PROCUREMENT FRAUD SCHEMES AND THEIR PRIMARY RED FLAGS

BRIBES AND KICKBACKS

A bribe is usually defined as the giving or receiving of a “thing of value” to corruptly influence the actions of another, most commonly to influence a contract award or the execution of a contract.  A “kickback” is a bribe paid by the contractor after it is paid. Most bribes in exchange for large contract awards in international development projects are paid as kickbacks, usually 5%-20% of the contract value.

Corrupt payments

The bribe need not be in money or cash, and often is not. Any benefit given or received with the intent to corruptly influence the recipient can be a bribe.

“Things of value” that have been given and received as bribes include:

• Expensive gifts, free travel and lavish entertainment
• “Loans,” whether or not repaid
• Use of credit cards
• Sexual favors (hiring of prostitutes, etc.)
• Overpaying for purchases, e.g., paying $20,000 for a car worth $5,000
• Cash
• Fees and commissions, even if recipient allegedly provided services to the payer
• Hidden interests in business transactions

Often the payments follow the general sequence outlined above, with the amount and form of payments becoming more significant and incriminating as the scheme progresses.

Corrupt influence

• Corrupt influence often is reflected as, among other things:
• Qualifying an unqualified or untested company to bid or be a vendor
• Improper or non-competitive contract awards
• Paying too much for goods or services
• Buying too much of an item, or buying inappropriate items
• Continued acceptance of low quality or non-compliant goods or services

As the corruption continues, the abuses often turn into fraud, such as fictitious invoices, with the parties conspiring to split the profits.  Eventually the excesses of the scheme lead to its detection, as the mounting evidence of favorable treatment and fraud, and the conspicuous expenditures of the conspirators, call attention to their behavior.

The major red flags of bribes and kickbacks

• Improper (e.g., non-competitive) selection of a contractor Unjustified favoritism of a certain contractor, e.g. approval of high prices, excessive purchases, continued acceptance of low quality goods, etc.
• Unnecessary broker or middleman involved in transactions
• Procurement official accepts inappropriate gifts and entertainment
• Unexplained increase in wealth by procurement official

COLLUSIVE BIDDING BY CONTRACTORS

Groups of bidders might secretly agree to submit complementary high bids to allow pre-selected contractors to win contracts on a rotating basis, or to divide contracts by territory, or take other steps to defeat the competitive process and divide work.

Collusive bidding, also known as “bid rigging” will drive up prices in the affected industry. It is most common in industries with high start up and entry costs and relatively few bidders, such as road construction, paving and waste disposal.

Some form of bid rigging often accompanies kickback schemes in order to insure that the corrupt company is selected.

The major red flags of collusive bidding

• Winning bid too high compared to cost estimates, published price lists, similar jobs or industry averages; persistent high prices over time
• Rotation of winning bidders by job, type of work or geographical area
• Losing bidders hired as subcontractors
• Unusual bid patterns. For example, the bids are:Too high
• Too close
• Too consistent
• Too far apart
• Round numbers
• Incomplete Identical or similar to prior or other bid
• Apparent connections between bidders: common addresses, personnel, phone numbers, etc.

CHANGE ORDER ABUSE

A contractor, in collusion with procurement official, can submit a low bid to insure winning a contract, and then increase its price and profits by submitting change order requests after the contract is awarded.

A dishonest contractor, acting alone or in collusion with contract personnel, can submit unjustified or inflated change order requests to increase profits, or, as the result of corruption, use the change order process to extend a contract that should be re-bid.

The major red flags of change order abuse:

• Weak controls and lax procedures regarding review of need for change orders
• Numerous, unusual or unexplained change orders for a specific contractor approved by same employee
• Pattern of low bid award followed by change orders that increase the price or scope of the contract, or extend the contract period
• Vague contract specifications followed by change orders
• Incomplete or “preliminary” specifications subject to change based on later engineering studies, etc.

CO-MINGLING OF CONTRACTS

Dishonest contractors can submit multiple bills on different contracts or work orders for work performed or expense incurred only once.  A contracting official can facilitate the scheme and share in the profits by writing similar work orders under different contracts and accepting the multiple billings.

The major red flags of co-mingling of contracts:

• The contractor submits several billings for the same or similar expenses or work under different jobs or contracts
• The contractor submits the same or similar documentation to support billings on different contracts
• Multiple awards for similar work are given to the same contractor
• Similar work orders are issued to the same contractor under more than one contract

CONFLICT OF INTEREST

Conflicts of interest can arise if procurement personnel have undisclosed interests in a supplier or contractor, accept inappropriate gifts, favors or kickbacks from vendors, or engage in unapproved employment discussions with current or prospective contractors or suppliers.

Kickbacks can be prosecuted as a conflict of interest, as well as bribery.  A conflict of interest case might be easier, as the prosecution need show only that the kickbacks, which can be in the form of gifts and favors, were not disclosed, rather than having to prove corrupt intent.

The major red flags of conflict of interest

• Unexplained or unusual favoritism of particular contractor or vendor
• Contracting or purchasing employee lives beyond means
• Employee has discussions about employment with current or prospective vendor
• Close socialization with and acceptance of inappropriate gifts, travel or entertainment from a vendor
• Procurement employee appears to conduct side business

EXCLUDING QUALIFIED BIDDERS

A dishonest procurement employee, probably in collusion with a corrupt bidder, can use a variety of tactics to exclude other qualified bidders, including arranging narrow or unduly burdensome pre-qualification criteria, establishing unreasonable bid specifications, splitting purchases to avoid competitive bidding, making unjustified sole source awards, and so on.

The major red flags of excluding qualified bidders

• A significant number of qualified bidders fail to bid
• Unreasonably narrow contract specifications
• Allowing an unreasonably short time limit to bid
• Adopting unreasonable “pre-qualification” procedures
• The failure to adequately publicize requests for bids, e.g., using only local publications, or failing to publicize the request for bids

FAILURE TO MEET CONTRACT SPECIFICATIONS

A contractor that knowingly delivers works, goods or services that do not meet contract specifications may be guilty of fraud if it falsely represents that it has complied with the contract or deliberately conceals its failure to do so. If it has not made fraudulent representations or concealed its acts, the contractor would be liable for breach of contract rather than fraud.

The major red flags of failure to meet contract specifications

• Discrepancies between test and inspection results and contract claims and specifications
• Failed tests or inspections
• Low quality, poor performance and high volume of complaints
• Early failure or high repair rates

FALSE, INFLATED OR DUPLICATE INVOICES

Suppliers or contractors can intentionally submit false (meaning that no services were provided), duplicate or inflated invoices. The scheme can involve a contractor acting alone or in collusion with an employee of the victim organization who shares in the profits.

The major red flags of false, inflated or duplicate invoices

General red flags

• Weak or un-enforced controls in the receipt of goods and payment of invoices
• Inadequate, copied or apparently altered supporting documents

Red flags of false invoices

• Invoiced goods or services cannot be located in inventory or accounted for
• No receiving report for invoiced goods or services
• Questionable or no purchase order for invoiced goods or services
• Red flags of inflated invoices
• Invoice prices, amounts, item descriptions or terms exceed or do not match:Contract terms
• Purchase order
• Receiving records
• Inventory or usage records
• Discrepancies between invoice and supporting documents.

Red flags of duplicate invoices

Multiple invoices:

• In the same or similar amount to the same or related vendors
• On the same invoice or purchase order
• For the same or similar goods or services

Multiple invoices with the same:

• Description of goods or services
• Amount
• Invoice number
• Purchase order number

Total payments to vendor exceed total purchase order or contract amounts

FALSE STATEMENTS AND CLAIMS

Contractors or suppliers can submit false information about their employee credentials and experience, invoice for goods and services that are not delivered, charge for higher quality items than are provided, submit false or defective bonds, or make a variety of other false statements and claims.

The major red flags of false statements and claims

• Discrepancies between reported facts and test and inspection results
• Refusal or inability to provide supporting documentation
• Inadequate or apparently altered supporting documentation
• High rate of rejections, returns or failures
• Complaints from users

IMPREST FUND ABUSE

Replenished “imprest funds” (also known as “operating accounts” or “petty cash funds”) can be embezzled or used improperly by contractor employees. The employees might submit false or inflated requests for reimbursement of expenses, use the fund for personal or unauthorized expenditures, or “double-dip” by submitting reimbursement both to the fund and accounts payable.

The major red flags of imprest fund abuse

• No oversight or weak controls on disbursements and reimbursements
• Lack of supporting documentation; altered or copied documentation
• Endorsement on check differs from payee; unusual or second endorsement
• Disbursement of same or similar amounts to same person from both imprest fund accounts and accounts payable
• Use of imprest accounts for unauthorized purposes, “loans” or in amounts in excess of those permitted

LEAKING OF BID INFORMATION

Procurement personnel can leak bid information from other bidders, or confidential pre-bid information, to a favored bidder to give it an unfair advantage in the bidding process. Such schemes usually occur as the result of corruption.

The major red flags of leaking of bid information

• Poor controls on bidding procedures, e.g., failure to enforce deadlines, non-public opening of bids, etc.
• Winning bid just under the next lowest bid
• Acceptance of late bids
• Bid due date extended unnecessarily
• Late bidder is the low bidder

MANIPULATION OF BIDS

A procurement employee, probably as the result of corruption, can manipulate the bidding process in a number of ways to benefit a favored contractor or supplier. These include leaking information regarding competing bids, accepting late bids, changing bids, re-bidding work and so on.

A contractor can also submit a “low” bid with the understanding that the corrupt procurement official will approve later contract amendments and price increases.

The major red flags of manipulation of bids

• Poor controls and inadequate bidding procedures
• Winning bid voided for “errors” in contract specifications and the job is re-bid
• Acceptance of late bids
• Bids are “lost”
• A qualified bidder disqualified for questionable reasons

FICTITIOUS VENDOR

In a weakly controlled environment, an employee with procurement responsibilities, or in accounts payable, or an outsider, can submit bills from a non-existent vendor. Normally fictitious vendors claim to provide services or consumables, rather than goods or works that can be verified.

