards to non-lowest bidder.
- Contract scope changes.
- Numerous post-award contract change orders.
- Urgent need or sole source.
- Questionable minority/disabled ownership.
1. REPEATED AWARDS TO THE SAME ENTITY
Determine why the same entity is repeatedly awarded contracts for the same services or products and if the stated reasons are justified. Review the contracting official's (CO) pre-award contract documentation to identify if he advertised the need or obtained other quotes or bids at the proper time.
Be on the lookout for backdated documents. During one contract examination, I found that a CO wrote, "A determination was made that Contractor X was the best value." A red flag was the use of the past tense word "was." I found printed pages of another vendor's prices from that vendor's website, but the small font printed at the bottom of the pages indicated they were printed two weeks after the contract was awarded.
The CO initially told me that she'd obtained the prices before the contract was awarded. However, when I confronted her with the evidence, she admitted that she'd never obtained the second price quote, and she'd prepared and printed competitor pricing information after the fact. The CO subsequently told me that she'd pre-selected the winning vendor.
2. COMPETITIVE BIDDER COMPLAINTS AND PROTESTS
A sure way to overlook corrupt procurements is to not listen to or consider losing bidders' complaints and protests. Contracting offices typically will determine if complaints have merit. However, a more objective way is to have knowledgeable, experienced, independent, objective and impartial Certified Fraud Examiners/investigators review the complaints. Also, many governmental groups enlist other objective governmental agencies to review official protests.
Periodically select a random sample of losing bidder complaints and scrutinize the outcomes to see if the complaints are being resolved appropriately. However, note that many entities never officially complain or protest because they believe they would never be awarded any future contracts if they did, or they believe complaining would be fruitless and a waste of time.
I interviewed one vendor who said he kept submitting bid proposals to an entity, but the entity would never award him any contracts. The vendor thought that if he blew the whistle just because he suspected corruption nobody would listen to him. The vendor was delighted to be interviewed and share his input. The investigation later determined the CO was prematurely and secretly opening sealed bids and providing competitors' bid prices to his buddy who was paying the CO bribes.
3. COMPLAINTS ABOUT QUALITY AND QUANTITY
Repeated complaints about a contractor or vendor's quality of services or products are red flags for many types of fraud, such as defective products, product substitution, short quantity shipments, "ghost" shipments (submitting invoices for payment but never shipping the items), double billings, etc. These deficiencies may or may not be accidental.
I asked one entity's quality control representative (QCR) what she did when she learned a vendor had submitted an invoice and received payment but never shipped the products. The QCR said, "I tell them they have 30 days to ship the products." In essence, the deficient vendor's punishment for submitting false claims was to do what they were supposed to do in the first place but only when they got caught. Keep in mind that it's easy for a vendor to underbid when they have no intentions of providing what's requested.
4.MULTIPLE CONTRACTS AWARDED BELOW COMPETITIVE THRESHOLD
During an investigation, I learned that many employees had complained that they hadn't received a vendor's (already paid for) shipments or the vendor had delivered reduced orders. The customers complained after the vendor had submitted invoices and received payment. I found evidence in the corresponding contract files' pre-award documentation that the CO had repeatedly favored the vendor in two ways.
First, the CO often eliminated competition by keeping prices under the $2,500 threshold, which would have required competition. (Sometimes, he seemed to split several orders to keep them under $2,500.)
Second, when the total contract price was more than $2,500 but under $25,000, the CO obtained telephone price quotations from three vendors, as was required in this price range. I found the suspect vendor's prices were always listed third in every contract file and were always slightly less then the competitors' prices. I thought it was strange that the CO never telephoned the suspect vendor first. I found evidence that the CO received bribery payments — cash and cashier's checks — from the suspect vendor. When I interviewed the CO he admitted he provided the competitors' price quotes to the suspect vendor to ensure the favored vendor could always underbid the competition.
The CO said he believed he was ensuring that his company saved money by getting the lowest price. He said he didn't know anything about all the complaints against the vendor because another department handled those.
