Procurement Fraud Understanding its Impact on Company Evolution, Prevention, and Real-life Examples

CFOs of growing companies often worry about compliance and preventing fraud. Preventing procurement fraud might not be the top priority for many growing companies, but it should be top of mind.

Procurement controls are a must to prevent fraud. If you think Company is immune to these problems, think again.

If you don’t have strong Procurement cost controls, it is not a question of if; it is a question of when Procurement fraud would happen—assuming that you can discover that in time.

Robust procurement controls help prevent Procurement fraud and help a company raise external funding.

This article will help you further understand what procurement fraud is, its impact to your company, and how your organization can navigate through it effectively.

What Is Procurement Fraud?

Procurement fraud is a type of fraud that entails the manipulation of a procurement process to obtain financial benefits illegally. It involves dishonesty and unethical behavior by a vendor, employee, or contractor working to secure a financial gain or one we can call an unfair advantage. Procurement fraud can lead to significant financial losses for organizations, especially government agencies, that rely on procurement processes to acquire goods and services.

Simply put, it is a kickback to the buyer from the supplier for selecting the supplier’s bidding process, which might not be in the Company’s best interest.

The scope of procurement fraud is not limited to supplier and buyer collusion, but it is a recurring theme in Procurement.

As per consulting firm PricewaterhouseCoopers Global economic survey, in 2014 twenty-nine percent (29%) of global organizations had experienced procurement fraud. Procurement fraud is more common at the beginning of the procurement process (vendor selection stage) than at later stages like vendor performance and delivery.

What Are The Signs Of Procurement Fraud?

Procurement fraud is a serious issue that can cause significant financial losses to organizations. Therefore, it is crucial to identify any red flags that indicate fraudulent activity within the procurement process.

Here are some of the common signs of procurement fraud:

1. Inflating Contract Prices: Inflating contract price lists allows the fraudster to earn a more significant profit at the organization’s expense. This fraud often occurs when the organizations do not compare pricing across different vendors or when the procurement team colludes with the vendor.

2. Collusion To Rig The Bid Process: In this scenario, the vendor and the procurement team write specifications and requirements so only the vendor can meet them. Therefore, the organization may pay a higher price for a product or service that could have been obtained at a lower real cost through competitive bidding.

3. Approving Inflated Invoices: This is another sign of procurement fraud. The fraudster may submit a higher invoice for services or goods that were less expensive or not delivered. This type of fraud may occur when the procurement team fails to review the invoices thoroughly or approves invoices without validating the receipt of goods or services.

4. Establishment Of A Dummy Company Or Supplier Account: This is also considered a red flag for procurement fraud. In this scenario, the fraudster creates a fake or non-existent supplier account and invoices the organization for services or goods that were never delivered. This type of fraud can be challenging to detect unless the procurement team carefully checks the supplier account details.

Click on the link below to download the free Procurement fraud checklist.

What Is The Procurement Fraud Triangle?

The Procurement Fraud Triangle is a concept that aims to explain the psychology behind employee procurement fraud. The Procurement Fraud Triangle is a model highlighting the three factors employees consider when committing fraudulent activity – Perceived Financial Pressure, Perceived Opportunity, and Rationalization.

As per ACFE (Associations of Certified Fraud Examiners), the fraud triangle consists of perceived financial need, perceived opportunity, and rationalization.

Perceived Financial Need

Financial need is the motivation or the reason behind the fraud. Examples include financial debt, gambling, or other short-term needs that an individual cannot fulfill with the current income source.

This typically comes when employees feel extremely stressed about meeting their financial obligations. For instance, an employee may have a financial need such as personal loans, medical expenses, or mortgages. The employee may turn to procurement fraud to fill the financial gap in such a situation.

Perceived Opportunity

Perceived Opportunity is the second factor in the fraud triangle. In this context, the employee must first perceive an opportunity that will enable them to act fraudulently. This opportunity comes in the form of control over procurement decisions, weak controls, or the inability of the organization to detect fraud.

