Preventing and Uncovering Employee Fraud at Construction Firms

Construction projects typically involve the purchase of costly materials, the lease or purchase of equipment, and payments to subcontractors, resulting in significant accounts payable.  It should come as no surprise that certain company employees might be in a position to accomplish substantial misappropriation of funds.

The risk of insider theft is almost always underestimated, as employers are inclined to trust their employees.  Many construction executives and managers who tend to pay closer attention to reducing the risk of theft by strangers, may pay less attention to preventing theft by insiders.  In addition, the size of the risk – in terms of the amount that could be lost — may be grossly underestimated.

For example, in one case, the contract manager of a construction company had authority to approve vendors and checks paid to them.  The manager made a deal with two of the vendors.  The vendors submitted phony or inflated invoices for materials or labor, the manager approved payment, and the three split the proceeds.  Fortunately, the company was a Fortune 1000 enterprise and had an internal communication program that allowed employees to request information on any subject.  When a curious worker inquired as to why this particular construction project was costing so much, an audit revealed the manager had pocketed more than $565,000.  

Certain management practices have shown to make it less likely employees will turn to insider theft.   Most importantly, create an environment that promotes honesty, and increase the perception that theft will actually be discovered.  Experts believe that an environment of trust is important in fraud prevention.  If an employer expects its employees to steal, they are more likely to perform as expected, that is to steal.  To reduce the risk of insider theft the best attitude is one of trust, while conveying that those who betray the trust are likely to be exposed. 

Most employee fraudsters initially start stealing as the result of financial pressures, such as: family, medical or other large expenses; desire to live beyond their means; gambling or drug habits.  Since most employee fraudsters are first-time criminals, they stand to lose a lot from being caught stealing, subsequently arrested, and possibly sent to jail.  Consequently, they tend to care whether they are caught and are less likely to steal when there is high probability they will be discovered. 

Equally important is a strong anti-fraud policy.  The policy should include instructions on how to report suspected fraud and assurances that the company encourages such reporting and will protect from retaliation.  Employers might even consider a confidential, dedicated telephone number for reporting potential fraud.  Honest employees are much more likely to report fraud when the organization invites and encourages them to do so.  Emphasis on ethical practices in an ethical environment, rewards for company loyalty, and clear performance standards are some of the practices that decrease the likelihood that employees will steal. 

Accounting controls, built-in detection mechanisms, reconciliation of records, compartmentalization of access and duties, requiring multiple approvals for expenditures, and frequent audits that include steps to uncover fraud increase the actual and perceived probability of discovery.  A firm’s accountants or auditors may not necessarily be looking for fraud, unless specifically requested to do so.  To reduce the risk, it may be advisable to consult with professionals about fraud prevention and detection systems, including making periodic informal or even formal surveys of employees about whether they know of any fraud by their fellow employees.  Where such checks and balances exist, it is more difficult (though still not impossible) to defraud an organization.

Coverage for theft by insiders is not part of standard insurance policies and must be purchased as a special employee dishonesty policy to insure losses caused by fraud, embezzlement, or other internally committed thefts.  Such insurance is available and should be considered due to the high risk of insider theft in some types of companies.

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