5. ABNORMAL BID PATTERNS
Most companies that receive multiple bids for high-dollar procurements will log the bid prices received on a bid abstract or similar document. If most bid prices are high, and one is low, that's an obvious anomaly. For example: If five vendors bid $60 to $75 per foot of cable, and one vendor bid $15 per foot, that's a red flag indicating the lower-priced cable may not meet the requirements or specifications asked for. That's exactly what happened in a case I investigated; my client later determined that the vendor provided defective cable. Similarly, something might be amiss if three vendors bid $60 to $75 per foot of cable, and three bid $10 to $15 per foot. Interviewing all the vendors separately could result in some interesting details.
If you observe three similar high bids and one low bid you should also suspect that the three high bidders never expected an honest low bidder to submit a price proposal for the same contract. It could be that the low bid is honest, and the three highest bids are intentionally inflated. Ascertain what other contracts the three high-priced vendors bid on, and review those contract files.
6. AGENT FEES
Often contractors or vendors are required to provide and/or certify their costs and pricing data (which most would rather not do) prior to being awarded contracts. Scrutinize anything listed as "agent fees." You'll want to discover the name of the agent and what he or she would do to earn those fees.
An "independent" agent in an investigation I conducted was known as a "10 percenter." As the name implies, he would receive 10 percent of the contract price but only if his contractor was awarded the contract. (Yep — that was a red flag to me too!) The 10-percenter agent was known to frequent the COs' office areas, and he often took them to lunch. And there's no telling how many gift cards or sporting event tickets he gave the COs.
When I questioned contractors about their agents' participation in contracts, a typical response would be, "He helped us put the bid together." (Yeah, I bet he did.) Sometimes an agent represents more than one bidder perhaps for the same contract. In one case it was determined that the 10-percenter was also the middleman to facilitate bribery payments. Entities need to have written policies describing when outsiders can frequent their work areas plus written rules and training for their employees on the dollar amount limit per year that COs and other employees may receive in gifts from vendors, contractors and others. If there are no in-house rules, there are no rules — period!
7. QUESTIONABLE BIDDER
Entities' policies differ on how they determine price reasonableness. Some perform market analysis, some research their entity's price histories for the same or similar items/services, some search the Internet, some do all three, etc. But many rely on the bidders' integrity to submit fair and competitive prices. Entities often reason that no serious vendor would intentionally submit a price that was too high because it would never be awarded the contract or too low because it wouldn't make a profit.
However, vendors sometimes take advantage of entities' trust. I worked a case in which several bidders secretly conspired to take turns being the low bidder — bid rigging at its worst. All the bids, including the low bid, were much higher than the market average. But because the prices were similar, the CO assumed the low price must be reasonable.
Some contractors also invite "complementary bids" because there are other advantages for vendors if awarded those contracts. For example, in federal procurements, adequate competition and price comparability is sufficient to determine price reasonableness and allows the low bidder to avoid certifying their cost and pricing data. (See Federal Acquisition Regulation 15.402 and 15.404.)
When contractors don't have to certify their cost and pricing data, they may switch suppliers and vendors during contract performance. However, if they have to certify the cost and pricing data, the contractor will have to get permission from the CO before making any changes. If those changes result in reduced expenses for the contractor, the government can reduce the contract award price. In short, based on such rules, a fraud examiner or investigator shouldn't assume it's an honest coincidence that there is competition and/or price comparability.
Sometimes contractors that compete for the same contract actually perform subcontract work for the winning bidder. This can be determined to be more than a coincidence when it's observed repeatedly over time, and contractors seem to be taking turns being the low bidder. By alternating contract awards and subcontracting to each other, all the conspiring contractors always have work (and income) — often at inflated prices.
Reviewing contracts and paper files alone will not prove a conspiracy. At some point, you'll have to conduct well-planned interviews. With skill (and perhaps leverage), you can sometimes obtain useful information during interviews.