For example, if the person committing the fraud understands the controls well, they can quickly identify opportunities for committing fraud.

Rationalization

Rationalization is the third factor in the Procurement Fraud Triangle. Rationalization means the employee convinces themself that the fraudulent activity is acceptable. This takes the form of an internal dialogue, where the employee justifies the action with reasons such as underpayment, feeling undervalued, or feeling that the organization won’t miss what they are stealing.

This stage involves an individual planning to commit fraud to rationalize their actions. For example, the amount is so tiny that it will not affect the organization, or no one will notice such a small change.

Others rationalize by relating to their situation and rationalizing in their mind that the situation is temporary and the fraud is one time and will never happen again. You can say the same for gamblers; it always starts with a small bet.

What Are The Types Of Procurement Fraud?

Procurement fraud occurs when an individual or group deliberately manipulates the procurement process for personal gain or the advantage of another party. Procurement fraud comes in many forms and can have severe consequences, including financial loss, legal liability, and reputational damage.

Here are the most common types of procurement fraud:

Employee/Supplier Collusion

As per cporising.com, this is the most common example of procurement fraud. In this case, an employee responsible for purchasing a product or service colludes with a supplier to purchase a product at a higher cost or a cheaper product that doesn’t meet the quality requirements.

In return, the buyer receives a kickback. It is widespread, especially in companies with no well-defined sourcing process, or the Procurement is decentralized to the individual location or departments.

Company Controller could limit the impact of such procurement fraud in specific locations.

Still, it could devastate your product reputation if you buy inferior raw materials, leading to a poor-quality product for your customers.

The arrangement often involves accepting false invoices for goods or services that were never received or invoicing the company at an inflated price for goods or services.

Conflicts of Interest

Conflicts of interest arise when an individual’s interests fail to align with their professional responsibilities. Conflicts of interest might occur when a procurement officer awards contracts based on personal relationships or favors a particular supplier, even though it may not be in the company’s best interest.

Even if you have tighter controls and well-defined processes, the chances are that fraud can happen in the form of a conflict of interest.

You would often see this even in companies with well-established processes.

The individual is responsible for purchasing and selecting a vendor related to them in some fashion.

Nothing is wrong with that if you have conducted a bid process, the selected supplier meets all your qualification criteria, and the individual responsible for purchasing has declared the conflict of interest.

Unfortunately, that is not always the case.

Procurement fraud impacts your procurement process integrity. But the reverse of this is also true.

If your sales team is colluding with buyers of your customers and giving a kickback to buyers.

In 2010, HP paid $55M to settle allegations it paid to individuals to win US government contracts. So, it would help if you were looking at preventing procurement fraud and how not to engage in such practices with your customers.

Creating Fake Companies

Creating fake companies is another way in which procurement fraud is perpetrated. Scammers create fictional companies with fabricated documents to qualify for procurement opportunities they would not otherwise be eligible for. They win contracts for goods or services they never intend to deliver, take the profits, and abscond.

Though this is not the most common example of procurement fraud, this might cost you the most.
In this type of fraud, a few employees may collude to form a fraudulent company and then keep issuing payments in that Company’s name.

The payments are generally small enough not to raise any alarm, but this can cause severe damage to your Company over time.

This could happen for multiple reasons – first, the Company doesn’t have a purchase order process, so they don’t match invoices against purchase orders before the payment.

Second, if an individual manages the entire process from purchase to payment, it is easy for that individual to commit fraud.

Processing Inflated Invoices

Another example of procurement fraud is the overinflated invoices from the suppliers.

Inflated invoicing entails a vendor submitting an invoice higher than the actual price of the goods or services provided to a company. In collusion with the company’s procurement officer, the vendor may list additional goods or services that were never provided or increase the number of items provided to generate a larger revenue stream.

