contract performance fraud

Contract Performance Fraud

February 2016

Ron Steinkamp, CPA, CIA, CFE, CRMA, [email protected]

mailto:[email protected]

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Elements of a Contract

Methods of Procurement

Procurement Phases

Contract Performance Fraud Schemes

Red Flags

Preventing Contract Performance Fraud

Detecting Contract Performance Fraud

© 2016 All Rights Reserved Brown Smith Wallace LLP

Table of Contents

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A contract is a mutual oral or written agreement between two or more parties that must contain the following elements:

– Competent parties– Lawful subject matter or objective– Mutual consent– Legal consideration– Form permitted by law



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• Competitive bidding using sealed bids.• Contracting by negotiation:

– Competitive negotiation.– Sole-source contracting.

• Simplified acquisition procedures:– Charge accounts.– Purchase cards.– Purchase orders.– Petty cash funds.




Procurement Phases

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• Identify needs.• Develop bid specifications.• Determine method of procurement.• Develop criteria to award the contract.


Pre-solicitation Phase

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• Prepare solicitation document (RFI, RFQ, RFP, etc.).• Provide notice of solicitation.• Issue solicitation document.• Receive bids and proposals.


Solicitation Phase

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• Evaluates bids/proposals.• May conduct discussions/negotiations.• May provide opportunity to revise bids/proposals.• Select winning bid/proposal.• Execute contract and terms.


Bid Evaluation & Award Phase

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• Performance of contractual obligations.• Contract modifications/change orders.• Review of completed portions and release of funds.• Assessment of deliverables for compliance with

contracts terms and quality.


Post Award & Administration Phase


Contract Performance Fraud Schemes

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• Non-conforming goods or services.• Change order abuse.• Cost mischarging.


Performance Fraud Schemes

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• Contractor knowingly delivers goods or services that do not conform to the underlying contract specifications and bills and receives payment without informing purchaser of the deficiency.

• Examples:– Delivering/using products/materials or lesser quality than specified in contract.– Substituting products/items different than what is specified in the contract.– Delivering/using using lower quality staff than specified in the contract.– Delivering/using counterfeit, defective, reworked, or used parts.– Delivering/using materials that have not been tested.– Falsifying the test results of materials, products, or goods.– Making false certifications for example:

• New materials• Domestically manufactured.• Meet contract specifications concerning quality or quantity• Company minority owned


Non-Conforming Goods or Services

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• Contractor submits a low bid to ensure they win the contract, but increases the price with subsequent change orders.

–OR-

• Contractor uses change order process to improperly extend or expand contracts and avoid rebidding.

• Usually involves collusion with employee.

• Change orders receive less scrutiny than the original bid selection process, making them a popular way to fraudulently access funds or generate funds for kickbacks.


Change Order Abuse

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• Contractor charges the procuring entity for costs (material and labor) that are not allowable, not reasonable, or cannot be allocated to the contract.

• Three types:

– Accounting Mischarge: Contractor knowingly charges unallowable costs to the buyer, concealing or misrepresenting them as allowable costs, or hiding them in accounts that are not closely monitored/audited.

– Material Mischarge: Contractor charges higher price for materials than agreed or substitutes inferior materials.

– Labor Mischarge: Contractor charges for work that was not actually performed or overcharges for labor.


Cost Mischarging

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• Examples:– Charging the same cost to more than one contract.– Charging non-existent costs or costs at inflated amounts.– Charging unallowable costs (e.g. entertainment, advertising, etc.) to the contract.– Charging costs to the wrong cost category or contract.– Failing to disclose discounts and credits.– Using outdated standard costs.– Colluding with contractors directly to charge high process and rebating part of the price

increase without disclosure.– Using phantom suppliers to inflate costs.– Falsifying support documentation.


Cost Mischarging (Cont.)


Red Flags

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• High percentage of returns for noncompliance with specifications.• Product compliance certificate missing or appears altered or modified.• Compliance certificates signed by low-level employee with no quality assurance

responsibilities.• Materials testing done by supplier.• Evidence that tests or inspection results were falsified.• Highest profit product lines have highest number of returns or reshipments.• Discrepancy between product description and appearance.• Offers by contractors to select the sample and prepare it for testing.• Delivery of look-alike goods.• Unusually high number of early replacements.• Contractor restricts or avoids inspections of goods or services upon delivery.


Non-Conforming Goods or Services

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• Poor contractor internal controls over determining the need for change orders.• Procurement employee acts outside normal scope of duties.• Numerous change orders justified on a variety of grounds, for example:

– Change in prices.– Inflation.– Unavailability of specific materials/equipment.– Need to substitute more expensive alternatives.

• Employee of procuring entity approves numerous unexplained or unjustified change orders for same contractor.

• Repeated pattern of change orders that increases price, scope, or period of agreement.

• Questionable, undocumented, or frequent change orders awarded to a particular contractor.