For example, when I investigated a vendor for providing defective products, I learned he wasn't the lowest bidder. I asked the owner of the company how his company was awarded the contract because his bid price was higher. The owner said that the low bidder ended up landing a separate higher-dollar contract with another company, and so that low bidder backed out just before the contract was to be awarded.
The owner told me, "After the other contractor backed out, I had no choice; I had to go through with it." I thought that was a strange choice of words. I would have expected the owner to respond with something like, "I was ecstatic when the low bidder backed out because that allowed my company to get the contract!" The owner's response prompted me to examine the contract's bid abstract. By conducting additional research, I found that the original low bidder and several of the other bidders had since been convicted in federal court for bid rigging. Some of those other bidders also had been convicted of paying bribes to COs to obtain U.S government contracts. During the investigation, one suspect plant manger committed suicide.
Because of the "adequate competition and price comparability" clauses, the contractor I was investigating didn't have to certify cost and pricing data. After the contract was awarded, the owner switched (without needing the CO's approval) from using a previously quoted supplier to a less-expensive supplier who had provided cheaper substandard material. By making the switch, the owner stood to make an extra $1 million profit. By using laboratory handwriting comparisons and conducting interviews, I later proved that the company officials conspired to and did submit false samples of the less-expensive material for testing because the cheaper material couldn't meet required specifications. (That's why it cost $1 million less).
Sometimes vendors submitting bid proposals don't even have the facilities to do the work. They're essentially shell companies that are either submitting complementary bids for the above reasons, or, if they're awarded the contracts, they intend to subcontract the work to others — perhaps to one or more of the other bidders.
Government contracts usually include a clause limiting the amount of work that can be subcontracted (See FAR 52.219-14 Limitations on Subcontracting). However, in one case, I learned the "required" clause was intentionally omitted from the contract by a CO, thus allowing the contractor to sub-out 100 percent of the work.
Some unscrupulous contractors have been known to submit bids using fictitious companies or bids submitted by relatives. Be alert for bids submitted with the same mailing addresses or telephone numbers. In one case, I found three companies located at one residential address. Also be alert for bids that have the same misspellings, are sent with the same fax number or show similarities in handwritten signatures.
8. AWARDS TO NON-LOWEST BIDDER
As in the opening case of this article, sometimes bid evaluators — those who rate and score each bid — intentionally decide early which companies they'll award contracts — no matter what. Entities often award contracts on "best value" determinations, not lowest price. For example, a brand-new company with the lowest price might not be selected because a more seasoned contractor, which has previously completed jobs for the entity, seems to be a better value by offering less risk.
It's also a good idea to verify bid evaluators' statements that bidders were "unresponsive." Sometimes bid evaluators falsely report that bidders failed to respond to certain questions or requests, and then they eliminate those bidders from further consideration.
In a case I worked, the bid evaluators reported that Vendor A refused to provide required financial records to determine if the vendor was "responsible." Vendor A was then considered, "unresponsive." Regarding Vendor B (a bid evaluator's friend), the bid evaluators wrote, "Vendor B stated he understood the requirement to provide financial records." But alarmingly, the bid evaluators failed to also write that Vendor B also had refused to provide the financial records. Vendor A was kicked to the curb, and Vendor B was subsequently awarded the contract.
9. CONTRACT SCOPE CHANGES
Bidders often submit price quotes based on detailed descriptions of services/products the customers wants. By advertising specific needs, COs can compare apples to apples. In an investigation I conducted, the CO added work to the contract after it was awarded that was totally unrelated to what was advertised. That contractor was delighted because it stood to make much more money. But the other bidders rightfully complained that they never got a chance to bid on the other new work.
Surreptitiously changing the scope of the contract requirements may be a violation of internal contract rules. Keep in mind that the CO and the contractor might have planned or conspired to make the changes even before the contract was awarded. Entities normally require changes to contracts to be documented in the form of contract modifications or amendments.
