3 Strategies for Preventing Procurement Fraud

As recently profiled on our Financial Statements blog, research by Pricewaterhouse Coopers notes that a staggering number – 30% – of US organizations report incidences of procurement fraud. The research defines procurement fraud as “illegal conduct by which the offender gains an advantage, avoids an obligation, or causes damage to his organization.” The recent trial of former New Orleans Mayor Ray Nagin is an excellent example of procurement fraud, as Nagin accepted bribes in exchange for awarding contracts.

Procurement fraud can be difficult to detect, as it comes in many forms and often involves off the record bribes, kickbacks, and conflicts of interest. However, there are several important steps you can take to help to safeguard your company and prevent procurement fraud in its various forms.

Types of Procurement Fraud

While this is not a comprehensive list, these are some of the major procurement schemes your company may encounter:

Kickbacks and Bribery. Your employee may receive a kickback for inflating an invoice or creating a false invoice. Bribery is defined as a situation in which someone is provided a benefit with the intent to corruptly influence – an intent to sway a purchasing decision or a contract award. Any benefit received in this manner – cash, gifts, entertainment, business interests – are considered bribes and are illegal.

Conflict of Interest. If your employees have an undisclosed interested in a supplier, it is considered a conflict of interest and can lead to fraudulent activity (conflicts of interest often go hand-in-hand with kickbacks). This often happens when an employee favors a company owned by a family member or friend and purchases overpriced goods/services from these companies.

Phantom Vendors and/or False Invoices. An employee can create a fictitious company to invoice and “pay.” The money is being paid right under your nose, but is pocketed by an employee. Or, a real vendor can submit a fake invoice for work not performed, or a duplicate invoice in the hopes you will not notice a double payment. This is often done in collusion with an employee
In addition to these scenarios, procurement fraud may be initiated from parties outside of your company when bidders collude to rig bids or fix prices.

Preventing Procurement Fraud

As with any fraud scheme, internal controls are essential to prevent graft and protect your company. Here are three specific strategies you can employ to prevent procurement fraud in your business:

Verify Vendors. Whenever you begin a new business relationship, verify the existence and the validity of the vendor. A simple PO Box address is often used to create phantom vendors, so the existence of an address is not verification. Require a W-9 for all vendors and establish an approved vendor list to guide your invoicing process.
Review Your Financial Reports. Quite simply, you can’t see the warning signs if you don’t look. A regular review of your financials will help you spot duplicate payments, vendors who appear to win a disproportionate share of contracts, and unreasonable prices.
Require Back-Up. Employees are often able to create phantom vendors and false invoices because no supporting documentation is required. Establish a policy that mandates appropriate back-up for invoices and periodically review vendor files to ensure the back-up documentation is included.
Yes, procurement fraud is hard to detect, but it is important to take proactive steps to manage your accounts payable processes and prevent these insidious losses.

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