Contractors Must Take Steps to Combat Fraud

Construction industry business owners often focus more on the structures they build than on the books they keep. But contractors must be vigilant about the risks of fraud - even from specialists they trust to manage financial matters.

By Richard Gavin

Today's front-page stories about fraudulently inflated stock prices and insider trading are captivating reads. But fraud doesn't have to be headline news to be a big risk to the average small business, especially in the construction industry.

As business owners, contractors are particularly susceptible to fraud, often due to betrayal from those they most trust. Most contractors focus on the business of building and construction itself. Most went into the construction business with a desire to create and work with their hands, not just to sit behind a desk. But among them, awareness of the potential for fraud is critical.

In my experience, successful contractors enjoy almost every aspect of the business except one - the financial side. They tend to hire bookkeepers, controllers, or CFOs, putting their faith and trust in these financial experts and giving them the necessary control and responsibilities. Of course, most of these financial specialists are indeed trustworthy. But for the few that are not, most contractors and small business owners unwittingly afford them plenty of opportunities to perpetrate fraud. As Frank Abagnale - one of the most respected authorities on forgery and fraud, and on whom the movie "Catch Me if You Can" was based - once said, "If you make it easy for people to steal from you, they will."

I have seen several versions of a classic fraud case that has hit contractors. While these firms usually have few inbound checks on a monthly basis, they tend to have a lot of outgoing payments to vendors. Therefore, it's easier to steal the money going out.

I have found cases of a bookkeeper or project manager setting up a fake company with a name similar to one of the contractor's primary vendors. That individual will then either double-pay legitimate invoices, once to the real vendor and once to the dummy account, or create false invoices and pay them to the fake company.

The individuals were able to pull off the fraud because of lax internal controls. In one case, it resulted from inadequate oversight of outgoing invoices. In another, the bookkeeper had too much control - she was the person who both approved the invoice for payment and also signature-stamped the checks.

Owners can avoid such schemes by signing checks themselves, reviewing background information on invoices due for payment, and tracking invoice patterns. During one audit, I helped an owner uncover this type of plot simply by presenting a list of recently paid vendors. He immediately saw one vendor that seemed to be getting an abnormal number of payments, and we spotted the fraud.

Fortunately, contractors can protect themselves from such schemes by understanding why employees steal and by taking simple precautions.

First and foremost, contractors must accept the responsibility to prevent fraud in their businesses. Observe what is going on in your business and ask questions. Likewise, make sure employees who have suspicions about fraud know to whom they should report it.

Secondly, be aware that embezzlement, by definition, is an inside job. The perpetrator is known and trusted, and the fraud stems from deception and stealth. The individual transactions could even be small, but the accumulation over time can be substantial. Few perpetrators stop until they are caught. Early detection is essential to minimize losses.

Next, know whom to worry about. Many who commit fraud do not begin their employment with plans to embezzle. But telltale signs can emerge. Fraudsters typically show resentment toward the company or its owners. They may have personal crises outside the office. Most are in a position of trust within the company and have access to company assets. And ultimately, most see the opportunity, believe that they will not be caught, and justify their actions with notions such as "Everyone does it," "I work hard, I'm entitled," or "The company won't miss it."

Another important step is for contractors to establish a threat of detection. It can be the most powerful deterrent. Review and bolster your internal controls. Trust controls, not people.

The last measure is to create a culture within your company of honesty and high ethics. Don't forget that this culture starts at the top. Owners who take questionable business actions are setting the tone for employees.

Richard Gavin is a partner and certified public accountant for Grassi & Co., of Lake Success, N.Y. He heads the firm's finance department.