• After contract award, bid specifications that lack detail are clarified through change order.


Change Order Abuse

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• Poorly drafted requests for change orders.• Pattern of change orders just below threshold limit.• Employee of procuring entity that is directly involved in both determining

requirements and procuring the item.• Period of agreement extended by change order instead of re-bidding.


Change Order Abuse (Cont.)

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• Contractor refuses, delays, or is unable to provide complete supporting data.• Contractor’s supporting data is missing or unavailable for review.• Contractor’s supporting documents are of poor quality.• Contractor provides different supporting documents for the same item and unit

prices vary widely.• Evidence of falsifications or alterations to supporting data.• Contractor fails to submit cost data that is current, accurate, and complete.• Contractor fails to disclose internal documents on vendor discounts.• Cost estimates are not consistent with contractor’s prices.• Repeated non-compliance with the contractor’s disclosed bidding or estimating

practices.• Old, outdated standards used to support proposals.• Contractor fails to disclose information regarding significant cost issues that will

reduce proposal costs.


Cost Mischarging Abuse

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• Contractor uses unqualified personnel to develop cost or pricing data used in the estimating process.

• Contractor uses vendors or subcontractors other than those listed in the proposal.• Contractor repeatedly fails to comply with their disclosed bidding/estimating

practices.


Cost Mischarging Abuse (Cont.)


Preventing Contract Performance Fraud

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A program designed to prevent and detect contract procurement fraud should include the following elements:

– Employee Education

– Internal Controls

– Monitoring Activities

– Vendor Due Diligence

© 2015 All Rights Reserved Brown Smith Wallace LLC

Elements of Fraud Prevention

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Organizations should:

– Educate employees about procurement fraud.

– Focus education efforts on employees in best position to identify vulnerabilities or red flags.


Employee Education

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Key internal controls include:– Documented policies and procedures.– Selection committees and criteria.– Segregation of duties.– Supervisory controls.– Receiving controls.– Authorization/approval controls.– Reconciliation controls.– Recording controls.


Internal Controls

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Implement programs to measure the performance of procurement activities:

– Continuous monitoring using data analytics.

– Regular internal audits.


Monitoring Activities

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A vendor due diligence program should include:

– Vendor background checks.

– Controls for vendor master file management.

– Vendor monitoring.


Vendor Due Diligence


Detecting Contract Performance Fraud

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• Examine the following documents for red flags:– Contract or purchase order specifications.– Contractor’s statements, claims, invoices and supporting documents.– Received products.– Test and inspection results.

• Review correspondence and contract files for indications of non-compliance.• Request assistance from outside technical experts to conduct after the fact tests.• Inspect or test questioned goods or materials.• Segregate and identify the source of suspect goods and materials.• Review inspection reports to determine whether the work performed and

materials used were inspected and considered acceptable.• Review the contractor’s books, payroll, and expense records to see if they incurred

necessary costs to comply with contract specifications.• Review the inspection and testing reports of questioned goods/materials.


Non-Conforming Goods Or Services

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• Conduct routine and unannounced inspections and tests of goods/materials.• Examine the contractor’s books and manufacturing or purchase records for

discrepancies between claimed and actual costs, contractors, etc.• Interview procurement personnel about the presence of any red flags or other

indications of noncompliance.• Search and review external records (e.g. court records, prior complaints, audit

reports, investigative reports, media sources, etc.) to determine if history of misconduct.


Non-Conforming Goods Or Services (Cont.)

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• Examine change orders that add new items.• Examine change orders that increase scope, quantity, or price of contract.• Analyze change orders for red flags.• Interview complaining contractors, unsuccessful bidders, and procurement

personnel about the presence of red flags.• Search and review external records (e.g. court records, prior complaints, audit



Change Order Abuse

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• Examine contract , material and labor cost files for red flags.• Review for unallowable costs.• Examine material cost transfers.• Examine contract charges to determine if materials properly charged to the job.• Examine materials ordered and charged in excess of contract requirements.• Compare material and labor costs over a specific period to identify any unusual

changes and determine reason for the change.• Review standard vs. actual material and labor costs to determine any variances.• Investigate contractor to determine ownership and search for signs of corruption.• Scan the general ledger for unusual adjusting entries.• Review audit reports, reimbursement requests, construction reports, etc.• Examine time cards and hours expended on the contract and compare to hours

billed.


Cost Mischarging

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• Conduct site visits to verify labor.• Compare direct and indirect labor account totals between years and investigate

significant changes.• Analyze labor charges to determine any shifts in charging patterns.• Prepare a schedule of salary/wage changes and compare to rates at contract

award date.• Look for terminated employees charged to contract.• Compare employee personnel records to contract position qualification

requirements.• Search and review external records (e.g. court records, prior complaints, audit



Cost Mischarging (Cont.)


Questions?

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Ron [email protected]

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