Kroll Global Fraud Report - detecting a climate of procurement fraud

The Economist commissions Kroll to conduct an annual report of the state of fraud risk in the world's economies. This report is an excellent guide to fraud risk generally and procurement fraud more particularly.

The Kroll Global Fraud Report for 2010/11 is online here.

I found the following advice particularly practical and worthy for detecting procurement fraud generally, though this particular extract was taken from the Kroll report on Brazil's transportation infrastructure issues.

For companies seeking to exploit upcoming investment opportunities there are several ways to build up a layer of protection against fraud.

The first step is to evaluate the transparency and fairness of the bidding process carefully. Some of the key questions that should be asked include: Have the details of the process been clearly communicated? Is an independent committee or person presiding over the process? What criteria will be used to qualify or disqualify bidders? Are these criteria fair or tailored to disqualify all but a select few companies? Are they reasonably related to the necessities of the present project? What factors will be considered in selecting the winner? All of these questions should be answered to the company’s satisfaction before it submits a bid.

The second step for a business is to conduct background checks on its own employees and on those companies which it will engage. This is especially important when subcontracting local workers and businesses. A thorough background check can provide clearer details of their qualifications and prior experience, how they are perceived by their competitors and clients, and whether they have previously been involved in fraudulent projects or have otherwise been the subject of a fraud investigation.

Competitive market intelligence is an additional weapon in the investor’s arsenal. Fundamental questions to consider in this analysis include: Are competitors able to sell their services and products at abnormally low prices? If yes, is there a legitimate reason or is the real explanation that fraudulent methods are being employed, such as the use of substandard or counterfeit materials and products? Is there a cartel or similar organization in place that is preventing other companies from entering the market in general or a particular bidding process? Is it possible other relationships exist between competitors that would constitute unfair competition?

Safeguards against possible fraud and exposure to corruption during the project’s execution are equally important. It is essential that corporate executives be aware of local and international laws, regulations, and industry standards, particularly when doing business in new jurisdictions. These must therefore be researched and resultant actions and policies clearly communicated and enforced through appropriate training and periodic monitoring of the work underway. Additionally audits of, for example, purchase orders, invoices and payroll information will provide information that can raise red flags.

For years, transportation infrastructure projects in Brazil have been rife with fraud and the problem shows no sign of abating. As recently as August 5, 2010, arrest warrants were executed for 28 individuals accused of rigging bids and diverting funds related to several transportation infrastructure projects in Brazil. Losses are estimated to be nearly $2.9 million and the accused range from government administrators and officials to owners and employees of the companies contracted to perform the work. They face a wide range of charges, from corruption, embezzlement, and money laundering to forgery, conspiracy, and other criminal violations of Brazilian bidding laws.

Another recent example of fraud in the sector came to light in September 2009 when a whole host of individuals, companies and other entities that provide or manage services related to the air travel industry were investigated for allegedly rigging online auctions and forming a cartel that served to exclude potential competitors from the market. Of the 305 companies authorized to participate in bids, only 16 actually registered. The fraud, estimated to have reached more than $286 million, was one of the largest of its kind in recent Brazilian history.

The ways in which fraud in the industry has been perpetrated are seemingly endless: overbilling, overpayments, use of ghost employees, use of materials of inferior quality, attesting to work that has not actually been completed, forewarnings about upcoming audits, altering or concealing documents.

Given the widespread presence of fraud, the risks inherent in participating in infrastructure projects can outweigh the benefits. In most cases, these projects involve government officials or entities in some capacity. Consequently, if your company has any significant link to the United States or United Kingdom, the far-reaching provisions of the Foreign Corrupt Practices Act (FCPA) or UK Bribery Act could lead to crippling costs, including penalties, disgorgement of profits, and mandatory monitoring. Moreover, Brazilian authorities can separately impose their own hefty fines and initiate criminal and civil litigation.

Finally, conviction for fraud, or even investigation, can result in reputational damage which, while difficult to quantify, will certainly leave a long-lasting scar on any company or individual involved.