​​​​​​​Constructing Corruption

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Construction fraud

​Construction firm Structure Tone has pleaded guilty to corruption charges of defrauding clients and will forfeit US $55 million, according to The New York Times. Prosecutors in Manhattan say over a five-year period the company falsified records to enable subcontractors to falsely inflate their bills on projects to build office space for clients, including advertising agencies, banks, and law firms. The plea deal is part of a larger investigation by the Manhattan district attorney's office into corruption in New York City's construction industry, which has resulted in guilty pleas or convictions against six other building firms. ​

Lessons Learned

Construction fraud is pervasive — even a cursory look at recent reports and studies is evidence of this phenomenon (see "Additional Information" at the end of this article). Moreover, the real estate and construction industries ranked second and seventh, respectively, in terms of median losses from fraud, according to the Association of Certified Fraud Examiners' 2014 Report to the Nations on Occupational Fraud and Abuse. Billing fraud is the No. 1 fraud scheme, the report notes.

Intriguingly, another study conducted by PricewaterhouseCoopers suggests that billing fraud in the U.S. construction industry ranks proportionately higher compared to other countries and regions worldwide. So how is it that the same company in the Manhattan case has pleaded guilty to essentially the same kind of fraud that it previously had admitted guilt for committing in 1998? What can auditors learn and do about it?

Although it may be true that the self-governing/regulating practices of the construction industry itself have improved, it would seem as important, or more important, that the clients/companies buying products and services from that industry take strong measures to educate, identify, detect, and address fraud risks. The construction project may appear to be on time and on budget, and correct arithmetic on invoices and change orders may appear to follow policies and procedures. Nevertheless, poor or nonexistent internal controls are frequently cited as a major factor in construction fraud cases. As the Manhattan case focuses on billing fraud, it's important to pay special attention to these red flags:

  • Master services agreements negotiated with several contractors to help ensure competitive pricing and reliable resources.
  • Lack of segregation of duties (and other controls), such as having one dominant person control an entire process.
  • Poor job-costing systems.
  • Atypical application-for-payment forms.
  • Billing procedures with:
    • Nonexistent or disorganized backup.
    • Materiel, equipment, and services billed at higher rates than were agreed to in the master services agreement.
    • Invoices with different billing rates for the same piece of equipment, also used during the same time period and at the same location.
    • Billing rates newly negotiated with an effective date in the future from the date of work.
    • Invoices billed late to imply that the work dates coincided with contract effective dates.
    • Invoices that were intentionally mislabeled with the wrong contract code, so that the invoice is linked to contracts with higher billing rates.
  • Use of contingency funds without adequate or timely explanation.
  • Changes in the schedule of values without adequate or timely explanation.
  • Subcontractor complaints regarding delayed payment.
  • Missing subcontractor lien waivers.
  • Unusual bid patterns.
  • Unsuccessful bidders hired as subcontractors.
  • Unauthorized changes to time records or missing time records.
  • Missing weight tickets.
  • Related parties and common ownership.
  • Internal audit:
    • Performs a limited construction audit of the projects annually.
    • Produces audit reports that never reveal any significant findings.

In the above context, fraud risk mitigation strategies should include these types of measures:

  • Plan and perform full construction audits regularly, including testing 100 percent of the billed transactions from a particular vendor.
  • Include contract compliance measures specifying the completeness and comprehensiveness of costing, particularly handling of cost overruns and unpredicted or unspecified additional costs.
  • Implement a construction project information management solution suitable for the organization, including project-wide controls:
    • Every individual on the project team, regardless of organization, has appropriate access to the same project information and adheres to the same project workflows, as defined by the project owner or manager.
    • Every project document, drawing, and model is registered, and every transmittal, submittal, or other communication between project team members is recorded.
    • All project discussions, decisions, reviews, and approvals are captured in a cumulative audit trail.
    • Bids and tenders, contracts, schedules, requests for information, change orders, invoices, and materials are subject to the same structure and visibility.
  • Pressure industry regulators to adopt more severe penalties for fraudulent activity. In the Manhattan case, Structure Tone was forced to pay US $55 million in penalties — which is 1.8 percent of the US $3 billion in revenue the company generates annually. At this point, no one from Structure Tone appears to be headed to jail.

Additional Information

The Association of Certified Fraud Examiners, Report to the Nations on Occupational Fraud and Abuse: 2014 Global Fraud Study

PricewaterhouseCoopers, Corruption Prevention in the Engineering & Construction Industry, 2013

Grant Thornton International, Time for a New Direction: Fighting Fraud in Construction, 2013

EY, Managing Bribery and Corruption Risks in the Engineering and Construction Industries, 2012



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