Protecting Public Interests: Mismanagement of Government Grant and Contract Funds

Fraud, waste, abuse, and mismanagement of government contract and contract funds will never be eliminated. But frequent, modest proactive audits and reviews that focus on fraud indicators will help identify and prevent misuse before the funds are expended.

For at least two years the Institute for Non-Violence received hundreds of thousands of dollars from New York State. However, unbeknownst to state officials, the institute's management treated the government proceeds as disposable income. In one instance, the organization paid more than $1,500 in meal charges incurred by spouses and children of senior management who were allowed to attend an out-of-state conference (In all fairness, the meals were a bargain considering that the wives and children indulged themselves with salmon, stuffed shrimp, sirloin steaks, smoked trout and escargot).

The misuse of grant/contract funds by the institute staff was so common that it was no longer remarkable, only its scale. Other instances of mismanagement involved the personal use of corporate credit cards. The executive director incurred more than $2,300 in personal charges within two months and then reimbursed the institute two months later with a check that was drawn on an account with insufficient funds. These and other abuses were widely publicized after a critical report by several state agencies. However, despite the adverse publicity and harsh criticism, the new management team continued to mismanage the funds. For example, the new executive director incurred more than $7,600 in reported business meal charges within the first eight months of the fiscal year and made numerous personal long distance telephone calls with his corporate cell phone.

Federal, state, province, and local grants and contracts fuel a large portion of a nation's economy but are an easy source of fraudulent and wasted dollars.1 Decreasing governmental funds, especially in the United States, increase outsourcing and lessen routine audits, which escalate fraud risk. Though grant and contract mismanagement detection and prevention methods have become more sophisticated through the use of data analysis software and methods (ACL, IDEA, Benford's Law), it appears fraudsters are still one step ahead of fraud examiners.

Here we'll focus on the types of mismanagement schemes that take place in the grant/contract sector and ways governmental entities identify and prevent these types of mismanagement.

Following is a synopsis of general contract awarding: in the United States, contracts and grants are generally awarded as a result of a request for proposal (RFP) issued by governmental units. The RFPs communicate the government's needs and identify how and when the contractors should respond. The contractors respond by submitting sealed bids which identify the deliverables (services to be provided) and a proposed budget. The contracts are generally awarded to the lowest responsible bidder.2

On some occasions, the contracts are awarded on a sole-source basis. Sole-source awards generally occur when only one vendor can provide the service, the service involves national security, or there's a compelling urgency to award the contract. On still other occasions, funding is provided as a result of initiatives mandated by legislation commonly referred to as "pork barrel items." These grants represent funds awarded to the governmental districts of the state and county legislators who approve the budgets. In addition to being approved by the awarding agency, most contracts/grants are also approved by the state or local attorney general and/or the comptroller.

Contracts are either fixed price or cost reimbursable at a negotiated rate. The fixed price contracts/grant funds can be distributed in a lump sum or in monthly increments whereas the cost reimbursable contracts/grant funds are usually disbursed upon receipt of a monthly time-and-materials summary submitted by the contractor/grantor.

Typically, the services provided by the entities that receive the grants include training, remediation, regulation, entertainment, or economic development. However, regardless of the awarding process or the services provided, the granting agencies (such as the Department of Housing and Community Renewal, the Department of Social Services, or the Department of Economic Development) don't have the resources to insure that all grant funds prudently administered and/or if the desired social needs were achieved or obtained.

To summarize:

Finding fraud, waste, and mismanagement

Waste and mismanagement occur when organizational funds are inefficiently applied and/or used in instances where the costs outweigh the benefits.

The U.S. False Claims Act established these prohibited acts: knowingly presenting a false or fraudulent claim for approval to the federal government, knowingly making a false statement to get a claim paid by the federal government, or conspiring to defraud the federal government by having a claim allowed or paid.

Contract/grant fraud schemes may involve the theft or diversion of cash or other tangible assets and the misuse or mismanagement of funds.

Typical grant and contract fraud and abuses

Telephone usage
Senior management, and occasionally staff, use the telephone to make necessary and permitted personal calls. However, egos sometimes displace common sense and people rationalize excessive use of the telephone to make personal calls because they believe they deserve the benefit. Even worse, they make unauthorized long-distance calls.

When conducting periodic, proactive telephone usage reviews, examine the cell and land-line invoice files for patterns, calls of long duration, frequent calls to the same number, calls charged to the office number but made at an outside location, calls to out-of-state numbers, calls at unusual hours, and calls on weekends. Perform reverse directory searches using Google.com and ascertain the names registered to the numbers on the phone bill.

Company vehicles
Organizations occasionally budget "travel expenses" when the charges actually relate to company vehicles. The organization may also lease or purchase vehicles for senior staff. On multiple occasions, we determined that an organization's vehicles weren't needed but were provided to managers because the managers didn't have the resources to purchase their own vehicles or they found it much cheaper to use the company vehicles. The result was the same: they ended up using the vehicles for unauthorized purposes.

Airline travel
High-level officials often abuse airline privileges because they believe they deserve more. We've seen instances in which managers' family members traveled free on chartered airlines. We've discovered management who flew first-class, bought expensive tickets at the last minute, or traveled to exotic locations on contract or grant money. On one occasion, the executive director and his deputy incurred one-day, round-trip airfare charges of $1,813 while their support staff charges only amounted to $321 per person.

Out-of-town meals
Generally staff members are paid a per diem. However, managers often exceed that daily amount or claim meals at conferences even though they're included in the conferences' fees. Also, they'll claim additional meals (and drinks) at conferences as business meeting expenses. Additionally, look for out-of-town staff events held at resort locations at which family members may be treated.

