Employee Fraud - Directing Subcontractors to Use Designated Lower-Tier Subcontractors

Whenever we read of a fraud case, our interest goes immediately to questioning what went wrong - what internal control system did not exist or was not adequate to prevent it from occurring. According to the Fraud Triangle model, there are three factors that, when taken together, lead to fraudulent behavior. These three factors are (i) perceived unshareable financial need, (ii) perceived opportunity, and (iii) rationalization. Take away any of these three conditions and you will reduce the likelihood of occupational fraud occurring in your organization. Internal control systems fall within the "opportunity" condition - good internal control systems should decrease the opportunity for someone to commit fraud against your organization.

Yesterday, the Department of Justice publicized the results of a jury trial where an employee of a large, multi-national construction and engineering firm was convicted of fraud. In this case, the employee was able to direct the recipients of subcontracts he had awarded, to hire certain other companies as lower-tier subcontractors. Directing a subcontractor to award lower-tiered subcontracts to specific firms would be inappropriate in any purchasing system. But to compound the problem, these lower-tiered subcontractors happened to be companies he himself controlled. In one case, he owned a shell company with no employees had the employees of the prime contractor - his co-workers - perform the work. In the other case, he owned 51 percent of the shell company but it also had no employees to perform the construction work.

In these cases, the subcontractors who agreed to the conditions were partly to blame. They probably knew what was going on but perhaps they figured that it was just the cost of doing business. If they didn't play, they wouldn't get the work. Kickbacks are difficult to detect but there are some red flags that contractors should be aware of.

• Lack of competitive bidding procedures
• Poor supervision of the purchasing function
• Prices of goods or services appear to be higher than market value
• Employees promote or lobby for a vendor who others in the industry shun
• Employees appear to be unusually chummy with a particular vendor
• Management applies inordinate pressure on purchasing employees to use a particular vendor
• The vendor is in a highly competitive industry where kickbacks and bribery are connonplace

Contractors need to be cognizant of conditions within their organization that would allow opportunities for fraud to occur. Once identified then, contractors need to develop and implement control systems that will prevent and detect fraud from occurring.