Using Technology to Head Off Construction Fraud

While it might seem like there are new cases of construction fraud reported practically every week, the good news is that the construction industry is pretty far down on the list of businesses affected by fraudulent acts by employees and subcontractors. Banking and finance, according to the Association of Certified Fraud Examiners (ACFE), followed by manufacturing, government and public administration, health care, retail, insurance, education and energy industries all have more incidents than construction does.

The bad news is that even though the construction industry doesn’t lead the pack, it is still impacted significantly by fraud.

Angela Morelock, managing partner and forensics expert at BKD LLP in Springfield, Missouri, said that around 6% of annual industry revenue is lost to fraud, so taking into consideration that the U.S. construction industry is an approximately $1.2 trillion-per-year field, that means a significant amount of money is handed over to bad actors each year.

And if construction isn’t at least one of the top industries targeted by fraud, why does it seem to get more than its fair share of the headlines?

“Construction gets a bad rap as having so many fraud problems,” Morelock said.  “A lot of [the cases] are so highly publicized when they happen because they are often kickback schemes or they are on government construction projects or there's bribery involved.”

In fact, she said, 42% of all of construction fraud cases involve corruption — i.e.,  bribery, kickbacks, bid-rigging, cash under the table and nefarious “handshake” kind of deals. 

Last month, federal prosecutors levied charges against Tennessee construction executive David Kennedy for allegedly giving a subcontractor work on two military base projects and approving fake invoices in exchange for cash, wire transfers and other gifts. The proceeds were then reportedly directed to a bank account owned by the subcontractor, Gary Hamby, who pleaded guilty to his role in the scheme two years ago. Kennedy is awaiting trial.

Red flags

The other major category of fraud in the construction industry, Morelock said, involve billing or accounts payable-related scams. This represents 37% of construction fraud cases.

A typical billing or accounts payable fraud scenario happens when a project manager or other employee of a general contractor creates a shell subcontracting firm and then submits invoices to the general contractor, receiving payment for work that was never performed.

Citing ACFE statistics, Morelock said that when it comes to fraud, there are ways to pick out those individuals most likely to be involved in these scams. The most common red flags are if an employee has:

• Personal or business-related financial difficulties
• An unusually close relationship with a subcontractor or vendor
• Unwillingness to share duties and insistence on maintaining a great deal of control
• A “wheeler dealer,” high-pressure approach to negotiating and making deals

Almost 90% of those who engage in fraud have no prior record, according to the ACFE, mostly because employers tend not to bring charges. The top reason is fear of bad publicity, with employers opting many times to impose some kind of internal discipline instead. For some companies, pursuing criminal charges and trying to recover the stolen funds is just too expensive.

Fraud prevention

What some contractors might not realize, though, is that they already have the technology to head off much of this fraud through the very systems they already use to complete everyday accounting duties.

“We’re not a fraud-detection system per se,” said Matt Harris, chief product and strategy officer at Viewpoint, “but what we do is provide very tight workflows, approval chains and audit trails for processes … that would otherwise [leave] opportunity for fraud.” 

Encryption, a secure cloud environment, workflow rules, three-way matching for material and other purchases, payment tracking, subcontractor approval and verification — all of these control measures are part of the Viewpoint system.

“In all cases, Harris said, “a controller, CFO or owner have reports that tell him or her what was approved that day from a purchase perspective and from a payment perspective. They can see fund flows on a daily basis," he said. "So, if there were to be a problem and the [suspicious] payment was made … to a vendor, at least it’s caught immediately."

Another critical feature of Viewpoint is workflow-level security, which gives an authorized individual access to payment approvals and processes. Multi-level approvals keep one person from being the decider.

An accounts payable clerk, for example, Harris said, might receive a pay request and then send it to a project manager and project coordinator for approval and then forward that package on to a controller or CFO, depending on the amount of the check.  Viewpoint would track that entire flow.

Reducing risk

One advantage in implementing a solid accounting tech tool, said Mike Antis, vice president of client services in Oracle’s construction and engineering global business unit, is to take the potential for human circumvention of set processes out of the equation — at least as much as possible.

Oracle’s Textura is another layer of protection. The software is an internet-based invoicing and payment system through which subcontractors submit their regular pay requests. Since vendors and their contract information are preloaded into the system, it ensures subcontractors not being able to bill in excess of their contracts and makes it all but impossible for bad actors to process payments for a sham company. 

“The goal here,” Antis said, “is to reduce risk for the contractors but also free up their time so that they can focus on things that are more beneficial to their businesses.”

Textura is especially helpful in collecting lien waivers, using digital signing technology to ensure the legitimacy of the paperwork subcontractors must present in order to receive payment. And subcontractors benefit from this process as well because their executed lien waivers are stored in a virtual lockbox until they have received payment from the general contractor, putting Textura in the position of trusted middleman.

The Textura system is also able to make joint check payments to subcontractors and their material suppliers, a process that is sometimes susceptible to fraud when handled manually or outside the security of a system like Textura.

As an inducement to sell to a new customer that has had financial problems in the past or to an existing customer that is requesting a higher than usual amount of credit, a supplier will sometimes do so under the condition that the general contractor pay it directly in the form of a joint check with its customer.

“Oftentimes,” Antis said, “if the GC is not very cautiously shepherding that check through the process, there have been cases where the prime sub just simply takes the check and deposits it in their own bank account. The bank doesn’t catch it. And now that process has failed.”

If any items that the general contractor has designated necessary for payment are missing or incorrect, Textura automatically puts payment on hold.

Asset tracking

Outside of the realm of financial software, said Josh Progar, global technical solutions manager of Autodesk Construction Solutions, there are other tech tools that contractors can use to prevent fraud.

Project teams need to assess risk before the job starts, Progar said, and BuildingConnected’s TradeTapp helps general contractors by giving them visibility into a subcontractor’s financial and safety risk. TradeTapp validates subcontractor documentation, he said, so that general contractors can make sure they’ve hired the right sub for the job.

Once the project has started, contractors need a way to track their assets and work in place. Assemble, Progar said, allows teams to see every asset on the jobsite, as well as their order and installation status. This helps contractors ensure that paid-for items arrive and stay on the job and that billed-for work has actually been performed.

Even a field software tool like PlanGrid, Progar said, can help supervisors and project managers track completed work, avoiding both intentional and unintentional overbillings.

Obviously, heading off incidents of fraud is more beneficial to contractors than catching them after they happen, and these tools provide the means to do just that. “It is that real time visibility,” Harris said, “that we think is … imperative to better control of the environment and and better prevention of fraud.”

Written by Kim Slowey for Construction Dive

Trenton H. Cotney

Florida Bar Certified Construction Lawyer

Cotney Construction Law, LLP

3110 Cherry Palm Dr., Ste. 290

Tampa, FL 33619

www.cotneycl.com