Combatting Procurement Fraud

Procurement, the backbone of every organization's operation, is entrusted with the critical task of acquiring goods and services essential for business to operate effectively. However, hiding in the shadows of this function lies a pervasive threat – procurement fraud. In this article, we’ll examine what procurement fraud is and discuss its detection and prevention.

Procurement fraud tends to occur more frequently during the first stages of the procurement process, particularly at the vendor selection stage. Personal gain at the organization's expense is often the primary driver behind these frauds. It’s a serious threat that can result in significant financial loss for organizations. A report by the SAS Institute found that one of the biggest difficulties with this issue is that procurement errors, fraud, and abuse are often committed by internal employees acting in collusion with outsiders and our experience confirms that this is frequently a critical component. Almost a quarter of organizations have experienced collusion between suppliers (23%) and collusion between employees and suppliers (24%).

?Typical procurement frauds

1.?????? Conflict of interest - Situations where the procurement related decisions are influenced by personal relationships that may not align with the required process or policies, nor the company’s best interest.

2.?????? Kickbacks and bribery - When employees are offered kickbacks or bribes in exchange for granting a lucrative contract or favored treatment in procuring certain goods or services.

3.?????? Ghost vendors – Payments being made to fictitious or dummy vendors.

4.?????? Irregular vendor selection - When a vendor is selected without going through a formal competitive bidding process, or when the chosen vendor lacks the necessary qualifications, potentially indicating collusion.

5.?????? Bid rigging - Collusion among vendors to artificially inflate prices or manipulate the bidding process to ensure a particular vendor gets the contract.

To help combat procurement fraud effectively, identification of red flags can be a highly effective control. Some of the major red flags to spot on procurement fraud include:

• Unusual employee-supplier relationships - Be vigilant of suppliers who do not have a prior history with the organization suddenly being awarded significant contracts - this could indicate potential collusion.
• Quick invoice payment - Frequent and unusually rapid invoice payments may indicate an attempt to expedite payments before any potential fraud is detected.
• Unusual payment terms - Pressure to accelerate procurement processes, particularly from specific employees, may suggest attempts to circumvent controls.
• Invoice inconsistencies - Discrepancies among purchase orders, invoices, and delivery receipts may indicate fraudulent invoicing or overbilling.
• Inflated invoices – A significant increase in the price rates as compared to the market rates may indicate billing schemes or overcharging.
• Poor documentation and record keeping - A lack of documentation, including contracts, purchase orders, and delivery receipts, could indicate efforts to conceal fraudulent activity.

Organizations that conduct spot checks are usually less vulnerable to fraud, although this method remains one of the most underutilized in detecting procurement fraud. The importance of establishing a robust internal control framework to identify and mitigate fraud cannot be overstated. To help prevent procurement fraud, consider the following precautions:

• Implement a robust and centralized procurement system - Establish a robust centralized procurement system with stringent protocols for supplier selection, purchasing authorization and payment processing. Introduce accountability measures mandating that procurement personnel document and monitor each action taken, promoting transparency, and discouraging fraudulent conduct.
• Conduct vendor due diligence - Conduct thorough due diligence on vendors before engaging them to verify their legitimacy, financial stability and reputation. This can help prevent fraudsters from entering your supply chain.
• Educating employees and vendors - Provide comprehensive training to employees engaged in procurement processes, focusing on policies, procedures and ethical standards to help minimize the risk of fraud and create awareness. Vendors should also receive training, so they are aware that adhering strictly to procurement guidelines and practices is not optional. A vendor code of conduct should be introduced and all vendors should certify and confirm their acceptance and understanding of that code.
• Periodic internal and external audits - Perform regular internal and external audits focused on the procurement process to identify any irregularities from established standard practices. This may involve identifying higher risk transactions, especially those that include fraudulent vendors or sudden price changes.
• Whistleblowing solution - Develop a whistleblowing policy, procedures, and independent hotlines through which employees can report any suspected fraudulent behavior. Clearly define the measures for reporting and guaranteeing confidentiality. A clear process for handling and responding to these reports should be put in place and accountability for doing so assigned to the appropriate individuals.
• Promote an anti-fraud culture - Foster a zero-tolerance culture toward fraud and encourage the development of an ethical and transparent organizational culture at all levels. Employees should feel empowered to voice any concerns or suspicious activities.

Conclusion??

As procurement fraud becomes an increasingly common risk, both private and government organizations require a proactive and comprehensive approach that effectively combines policies, procedures, and controls with a strong anti-fraud culture. Identifying the red flags of procurement fraud is an excellent initial step to help detect and prevent fraudulent activities. Through a combination of strong internal controls, comprehensive employee training, and the deployment of effective anti-fraud technologies, organizations can make themselves more resistant to any attempts to exploit their procurement process.

For further information or assistance, please do not hesitate to contact me directly, or my co-author Soham Naik .