Suppliers generally do this systematically so that Finance can’t detect fraud easily.

For example, the unit price exceeds the purchase order unit price by a few cents.

Imagine if the vendors submit high invoices; these cents quickly add to thousands of dollars in a few years.

Bonus: We have compiled a Procurement fraud prevention checklist to help you implement fraud prevention controls. You can download it here for free.

How To Prevent Procurement Fraud

Procurement fraud is a critical problem that can hinder business growth and efficiency. Organizations must proactively prevent procurement fraud and protect their interests from fraudulent practices.

Here’s how to prevent procurement fraud within your organization.

Educating Employees And Suppliers

The first and foremost step towards procurement fraud prevention is the education of employees about your procurement practices, including your bid process, how you select vendors and conflict of interest. The same is true for your suppliers.

Create a supplier code of conduct, and ensure that suppliers have read and acknowledged it.
It is not a full-proof process, but it will at least inform employees of expected consequences, including termination, which should prevent conflict of interest cases.

Consistently Maintain Proper Control Over Your Procurement Processes

Having proper controls helps in the prevention of procurement fraud. Following are some examples of purchasing controls you should have in place.

• All purchase requisitions should be authorized and approved by the authorized individual in the organization. Based on the transaction amount, the approval should come from different individuals. For example, a manager can approve only up to $5,000; a senior manager can approve up to $10,000, and so on.
• A purchasing system can easily implement purchasing controls and automate the basic purchasing process.
• All invoices should have a pre-authorized purchase order; if that is not in place, Company’s Controller should do a proper investigation to understand the gaps in the process and how to fill those gaps.
• For purchases that are happening through credit cards, a valid receipt and justification are required to approve the expense, including proper business approval.

However, having controls doesn’t prevent procurement fraud; you must also have an internal audit department auditing purchases regularly.

The audit department should randomly select purchasing transactions and ensure that there are no gaps in the implementation of the control.

Segregation Of Duty

Ensure that duties are segregated, and the same individual doesn’t control the purchasing process.
In other words, a single individual shouldn’t be able to create purchase orders, key in invoices, and issue payments.

Even if you have solid controls, segregation of duty minimizes the chances of procurement fraud.

An ideal case is that two different departments handle purchase orders and invoices.
The procurement department manages the purchase order process and accounts payable, managing invoice capture and issuing payment.

If you don’t have dedicated resources, employees requesting purchases can handle issuing purchase orders directly, but Accounts payable can only handle invoices.

Be Watchful Of Supplier/Buyer Collusion

We are not suggesting that you have a full-time investigator watching every action of your employees. But be watchful of lifestyle changes.

The extravagant personal spending of people involved in purchasing could be a sign that something is incorrect. They could have hit the jackpot; in that case, they might not need the job after all!

Ricky D. Sluder, a certified fraud examiner, offers a helpful tip about reviewing social media accounts; for example, if a procurement officer makes $60,000 a year and posts pictures of extravagant purchases on social media, that could be a sign that something is not right.

Automation Of Control

Automation not only helps with productivity improvements; it also helps with fraud prevention. Automated purchasing systems have many benefits, but from a procurement fraud perspective, they can offer the following benefits

• An electronic system for creating purchase orders ensures all orders are approved at the right authorization levels.
• The ability of end-users to create a receipt for purchases ensures that employees purchased the item and it is not a fraudulent purchase order.
• Automatically matching a purchase order with a receipt and invoice (also called a 3-way match) ensures that you are paying for the same items purchased and delivered.
• With complete visibility into Spend, the data is in one place, and any decent purchasing system can run reports and provide historical purchasing information.

Provide Training On Company’s Procurement Process

Employees responsible for procurement processes should receive training on the company’s procurement process, procedures, and ethics to reduce the likelihood of fraud.

This training should include instructions on following procurement guidelines and identifying potential indicators of fraudulent schemes, such as inflated or duplicate invoices.

