Publisher’s Note: Procurement fraud is a complex topic and one we take very seriously. For more information on procurement fraud, make sure to review the “Related Articles” at the bottom of this article.

Yesterday, we answered the question What is Fraud? by offering up a variety of definitions from a group of reputable sources. Today’s article is designed to help organizations know where to look by providing different examples of procurement fraud so that policies can be put in place to clearly steer the procurement team away from these areas and understand the implications of breaking policy. Similar to yesterday’s article, we will use our own primary research on the topic as well as information from a variety of reputable (and quite verbose) sources.

Examples of Procurement Fraud

• The classic example of procurement fraud is where an employee (or employees) conspires with an outside supplier to defraud the employer in a variety of ways; usually the employee receives some type of kick back, remuneration, bribe, gifts, or other benefits in exchange for their assistance. Procurement fraud can still occur if the employee receives no gain.
• Inflating contract prices above market or fair prices
• Approving inflated invoices that are above contractual or market prices
• Approving invoices for work that was not done or products that were not delivered
• Collusion to fix pricing
• Collusion to rig the bid process
• Another common form of procurement fraud is when an employee (or employees working together) establishs a dummy company or supplier account in the company’s systems and then works to steal from the employer via fraudulent contracts, invoices, and/or payments
• Black’s Law Dictionary states that “Fraud, as applied to contracts, is the cause of an error bearing on a material part of the contract, created or continued by artifice, with design to obtain some unjust advantage to the one party, or to cause an inconvenience or loss to the other.”
• The UN, no stranger to this issue offers its own list of potential procurement frauds (more from the UN in a future article)
• Conflict of interests  Any input into the procurement process by a party with vested interests in the outcome creates a conflict of interest situation.  Conflicts can be actual, perceived or potential.  These are most common during
• Strategy development phase:  Where inadequate or biased supply market research limits sourcing options in favor of particular products or suppliers.
• Solicitation phase: Development of specifications or requirements that could favor a particular product or supplier.
• Bid preparation phase: Giving any preferential or prejudicial treatment, or undue advantage of information.
• Receiving of bids: Improperly secured bids, exposing them to risks of undisclosed / illegal tampering or modification by any party or actually performing the tampering/modification
• Evaluation phase:  Deliberately manipulating evaluation criteria or scores to get certain results.
• Contract management phase:  Acting so the interests of the supplier, not those of the procuring entity, are served.
• Collusion between procurement staffers or between other personnel and suppliers  Practices could involve “kick-backs” or bribes, resulting in the internal personnel manipulating the process by restricting a list of suppliers, or restricting competition to one local area
• Non-genuine competition  When different suppliers have the same owners or are otherwise associated, the perceived competition is not real. Limited invitations increase exposure to this risk since the suppliers could act as a cartel to affect pricing or decisions.  Also improper granting of “sole supplier” status reduces competition and can lead to this kind of non-genuine competition. 
• Unfair advantage to individual suppliers  Information is not disclosed consistently to all potential suppliers during the solicitation process, or inside information is disclosed to a potential supplier or existing vendor. Permitting personnel to act alone or undertaking ineffective market research can give rise to unfair advantage. 
• Circumventing thresholds  This would include the thresholds for undertaking formal solicitations and for review by procurement review committees. These requirements can be left unfulfilled when splitting orders and estimating costs below real costs to bring in low value contracts that are later adjusted. When extending or amending contracts, determine the contract history and current cumulative contract amount, and justify why the contract is being extended/amended.
• Inadequate knowledge of market or nature of goods/services being procured  Inadequate knowledge can lead to restrictions in competition by not properly approaching the market; obtaining poor quality goods/services; not getting value for money, by making procurement decisions that result in overpricing.
• Improper hospitality, gifts and inducements  These could be improper hospitality, bribes, incentives such as free or discounted goods and private services.
• Lack of substantiated need for goods or services  In addition to being wasteful, this provides an opportunity for directing a disproportionate share of business to a company.
