Construction Fraud: Beware the 'Outside Facilitator'

Crafty manipulators will use weak employees at construction job sites to defraud companies for many months – long before the home office smells any problems.

Jake was such a talented mimic that he could have been a hit on open-mike night at the local comedy club. But he geared his impersonations to garner cash and not laughs.

Through his many contacts in the construction business, Jake heard that Sam, the owner of Bacme Specialty Contracting, had recently retired and closed his business. Jake enlisted the help of a crooked employee at a job site of Ace Construction and soon was preparing fake Bacme letterhead and then opened a bank account in Bacme’s name. Finally, he sent bogus invoices to Ace Construction. By the time Ace’s home office smelled any trouble, Jake, the outside facilitator, was on to his next gig.

A typical internal control analysis and investigation usually begins with a focus on the entity’s internal systems and procedures and its employees who are in critical positions of exposure to fraud. From my years of investigating construction contracting, I’ve found that the most significant exposure in this field stems from unscrupulous individuals outside the company who “facilitate” the fraud or embezzlement. These improprieties usually take place at the job site (away from the contractor’s home office) where internal controls are dependent on the honesty and integrity of the key job-site employees.

Indeed, a traditional investigation eventually will uncover an inflated expense report, a ghost employee, a payroll clerk who pads timecard hours for a co-worker, excessive entertainment, or the theft of tools and equipment. But the sizeable thefts in the construction field undoubtedly will include an outside facilitator.

A facilitator is a master at maintaining a low profile and waiting for opportunities to approach key employees and tempt them with promises of lucrative financial rewards by simply following a proven scheme.

You don’t have to be a fraud examiner in the construction field to appreciate the millions that are lost every year due to these sneaky, patient fraudsters.

Key Job-site Employees 

Typically, traditional internal controls on construction projects are unreliable because budgets don’t allow hiring sufficient numbers of employees to assure traditional segregation of duties. A key job-site employee responsible for purchasing often is the same person who receives materials, approves invoices for payment, and manages the cost reports to record purchases. The home office processes invoices for payment and usually relies solely on the signature approval of the key job-site employee and for reviewing monthly cost reports and explaining cost overruns. This employee can be involved in perpetrating an illegal money-making scheme that he or she can conceal from the home office by manipulating the cost report and project records. The internal controls system completely breaks down. The outside facilitator makes it easy for the key employee to be involved in false schemes because other internal company employees don’t need to cooperate.

Following are descriptions of a few facilitators, and their related schemes that we’ve uncovered through our years of auditing and investigating construction projects.

Facile Facilitators

The Impersonator
The Impersonator, who is usually a sole proprietor, keeps track of small specialty contractors. When he hears about the demise of a contracting business, or the death or retirement of the owner, he often will assume the company’s identity. He’ll operate fraudulent invoicing schemes through the otherwise legitimate entity for a short time, usually no more than six months, before the home office of the victimized contractor discovers the contractor’s recent history. The Impersonator will create letterhead and contractor brochures and even open bank accounts for cashing the checks he receives. With the key employee’s cooperation, he’ll submit bogus invoices. The home office processes the invoices because they are approved and signed by the complicit key job-site employee.

After examining sizeable cost overruns, suspicious transactions, and inflated cost-plus change orders, we identified more than 20 instances in which The Impersonator had used fictitious companies to perpetrate this scheme on numerous construction projects. The Impersonator, in total, managed to process millions through bank accounts set up specifically for the schemes. In each case, banking officials thought the cash transactions were somewhat unusual but surprisingly didn’t suspect any illegal activity.

The Bagman
The sole purpose of The Bagman is to work in tandem with another facilitator, such as The Impersonator, and deliver cash kickbacks to the key employee perpetrator. The Bagman fulfills two objectives: first, he breaks the identity chain in the money flow by completing the cash kickback for The Impersonator. If The Impersonator is ever caught, he simply says he paid an unidentifiable subcontractor and never delivered the cash kickbacks. Secondly, The Bagman makes job-site visits so job-site personnel don’t become suspicious of too many visits by The Impersonator.

