Internal controls are the foundation every government needs to ensure fraud can be detected and prevented, internally and externally. Previously in this series, we wrote that the war on government fraud starts with the five components of internal control known as the Committee of Sponsoring Organizations (COSO) framework. This article continues the discussion by highlighting another critical area in which every government should apply this framework.
Governments issue contracts for many of the supplies and services it requires. These contracts include outsourced government services and major construction projects for facilities, roads, and infrastructure. With this wide variety of contracts comes many fraudulent contracting schemes. According to a study published in 2020 by the National Institute of Justice (NIJ), the behaviors of fraud, bribery, extortion, and conspiracy account for nearly all public corruption convictions since 1985.
Bribery and Corruption
The most prevalent of the schemes are bribery and corruption. Bribery is the offer of money or other goods or services in exchange for favorable treatment. Corruption is when bribery involves a government official. The fraudsters use power or money to influence a transaction to benefit them at the expense of others.
On August 24, 2021, the former Norfolk City Sheriff, Robert James McCabe was convicted of public corruption charges. While serving as a public official for Norfolk, he engaged in illicit quid pro quo relationships with vendors. From 1994 through 2016, vendors provided McCabe with cash, travel, entertainment, gift cards, catering, personal gifts, and campaign contributions. McCabe provided the vendors with official actions that favored them in their contracts with the Norfolk City Jail. Dependent on the results, he faces a maximum penalty of 20 years in prison for each of the eleven counts in his conviction. Read here for information on this case.
Other Schemes
Other schemes found in government contracting include unnecessary contract amendments (change orders), product substitution, various types of inflated billing, and performance misrepresentations.
On November 5, 2018, Jim A. Meron of Granite Bay, California, pleaded guilty to wire fraud related to a government-procurement fraud scheme. From May 2011 through July 2017, Meron used his two office supply businesses to defraud federal government agencies for $3.5 million. He substituted cheaper, generic versions of expensive, name-brand products for thousands of transactions and pocketed the difference. On June 17, 2019, the court sentenced Meron to 33 months in prison and three years of supervised release. In addition, the court ordered him to pay restitution of $1,622,729.13 to dozens of victims. During the investigation, the court also seized $1.7 million in assets. Read here for more information on this case.
In both examples of corruption involving government contracts, the fraudster was able to continue their fraud for a significant number of years. With these schemes being so prevalent, governments need to implement procedures that minimize vulnerability. Could the City of Norfolk or the federal government agencies have detected or prevented these frauds?
The following are risks, red flags, and best practices against frauds in government contracts:
| RISKS |
RED FLAGS |
BEST PRACTICES |
| Collusion with Employees or Other Vendors on Bids/Awards |
- Procurement files are missing standard forms and/or signatures.
- The competitive process was not followed.
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- Ensure that all required forms are submitted prior to contract award and verify information provided.
- Award contracts in accordance with applicable procurement process, laws, regulations, and sound business practices.
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| Conflicts of Interest |
- Failure to file financial disclosure forms.
- Employee declines promotions.
- Vendor/contractor and employee address/phone match.
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- Sometimes an employee has a direct or indirect interest in a vendor and may be in a position to favor the vendor or contractor.
- Conflicts of interest can result in higher contract costs, significant contract changes, and purchases of goods or services not needed.
|
| False Billing |
- Frequent invoice/voucher errors.
- Claims for unallowable costs.
- Double counting costs as both direct and indirect.
- Unauthorized changes.
- Payments made that are unsupported by invoices.
- Misdirection – goods or services to be delivered to the business or job site are delivered, instead, to an employee’s home.
- Double billing.
- Improper indirect cost pool components.
- Altered or missing documents.
- Irregularities between styles or logos found on stationary, invoices, and statements.
- Documents presented are photocopies, not originals.
- Failure to claim discounts.
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- Any of these red flags can point to false billing.
- It is essential that personnel in charge of vendor management work with accounts payable to identify and follow up when a pattern of these red flags develop.
- There is software available to identify some of these patterns, such as double billing.
- The government can reduce other false billing by introducing policies that require expenditures to be adequately supported by documentation.
- Segregation of duties and appropriate review of documents by someone outside of vendor management, procurement, and accounts payable would make the ability to commit these types of frauds more difficult.
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| False Pricing Data |
- Frequent invoice/voucher errors.
- Poor cost documentation.
- Material mischarging – price, quantity, and/or quality.
- Restricted/delayed access to records.
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- Some contracts are based upon cost recovery or cost-plus profit. A common fraud is to overstate the cost of using materials. Since costs, prices, and quantities are being manipulated (the vendor’s records are not being used to produce the invoice), errors are more common than is normal. To cover the manipulation up, a vendor often does not provide appropriate documentation to support the billing and/or restricts access to records.
- When applicable, contracts should allow the buyer unrestricted audit rights. Also, material utilization rates should be checked against budgets/plans/expectations/industry norms. Prices should be verified against market prices. Goods received should be physically inspected to determine appropriate quality and quantity.
|
| False Time Records |
- Labor mischarging time.
- Labor mischarging rate.
- Professional fees with large amounts charged for “services rendered” with few details.
- Restricted/delayed access to records.
- If the hours charged are equal to or very close to budget estimates.
- Altered timecards.
- Timecards are filled out by management.
- Inconsistencies between timecards and charges.
- Job misclassification.
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- The actual amount of labor that will be required to complete a task is often difficult to predict. When the actual equals the estimates, it should be investigated.
- Some work needs to be done by licensed professionals. Administrative tasks should not be billed at the professional rate.
- When auditing vendor timecards, alterations or execution by management are both signs of potential trouble. Extend audit procedures to identify patterns of fraudulent activities.
- Always require professional invoices to have sufficient detail. Review the detail for reasonableness. If suspicions arise, examine the time sheets or timecards.
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| Fraudster Tries to Reroute Payments from a Legitimate Vendor |
- Change in address, bank account information is not signed by an authorized agent of the vendor.
- Documents submitted are not on official vendor stationary.
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- Establish a process to verify that all changes to vendor records (name, address, bank account) are submitted by an authorized vendor signatory and approved by an agency signatory.
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| General Contract / Vendor / Procurement / Bidding Fraud |
- No segregation between contracting, purchasing, receiving, storing, issuing, inspection, etc.
- Continued acceptance of high-priced goods or services.
- Continued acceptance of substandard goods or services.
- Numerous/costly change orders.
- Contractor inability to perform.
- Multiple purchases under bid limits.
- Protests.
- Failure to use existing contracts.
- Off-contract purchases.
- Emergency procurements.
- Sole source procurements.
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- Watch for red flags that point to collusion between the vendor and one of the buyer’s employees. Both the vendor and the employee overseeing the letting or the administration of the contract should be scrutinized.
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APPLYING BEST PRACTICES
These best practices would ensure that the government has established a robust system of internal control in line with the Committee of Sponsoring Organization (COSO) framework. Our next article in this series will continue to present the risks, red flags, and best practices against fraud in government contracts.
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RECOMMENDED RESOURCES
Online tools that can help a government win war against fraud in contracts:
