Procurement Fraud Schemes Flashcards

Bid Rotation

• Also known as bid pooling
• Occurs when two or more contractors conspire to alternate business among themselves on a rotating basis.
• They exchange information on contract solicitations to guarantee each contractor wins a share of the purchasing entity’s business.
• Example: Vendors Ace, Binko, and Cooper bid on three contracts.
  • Ace bids lowest on the first, Binko on the second, and Cooper on the third.
  • None get all three jobs, but all are guaranteed at least one.
  • They conspire to increase prices due to pre-planned bids.
• Bid rotation schemes might involve subcontracts awarded to losing bidders by the winning bidder.
  • This improves the cash flow of losing bidders as they wait their turn to win.
  • Losing bidders might receive a percentage of the winning company’s profits.

Bid Suppression

• Occurs when two or more contractors enter an illegal agreement.
  • At least one conspirator refrains from bidding or withdraws a submitted bid.
  • The goal is to ensure a particular competitor’s bid is accepted.
• Schemes can take other forms.
  • Limited bidders in collusion require dealing with new or uncooperative bidders.
• Conspirators might pay off outside companies to refrain from bidding or withdraw bids already submitted.
• Forceful means might be used to discourage non-cooperating entities from participating.
• Conspirators might fabricate bid protests or coerce suppliers/subcontractors to avoid dealing with non-cooperating companies to protect their monopoly.

Market Division

• Market division (or market allocation) schemes involve agreements among competitors.
  • They divide and allocate markets and refrain from competing in each other’s designated market portion.
• Markets divided by:
  • Geographic area (competitors take turns on contracts according to area)
  • Customer (specific customers or types allocated among competitors)
• Competing firms will not bid against each other.
  • Submit only complementary bids when a solicitation is made by a customer or in an area not assigned to them.
  • The customer loses the benefit of true competition and pays a higher price.
• Contractors conceal schemes by submitting bids from shell companies.
  • Shell companies have no physical presence and generate little economic value.
  • This gives the appearance of competition.
• Real contractors can increase prices due to fraudulent bids that are sure to be higher.
  • Bids from fictitious suppliers serve to validate the exaggerated quote from the winning contractor.

Red Flags of Schemes Involving Collusion Among Contractors

• Limited competition in the industry.
• The same contractors bid on each project or product.
• The winning bid appears too high.
• All contractors submit consistently high bids.
• Qualified contractors do not submit bids.
• The winning bidder subcontracts work to one or more losing bidders or non-bidders.
• Bids appear to be complementary bids by companies unqualified to perform the work.
• Some bids fail to conform to essential requirements of the solicitation documents.
• Some losing bids were poorly prepared.
• Fewer competitors than usual submit bids.
• Bid prices decline when a new contractor enters the competition.
• A rotational pattern exists among winning bidders (geographical, customer, job, type of work).
• Evidence of collusion in the bids (same mathematical or spelling errors; bids prepared using same typeface, handwriting, stationery, or envelope; identical bids).
• A pattern indicates that the last party to bid wins the contract.
• Patterns of conduct by bidders/employees suggest collusion (competitors socialize, meet, visit offices, subcontract with each other).

Collusion Between Contractors and Employees

• Procurement fraud schemes often involve collusion between contractors and the procuring entity’s employees.
• The schemes depend on the corrupt employee’s level of influence.
  • More power means more influence over contract awards.
• Procurement employees involved often have significant influence on the competitive bidding process.
• Potential targets include buyers, contracting officials, engineers, technical representatives, quality assurance representatives, subcontractor liaison employees, and anyone with authority over awarding contracts.
• Bribes are included in the corrupt vendor’s bid, so the purchasing company bears the cost.
• Procurement fraud schemes involving contractors and employees include:
  • Need recognition
  • Bid tailoring
  • Bid manipulation
  • Leaking bid data
  • Bid splitting
  • Unjustified sole-source awards or other noncompetitive methods of procurement

Need Recognition

• Procurement actions begin with the procuring entity determining its general needs.
  • Includes assessments of goods/services required to meet the entity’s needs.
• Need recognition schemes:
  • Procurement employees convince their employer it needs excessive/unnecessary products/services.
  • Occur in the pre-solicitation phase.
• Employees receive a bribe/kickback for convincing their employer to recognize a need.
• Red flags:
  • Unusually high requirements for stock and inventory levels - justify unnecessary purchases from a certain supplier.
  • Materials not ordered at optimal reorder point.
  • Unnecessary inventory purchases justified by writing off surplus items as scrap.
  • Need defined in a way that can only be met by a certain supplier/contractor.
  • Failure to develop a list of backup suppliers.
  • An unusually strong attachment to a primary supplier—explainable by the acceptance of bribes from that supplier.
• Other red flags:
  • Inadequate or inaccurate assessment of needs.
  • No list of backup suppliers for items/services continually purchased from a single source.
  • Estimates not prepared or prepared after solicitations are requested.
  • Items/services obtained from a single source.
  • A suspect employee displays sudden wealth, pays down debts, or lives beyond their means.
  • A suspect employee has an outside business.
  • Multiple purchases made that fall below the threshold limit.
  • Purchases made without receiving reports.