• Inadequate competency (knowledge and skills) of personnel  Procurement is a strategic and complex administrative task that requires expertise at many levels.  Low level of competency increase exposure to risks, especially supplier fraud. This is a risk in emergency situations where the enterprise may have to undertake substantial activities with limited number of staff.
• Shortcut processes  By limiting time for bidding and inappropriately issuing expressions of interest or requests to quote, risks of fraud rise dramatically, as both suppliers and internal personnel act on insufficient information. This is a critical risk, especially in emergency situations.
• When it comes to cost-plus contracts, the US Naval Inspector weighs in to say the “procurement fraud includes, but is not limited to, cost/labor mischarging, defective pricing, defective parts, price fixing and bid rigging, and product substitution.” As you can see by their examples below, some of the procurement frauds need not involve any internal procurement staff.
• Cost/labor mischarging. These are schemes by suppliers on cost-type contracts to fraudulently inflate the contractual cost and/or amount of labor or materials.
• Defective parts.  A known defect in design, specification, material, manufacturing and workmanship,
• Product substitution:  The introduction of counterfeit and/or substandard material and other forms of unauthorized product substitution into the procurement system. 
• Price fixing and bid rigging.  Bid rigging is any activity to suppress and eliminate competition on contracts. Price fixing and bid-rigging is an agreement where, in response to a call or request for bids or tenders, one or more bidders agree not to submit a bid, or two or more bidders agree to submit bids that have been prearranged among themselves. They usually fall into one or more of the following categories:
• Bid Suppression: One or more competitors who otherwise would be expected to bid, or who have previously bid, agree to refrain from bidding or withdraw a previously submitted bid so that the designated winning competitor’s bid will be accepted.
• Complementary Bidding: Complementary bidding (also known as “cover” or “courtesy” bidding) occurs when some competitors agree to submit bids that either are too high to be accepted or contain special terms that will not be acceptable to the buyer. Such bids are not intended to secure the buyer’s acceptance, but are merely designed to give the appearance of genuine competitive bidding. Complementary bidding schemes are the most frequently occurring forms of bid rigging, and they defraud purchasers by creating the appearance of competition to conceal secretly inflated prices.
• Bid Rotation: In bid rotation schemes, all conspirators submit bids but take turns being the low bidder.  The terms of the rotation may vary; for example, competitors may take turns on contracts according to the size of the contract, allocating equal amounts to each conspirator or allocating volumes that correspond to the size of each conspirator company.  A strict bid rotation pattern defies the law of chance and suggests collusion is taking place.
• Subcontracting: Subcontracting arrangements are often part of a bid-rigging scheme. Competitors who agree not to bid or to submit a losing bid frequently receive subcontracts or supply contracts in exchange from the successful low bidder.  In some schemes, a low bidder will agree to withdraw its bid in favor of the next low bidder in exchange for a lucrative subcontract that divides the illegally obtained higher price between them.  Almost all forms of bid-rigging schemes have one thing in common: an agreement among some or all of the bidders, which predetermines the winning bidder and limits or eliminates competition.
• Market Division: Market division or allocation schemes are agreements in which competitors divide markets among themselves.  In such schemes, competing firms allocate specific customers or types of customers, products, or territories among themselves. 

By providing these examples in a bulleted format, we are trying to make it easier for your teams to review and incorporate, as appropriate, any of these examples into your own policy guidelines. I should note that this list does not attempt to equate the different examples on the list nor are we suggesting that every example on this list is illegal. Please let me know if you think I missed any examples and I will append the list, with full credit.

RELATED ARTICLES

Shhhhhhhhh! – (Tricks) To Catch a Fraudster

Twelve Top Tips to Limit Procurement Fraud

Fifteen Top Tips to Limit Procurement Fraud – Payments Edition

Key Fraud Risks across Procurement Phases (Courtesy of the UN)

Procurement Fraud – An Issue for Public and Private Enterprises

(Procurement) Fraud Prevention (3) – Why It’s Important

Fraud Prevention (2) – CPO Strategies

How eSourcing Can Help Limit Procurement Fraud

Procurement Fraud Prevention – The Expert (Part 1)

Procurement Fraud Prevention – The Expert (Part 2)

Procurement Fraud Prevention – Two More Strategies

Tagged in: People, Process, Procurement Fraud