MLR

What is procurement fraud … and how do you prevent it?

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The most cost-effective way to deal with fraud is to prevent it. A dishonest employee will exploit any loophole in an organization. So, to prevent fraud, it is important to close those loopholes.

The median loss to U.S. companies is $140,000 from occupational fraud, and the fraud takes an average of 18 months to be discovered, according to the most recent report of the Association of Certified Fraud Examiners, the 2012 Report to the Nations on Occupational Fraud and Abuse.

man with fingers crossed

When collusion takes place, and two or more individuals work together to systematically defraud an organization, losses will be multiplied. Collusion is often at work in procurement fraud.

Most employee fraud took place in one of six departments: accounting, operations, sales, executive/upper management, customer service or purchasing.

Small businesses are at the most risk for fraud because they are typically lacking in anti-fraud controls compared to their larger counterparts. This makes small businesses particularly vulnerable to fraud. To prevent fraud at small businesses, owners should establish an efficient system of internal controls.

What is procurement fraud?

Procurement fraud is dishonestly obtaining an advantage, avoiding an obligation or stealing or redirecting funds during the acquisition, sale or management of goods or services.

Procurement fraud extends across many industries, and the types of fraud vary in levels of sophistication. The purchasing function represents one of the biggest opportunities for fraud in any organization – and the potential for expensive losses.

By being alert to the various forms and schemes procurement fraud can take and identifying the risks, you will be better able to protect your organization from falling victim.

What are the types of procurement fraud?

Embezzlement –Stealing money or property by a person who is in a position of trust, such as an employee or an agent. Embezzlers typically come into possession of money or property legally, but take it fraudulently. Embezzlement is a white-collar crime and involves no physical violence. Embezzlement charges may be filed for almost any amount, but the amount of money taken usually determines the charge. High-profile embezzlement cases can involve the misappropriation of millions of dollars.

Mischarging for Cost or Labor – Knowingly charging customers higher rates or costs than contracted or for more hours than were worked.

Product Substitutions – The substitution of inferior or substandard products that are delivered to customers instead of contracted goods or services.

Selling Defective Parts or Supplies – Selling customers defective goods or products that do not meet an acceptable standard or level.

Bid Rigging – A form of price fixing, in which a commercial contract is promised beforehand to one party although other bids are received for appearance’ sake. Bid rigging takes several forms, including bid suppression, courtesy bidding, bid rotation and subcontract bid rigging.

False Claims – Filing false claims for reimbursement, usually to the government.

Bribery – Offering, giving, receiving or soliciting something of value for the purpose of influencing the action of an official or other individual in the discharge of their duties. Bribery in the business world is most typically found in the area of bidding.

Money Laundering – Disguising the origin of illegally obtained money to make it appear to be legitimate.

How do you prevent procurement fraud?

Recommending employee education is the foundation of preventing and detecting occupational fraud, according to the ACFE’s 2012 Report to the Nation on Occupational Fraud.

Data collected in the report indicates that organizations that offer fraud training experience lower losses to fraud. Owners and managers should set an ethical tone for their employees, and staff members should be trained in what constitutes fraud, how it is harmful to everyone in the company and how to report questionable activity. This is commonly called the “tone at the top.”

Employee tips account for more than 43 percent of initial fraud detection. Hotlines are an extremely cost-effective means of detecting employee fraud, and companies with employee hotlines receive considerably more authentic tips than those without a hotline.

After employee tips, the most common ways the ACFE report found that businesses detect fraud are by management review (14.6 percent); internal audit (14.4 percent); by accident (7 percent); account reconciliation (4.8 percent); document examination (4.1 percent); external audit (3.3 percent); notification by police (3 percent); surveillance/monitoring (1.9 percent); confession (1.5 percent); IT controls (1.1 percent).

Organizations that perform surprise audits typically have less loss due to fraud, but surprise audits are one of the most underutilized fraud detection methods. Every business should develop a strong internal control framework. Some safeguards that can prevent procurement fraud include:

  • A centralized procurement department that routinely rotates purchasing managers across different vendor relationships.
  • A strong contracting process that includes well-written contracts and a strong code of ethics that vendors acknowledge and must abide by.
  • A thorough review and disclosure process to investigate all new vendors, including any possible association with existing vendors or employees of the organization.
  • An efficient process of accepting and acknowledging that goods and services are adequately delivered in accordance with the terms of their contracts.
  • Routine auditing of vendors to ensure that pricing is in accordance with agreements and other contractual terms are being met.
  • Regular auditing of accounts payable to look for duplicate disbursements and to verify that credits and discounts are being properly administered.
  • Development of a routine bidding process for contractual items to determine if pricing is at market rates. Bids should be reviewed by the procurement department, independent of those requesting the goods or services.