Bid Tailoring

• Also known as specifications schemes.
• Occur during the pre-solicitation phase.
• An employee with procurement responsibilities, often colluding with a contractor, drafts bid specifications to give an unfair advantage to a certain contractor.
• Bid specifications:
  • A list of elements, measurements, materials, characteristics, required functions, and other specific information detailing the goods and services that a procuring entity needs from a contractor.
  • Assist prospective contractors in bidding.
  • Provide a firm basis for making bids and selecting bids.
• Primary methods to commit bid tailoring schemes:
  • Drafting narrow specifications. Tailoring the bid specifications to accommodate a vendor’s capabilities and eliminate other competitors.
  • Drafting broad specifications. Designing unduly broad qualification standards to qualify an otherwise unqualified contractor.
  • Drafting vague specifications. Writing vague specifications or intentionally omitting bid specifications to enable subsequent contract amendments, allowing the contractor to increase the contract’s price.
• Common red flags:
  • Weak controls over the bidding process.
  • Only one or a few bidders respond to bid requests.
  • Contract is not rebid even though fewer than the minimum number of bids are received.
  • Similarity between specifications and the winning contractor’s product or services.
  • Bid specifications and statements of work are tailored to fit the products or capabilities of a single contractor.
  • Unusual or unreasonably narrow or broad specifications for the type of goods or services being procured.
  • Requests for bid submissions do not provide clear bid submission information.
  • Unexplained changes in contract specifications from previous proposals or similar items.
  • High number of competitive awards to one supplier.
  • Socialization or personal contacts among contracting personnel and bidders.
  • Specifications developed by or in consultation with a contractor who is permitted to compete in the procurement.
  • High number of change orders for one supplier.

Bid Manipulation

• A procuring employee manipulates the bidding process to benefit a favored contractor/supplier.
• Occurs during solicitation and evaluation phases.
• Involves influencing the selection of a contractor by restricting the pool of competitors.
• A corrupt vendor persuades a purchasing company employee to ensure one or more of the vendor’s competitors cannot bid on the contract.
• Ways to commit these schemes:
  • Using obscure publications to publish bid solicitations.
  • Publishing bid solicitations during holiday periods.
  • Accepting late bids or falsifying the bid log.
  • Altering bids.
  • Extending bid opening dates without justification.
  • Opening bids prematurely.
  • Releasing confidential information.
  • Discarding or losing a bid or proposal.
  • Disqualifying bids for improper reasons.
  • Adding new vendors to the qualified bidder list for no apparent reason.
  • Limiting the time for submitting bids so only favored bidders have adequate time.
• A corrupt sales representative bribes a contracting official to rig the solicitation process.
  • Ensuring only companies the sales representative represents can submit a bid.
• It is not uncommon for buyers to “require” that bidders be represented by certain sales/manufacturing representatives.
  • These representatives might pay a kickback to the buyer to protect their client’s interest.
  • The result: the purchasing company is deprived of getting the best price.
• Red Flags:
  • Weak controls over the bidding procedures.
  • Evidence of changes to bids after they were received.
  • Winning bid voided for errors and the job is rebid or awarded to another contractor.
  • Otherwise qualified bidder disqualified for arbitrary, false, frivolous, or personal reasons.
  • Procurement employee accepts late bids.
  • Contract awarded to a non-responsive bidder.
  • Competing bids are lost.
  • Bid deadlines are changed.
  • Despite receiving fewer than the minimum number of bids, the contract is not rebid.
  • Invitations for bids are sent to unqualified contractors or contractors that previously declined to bid.

Leaking Bid Data

• Competitive bids are confidential and supposed to remain sealed until a specified date.
• Employees can leak pre-bid information or confidential information to a favored bidder for an unfair advantage.
• The employee gives the favored vendor a head start by planning their bid and preparing for the job.
• Corrupt vendor pays a procurement employee for the right to see the specifications earlier than the competition.
• Those with access to sealed bids are often targeted by unethical vendors.
• Leaking schemes might also involve restricting the time for submitting bids.
  • This limits the period bidders have for developing proposals.
• Example: Gifts and cash payments given to a majority owner of a company for preferential treatment during bidding.
• Red Flags:
  • Weak controls over its contracting system.
  • The winning bid is just under the next lowest bid or unusually close to the procuring entity’s estimates.
  • Last party to bid wins the contract.
  • Contract is unnecessarily rebid.
  • A contractor submits false documentation to get a late bid accepted.
  • Contracting personnel provides information on a preferential basis.

