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8/10/2019 Procurement Fraud - Are You Prepared
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Are You Prepared?
Procurement
Pressures and incentives, opportunity, and
rationalization its the recipe for fraud, any
type of fraud. Abuse within the procurement
cycle is common and can be damaging, from
the magnitude of potential monetary losses to
the reputational damage that can come from a
loss of trust of important stakeholders such as
investors, customers, and other suppliers.
Consider a long time employee who is suddenly
struggling with making ends meet at home.
Through many years of service in the
procurement department, he has gained the
trust of co-workers, established personal
relationships with vendors, and has an intimate
knowledge of the controls system and any gaps
that may exist. Almost effortlessly, he could
approach a vendor to inflate invoices and direct
surplus payments to his personal bank account.
Such collusion is common in procurement frauds
2 | At Risk | Volume 6, No. 1
2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independentmember firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved
8/10/2019 Procurement Fraud - Are You Prepared
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At Risk | Volume 6, No. 1 | 3
is a Manager in KPMGs Forensic practice and holds a Chartered
Accountancy designation. Over the course of her three years with the
practice, Erin has participated in alleged procurement fraud investigations
and has provided proactive fraud risk management services to clients.
Her Forensic experience extends to data analytics, as well as litigation
support, damage quantification, and contract compliance assignments.
In addition to her Forensic experience, Erin has assisted clients with
evaluating their internal controls over financial reporting, including the
evaluation of fraud risk mitigation in the procurement cycle.
Erin Wight
Contact:[email protected](416) 777-3019
The economy these days is in flux. For some
companies, the agenda is recovery while others
are still struggling. Experience shows that
fraud can flourish in times of economic boom
or bust. Change can have a significant impact
on people at all levels in the organization. As
management works through the turbulence,
corners may be cut. Less staff resources may
be available due to earlier cutbacks and the
demands on experienced staffs time may
be split between control responsibilities and
managing the integration of newly acquired
business units.
In either scenario, the offender will justify their
actions: the company wont miss this; its a small
drop in the bucket, or Ill pay it back as soon as I am
able. Perhaps less obvious; but equally alarming,
it becomes increasingly enticing to accept gifts
from a supplier when the demands on staffs time
is expanded and compensation is frozen or not
increasing to the extent of the former glory days
of growth and profitability when the economy was
flourishing. Employees rationalize actions that are
not in the best interest of the company and this
attitude and abuse of opportunity can spread through
the organization if not kept in check throughout the
transitional phase of the business lifecycle.
In the push for short-term results it becomes
more challenging to stay two steps ahead of the
more unethical among us. Could this happen to
you? Are you prepared? How confident are you
with your answer?
2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firmsaffiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
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4 | At Risk | Volume 6, No. 1
Could This Happen to You?It is very true that most payments tovendors are legitimate; but, consider
what it would mean to your businessif even a small proportion of suchpayments were fraudulent.
Fraud does not discriminate, not bygeography or industry. Globally, KPMGs
Forensic professionals have seen arise in fraud over the past few years as
industries and global economies havefound themselves working to emerge
from financial crises.
In KPMG in the US' 2009 survey,
65% of respondents perceivefraud as a significant risk in their
industry today while 32% expectfraud will continue to increase. Themost significant risk for 31% of
respondents is bribery, corruption,
market rigging, and/or conflicts ofinterest. This perception is morepredominant in government and
healthcare industries (39%) thanconsumer markets and information,
communication, and entertainment(21% and 15% respectively); but an
admitted prevalence of fraud within15% of companies is not somethingto ignore.1
Respondents to KPMGs 2008 fraudsurvey in Australia and New Zealandhave seen a significant increase in
the occurrence of fraud, where 45%of respondents to that survey had
experienced at least one fraud during
the survey period. When reported,the average losses amounted to
AUD$1 million.2
KPMG in Indias 2010 survey alsonotes an increase in the prevalence
of fraud, particularly in supply chainfraud, including the procurementfunction. Seventy-five percent of
respondents to that survey said thatfraud in corporate India is on the rise.