The Junkie
Large electrical projects often require sizeable amounts of electrical wire. The wire contains copper – a valuable commodity for the key employee willing to cooperate with The Junkie who operates in the wrecking or junkyard business. The scheme is simple. The key employee purchases excess electrical wire and hides it in the cost report. (His purposeful lack of adequate inventory procedures makes the detection of excess purchases difficult.) He sells the wire for cash to The Junkie who strips the plastic and lead covering from the copper. The cash never makes it to the company’s books, and The Junkie then sells the copper wire for a profit.

They accomplish a similar scheme on construction renovation projects, which involve demolition of valuable scrap metal.

On one large electrical project, we investigated significant contractor cost overruns and the lack of accountability in wire purchases. The legitimate wrecking yards were quite willing to help eliminate the bad apples from their industry. We visited all wrecking yards near the job site and we discovered legitimate sales of truckloads of clean lead from the construction site but no sales of stripped copper wire. We found that the perpetrator had sold the wire to a Junkie who had stripped the copper and given the lead back to the perpetrator who had sold the lead to legitimate wrecking yards to appease suspecting company employees who would expect to see scrap sales on the books. The Junkie had sold the copper to an unknown company.

In the final accounting, the key employee’s transactions were much broader than we suspected and included other schemes. The construction company lost more than $1 million in cash and false material purchases; the key employee used much of this to construct a personal condominium project.

The Grease Monkey
Construction projects with a large budget for equipment maintenance and spare parts usually employ a mechanic to maintain the equipment for the duration. A key employee will hire a crooked outside mechanic, The Grease Monkey, who will submit phony invoices for parts and repair work that were never provided. The key employee buries these invoices in the equipment maintenance budget or some other large budget.

In one case, we examined transactions in maintenance parts and labor for a construction project involving a fleet of trucks and equipment. We uncovered photocopies of invoices for spare parts purchases for a 1992 Oldsmobile from a demolition wrecking yard about 50 miles from the job site. The key employee said the Oldsmobile parts were cheaper than buying parts from the dealership and were interchangeable with the company’s pickup trucks.

We weren’t so sure. On a hunch, we drove to the wrecking yard and requested the original purchase tickets. The purchases were actually for parts for a 1972 Oldsmobile but the year 1972 had been cleverly altered to 1992 to give the appearance that the parts purchases were for the newer job-site pickup trucks.
We found that the Grease Monkey and the key employee maintained a side business of refurbishing older cars. Their scheme cost the construction company tens of thousands for the payment of false parts and repair invoices.

Investigative Procedures

These and other schemes can be uncovered by a thorough and repetitive review of the same project documents used for a traditional internal audit review of a construction project. The auditor should initially review the contract, cost reports, and original budget, and identify red flags of potential exposure areas. For example, some questions will need to be answered before beginning the detailed work:

1) What type of contract is it (fixed price, cost plus, unit price)?
2) Are equipment, maintenance, parts, and/or electrical wire integral to the project?
3) Are there significant cost overruns in specific areas?
4) Are there large budgets, or cost underruns, to transfer and conceal costs?
5) Should there be scrap sales on the project? If so, how much?
6) Are change orders, particularly time-and-material change orders, excessive in relation to the original contract amount?
7) Who are the approved company vendors and subcontractors?
8) Who are the key job-site personnel and who is responsible for approving invoices and reviewing cost reports?

The detailed analysis might require multiple reviews of the underlying project documents such as invoices, purchase orders, and payroll records before the auditor is able to piece together unusual transactions for investigation. Unusual items that would surface for additional follow-up might include:

1) invoices for materials with no “Ship To:” address indicated;
2) unusual items or services purchased such as materials that don’t relate to the type of construction project;
3) the same address or phone number among various vendor invoices;
4) invoices with special processing notations such as “Pay Immediately”;
5) hand-prepared invoices with non-descript or general descriptions of the materials or services provided;
6) purchases from unusual or non-preferred vendors; and
7) lack of inventory or inadequate receiving procedures for valuable purchases such as electrical wire.

An Outside Job

Some of the greatest losses in construction fraud don’t come from inflated expense accounts, ghost employees, or theft of tools and equipment. Beware of the outside facilitators who’ll patiently wait for the opportunities to use key crooked employees at remote job sites to defraud unsuspecting construction companies.

Jack W. Harris, CFE, CPA, CIA, is principal with Harris & Associates, P.C., Certified Public Accountants, in Littleton, Colo. The company Web site is www.CostVerifiers.com.