Bid Splitting

• Procuring entities must use competitive methods for projects over a certain amount.
• A dishonest employee might divide a large project into several small projects below the mandatory bidding level.
  • They then award some or all of the component jobs to a conspiring contractor.
• Red Flags:
  • Two or more similar procurements from the same supplier in amounts just under the upper-level review or competitive-bidding limits.
  • Two or more consecutive, related procurements from the same contractor that fall just below the competitive-bidding or upper-level review limits.
  • Unjustified split purchases that fall under the competitive-bidding or upper-level review limits.
  • Sequential purchases just under the upper-level review or competitive-bidding limits with change orders.

Unjustified Sole-Source Awards or Other Noncompetitive Methods of Procurement

• Noncompetitive methods, such as sole-source contracting, exclude competition.
  • Used improperly to eliminate competition and direct contracts to a particular vendor.
• Sole-source contracting is a noncompetitive process through the solicitation of only one source.
• More vulnerable to fraud because it provides freedom for manipulation and collusion.
• Organizations require justification to use sole-source procurement.
• Justification occurs when:
  • Goods/services are available only from a single source.
  • Exigent circumstances do not permit delay resulting from a competitive solicitation.
  • Solicitation is deemed inadequate after soliciting multiple sources.
• Supplier charges a much higher price than could have been obtained through bidding.
• Example: A requisitioner distorted contract requirements, claiming the specifications required a sole-source provider.
• Red Flags:
  • Frequent use of sole-source procurement contracts.
  • High number of sole-source awards to one supplier.
  • Requests for sole-source procurements when there is an available pool of contractors.
  • Procuring entity did not keep accurate minutes of pre-bid meetings.
  • False statements made to justify noncompetitive method of procurement.
  • Justifications signed/approved by employees w/o authority.
  • Employee fails to obtain the required review.
  • Justifications developed in consultation with a contractor permitted to compete.

Defective Pricing Schemes in Negotiated Contracts

• Defective pricing arises contractors intentionally use inaccurate cost data to inflate costs in negotiated contracts. Occurs primarily in negotiated contracts.
• Negotiated contracting used when conditions are inappropriate for competitive, sealed bidding.
• Contractors submit cost or pricing data (vendor quotes, make/buy decisions, production changes, discounts).
• Defective pricing data inflated contract price when more current, complete, or accurate data existed but were not disclosed.
• Not every instance of defective pricing is the result of fraudulent behavior.
  • May be non-fraudulent reasons, such as negligence, accident, incompetence, or mistake.
• Methods of defective pricing involve inflated labor or material costs:
  • Inflated labor costs:
    • Using outdated cost schedules
    • Using lower-wage personnel at higher rates
    • Using salaried personnel to perform uncompensated overtime
    • Failing to account for learning-curve cost reductions
    • Subcontracting to affiliated companies at inflated rates
  • Inflated material costs:
    • Failing to disclose discounts and credits
    • Using outdated standard costs
    • Using small-quantity costs to price large-quantity purchases
    • Subcontracting/purchasing from affiliated companies at inflated prices
    • Failing to disclose residual inventory
    • Using phantom suppliers
    • Failing to disclose changes in make-or-buy decisions
    • Estimating costs based on invalid allocation methods
    • Using unsupported cost escalation factors
• Red Flags:
  • Inadequate, inaccurate, or incomplete documentation to support proposals.
  • Contractor is late, delays, or cannot provide supporting cost or pricing data.
  • Contractor’s cost estimates are inconsistent with its prices.
  • Out-of-date pricing information in cost proposals.
  • Fails to update cost data when past history decreased costs or prices.
  • Fails to disclose internal documents.
  • Fails to disclose information regarding cost issues that reduce proposal costs.
  • Uses vendors/subcontractors different from names in the proposal or contract.
  • Uses different materials than listed in proposal.
  • Delays releasing information that could result in price reductions.
  • Falsifications or alterations of documentation.
  • Unrealistically high profit margins.
  • Fails to correct known system deficiencies.
  • Unqualified personnel developed cost/pricing data.

