Contractors are managing more uncertainty than ever as the construction industry moves into the unknown frontier of a modern pandemic. Previous recessions and market downturns have taught us that fraud tends to increase during these difficult times, so detection and prevention is imperative. Detecting fraud can be challenging – especially when many of the processes, controls, procedures, and policies get tossed out the window as the new reality of surviving during a pandemic begins to settle in.
This article will offer practical advice using a real-world example to help protect your company from fraud during these uncertain times.
The Fraud Triangle
For almost 70 years, the Fraud Triangle (Exhibit 1 at right) has been used to describe how and why fraud occurs. The triangle consists of three separate elements – perceived pressure, perceived opportunity, and rationalization – all of which must be present for fraud to occur.
These elements are present even during good economic conditions. However, with the pandemic causing societal changes and ushering in a recession, these risks will continue to increase.
Fraud often starts as a result of some type of financial pressure on an individual or individuals. This, coupled with the additional pressure of more than 40 million Americans filing for unemployment over the span of a couple of months1 and millions of others facing reduced hours and pay cuts, could have some people looking for a “release valve.”
As a result of the pandemic, the opportunity to commit fraud will likely increase as desperate (or potentially greedy) individuals look for that release valve. The pandemic has changed our processes, controls, and procedures – the same ones that are not able to prevent all fraud from occurring even during the best of times. When changes occur abruptly, businesses understandably react by doing what is needed to maintain operations and cash flow; risk management and fraud detection often take a backseat to survival.
During times of upheaval, risk management and fraud controls can be temporarily discarded, which can lead to employees having access to funds and accounting records to which they otherwise would not. This is especially true in an environment where some of those individuals may be working remotely and practical solutions must be implemented to keep the doors open.
The rationalization element of the triangle is the one that most employees do not cross. Even if they are experiencing increased financial pressure and have the opportunity, they are usually unable to justify defrauding their employers. But the Fraud Triangle is equal on all sides, so as financial pressure and opportunity increase, experience tells us that more people start to rationalize behavior they otherwise would not. It typically starts with a thought like, “I will only do it while I have to, and then I’ll stop.” Later, they realize they can get away with it and continue, or the pressures do not let up as expected or new ones arrive to take their place and the fraud continues.
ACFE’s 2020 Report to the Nations
The Association of Certified Fraud Examiners’ (ACFE) Report to the Nations: 2020 Global Study on Occupational Fraud and Abuse is a wide-ranging study on fraud from across the world. The most recent release analyzes 2,504 cases of fraud that took place from January 2018 through September 2019.2 Overall, this time period had historically low unemployment and reasonable growth3 – in other words, very good times in comparison to 2020. Even with a solid economy, the study showed that fraud was alive and well across the world as well as the U.S., which represents 829 (33.1%) of the total cases studied.4
Fraud in Construction
Let’s start with the good news: construction did not have the highest frequency of fraud out of the 23 other industries. However, in the ACFE report, it was ranked ninth in frequency with 77 cases (Exhibit 2).
According to the ACFE report, the construction industry ranks as the fifth-highest in median loss ($200,000) per fraud incident (Exhibit 3). While it may not be as frequent, the dollars flowing around are typically in larger amounts compared to other industries, giving rise to larger fraud losses when they do occur. What is perhaps more concerning is that the average loss per fraud across all industries is about $1.5 million, meaning there are some very large frauds occurring that drive up the average loss.5 Let’s dig deeper into these numbers to better understand the various types of fraud that occur within the industry.