For councils, a constant stream of procurement is part of day-to-day operations. From approving stationery for the office, to greenlighting contractors on multi-million-dollar infrastructure contracts.
Complex procuring systems and the sheer number of dollars spent means contracts can often “leak”. Leakage refers to expected costs of procurement being vastly underestimated to costs incurred.
This could be from either internal or external malpractice.
No matter how the leakage occurs, the risks are high: from monetary loss to reputation damage. That’s why you need to be aware of the most common fraud schemes – and how to detect and prevent them.
Managing vendor selection
The first step in any procurement is putting together a tender, calling for bids, and selecting a vendor.
When vendor sourcing best practice isn’t followed? It can lead to councils suffering from project delays, budgeting issues – and even suppliers disappearing mid project.
That’s why it’s important vendor sourcing is a fair, transparent process. A successful vendor should be selected based on their ability to fit your needs – and meet your budget.
Giving vendors unfair advantage
There are several common ways vendors may be given unfair advantage – either through deliberate action or simply by procurement negligence. These include:
- Leaking advance knowledge of procurement activity, giving a vendor or certain vendors extra time and context to prepare their bids
- Creating product requirements that favour a specific vendor
- Inadequate market research that results in a tender having unnecessary restrictions or caveats on bidders, limiting the number of bids received
It’s important to be aware of these issues to ensure tenders are well researched and presented fairly to all bidders.
Using unbiased vendor judgement
When it comes to reviewing bids, it’s paramount that council staff involved in vendor selection are unbiased. The two biggest issues councils face in this arena are:
- Conflicts of interest
Bribery involves the bidder giving vendor panel members money or gifts in order to consciously or unconsciously sway their opinion.
Bear in mind that bribery isn’t necessarily a briefcase containing thousands of dollars handed over in a dark, shady car park. A lovely gift basket delivered straight to a vendor panel member’s doorstep might be enough to shift their favour.
Conflicts of interest occur when a council member procures from a vendor that they have undisclosed connections with.
While the council may not suffer monetary damage with the selection, if uncovered, their reputation will take a hit.
So how do you manage the issue?
Ensuring your staff know they must disclose conflicts of interest is the first step. It’s also important to have a gifts policy in place that’s known by all staff.
If, despite having these policies in place and a robust culture around risk management, you suspect there might be foul play, there are a number of red flags to look for.
Unusual prices or discounts might be a first sign of malpractice. Then deep dive into a vendor’s history and shareholders for any undisclosed connections.
Avoiding bid rigging
Despite best laid plans, even when council staff thoroughly follow best practice, it’s possible forces outside your organisation may upset the vendor selection process – namely, through bid rigging.
Bid rigging happens when two or more contractors collaborate to control the bidding process. Their goal is to scheme together with their tenders to ensure the winning bid will continually rotate among them, allowing them to work together to artificially inflate prices.
Bid rigging may involve the following tactics:
- Bid suppression – certain suppliers agree to refrain from bidding
- Complementary bidding – certain suppliers submit bids with unacceptable terms
- Bid rotation – vendors take turns to submit the lowest bid
To deal with this fraud, you can:
- Research the suppliers and their market prices
- Keep bids confidential
- Examine the supplier’s prices at different purchase locations
Structuring payment schedules
So, you’ve awarded your contract to your preferred vendor and followed best practice protocols. Your next challenge is ensuring your payment contract with your vendor can’t be rorted.
The most common fraudulent practices we see by vendors in this area include:
- Structuring contract payments with terms and conditions that may result in over invoicing by vendors. For example, selecting a cost reimbursement model instead of a fixed price one.
- Creating a pricing schedule that may result in over-charging, such as clauses relating to travel or subcontracting from the vendor.
The best ways to navigate these issues are to be on a lookout for them and to query anything that looks suspicious with the vendor.
Looking for contract pitfalls
Aside from pricing anomalies in contracts, the other area requiring serious scrutiny is ‘substitutions’. Suppliers may commit fraud by giving substandard goods or materials than the ones agreed to.
Frauds like these can pose serious risks in civil works projects, where substandard goods may result in infrastructure collapsing or injuries from use of poor materials.
To prevent any harm:
- Be alert to any wording in the document that allows for substitutions and query it with the vendor where needed
- Ensure the contract is solid by making sure substandard goods are refundable
- If substitutions are necessary throughout the project, check for cost differences, manage risk appetite and gain approval from directors
Managing the buying process
The next step in your procurement process is getting your vendor into your system so that they can get paid.
Internal leakage is your major risk at this stage – and it’s often unintentionally created. The issues you’re likely to run into here are:
- Long open purchase orders (POs)
- Unauthorised PO changes
- Unjustified PO terms
Often, issues arise because councils aren’t centralising purchase departments. So procurement managers are only notified of a good’s delivery through the invoice.
To prevent buying leakages:
- Run exception reports
- Analyse weekend and holiday payments
- Inform finance and department directors on purchases
Safeguarding the payment process
Preventing duplicate payments
The advent of computerised payment processes has made duplicate payments almost impossible, with systems generally flagging when an invoice of the same number has been processed.
However, it is possible to beat the system. And the key way the system is rorted here is through vendor collusion with council staff.
When queried, the staff member may say “this payment was for part A and this was for part B of the project,” or “we thought we would only need 20 units, but ended up needing 40”.
To prevent any fraud, make sure to do your monthly reconciliations to catch any unusual transactions.
Prevent vendor master file tampering
For efficient management, vendor master files allow procurement leaders to compile all the vendor data. Even the payment files.
If staff have access to this master file, they can easily redirect the vendor funds into the bank accounts of parties not in the original agreement.
To prevent this leakage:
- Organise a quarterly fraud detection check
- Delegate the duties
Avoid paying phantom vendors
In 2017, Bayside Council’s former CFO and his payment officer committed a false invoicing scheme. The CFO set up a shell company and, for 18 years, siphoned off more than $5 million of taxpayers’ money.
Besides the monetary damage to the public, the state government had to spend $17 million to compensate for the damages.
Why? Because the former CFO passed away before he was charged. And Bayside Council is still recovering from the reputational hit.
Unfortunately, this case is not the exception to the rule. Invoice verifications are prone to leakage.
So how do you prevent such a common fraud?
- By conducting quarterly Vendor Due Diligence checks
- By checking dormant vendors that are suddenly receiving payments without activities
Be aware of kickbacks
For this fraud to occur, a vendor and a council member need to work together. The member approves an overcharged invoice, and in return, he’ll receive money or gifts.
To prevent this fraud:
- Conduct quarterly exception report check
- Introduce a gift and benefit policy – employees aren’t allowed to receive gifts over a certain amount.
A final word of advice
Procurement leakages are common and one of the oldest fraud schemes. Due to the complexities of procurement, it’s hard to trace these leakages.
So you must be aware of possible malpractices in order to detect them.
And importantly, you also need to nip fraud in the bud by putting in place preventative measures.
Need further information? Or help with procurement leakages? Contact your Regional Risk Manager for guidance.