Dishonest bidders also can submit “bids” from fictitious bidders as part of bid rigging schemes.

Phantom vending schemes occur more often than thought, and can be detected relatively easily through automated proactive fraud detection programs.

The major red flags of fictitious vendor

• Weak controls: same employee can order, receive and approve payment for goods or services
• Paid vendors not on the approved vendor list
• Vendors not listed in business or telephone directories.
• Invoiced goods or services cannot be located or verified.
• Vendor address is mail drop

PRODUCT SUBSTITUTION

A supplier or contractor can substitute products or materials of lesser quality than specified in the contract, or use counterfeit, defective or used parts, in order to increase profits or comply with contract time schedules.

The dishonest supplier might give gifts or favors to inspectors or pay kickbacks to contracting officials to facilitate the scheme, and will submit false documentation to conceal it.

The major red flags of product substitution

• Unusual or generic packaging
• Discrepancy between product's description or normal appearance and actual appearance (e.g., “new” product appears to be used)
• Product identification numbers differ from published or catalogue numbers or numbering system
• Above average number of test or operation failures, early replacements, or high maintenance and repair costs.

PURCHASES FOR PERSONAL USE OR RESALE

An employees can purchase items through his agency or company that are intended for his personal use, such as tools, personal computers, or automobile parts, or that the employee intends to resell as part of a side business, such as computer parts or inventory.

The major red flags of purchases for personal use or resale

• High volume or unusual purchases of “consumer items” or items suitable for personal use or resale
• Business purchases from vendors that sell consumer products
• Purchased items “returned” to vendor without vendor credit or refund
• Purchased items to be drop shipped or delivered to another location
• Suspect employee conducts an outside business

RIGGED SPECIFICATIONS

An employee with procurement responsibilities, probably in collusion with a supplier or contractor, drafts a request for bids or proposals that contain specifications that are either too narrow or too broad.

Unduly narrow specifications allow only a favored contractor to qualify, and unduly broad specs can be used to qualify an otherwise unqualified contractor to bid.  Broad specs can also be used in connection with later contract amendments and change orders to facilitate a corruption scheme.

The major red flags of rigged specifications

• Only one or a few bidders respond to request for bids
• Similarity between specifications and winning contractor’s product or services
• Specifications are significantly narrower or broader than similar previous requests for bids
• Purchaser uses brand name in request for bids
• High number of competitive or sole source awards to one supplier

SPLIT PURCHASES

A single procurement can be split into two or more purchase orders or contracts, each below upper level review or competitive bidding thresholds, to avoid review or competitive selection. Repetition of this scheme, favoring the same parties, can be a strong indicator of corruption.

The major red flags of split purchases

• Two or more similar procurements from the same supplier in amounts just under competitive bidding or upper level review limits
• Unjustified separation of purchases, e.g. separate contracts for labor and materials, each of which is below competitive bidding limits, but when combined is over such limits
• Sequential purchase orders or invoices under upper level review or competitive bidding limits
• Contracts under the competitive bid limit followed by change orders that increase amounts of the contract

UNBALANCED BIDDING

“Unbalanced bidding” includes a number of schemes in which bidders manipulate line item bid prices in order to gain an advantage in the bidding process. The schemes include:

• Quoting high prices on line items that the contractor knows or anticipates will be the subject of change orders increasing the quantity of goods or works required. For example, a in a road project might quote an exceptionally high price each of for 100 safety barriers, knowing that the number to be procured will later, after the contract award, be increased to 1000. The bidder might be informed of the proposed change as the result of a corrupt relationship with project officials.
• Quoting dramatically lower prices on line items that the bidder knows – perhaps by being tipped off as the result of bribes to project officials – will not be called for after contract award. This information allows the favored bidder to drastically lower its price on the unneeded items to defeat its uninformed competitors.

The major red flags of unbalanced bidding

• Particular line item bids appear to be unreasonably low
• Subsequent change orders reducing requirements for low bid line item
• Particular line item bids do not appear to have been performed or purchased as specified in the contract
• Bidder close to procurement personnel or participated in drafting contract specifications

UNJUSTIFIED SOLE SOURCE AWARDS

Often as the result of corruption, a procurement official can avoid or defeat competitive selection requirements by making an improper sole source award to a favored contractor.

Such awards can be made directly, citing special circumstances, or by manipulating the bidding process to avoid the competitive bidding limit, etc.  If corruptly motivated, such awards often result in higher prices, lower quality or other disadvantages to the contracting organization.

The major red flags of unjustified sole source awards

• Sole source award above or just below competitive bidding limits
• Previously competitive procurements become non-competitive
• No justification or documentation for non-competitive awards
• Split purchases to avoid competitive bidding limits
• Awards made below the competitive bid limits that are followed by change orders that exceed such limits

UNNECESSARY PURCHASES

Unnecessary, excessive or inappropriate purchases of goods or services, or unnecessary repairs, might indicate corruption or purchases for personal use or resale.

The major red flags of unnecessary purchases

• Unusual or unexplained high volume purchases of products or services from a particular supplier
• Surplus sales followed by reorders
• Replacement or repairs after unreasonably short time period
• Inadequate or rushed needs analysis and justification