10. NUMEROUS POST-AWARD CONTRACT CHANGE ORDERS
After an entity awards some contracts to the low bidder or to the contractor that presented the best value, the entity might amend or modify the contract to add similar requirements and therefore dollars to be paid. In one case I worked, the vendor and CO knew all along that additional work/requirements would be added, but that information wasn't listed in the advertisement so the competition wouldn't know about it. More often, work or services also might be added to an existing contract simply to save time and the additional expense of re-advertising the new need.
11. URGENT NEEDS OR SOLE SOURCE
Many entities allow contracts to be awarded without competition when there's an urgent need for items without delay. (The U.S. Department of Defense might do this during wars.) But sometimes the urgency doesn't exist or only exists because of poor planning. When there's no competition, the entity might have unjustly favored the selected vendor, and/or the entity might be paying more than necessary.
Occasionally entities consider some vendors to be the only suppliers ("sole sources") that can provide desired services or products and therefore award them contracts without competition. Check a contract file to determine how the entity determined the sole source designation, and then attempt to discover if the vendor actually is a sole source. Simply querying the Internet might find many others who could've provided the service or product.
12. QUESTIONABLE MINORITY/DISABLED OWNERSHIP
Federal, state and many municipalities award a certain percentage of their contracts to minority- and/or disabled-owned businesses. The rational is obvious. But statistics have shown that all too often, the reported owners aren't actually minorities or disabled. Many require that the minority- or disabled-owned business perform approximately 50 percent of the work/service, but investigations have found that sometimes a higher percentage is outsourced. Also, many set-aside contract requirements include that minority/disabled owners actually run the operations or be in decision-making positions. However, sometimes those owners are nowhere to be found in or around the business.
The U.S. Department of Defense, Office of Inspector General recently publicly published a report, "Inadequate Controls Over DoD Service-Disabled Veteran Owned Small Business (SDVOSB) Set-Aside Program Allow Ineligible Contractors to Receive Contracts" (Report No. DODIG-2012-059, Feb. 29, 2012). The OIG reported that several SDVOSB contracts were awarded to ineligible contractors and several more contractors misstated their SDVOSB status.
COMPROMISED CONTRACTING OFFICALS
Fraud examiners, investigators, auditors and compliance personnel who are responsible for examining, analyzing, reviewing or overseeing the compliance of contract and procurement award procedures should be mindful of these 12 red flags. Keep in mind that occasionally, dedicated COs are forced to compromise their integrity in contract-awarding decisions because of inappropriate guidance, directions or pressures from their superiors.
Skilled fraud examiners/investigators also will conduct thorough and well-planned interviews during their examinations. Even when only one anomaly is identified, don't automatically dismiss it as accidental or a coincidence because additional research, interviews and analysis may identify patterns, financial losses, collusion, corruption or conflicts of interest.
Charles Piper, CFE, CRT, is a private investigator, consultant and owner of Charles Piper's Professional Services in West Tennessee. Visit www.piper-pi.com.
Detecting schemes during the presolicitation phase
The most prominent schemes involved during the presolicitation phase of contracting or procurement are need recognition schemes and bid tailoring.
Need recognition schemes — The typical fraud in the need recognition phase of the contract negotiation is collusion between the buyer and contractor, in which the buyer's employee receives a gratuity or kickback for recognizing a need for a particular product or service.
Bid tailoring schemes — Entities prepare bid specifications and statements of work detailing the types and amounts of goods and services to be provided to assist in the selection process. They're intended to provide both potential bidders and the selecting officials with a firm basis for making and accepting bids.
A well-written contract will contain specifications, standards and statements of work that clearly detail the rights and entitlements of the contactor. Carelessly written contracts make it easier for a contractor to claim at a later time that he's entitled to more money than the buyer intended to pay.
Bid-tailoring schemes occur when an employee with procurement responsibilities, often in collusion with a supplier or contractor, tailors bid specifications to give an unfair advantage to a certain contractor.
There are various methods used to commit bid-tailoring schemes. Sometimes, the buyer's personnel and the contractor deliberately collude to write vague specifications. At other times, there's an agreement to amend the contract to increase the price immediately after the award.
Source: 2012 Fraud Examiners Manual, 1.1902
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