EXPERT OPINION
Construction Fraud: Don’t be a victim
By Bo Mocherniak
Construction fraud. Media stereotypes around these two words can feel pervasive and unfair. But did you know it’s actually much more likely that construction companies themselves will be victims of fraud?
If you are involved in construction, you might wonder how easy it really is to lose money to fraud perpetrated by employees, contractors, subcontractors and venture partners. In fact, construction fraud may be even more common than you’d think.
In Canada, the average fraud loss is higher than the global average. In construction, the average loss was an astonishing $628,500. That’s not small change. The growing prevalence of construction fraud is not a myth or the product of hype—it’s happening, and the stakes are high.
One of the first things you might ask yourself is why and how this is happening. What are the things that can create the right environment for construction fraud to take place? The causes can be many, but what we typically see are things like economic pressures, a lack of internal controls, increased opportunity for collusion, vaguely-worded contracts, using large amounts of cash, cost-based contracting, not clearly defining scope, and risky joint ventures. However, by understanding the environment in which fraud can happen, you can take steps to mitigate against it.
Let’s start with the 10 most common fraud schemes in the construction industry:
1. Non-payment of subcontractors and material suppliers by delaying lien waivers, falsifying lien waivers or using project cash receipts to pay bills for other projects.
2. Billing for unperformed work by overstating the units of production accomplished or the labour and equipment actually used.
3. Manipulating the schedule of values and contingency accounts. This can be done in several ways, including: failing to update schedule of values (SOV) line items as buyouts or changes are made; charging phony bills received from shell companies; failing to associate subcontractors or vendors with specific SOV line items; hiding cost overruns during the project; and using a contingency to cover non-reimbursable costs.
4. Diverting lump-sum cost to time and material cost by initially budgeting expenses as a lump-sum then billing for time and materials related to change orders.
5. Substituting or removing material, including using lower-grade material that requires subsequent repairing or replacing or that leads to a structural or system failure, and taking material from the work site for personal use.
6. Change order manipulation, including altering work scope, removing scope descriptions, adding charges, omitting design specifications in the original scope of work, and improper price reductions for work substitution.
7. Falsifying payment applications by covering up the purchase of personal items or funnelling money to a phantom company controlled by an employee; other examples include inflating invoices beyond actual costs by using profit or mark-up formulas.
8. Subcontractor collusion, including bid rigging, bribes, kickbacks, false or inflated change orders, undervalued deductive change orders or phantom subcontractors.
9. Diverting purchases and stealing equipment/tools by billing for equipment or tools for the jobsite which are then used for other subcontractor projects or personal use, or billing for tools not required by job specifications.
10. False representations, which could involve using undocumented workers; falsifying minority content reports, test results or insurance certificates; noncompliance with environmental regulations; and misrepresentation of small business status.
The benefits of understanding construction fraud risks, knowing how to mitigate them and taking proactive measures to combat them, are many—not only in what you can avoid, but in what you can gain. It not only can save you money, but a strong fraud strategy can help you steer clear of penalties for violating industry standards or regulatory requirements, avoid project delays or cancellations, maintain costs at stable and predictable levels, and control reputational risk.
We all know that construction fraud can be very dangerous if it involves the use of substandard or unsafe materials. A good fraud prevention program may also prevent injury or loss of life and the legal calamities that workplace accidents entail. Other gains include potentially reducing your insurance costs, ensuring a fair competitive process and enhancing your reputation.
Current levels of construction activity and investment in Canada are very high right now, making fraud prevention an even more important priority. Now, more than ever, the construction industry needs to implement proactive, preventive measures, and to invest the time and money to put a fraud prevention and detection plan into action. Take action now to prevent fraud before it happens.
With over 30 years experience with audit, acquisitions, divestitures and valuations, Bo Mocherniak, CA, CBV, provides services to both public and private companies in Canada and the United States. Bo is National Sector Leader for the Real Estate and Construction Group of Grant Thornton Canada, a member of the Grant Thornton International Real Estate Sector Group and past Chair of Grant Thornton LLP. He can be reached at bo.mocherniak@ca.gt.com.