Implement Control Measures

Implementing control measures is vital in reducing fraud risk.

A strong, centralized procurement system should be in place that incorporates strict procurement procedures to help control supplier selection, purchasing authorization, and payment processing.

Additionally, accountability measures should be established, requiring all employees involved in the procurement process to log and track every action taken. This provides transparency and can help to deter fraudulent behavior.

Conduct Periodic Internal Audits

It is crucial to conduct periodic internal audits throughout the procurement process.

An audit helps to identify any anomalies and deviations from standard procurement practices. Regularly reviewing procurement transactions and identifying any high-risk ones, such as those involving fictitious vendors or those with multiple price increases, can help prevent procurement fraud.

Conduct Fraud Risk Assessments

Conducting fraud risk assessments is essential to stay ahead of potential procurement fraud risks. This should involve identifying fraudulent activities, including possible collusion with third-party vendors or suppliers, price fixing, or bid-rigging.

Establish A Whistleblowing Policy And Processes

Lastly, establishing a whistleblowing policy and process that allows employees to report any suspected fraudulent activity is critical. The policy should make it clear to whom the employees should report, what information they should provide, and the assurance of confidentiality.

What Are The Consequences Of Procurement Fraud?

Procurement fraud is a grave offense that can have far-reaching consequences for individuals and organizations. Understanding the potential risks and ramifications is crucial to deter individuals from engaging in such illicit activities.

Here are some of the critical consequences of procurement fraud:

Legal Repercussions

Individuals guilty of procurement fraud may face severe penalties, including hefty fines and imprisonment. These legal consequences directly impact the individual’s personal life and irreparably damage their professional reputation, making it difficult to rebuild trust and secure future employment prospects.

Civil Litigation

Procurement fraud can lead to civil litigation, wherein the defrauded party seeks compensation for the damages.

The affected organization may be embroiled in lengthy and costly legal battles, diverting valuable resources from its core operations. Additionally, if found guilty, the organization may suffer the loss of government contracts, resulting in significant financial setbacks and a blow to its credibility within the industry.

Company Risks

The consequences of procurement fraud extend beyond legal and financial implications.

The individual responsible for the fraud jeopardizes their future and puts the entire organization at risk. The reputation of both the individual and the organization can be severely tarnished, causing a loss of trust among stakeholders, clients, and partners.

The damage to the organization’s image can lead to decreased business opportunities, strained relationships, and a decline in market standing.

Operational Damages

The financial and operational damages caused by procurement fraud can be substantial.

Misallocating funds, inflated costs, and substandard or defective products or services acquired through fraud can undermine the organization’s financial stability and hinder its sustainable growth.

The ripple effects of procurement fraud can affect not only the immediate bottom line but also hinder long-term success and stability.

How Can Your Company Investigate Procurement Fraud?

When faced with the possibility of procurement fraud within your company, conducting a thorough investigation is essential to uncover the truth and take appropriate action.

Understanding the steps in investigating procurement fraud can help your organization address the issue effectively.

Meticulously Review Financial Records

The first step in investigating procurement fraud is to review financial records meticulously. Scrutinize these records for discrepancies, irregularities, or unusual patterns and transactions. Pay close attention to invoices, payment records, and financial statements to identify any inconsistencies that may indicate fraudulent actions.

Interview Employees Involved In The Procurement Process

This step allows you to gather additional information, verify compliance with procurement policies, and gain insights into potential red flags. Engage in open and transparent conversations to ensure employees feel comfortable reporting any suspicious behavior or irregularities they may have witnessed.

Keep An Eye For Red Flags

Examples of red flags include mismatched invoices, unexplained vendor relationships, unusually high costs, or frequent supplier changes. These indicators warrant further investigation to determine if fraudulent activities are at play.

