Procurement fraud risks and prevention measures

And according to a report from the Association of Certified Fraud Examiners (ACFE), organizations lose an estimated 5% of annual revenue to fraud every year. The report, Occupational Fraud 2024: A Report to the Nations, also finds that the average loss per case is US$1.7 million. A large proportion of cases is due to procurement fraud, which includes bribes and kickbacks, bid rigging, conflicts of interest, change order abuse, and overbilling.

While many cases go unreported, there are some notable ones that make headlines. For example, London Health Sciences Centre, an Ontario-based hospital network, alleged last year that it lost $50 million when a former executive colluded with others to falsify documents, inflate invoices, and charge for work that was never performed.

Increased risks for fraud

There are three main drivers of fraud: Opportunity, motivation, and justification. Unfortunately, two of the three are out of your control, but opportunity is the factor you can influence. According to many fraud experts, organizations should be aware of the 10-80-10 rule. It states that 10% of employees will steal at every opportunity, 80% might or might not if they’re given an opportunity to commit fraud, and 10% will never steal. Hence, fraud prevention efforts should focus on eliminating opportunities for fraud by focusing on strengthening the organizational internal control environment.

Economic downturns and uncertainty can also increase the risk of fraud. Organizations that reduce their workforce could increase the opportunities for fraud to be committed because internal controls may be eliminated as a result of those cuts, according to the ACFE. 

Organizations can be vulnerable due to weak internal controls or a lack of enforcement of otherwise good controls. The ACFE report also finds that a lack of internal controls (32%), the ability to override existing internal controls (19%), and a lack of management review (18%) were the top internal control weaknesses that contributed to fraud. 

Detecting and preventing fraud

Detecting procurement fraud requires vigilance and diligence. Identifying suspicious transactions usually involves spotting anomalies such as unexplained cost increases or disproportionate contracts being awarded to a particular vendor.   

An organization can also monitor the actual costs of contracts over the contract term to ensure the terms of an RFP are being followed or the payment escalations in a multi-year contract are being followed. Similarly, it’s important to monitor transactions and make sure that billings are appropriate under the terms of the agreement. Again, these controls may take time to identify trends or anomalies  unless monitoring is ongoing as transactions take place.

Often, these are lagging indicators that require the passage of time and accumulation of data to facilitate analysis. Leading indicators or processes are available, such as ongoing monitoring of compliance with procurement processes, including third-party due diligence on reputation, conflict of interest, and review of past project performance. Verifying compliance with competitive tendering requirements for high-value contracts or reviewing bid evaluations can be effective in ensuring the integrity of procurement processes. 

Detection may be difficult if the fraudster is clever and has actively plotted to hide their misconduct. However, there may be red flags if the person is flaunting their newfound wealth.

They may begin to drive an expensive car, wear designer labels, or go on expensive vacations. It’s important to notice if their lifestyle becomes inconsistent with their known level of income. 

Employees faced with a higher cost of living or financial pressures may be tempted to make poor decisions and commit fraud. Being alert to employees experiencing financial distress is an effective control. Providing appropriate supports, such as financial counselling or removing them from high-risk positions (e.g., those that give them access to cash, allow them to approve payments, or select bids) can effectively safeguard corporate resources. 

Fraud can be detected and prevented by not creating conditions that allow people to make bad decisions. Below are some strategies organizations can follow.