Performance Schemes

• Procurement fraud schemes that occur during the award and performance stage:
  • Nonconforming goods/services schemes
  • Change order abuse
  • Cost mischarging schemes

Nonconforming Goods or Services

• Also known as product substitution or failure to meet contract specifications.
• Contractors attempt to deliver goods/services that do not conform to contract specs.
• Bill and receive payment for conforming goods/services without informing the purchaser of the deficiency.
• Deliberate departures from contract requirements to increase profits or comply with contract time schedules.
• Unintentional failure is breach of contract, not fraud.
• Contractors who deliver goods/services that don't meet specs might be guilty of fraud if they falsely represent compliance or deliberately conceal their failure.
• Substitution is appealing in contracts that ask for high-grade materials replaced by less expensive products.
  • Substitutions often involve undetectable component parts.
• Potential for product substitution is greatest where the procuring entity relies on contractor integrity.
• Committed by contractor alone, or facilitated by procurement/inspection personnel as a result of corruption.
• Dishonest supplier gives gifts/favors to inspectors or pays kickbacks to contracting officials to facilitate the scheme.
• A contractor who repeatedly fails to meet contract specifications without corrective action by inspectors indicates corrution.
• Examples:
  • Delivering/using lower quality products than specified.
  • Substituting products for those specified.
  • Employing less qualified staff.
  • Delivering counterfeit, defective, reworked, or used parts.
  • Delivering materials that have not been tested.
  • Falsifying test results.
  • Making false certifications (i.e., statements that parts/materials are new, domestically manufactured, and meet contract specifications).
• Red Flags:
  • High percentage of returns for noncompliance.
  • Missing, altered, or modified product compliance certificate.
  • Certificates signed by employees with no quality assurance responsibilities.
  • Materials testing done by supplier.
  • Falsified test/inspection results (altered documents, illegible test documents, signatures on documents illegible, unqualified personnel, or test reports are similar or identical to sample descriptions).
  • Highest profit product lines have the highest number of material return authorizations or reshipments.
  • Discrepancy between product’s description and actual appearance (a new product appears to be used).
  • Used surplus or reworked parts delivered.
  • Delivery of products that appear counterfeit (packaging, appearance, and description do not appear genuine; items that are consistently defaced; items that appear different from each other).
  • 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 inspections.
• Detecting Nonconforming Good/Services:
  • Examine contract or purchase order (PO) specifications.
  • Examine contractor’s statements, claims, invoices, and supporting documents.
  • Received product
  • Test and inspection results.
• More Extensive Methods:
  • Review correspondence files for indications of noncompliance.
  • Request assistance from outside personnel to conduct after-the-fact tests.
  • Inspect or test questioned goods/materials by examining packaging, appearance, and description to determine if they are appropriate.
  • Segregate and identify the source of suspect goods/materials.
  • Review inspection reports to determine whether the work performed and materials used were inspected and acceptable.
  • Review contractor’s books, payroll, and expense records to see if they incurred costs to comply.
  • Conduct routine, unannounced inspections/tests.
  • Examine contractor’s books and manufacturing/purchase records for discrepancies.
  • Interview procurement personnel about any red flags.
  • Search external records to determine if there is any history of misconduct.

Change Order Abuse

• A written agreement between the procuring entity and the contractor to make changes in a signed contract.
• A performance scheme that involves collusion between the contractor and procuring entity personnel.
• A corrupt contractor submits a low bid to ensure winning, then increases prices with change orders.
• Causes the procuring entity to lose any advantage received through the competitive bidding process.
• A dishonest contractor can use change orders to improperly extend or expand contracts and avoid rebidding.
• Receives less scrutiny than the process used to acquire the underlying contract.
  • A popular way to fraudulently access funds or generate funds for kickbacks
• Fraud examiners should view all change orders carefully.
• When a change order occurs, concern about whether the change was accidental or planned.
• Red Flags:
  • Poor contractor internal controls.
  • Procurement employee acts outside normal scope of duties.
  • Numerous change orders justified on a variety of grounds.
  • Pattern of change orders that increases the price, scope, or period of an agreement, issued after the procuring entity awards the contract.
  • Questionable, undocumented, or frequent change orders awarded to a particular contractor.
  • After contract is awarded vague bid specs clarified by issuing a change order.
  • Poorly drafted requests for change orders.
  • Pattern of change orders just below threshold limit.
  • Employee directly involved in determining requirements and procuring the item.
  • Period of agreement extended by change orders instead of rebidding.
• Detecting Change Order Abuse:
  • Examining change orders that add new items to the contract.
  • Examining change orders that increase the scope, quantity, or price of the existing contract.
  • Analyzing change orders for red flags.
  • Interviewing complaining contractors/unsuccessful bidders about the presence of any red flags.
  • Searching and reviewing external records to determine any history of misconduct.