Respondents from the real estateand industrial markets industriesidentified the procurement process
as the most vulnerable to fraud, 57%and 39% of the time respectively.3
Although respondents to the various
KPMG fraud surveys all agree thatfraud is a significant risk that has beenon the rise, it is important to be aware
that the nature of fraud conducted ineach region may differ from that in
your home industry. As businessesseek avenues to streamline productionand reduce associated costs,
supply chains are extending to new,international borders. Even smaller
companies today deal with offshoresuppliers who could have very
different values, controls or businesspractices. Companies must recognizethis and be extra diligent in managing
these relationships.
With this type of experience,
procurement fraud is something thatsimply cannot be ignored. People
contemplating fraud or other actions notin the companys best interest can side-
step those internal controls operatingas your first line of defense. Perhapsthe more pertinent question in todays
environment is why couldntthishappen to me?
Companies should reduce the
opportunity for employees to not actin the companys best interest byincreasing the risk of being caught. This
added risk to the individual can act as arather convincing deterrent.
1 Fraud Survey 2009, KPMG in the US, 20092 Fraud Survey 2008, KPMG in Australia, 20093 India Fraud Survey Report 2010, KPMG in India, 2010
2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firmsaffiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
8/10/2019 Procurement Fraud - Are You Prepared
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At Risk | Volume 6, No. 1 | 5
What Could Happen?The first step in assessing thevulnerability of your procurement cycle
and designing mechanisms to detectand prevent the fraud is to understandthe common fraud schemes.
There are many procurement fraudschemes, with multiple themes
and variations on certain basic fraudapproaches. Some of the more common
schemes are as follows:
Phantom vendors or other
manipulation of the vendor
master file by creating a record in
the vendor master file that directspayment to a fictitious company or
a legitimate company that does notprovide services to the organization,an opportunity is created to generate
a payment record and transfermoney to a recipient that may be
controlled by an employee or a thirdparty in collusion with procurementpersonnel. Detection may be
challenged where the magnitudeof such payments are designed to
fly under the radar of more seniorapproval authorities. A variation
on this basic approach involves
changing address and bank detailsof a legitimate but inactive vendor of
the company, essentially hijacking acompanys identity to facilitate illicit
payments.
Cheque forgery perhaps easilylost in the volume of transactions,a manual cheque can be transacted
through forgery of the designatedapproval authority.
Fictitious invoicing and inflated
billing rates invoices could be
generated for processing throughAccounts Payable that do not relate
to goods received or servicesrendered. Consider that an employee
may generate an invoice payable to
a vendor using their home address.
Alternatively, unannounced toyour diligent procurement staff, a
vendor, even one that is regularlyproviding legitimate services to yourorganization, may submit an invoice
for services that were not providedor at rates that are above those
agreed upon.
Conflicts of interest whereprocurement personnel have afinancial interest in the success of
a supplier entity, their purchasingdecisions may be biased towards
that entity to the detriment of yourorganization.
Vendor kickbacks and briberyalmost innocently, vendors may
send gifts to procurement personnelbecause of long-term relationships.
This can create a conflict where apersonal relationship between thebuyer and vendor is established that
may put pressure on the buyersefforts to act in the companys best
interest.
Less innocently, vendors maycollude with procurement staff in
order to work around establishedprocurement controls and
fraudulently withdraw money fromyour organization. Suppliers maybribe a buyer in your organization
to purchase from them despiteabove-market rates or poor product
quality. In another scenario, bribesor kickbacks may be offered to
procurement personnel to approvefictitious charges.
Bid rigging through collusion
between procurement personnel
involved in the vendor selectionprocess and outside vendors, or
between outside vendors participatingin the bidding process, inflated rates
may be contracted for projects.
Fraud does not discriminate,
not by geography or industry.
Globally, KPMG's Forensicprofessionals have seen a rise in
fraud over the past few years as
industries and global economies
have found themselves working
to emerge from financial crises.
2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firmsaffiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
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6 | At Risk | Volume 6, No. 1
Are You Prepared?
How to Prevent It
The foundation of any fraud prevention
program is the tone at the top,
the message that management isconveying to guide how business is to
be conducted. If staff see managementabusing authority or promoting unethical
activities, the flood gates are forcedwide open for all staff to demonstrate
the same abuse. Communication ofbehaviour expectations should beformalized in a code of conduct that
addresses such matters as avoidingpotential conflicts of interest and
reporting suspected fraudulent activity.Formalizing the documentation alone is
insufficient. It must be ingrained in theway business is conducted in a clear andunambiguous manner through active
enforcement of its principles.
