By Graham Newton, Partner - Forensic
Coming to terms with current and future risks
Australia is currently experiencing resurgence in the resources sector and continued growth in major projects and infrastructure investment. While Australia's last resources boom was built on coal exports, this time around our economy is boosted significantly by the a number of coal seam gas (CSG) to liquefied natural gas (LNG) operations on both the east and west coasts.
A surging export coal seam gas market, coupled with the presence of a high-growth LNG industry, has created significant opportunities for various parties to deliver infrastructure support to ensure that ports, rail and all associated infrastructure are in place to provide the necessary support to keep pace with continued demand from economies such as China and India.
The challenge that lies ahead for resource and infrastructure companies is how best to manage the fraud risk associated with procurement and contract arrangements. Contract and procurement fraud can occur on commercial transactions between contracting parties. Currently, the large volume of contracts being managed is creating an environment open to manipulation and fraud.
The Report to the Nations 2010, published by the Association of Certified Fraud Examiners (ACFE), outlined that the median loss1 of US$1 million experienced by the mining industry was by far the largest of any of the industries examined. The oil and gas industry reported 57 cases with a median loss of US$478,000.
Among the cases reported, it was noted that 58.3% (mining) and 54.4% (oil and gas) of cases involved trusted employees colluding with dishonest contractors to misappropriate considerable sums of money from the companies.
Now more than ever, the risk is being carried by a number of resources and infrastructure companies responsible for managing significant contract and procurement arrangements. Add to this the pressure on those companies to deliver major projects on time and on budget and the risk is compounded due to the potential for things to 'slip through the cracks'.
Those people responsible for managing and/or authorising contracts need to be armed with tools to prevent, detect and respond to the heightened risk environment. The publicity surrounding these events often impacts on the entire company, its reputation and personnel in key roles. It can also have a disruptive influence for years after the incident is exposed.
Some of the procurement contracting phases that are currently exposed to fraud risks include the following:
Collusion between the buyer and contractor for procurement contracts sometimes occurs, where the buying organisation's employee receives a gratuity, bribe, or kickback for tailoring the contract specifications to accommodate the contractor's capabilities for a particular product or service. This can allow a single tender to be favoured and competitive tendering to be disregarded. In some instances, contractors may manipulate people into divulging confidential information in order to prepare a winning bid that has used technical specifications, budgets and other information that has been disclosed without authorisation.
Non-arm's-length transactions are another prevalent fraud risk in resources and infrastructure projects. More often than not, non-arm's-length transactions results in significant losses to the buyer in procurement arrangements over extended periods of time due to the non-commercial nature of the dishonest arrangement.
Solicitation and Negotiation Phase
"Unsuccessful" bidders who later become subcontractors may potentially be a red flag for a bid submission and/or bid rigging scheme. Bid submission and bid rigging schemes typically involve collusion between the buyer and contractor in the bidding process where the buyer has the authority to influence the awarding of a contract. Common examples are bid rotation, bid suppression and phantom bids. With the materiality of the contracts involved, great care must be taken by management to facilitate due diligence during a contract tender/purchase process.
Defective pricing schemes can occur during the negotiations process when contractors fail to disclose accurate cost or pricing data in their price proposals, resulting in a subsequent increase in the contract price. At other times, the buyer's employee and the contractor deliberately collude to amend the contract to increase the price immediately after the contract is awarded.
Contract Performance Phase
There are a few schemes commonly perpetrated during the contract performance phase, including labour and material mischarges, misuse of assets and product substitution.
However, there are instances where contractors try to increase profits by using product substitution schemes, thus failing to meet contract specifications in the areas of either quantity or quality of products. False certifications of property, plant and equipment are another common red flag.
Resources and infrastructure groups likely have asset bases comprising of substantial amounts of cash (or cash equivalents) and large property, plant and equipment values. The physical location and/or isolation of these assets, particularly from those with ultimate control or responsibility, produces a higher risk of misappropriation or misuse of these assets for personal gain by employees and contractors.
With significant investment in contracts currently being executed and managed, companies are, more than ever, exposed to the issue of labour and product mischarges. Some of the fraud-related issues that are being identified as risks within contracts and agreements under management are:
- Conflicts of interest
- Non-compliance with contract schedules or rates
- Duplicate payments to suppliers due to vendor records being duplicated
- Invoice and purchase order splitting (i.e. amounts raised to just below delegation levels to override authorisation requirements)
- Purchase orders and invoices approved by the same person
- False or incomplete documentation in support of invoices
- Contracts not in place or expired
- Inflated charges for labour and/or machinery hire
Understanding and managing the risk of fraud in the management of procurement contracts can sometimes be compared to searching for a needle in a haystack. Isolated payments, or even patterns of unusual or anomalous supplier payments, can go undetected for extended periods of time due to the need to examine detailed line item entries in each transaction to detect the underlying false transaction or payment. The consideration to commit staff to search for something that may not be there can quite often weigh heavily on the consideration to proactively pursue these challenges.
Using data analytics capabilities that can accurately identify unique and suspicious transaction and/or vendor details can be more efficient and effective than the traditional means of trawling through documents to find red flags.
Deloitte Forensic partner Graham Newton describes the Deloitte approach to assisting companies to address this growing concern. "Deloitte Forensic understands the greatest challenge is often where to start because of the volume of transactions and contracts open to manipulation. Applying analytics to interrogate large volumes of transaction data quickly can provide a focus that can then be supported by traditional forensic examination of documents to identify the suspicious transaction and supporting documentation."
Moreover, Deloitte professionals work proactively with our clients to develop and implement broader risk frameworks that find the right balance of managing fraud risks that maintain an effective business without unduly impeding productivity.
Fraud awareness training and communications delivered to people who are at the front line of managing contract and procurement arrangements is one of the most effective ways of reducing the risk of fraud occurring. Implementing a reporting procedure that provides a mechanism for staff to confidentially report concerns of fraud is also an effective tool for managing fraud risk. Independently managed whistleblower hotlines can provide an additional layer of assurance that reports of fraud will be taken seriously and encourage an environment of high ethical values.
As the resources and major infrastructure industries continue to underpin Australia's economic prosperity, businesses must remain vigilant that their part of this prosperity is not being diverted to those who would fraudulently manipulate procurement processes for their own private gain.
The question now is how to efficiently monitor the mountains of data, transactions and contracts that are continuing to grow?
The answer is in the power of data at your fingertips and how to unlock this to quickly and accurately provide the answers you require.
For further details on how Deloitte Forensic can assist you, contact our experts in your local city.
1. 12 cases were reported to ACFE during the period Jan 2008 to Dec 2009.
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