Procurement Fraud: How to Spot and Mitigate It Early

Procurement fraud is one of the oldest types of fraud that companies have to safeguard against, and it’s no surprise that it’s going strong in emerging markets and costing businesses billions of dollars. In this article, we break down the main types of procurement fraud, how to investigate and spot this type of fraud, and how to prevent procurement fraud from becoming a threat to your business. 

What Is Procurement Fraud?

Procurement fraud occurs when there is deliberate deception within the procedure-to-pay process that results in some type of financial gain, or loss. In a typical scenario, companies lose when a vendor is awarded business at an above-market scale and then the employee that granted the contract receives a kickback of some kind. It could be cash, gifts or something else. There are also other parts of the procurement process chain ripe for fraud and abuse. It’s important that you learn how to identify and mitigate procurement fraud in your business in order to alleviate this risk to both your company’s integrity and its bottom line.

Procurement Fraud Triangle: The Three Requirements for Fraud

No company wants to think that an employee will commit fraud, but it happens. According to the Association of Certified Fraud Examiners (ACFE), there are three factors required for employees to engage in fraud: Perceived Financial Pressure, Perceived Opportunity, and Rationalization. 

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Perceived Financial Pressure

An employee under financial strain can be motivated to commit fraud. Pressure can stem from things like an addiction issue, unexpected medical bills, excessive personal debt or simply a desire to live beyond one’s means. Work-related pressure or dissatisfaction is also a cause, leading an employee to “get even” if they feel underpaid or overlooked.

Perceived Opportunity

An employee must find an area of opportunity to commit fraud. They need to determine that they can commit the fraud, effectively conceal it, and avoid punishment. This happens when assets are easy to access or poorly accounted for, proper oversight is missing and/or a company lacks good internal controls to prevent fraud.

Rationalization

If an employee has a perceived need to cheat and sees a way to do it, then they might rationalize the reason to do so. 

- “I deserve a raise.” 

- “The company owes me.”

- “It won’t hurt anyone.”

When Should Preventing Procurement Fraud Become a Priority for Organizations?

Companies should prioritize procurement fraud prevention when they begin to increase in size. For small businesses in a start-up phase with just a few employees, risk is low. This is because most small companies allow for open communication and closer insight into the procurement process. Once a company is in growth mode, they begin to hire more employees, open offices in multiple locations, and/or have multiple employees with company credit cards. Expansion allows for the growth of new communication paths and less direct insight into employees’ daily activities and the procurement process. As companies begin to expand, they should be thinking about how to prevent procurement fraud.

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What Are the Types of Procurement Fraud?

The simplest type of procurement fraud is employee/supplier collusion, or when an employee cuts a deal with a vendor at an overpriced amount and then receives a kickback. Companies lose billions of dollars in revenue from other forms of procurement fraud including conflicts of interest, creating fake companies, processing inflated bills, accepting substandard work, and either making or accepting false statements in obtaining contracts. 

1. Employee/Supplier Collusion

The most common type of procurement fraud, as noted by Financier Worldwide, is when an employee arranges for a good or service with a vendor at either a higher cost than needed, or with a cheaper product. That vendor then “kicks back” money or gifts to the employee for the inflated deal terms.

2. Conflicts of Interest

This occurs when an employee responsible for vendor selection picks a company with some kind of relationship to them. This is OK if a company has conducted a proper bid process, the selected vendor/supplier meets qualification criteria, and the employee declares the conflict. However, this is frequently not the case in these scenarios, and an employee hands a deal to a family member or friend either as a favor or for financial reward.

3. Fake Companies

If an employee creates a fake company and issues payments to it, those false costs build up. Oftentimes employees engaging in this fraud will make small payments so as not to raise alarms, and if a company doesn’t have a process to match invoices against purchase orders then it can be easy to commit.

4. Inflated Bills / Underdelivery

After the initial procurement phase, during the receipt of the contracted work, fraud can be committed either through the approval of inflated invoices or the acceptance of underdelivery. Underdelivery can be substandard work or failure to meet requirements. If an employee accepts subpar material, then that is a form of fraud — just as if they had approved of an inflated bill.

5. False Statements in Obtaining Contracts

Whistleblower law collaborative notes that making or accepting false statements when obtaining contracts is a type of procurement fraud. Examples of this include misrepresenting a minority contractor or small business status, or a vendor making false statements of compliance. 

How Do You Investigate and Spot Procurement Fraud?

Now that you know common forms of procurement fraud, there are things to look for to spot it happening in your company. Large companies with more steps in the vendor approval chain and bigger budgets are more susceptible to this kind of fraud, but small businesses should also be on the lookout. Things to look for to spot procurement fraud are employees with unexpected material goods, mismatched invoices, unusually low bids for contracts and unexpected relationships between an employee and a vendor — including a possible connection on social media.

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Material Goods

If an employee receives gifts or financial rewards from a vendor, that’s a potential kickback. If you notice an employee with sudden, unexplained material wealth, that could be a sign that something is amiss.

Mismatched Invoices

Sometimes vendors or suppliers create additional invoices to increase the amount they are paid. This can be done independently, or with a colluding company member. If a team member knowingly accepts work that’s less than what was agreed to in an invoice, they may be motivated by a bribe from the vendor or a portion of the profits. Spotting a mismatch of invoices to amounts received or paid is a flag for this.

Unusually Low Bids

When a project goes through the bidding process, there are a few things to look for to spot employee/supplier collusion. If there are several bids but only one is the obviously low bid, that may be a sign that a sourcing employee wants the job to go to the low-bid vendor and is making their bid attractive. Similarly, if a late bidder is the lowest bidder, that could be a sign that the company has inside information on competitor bids and is being positioned to get the contract. 

Employee/Vendor Connections

When employee conflicts of interest go unreported, and an employee has a vested interest in one of the suppliers through family or other connections, that’s problematic. This can be spotted if they show obvious preference for one supplier over another. Another thing to look for are unexpected connections or relationships between the employee and the vendor, such as contact outside of work or on social media.

How to Prevent Procurement Fraud

There are a few ways to prevent procurement fraud within your organization. Employees that are working in procurement and their supervisors should be trained in procurement process and procedures, as well as fraud risk and ethics. Internal auditors should conduct periodic reviews looking for anomalies and deviations from standard practices. In addition, companies should have a whistleblowing policy and process through which employees can flag anything they suspect of fraud. 

However these audits and whistleblower safeguard options for procurement fraud are after-the-fact, and in these scenarios the losses have already taken place and your company may not be able to recover them. If you can get ahead of possible procurement fraud by risk mitigation, that significantly reduces your company’s exposure to risk in this area. Companies should implement control measures and conduct fraud risk assessments throughout the procurement process.