How to Prevent & Detect Fraud in your Construction Company

Jul 13, 2022Construction & Real Estate

Prepare Your Business Against Potential Threats

The Association of Certified Fraud Examiners (ACFE) recently published its 2022 Report to the Nations, a global study on occupational fraud. The ACFE surveyed 7,890 examiners and reported that internal fraud drains more than $3.8 billion annually from global businesses. The median internal fraud loss for construction companies is $203,000.

Although construction companies can experience pilferage from clients, vendors, and other sources, employees account for the highest losses when considering offenses such as fraudulent insurance claims, unauthorized time off, and theft of proprietary information. Crimes can be as simple as stealing company supplies or as complex as sophisticated financial statement fraud. More specifically, fraud by managers and key executives generates the highest dollar losses because these employees are in an excellent position to falsify financial, credential, work-related, or test-related documents for personal gain. In today’s competitive environment, construction companies need sound systems to monitor and control all phases of their operations.

The following summary highlights the ACFE report as it relates to how frauds are being committed and detected and who are the victims and typical perpetrators. This information should be used to prepare your construction company better to prevent and detect potential frauds.

ACFE Report Highlights

How is Occupational Fraud Committed

Occupational fraud involves using one’s position to commit intentional wrongdoing against one’s employer. Occupational fraud has three primary categories as follows:

  • Asset Misappropriation – Involves an employee stealing or misusing the employer’s resources. Included in 86% of the reported cases, with a median loss of $100,000 per case. The most common asset misappropriation schemes are billing schemes, noncash schemes, expense reimbursements, and check and payment tampering.
  • Financial Statement Fraud – Intentionally causing a material misstatement or omission in the company’s financial statements. It is only included in 9% of the reported cases, but those cases have a median loss of $593,000 per case.
  • Corruption – Typically perpetrated by executive or management personnel and includes bribery, conflicts of interest, and extortion. Included in 50% of the reported cases, with a median loss of $150,000 per case. (32% of cases had both corruption and asset misappropriation)

Research indicates the median duration of fraud is typically 12 months before detection occurs. However, there is a significant increase in losses for cases that go beyond two years before detection. Research also shows that the more perpetrators involved in the fraud, the greater the loss per month to the organization.

The main methods used by fraudsters to conceal their fraud include:

  • Creating fraudulent documents (39%)
  • Altering physical documents (32%)
  • Creating fraudulent electronic documents or files (28%)
  • Altering electronic documents (25%)
  • Destroying or withholding physical documents (23%)

Detection of Fraud

Detection is an essential step in fraud investigations, since the speed with which detection occurs can significantly impact the overall magnitude of the fraud. Having proper detection procedures in place is important, as this may increase staff’s perception that fraud will be detected and could prevent future misconduct.

As has been the case in every ACFE report, tips continue to be the most common method used to detect fraud (42%). For example, more than half of fraud tips came from employees, while a third came from outside parties, such as customers, vendors, and competitors. Communication of reporting mechanisms should target both internal staff and external parties, as both can provide tips.

There are both passive methods of detection and active methods:

  • Passive methods include a notification from law enforcement, a fraudster’s confession, or even accidental detection.
  • Active methods include internal audit functions, management review, account reconciliations, surveillance and monitoring, and automated transactions.

The ACFE report shows active methods are much quicker at detecting the fraud and help to limit the overall losses, with detection occurring typically between six to 12 months. For companies using passive methods, detection typically did not occur until between 14 and 23 months, and they incurred much more significant losses.

Perpetrators

As part of the survey, respondents were asked about the fraud perpetrator’s job details, basic demographics, prior misconduct, and behavioral warning signs that may have indicated fraud. Data shows the largest median loss occurs when fraud is perpetrated by owners or executives at $337,000 per case. However, these owner and executive frauds only comprised 23% of the cases. Fraud committed by managers had a median loss of $125,000 per case, and fraud by employees had a median loss of $50,000 per case. This shows that fraud losses tend to be larger in schemes committed by higher-level fraudsters. The time to detect the fraud also varies based on who is perpetrating it, with owners and executives taking around 18 months to catch and staff-level employees typically only around eight months.

Construction companies experience the fourth largest median loss at $203,000, trailing only real estate ($435k), wholesale trade ($400k), and transportation and warehousing ($250k). The primary schemes used in construction industry frauds included:

  • Corruption (56%)
  • Billing (24%)
  • Payroll-related (24%)
  • Noncash (24%)
  • Financial statement fraud (18%)
  • Expense reimbursements (17%).

Several of the cases included multiple schemes in combination.

What can your construction company do to prevent theft?

  • Improve internal controls
  • Conduct background checks
  • Arrange for fraud audits
  • Prosecute perpetrators
  • Ethics training
  • Anonymous fraud reporting mechanisms
  • Install workplace surveillance devices
  • Look for behavioral red flags
construction industry anti fraud checklist graphic

Take a zero-tolerance stand on fraud. With a few basic procedures, internal business theft can be significantly reduced — or even eliminated — so your construction company can flourish. Contact us today to schedule a consultation with one of our construction industry experts.

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