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Study: Construction Fraud ‘Endemic'

Tuesday, November 5, 2013

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From graft to embezzlement to organized crime, fraud of every flavor is draining the global construction industry of hundreds of billlions of dollars each year, a new report warns.

Fraud currently costs the industry about $860 billion worldwide annually—a tab that could double by 2025, advises "Time for a New Direction: Fighting Fraud in Construction."

And yet, the report adds, many companies now treat all manner of fraud as "the cost of doing business."

"More companies need to take their head out of the sand and recognize that fraud and corruption costs—not only in terms of profits, but also a company's reputation," said Clare Hartnell, global leader of Real Estate and Construction at Grant Thornton, the global tax, audit and advisory concern that produced the report.

leading audit, tax and advisory firm,

What it Costs

Construction fraud has become so "commonplace" that it may account for five to 10 percent of revenues, a percentage likely to rise as the industry continues to recover, says the report, which focused on research carried out in Australia, Canada, India, the U.S., and the UK.

The report calls the construction and real estate industries highly vulnerable to fraud and urges action to stanch the losses.

fraud report
© iStock / shotbydave

A report calls construction and real-estate fraud commonplace. Mindsets that view fraud as a cost of doing business are sure to worsen the problem, experts say.

"It's a real threat to growth. Fraud is often seen as the cost of doing business. This does not have to be the case," Hartnell said in a press release.

The Cost of Fraud

The Grant Thornton research draws on other studies.

For example, the Association of Certified Fraud Examiners reported that 3.4 percent of all reported fraud cases were attributable to the construction industry during a two-year period up to December 2011. The median average loss from fraud was reported as $300,000.

A separate report from the UK's Chartered Institute of Loss Adjusters estimated a 10 percent impact on the construction industry's revenues from fraud.

In a series of studies, Global Construction Perspectives and Oxford Economics estimated that the global construction industry is worth $8.6 trillion and will rise to $15 trillion by 2025; therefore, the global cost of fraud could be $860 billion, reaching $1.5 trillion by 2025, according to the report.

Keeping it Quiet

Furthermore, "most fraud is undetected, so the quantum is impossible to accurately estimate," Hartnell said.

construction industry
© iStock / JacobH

The Association of Certified Fraud Examiners says 3.4 percent of reported fraud is from the construction industry, with a median average loss of $300,000.

"Businesses that have suffered from fraud are very reticent to let people know they have been a victim. Fraud happens, but it's another thing to report it—mainly for reputational reasons," Hartnell said.

The report calls fraud throughout Australia, Canada, India, the UK and the U.S. "commonplace" and sometimes "endemic," with many companies accepting it as part of doing business.

Flavors of Fraud

The report highlights eight main types of construction industry fraud:

  • Overbilling for labor, materials and equipment for a project;
  • Bid/contract rigging via price-fixing or directing customers to use certain contractors;
  • Bribery/corruption via secret agreements with financial incentives for a particular outcome;
  • Fictitious vendors in order to falsify payments and divert money
  • Change order manipulation: Diverting lump-sum cost to time and material cost;
  • Theft or substitution of lesser materials;
  • False representation by using undocumented workers, falsifying minority content reports or insurance certificates, ignoring environmental regulations, and misrepresenting small business status; and
  • Money laundering/tax avoidance.

Internal Threats, Organized Crime

Most construction companies have insufficient controls to identify fraud, the report says. As the number of stakeholders increases on a project, so do the opportunities for fraud, it says.

The greatest threat, it adds, comes from within a company.

construction fraud
Grant Thornton

Based on the experience of Grant Thonton teams, this map shows the likelihood of encountering the eight types of fraud in the countries studied for the report.

Outside influences are still a threat, however, especially given the evidence of organized crime involvement in construction fraud.

The report notes testimony at the Charbonneau Commission in Canada that stated that parts of Quebec's construction industry were controlled by a small group of contractors who took turns "winning" bids. According to one organized-crime expert, five major Mafia families in New York take an estimated 5 percent share of all construction projects in the city.

Breakfast Clubs

Bid rigging is also "extensive" and has almost become routine  in the UK, Canada and Australia, the report says.

"Contractors meet at so-called breakfast clubs to decide who will win the latest contract. This is a normalization of an illegal act," said Sterl Greenhalgh, fraud specialist for Grant Thornton UK.

The report recommends that companies speak more openly about fraud and implement steps to mitigate it, such as encouraging whistleblowing, being vigilant, adopting a zero tolerance policy, and being prepared to prosecute.

   

Tagged categories: Architects; Bidding; Construction; Ethics; Finance; Research

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