Wednesday, August 24, 2016

Contract Fraud, the Fraud Triangle, and Internal Controls

While perusing the Justice Department's press releases related to fraud, we were struck by the sheer numbers of reported fraud cases. Just this week, the was a company president pleading guilty to bribery at Tinker AFB, a woman sent to prison for trying to illegally export our latest fighter jet engines to China, Navy and contractor employees pleading guilty to taking and giving kickbacks, another Navy employee sentenced to 18 months in prison for accepting illegal gratuities, another contractor executive sentenced to prison for illegally exporting weapons parts, and a company using "front-companies" to obtain small-business set aside contracts.

Most of these cases involved owners or employees very high up in the organization. It doesn't matter then how good a company's ethics programs operate or the effectiveness of their standards of conduct if the top guy is the one committing the fraud. If no one is setting the proper "tone at the top", employees are less likely to care about integrity matters. In fact, employees with integrity are not likely to stay around or perhaps, stay around and blow the whistle.

The Association of Certified Fraud Examiners have developed a model for explaining the factors that cause people to commit occupational fraud. It consists of three components which, together, lead to fraudulent behavior. These three factors include:

  • Perceived unshareable financial need
  • Perceived opportunity
  • Rationalization

If we had more details on the fraud cases just mentioned, we could probably fit the scenarios into the fraud triangle model.

The other attribute we noted concerning the latest batch of fraud cases and many cases preceding these is that none of them seem to stem from the oversight of DCMA (Defense Contract Management Agency) or DCAA (Defense Contract Audit Agency). With all of the emphasis on fraud and on developing tests to detect the existence of fraud, one would think that these Agencies would have something to show for their efforts. The lack or DCMA/DCAA originated fraud cases might mean that there is very little fraud going on at the transaction level because the Agencies are effective in ensuring the adequacy of internal control systems or that investigators don't want accounting-related cases because they're difficult to understand and too time-consuming to prosecute.

Contractors can go a long way to minimizing the occurrences of fraud in their organization by knocking out at least one leg of the fraud triangle - the perceived opportunity. Reduce the opportunities by implementing effective internal control systems, policies, procedures, and practices and take away opportunities.

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