The real estate and construction industries are rife with potential pitfalls, from misrepresentations in property transactions to deceptive billing practices in complex projects. In their Occupational Fraud 2024: A Report to the Nations, the Association of Certified Fraud Examiners (ACFE) found that the typical amount lost due to fraud in these industries was $200,000 and $250,000, respectively. It also estimates that organizations worldwide lose 5% of their revenue annually to fraud.
Incidents at Bondfield Construction, as well as in Quebec's construction industry exposed by the Charbonneau Commission prove that companies in the sector are more susceptible to fraud than we think. And those cases are just the ones that are reported. There are often fraud-related incidents that are never made public.
Companies with good systems to reduce fraud exposure have generally been victims of fraud in the past. However, most organizations react to fraud rather than take proactive measures to prevent it from occurring. Studies indicate that proactively handling potential fraud exposure is far less stressful, easier on the wallet, and keeps businesses focused on what they do best, which is running their business.
To effectively manage fraud risk, companies must take measures to reduce exposure to fraud and implement systems that assist in detecting red flags indicative of fraud.
Recognizing fraud
Understanding who the perpetrators of fraud are, how they commit fraud, and why fraud may be committed will provide great insight to any organization that has the desire to proactively control fraud risk. A typical fraud case lasts 12 months before detection.
Given the complexity of the procurement process in real estate and construction projects, fraudulent activities are commonly identified during procurement. The potential culprits can be both external and internal stakeholders, including suppliers, contractors, joint venture partners, third-party agents, property managers, and employees (in purchasing, accounting, or sales).
Sometimes, fraud is committed when there's a lack of segregation of duties. One person may be responsible for many different functions in an organization with little oversight. Business practices with lack of oversight and inadequate checks and balances can create an environment where sub-contractors and vendors inflate the value, they're providing without it being noticed.
A fraud-susceptible environment in the real estate and construction industry is generally fostered by weak/lack of internal controls, use of non-arm's length/related parties, use of joint venture parties (especially in unfamiliar jurisdictions), poorly designed project scope, poorly worded contracts, employee/supplier collusion, use of undocumented workers, and use of cash, among others.
Most common types of real estate and construction industry frauds
The most common fraud schemes noted in the real estate and construction industry include bribery and corruption, bid rigging, billing schemes, cheque tampering, expense account abuse, stealing non-cash assets, phantom suppliers, and payroll schemes. Let’s delve deeper into each one.
Some of the biggest threats in real estate and construction fraud come from corruption. It often involves employees abusing their position of trust (fiduciary duty) to gain an unfair advantage. This can take many forms, from accepting bribes and kickbacks to engaging in conflicts of interest. These schemes can also be challenging to detect because transactions may be hidden entirely,disguised under broad expense categories and involve collusion with other parties. Traditional accounting safeguards are often insufficient to identify these activities.
This deceitful practice can take various forms, including billing for work that was never actually performed, submitting phony invoices from fictitious companies, charging for items or services that were never required, falsely billing equipment or tools meant for work sites and then using them for personal gain, and even hiring subcontractors to carry out personal tasks and billing the expenses to the company. These tactics exploit loopholes in financial oversight systems, ultimately leading to substantial financial losses and eroding trust within the industry.
Cheque tampering poses a significant threat to financial security, with perpetrators employing deceitful tactics to manipulate funds. One common method involves forging cheques by printing duplicates or altering payee and amount details after signing the cheque. Additionally, forged signatures and endorsements are frequently used to deceive unsuspecting victims. These fraudulent practices undermine the integrity of financial transactions, highlighting the importance of robust safeguards against such deceptive manoeuvers.
Prevention and detection
The best fraud prevention strategies begin with knowing your weaknesses, the areas of operations susceptible to fraud and implementing appropriate internal controls. A thorough risk assessment of a company's operations is the first step. This can include both a general fraud risk assessment and cybersecurity specific assessment. This risk assessment should include identification of risks, review of existing controls, policies, and procedures.
Also, a good prevention program will certainly reduce exposure to fraud. While no prevention program can eliminate fraud, it can lower the chances of it from occurring and increase the chance of being caught early (i.e., reduce the impact). Some specific detection procedures relevant to the real estate and construction industry include:
- Detailed comparison of budgeted costs to actual costs, including all budget revisions.
- Scope change order analysis—comparison between original scope and budget, and reasons for the change orders (i.e., change in specifications/drawings).
- Review the bid selection process to ensure compliance with policies.
- Review support provided as proof of reimbursable charges being claimed.
- Detailed analysis of any general/soft accounts, such as contingencies.
- Random checks of payments being made to suppliers to identify phantom suppliers, fictitious invoices and/or inflated billing rates.
Based on the company's size and transactions, these checks may be conducted on ad hoc basis or as part of a formal continuous monitoring program.
How BDO can help
The real estate and construction industries are both susceptible to fraud, but there are steps businesses can take to impede fraudsters and thwart cyber-attacks. We've helped a number of companies with fraud prevention and implement cybersecurity measures.