Staff meals
Frequently, organizations will use governmental funds to pay for in-house luncheons and dinners. (The Institute for Non-Violence spent thousands of dollars on employee-of-the-month luncheons despite experiencing budgetary cash shortages.) Generally, these abuses can be discovered simply by reviewing and questioning checks, payment histories, or unusual or miscellaneous vendor files.

Hotel use
Sometimes management will book exorbitantly priced rooms or suites. Review hotel folios (or conference files) for the number of people in a party. Generally the folio will indicate if more than one person was present. Also note the check-out time, meals ordered to the room, and other incidental expenses. Most hotels will generally provide the back-up documentation if you call and identify yourself. Also ask to check the staff use of "high-maintenance" (four-star luxury) hotels. (At the Institute for Non-Violence, the executive director and his wife once rented a suite at a luxury hotel for $1,170 while the staff stayed at an economy hotel.)

Other fraud or abuse possibilities:

No-bid contracts:
Contracts are awarded to related entities, friends or relatives, oftentimes at a premium. Services are deliberately vague.

Excessive salaries:
A budget may frequently call for two people to perform separate functions. However, the salary is often combined and one person receives an unusually high salary while delegating the responsibilities to other staff.

Non-interest-bearing loans:
These loans generally are issued to senior staff members but without the knowledge of board members or other staff. Payment terms normally aren't delineated and eligibility criteria aren't determined.

Nepotism:
Unqualified relatives and/or friends are hired at above-market rates or at rates which don't correspond to the experience and/or education level.

Related-party transactions:
Sometimes these are less-than-arms-length transactions at above-market rates that neither the board nor staff knows about.

Improper use of facilities:
Sometimes the entity will host events, use photocopiers for other not-for-profit functions, provide comp rooms, meals, training, etc.

Equipment:
The entity will purchase equipment and then create a lease contract in which the governmental organization makes the lease payments to the grant recipient. At the termination of the contract, the organization retains the right to the piece of equipment. Normally, equipment purchased with grant funds reverts back to the governmental organization. However, by claiming the equipment is leased, the grant recipient keeps the equipment at the termination of the grant or contract.

Red flags and proactive contract reviews

Here are some dubious conditions to look for. Be wary if the board members don't meet regularly, don't prepare an agenda and minutes, don't question management about budget deviations, don't possess adequate financial skills, and don't review canceled checks or approve negotiated contracts.

Be concerned if the organization lacks a hotline or other ways to report suspected instances of fraud; doesn't have policies or procedures on disbursements, time and attendance, and expense reimbursements; and if there isn't a code of conduct/ethics policy addressing the use of organizational assets and conditions that constitute inappropriate conduct.

Be suspicious if there's no right-to-audit clause (which allows a responsible authority to investigate questionable expenses), no background checks performed on senior management, and positions awarded based on political affiliation.

Also, red flags should be flying if audits aren't performed, CPAs or internal auditors aren't on staff, contract deliverables are vague or are referenced in a way that permits liberal interpretation, reports aren't filed with governmental agencies, and management is dominated by a single person.

When conducting proactive contract reviews be sure to examine travel agency, airline, conference, and travel files; telephone statements; and contracts awarded by the organization. Identify the deliverables and the relationship, if any, with the contractor.

Also be sure to review canceled checks and identify suspicious payees and endorsements, payroll and checks issued to employees, vehicle usage logs to determine need for vehicles, gas consumption logs, odometer readings and gas credit cards, equipment purchase and lease files, and credit card files and statements.

Prevention is always better

Much grant and contract fraud, waste, and mismanagement can be prevented with some basic internal measures. Make sure that a vendor audit clause is included in contract work and that it addresses the destruction of documents. Don't forget the ever-important fraud hotline. (See page 24.) In the United States, the Sarbanes-Oxley Act emphasizes hotlines for public companies but they're still a novel idea for not-for-profits (as are many basic internal controls).

Codes of conduct and ethics policies should include sections on nepotism, use of company funds and equipment for personal use, use of the Internet during work hours, acceptance of gifts from vendors, conflicts of interest, dual employment, time and attendance, illegal betting, reporting misconduct, expense reimbursements, destruction of organizational records, political contributions, and use of position to secure unwarranted privileges.

Not-for-profits often lack strong and qualified boards of directors. Obviously, board members should have some knowledge of the industry. Each board should have at least one member with a financial background. Frequent board meetings should be held. Members should sign statements acknowledging their fiduciary responsibilities and potential conflicts of interest.

The board, not senior management, should dictate and control board meetings and the agenda; nominate, approve, and appoint all new board members; approve all major purchase and lease transactions; and sign-off on the code of conduct and have a say in what's included in the code.

Fraud, waste, abuse, and mismanagement of government grant and contract funds will never be eliminated and government contract agencies will never have the resources to effectively monitor each grant and contract. However, more frequent and smaller scope proactive audits and reviews that focus on fraud indicators will help identify and prevent misuse before the funds are expended. In addition, the nature of these restricted scope audits will allow the contracting agencies to perform more audits and reviews during the course of the fiscal year.

1. The U.S. federal government alone issues more than $50 billion per year in government contracts.
2. A responsible bidder is generally one who hasn't been convicted, debarred, or faulted for poor past performance.

Christopher J. Rosetti, CFE, CPA, is a partner, forensics at BST Advisors LLC in Albany, N.Y.