Cost Mischarging Schemes

• Occur during the performance stage of the procurement process.
• Contractor charges for costs not permissible, reasonable, or allocable to the contract directly or indirectly.
• Contractors contend a mischarge was a mistake.
  • Examiners should investigate the issue of intent.
• Here are some common methods contractors use to mischarge costs:
  • Charging the same cost to more than one contract
  • Charging nonexistent costs or costs at inflated amounts
  • Charging unallowable costs to the contract (entertainment or advertising)
  • Charging costs to the wrong category or contract
  • Failing to disclose discounts and credits
  • Using outdated standard costs
  • Colluding with contractors directly to charge high prices and rebating part of the price increase without disclosure
  • Using phantom suppliers to inflate costs
  • Falsifying supporting documentation
• Red Flags:
  • Contractor refuses, delays, or is unable to provide complete supporting data.
  • Lacks or is of poor quality.
  • Provides different supporting documents for the same item, with wide varying unit prices.
  • Evidence of falsifications or alterations.
  • Fails to use current, accurate, and complete data.
  • Fails to disclose internal documents.
  • Old, outdated standards used to support proposals.
  • Uses unqualified personnel to develop cost/pricing data.
  • Uses vendors/subcontractors other than those listed in the proposal.
  • Repeatedly fails to disclose bidding/estimating practices.
• Three Main Types of Cost Mischarging Schemes:
  • Accounting mischarges
  • Material mischarges
  • Labor mischarges

Accounting Mischarges

• Contractor knowingly charges unallowable costs to the buyer by concealing or misrepresenting them as allowable costs.
• A variation of this type of scheme involves evading the limits for certain cost categories by charging those expenses to other cost categories that do not have such limits.
• For example, a contractor might charge bid/proposal costs or independent research and development costs to salaries, wages, repairs, maintenance, and other categories.

Material Mischarges

• Material costs are mischarged as to their reasonableness and their allocability. Material means physical inventory and component deliverables.
• Mischarges of finished materials are infrequent because the nature of the limits.
• Mischarging specialized material infrequent due to limited use.
• Common methods used to mischarge material costs include:
  • Charging material costs incurred on a fixed-price contract to a cost-type contract
  • Applying inappropriate indirect rates to material costs
  • Charging at standard rather than actual rates
  • Making unrecorded transfers of materials to another contract
  • Purchasing excessive materials on one contract and using them on another contract
  • Purchasing materials from a subsidiary/affiliated company at inflated prices
  • Manipulating inventory pricing methods to inflate material values
  • Charging materials from inventory at current high prices
  • Obtaining vendor quotes from high-priced suppliers
• Red Flags:
  • Previously delivered items are transferred from ongoing jobs to open work orders.
  • Items scheduled for delivery in the distant future are transferred from ongoing jobs to open work orders.
  • Transfers at costs that are substantially different from actual costs.
  • Mass transfers from one job order to various others.
  • The used in production are different from those used in the proposal/contract.
  • Includes unnecessary/obsolete items in proposals.
  • Charges costs to the original job order when there is no physical inventory left.
  • Increases transfers to inventory write offs/scrap accounts.
  • Transfers to a holding account, doesn't report excess/residual inventory, vague bidding terms, internal controls are weak
• Detection Activities Include Examining:
  • Examining contract/cost files, material cost transfers from government contracts to commercial or suspense accounts
  • Verifying costs, materials, and standards
  • Scanning general ledger, accounts receivable

Labor Mischarges

• Labor costs significantly impact future contract estimations. Direct labor charges are specific contract costs. Indirect labor charges are allocated through a factor or rate.

• Mischarging occurs when the contractor charges the procuring entity for work not performed.

• Labor costs are susceptible to mischarging without external documentation or balance checks.

• Ensuring labor cost accuracy requires observing each employee’s work and verifying that the cost is charged to the proper contract through accounting records.

• An incorrect labor charge may indicate fraud or stem from poor business practices or weak internal controls.

• Labor costs can be inflated by various means, including:

  • Inflated salaries
  • Outdated schedules
  • Transfer from fixed prince contacts
  • Fictitious time cards

• Red Flags:

  • Billings inconsistent with estimates
  • Excessive labor charges
  • Sudden shifts charge levels
  • minimal qualifications
  • Procurement personnel do not review
  • High employee turnover
  • Personnel rarely take vacations

• Detection Methods:

  • Examining labor cost and audit reports
  • Visits
  • Time cards

Phases in the Procurement Process

• Reference the link within the document at the beginning of section categories of procurement fraud schemes.

Phases in the Procurement Process

• Reference the link within the document at the beginning of section categories of procurement fraud schemes.