Fraud awareness training is also an
effective tool in empowering frontlinepersonnel to minimize inappropriate
behaviour; but, it also sends themessage to potential fraudsters thatdetection is a priority and there are
many eyes watching to minimize fraudopportunities.
Finally, invest the appropriate time anddue diligence in performing a detailed
fraud risk assessment surrounding theprocurement process. In your business
and industry today, what are the risksthat pose the most significant threats?The answer to this question is ever
evolving and requires regular evaluation.Focusing the efforts of procurement
personnel on the key controls to mitigatethese fraud risks is critical. Making staff
accountable for the performance of these
controls is also fundamental in ensuringtheir effectiveness. Conducting regular
reviews of the compliance with the fraudprevention control program through
audits is a good approach.
At a very practical level, one of theweaknesses common to many of the
most basic (and easily preventable)schemes is control over a companysvendor listing. Adding vendors or
changing vendor information needs to
be tightly controlled. When activity witha vendor is dormant for a set periodof time, the vendor should be deleted
from the approved vendor list. Otherinternal controls related to commonprocurement processes, approval and
monitoring should be reviewed toensure that they are appropriate and
sufficient to minimize risk in this area.
How to Detect It
Perpetrating these types of frauds
often involves the side stepping oroverriding of controls that are designed todetect inappropriate spending. In these
scenarios, it is important to be aware ofthe red flags that may raise suspicion
before too much loss is suffered [seeRed Flags sidebar]. In KPMG Australias
2008 fraud survey, 22% of fraudsreported by respondents were ultimatelydiscovered after many red flags were
ignored. In efforts to identify fraudearlier, an awareness of potential red
flags and an establishment of reporting
mechanisms to detect these indicatorswill be beneficial.
Many business information systems
contain the facts that can point a fingerat impropriety if the right lens is appliedto the data. Data analytics tools can
be used to focus detection efforts.Whether analyzing spending trends,
irregular transactions, or potential buyerand supplier relationship indicators,
these tools have the capacity to filterlarge volumes of information [see table].
Efforts to implement a continuousmonitoring program with these tools,or response to a suspected fraud are
two avenues for leveraging the vastcapabilities of data analytics.
ProcurementFraud Red Flags Round dollar value invoices
Lack of control around thebidding process including poordocumentation, absence of
appropriate competition
Poor documentation ofexpenditures or failure to
complete a match of invoicesto receiving and orderdocumentation
Consistent use of a vendor
who is delivering poor qualitygoods, particularly where this
issue is concentrated withone buyer
Duplicate invoice payments
Excessive entertaining ofprocurement staff by suppliers
Vendors with a post office boxas the sole address
Absence of a legitimate GST or
HST registration number
Off-hour transactions
Out-of-sequence invoicenumbers for a particular vendor
Payments to inactive vendors
Low initial bids followed byexcessive change orders
Poor cash management
practices (i.e., paying invoicesright away despite theaccepted practice of 30 to
60 day payment terms in aparticular industry)
Cheques set aside for pick-up
2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firmsaffiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
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At Risk | Volume 6, No. 1 | 7
ConclusionThe procurement cycle is fundamentalto the profitability of an organization,especially in times when top line growth
is challenged. Increasing focus onthis cost centre, controls and financial
results can help avoid unnecessary cashflow leakage from fraud. While the cost
of obtaining this business intelligencemay seem to outweigh the probabilityof losses from such a theft, consider
for a moment the other repercussionsof such a breach of trust: loss of
public trust, legal fines or sanctions, ordamaged share price.4
Data Analytics
Irregular Transactions Trends & Summary
Reporting
Relationship Indicators
Duplicate invoices
Unusual invoice sequencing
Inactive vendors receivingpayments
Off-hour transactions
Transactions exceedingapproval authority or invoicesplitting to bypass authority
Vendors with fake GST orHST numbers
Invoices received afterpayments are made
Top vendors by paymenttype
Top vendors with qualityissues (e.g., returns)
Top vendors with thehighest short shipment rate
Vendor address or phonenumbers vs. payroll records
Vendor directors vs.procurement personnel
Multiple vendors withsame contact coordinates(address, phone numbers,PO boxes, etc.)
4 Fraud Survey 2009, KPMG in the US, 2009, page 4, respondents identified these as the most concerning costs of
fraud 71%, 54%, and 34% respectively.
2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firmsaffiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.