Construction Fraud and Auditing presentation construction fraud ¢â‚¬¢ Describe leading practices and controls

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  • Construction Fraud Auditing

    AGA/EEI Utility Internal Auditor's Training

    August 26, 2015

  • Today’s Presenter

    KEVIN MAX Managing Director

    KPMG LLP kmax@kpmg.com www.kpmg.com

  • Objectives

    • Describe the most common types of construction fraud

    • Identify the indicators, ‘red flags’, and control weakness often associated with construction fraud

    • Discuss methodologies employed to detect and investigate construction fraud

    • Describe leading practices and controls designed to prevent construction fraud

    • Understand the key aspects of the most common types of construction contracts

    • Describe the key considerations, techniques, most likely findings and indications of fraud when auditing construction projects

    2

  • Agenda

    ■ Construction Fraud: Headlines, Surveys and Statistics

    ■ Fraud Schemes by Project Phase

    ■ Indicators of Construction Fraud

    ■ Fraud Deterrence and Prevention

    ■ Fraud Detection and Response

    ■ Construction Fraud Investigation

    ■ Notable Construction Fraud Cases

    ■ Auditing Construction Projects for Fraud

  • 4 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.© 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Occupational Frauds Based On Industry – Sorted By Median Loss Industry Percent of Cases Median Loss

    Mining 1.0% $900,000 Real Estate 1.8% $555,000 Oil and Gas 3.6% $450,000 Wholesale Trade 2.3% $375,000 Technology 2.9% $250,000 Manufacturing 8.5% $250,000 Construction 3.1% $245,000 Agriculture, Forestry, Fishing and Hunting 2.0% $242,000 Transportation and Warehousing 3.5% $202,000 Banking and Financial Services 17.8% $200,000 Services (Professional) 2.7% $180,000

    Construction Fraud Statistics – 2014 Report to the Nations

  • 5 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.© 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Construction Fraud Statistics – What other surveys say about fraud

    AFCE 2014 Report to the Nations

    The typical organization

    loses 5% of revenues each year

    due to fraud.

  • 6 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Fraud Schemes by Project Phase – Pre-Construction Phase

    Construction ■ Project Execution &

    Monitoring ■ Fraud Risk

    – Product Substitution – Labor & Material

    Mischarges – Kickbacks

    Pre-Construction ■ Design Development ■ Contract Documents ■ Fraud Risk

    – Contract and Procurement Fraud (Bid Submission and Rigging Schemes)

    Post- Construction ■ Project Close-Out ■ Construction Claims and

    Disputes ■ Fraud Risk

    – Inflated Change Orders and Claims

  • 7 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Fraud Schemes by Project Phase – Pre-Construction Phase (continued)

    The most prominent schemes involved at this phase of contracting are:

    Bid Submission Schemes:

    ■ Collusion between buyer and contractor or contending companies to create an unfair advantage to one of the bidding parties during the bid submission process

    Bid Rigging Schemes:

    ■ Conspiracy, usually between competing contractors, to artificially raise prices of submissions and create a larger profit margin

  • 8 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Construction ■ Project Execution &

    Monitoring ■ Fraud Risk

    – Product Substitution – Labor & Material

    Mischarges – Kickbacks

    Pre-Construction ■ Design Development

    Phase ■ Contract Document Phase ■ Fraud Risk

    – Submission Schemes – Bid Rigging Schemes

    Fraud Schemes by Project Phase – Construction Phase

    Post- Construction ■ Project Close-Out ■ Construction Defects ■ Construction Claims and

    Disputes ■ Fraud Risk

    – Inflated Change Orders and Claims

  • 9 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Fraud Schemes by Project Phase – Construction Phase (continued)

    Product Substitution

    ■ Contractor can increase profit by substituting contract specified products with less expensive or more convenient alternatives

    Accounting, Material and Labor Mischarges

    ■ Unallowable charges

    ■ Raw materials used on different projects

    ■ Labor charged to various projects

    Related Party Transactions

    ■ General Contractor may subcontract with related parties or use vendors owned by the general contractor itself, thus creating hidden profit centers

    Prevailing Wage Fraud

    ■ Contractors and subcontractors fraudulently avoid paying the prevailing wage or fringe benefits in violation of the Davis Bacon and Related Act (DBRA)

  • 10 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Construction ■ Project Execution &

    Monitoring ■ Fraud Risk

    – Product Substitution – Labor & Material

    Mischarges – Kickbacks

    Pre-Construction ■ Design Development

    Phase ■ Contract Document Phase ■ Fraud Risk

    – Submission Schemes – Bid Rigging Schemes

    Post- Construction ■ Project Close-Out ■ Construction Defects ■ Construction Claims and

    Disputes ■ Fraud Risk

    – Inflated Change Orders and Claims

    Fraud Schemes by Project Phase – Post-Construction Phase

  • 11 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Inflated and/or Unjustified Change Orders:

    ■ Contractors may inflate the cost and impact of change orders in order to make additional profit or submit change orders with no merits

    Inflated and/or Unjustified Claims:

    ■ Contractors may inflate the claim amount or submit claims with no merits

    Fraud Schemes by Project Phase – Post-Construction Phase (continued)

  • 12 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.© 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Indicators of Construction Fraud

    Contract Development

     Omitted / modified right-to-audit clause  Unclear change order language  Omitted termination for convenience clause  Missing attachments  Weak language regarding to reimbursable expenses, general conditions,

    overhead  Minimal guidance on subcontracting – bidding, form of contracts  Unreasonably narrow contract specifications

  • 13 © 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.© 2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

    Bid Submission Schemes

     Few bidders respond to request for bids  Unusual or unreasonable specifications  High number of awards to one supplier  Allowing an unreasonably short time period to bid  Unre