Conduct Examination Of Vendor Contracts

To delve deeper into the investigation, thoroughly examine contracts to vendors and the bidding processes. Look for any inconsistencies, deviations from established protocols, or potential breaches of ethical practices. By closely analyzing these elements, you can identify any irregularities that may point toward procurement fraud.

Leverage Technology

Leveraging technology can significantly aid your procurement fraud investigation efforts. Consider implementing a centralized system or software to streamline procurement data and automate processes.

Such technology allows for efficient monitoring of transactions, identification of anomalies, and timely detection of potential fraudulent activity. It simplifies data analysis and enhances your ability to detect patterns indicative of fraud.

What Is The Impact Of Procurement Fraud On Your Organization?

Procurement fraud can devastate your organization, affecting your financial health, operational efficiency, and overall reputation.

Understanding these potential consequences is crucial for your business so you can prevent and address procurement fraud effectively.

Here are some of the devastating impacts procurement fraud can do on your company:

1. Financial Loss: Fraudulent activities, such as inflated prices, kickbacks, or invoice manipulation, can drain resources and deplete budgets. These financial losses directly impact your organization’s bottom line, impeding its ability to invest in growth, meet obligations, or deliver on its strategic objectives.

2. Compromised Operational Efficiency:  Fraudulent practices disrupt the procurement process and create inefficiencies for your business. For instance, your organization may delay acquiring essential goods or services, experience quality issues with products obtained through fraud, or face legal and regulatory complications due to non-compliance. These disruptions can hinder day-to-day operations, hamper productivity, and strain stakeholder relationships.

3. Inflict Organization’s Reputation: When fraudulent activities are exposed, your organization’s integrity is questioned, eroding trust among clients, partners, and the general public. The negative publicity and loss of credibility can lead to a decline in customer confidence, strained business relationships, and a negative impact on future opportunities. Rebuilding a tarnished reputation can be a lengthy and challenging process.

4. Legal And Regulatory Consequences: Procurement fraud can result in legal and regulatory consequences for your organization. Engaging in fraudulent activities can lead to legal actions, fines, penalties, and even criminal charges depending on the jurisdiction. These legal repercussions have financial implications and can cause significant reputational harm to your company.

5. Undermine Employee Morale And Trust Within The Organization: When fraudulent activities are uncovered, it can create a toxic work environment and damage employee relationships. Discovering fraud may also necessitate disciplinary actions or terminations, leading to losing valuable talent and further organizational disruption.

Advantages of Utilizing the Right Technology to Prevent Procurement Fraud Early

In the fight against procurement fraud, leveraging the power of technology can be a game-changer for organizations. By utilizing the right technological tools, companies can proactively detect and prevent fraudulent activities, minimizing the potential impact on their operations and financial well-being.

Cloud-based compliance and risk management software are vital in preventing procurement fraud early on. These sophisticated systems provide a centralized platform that connects critical information, enabling organizations to identify and address vendor issues before they escalate into fraud or payment errors. By streamlining data and processes, cloud-based software enhances transparency, efficiency, and accountability throughout the procurement cycle.

One significant advantage of utilizing such software is conducting periodic reviews effectively. The software can automatically analyze data and transactions, detecting anomalies and deviations from standard practices that may serve as red flags for potential fraud. This proactive monitoring ensures that irregularities are promptly identified, investigated, and addressed before they cause significant harm to the organization.

Conclusion

In conclusion, implementing and going through an investigative process is crucial in preventing procurement fraud.

While some may argue that smaller organizations may not be susceptible to fraud, it is important to recognize that establishing basic controls is much easier when your organization is still in its early stages, with fewer employees and locations. Starting early and implementing preventive measures can establish a strong foundation for fraud prevention as your organization grows.

If you’re looking for software to help you combat procurement fraud, schedule a demo with ProcureDesk today!

FAQs

Is Procurement Fraud A Crime?

Yes, procurement fraud is considered a serious legal offense. It involves manipulating procurement processes for personal gain or to defraud the organization. Common forms of procurement fraud include bid rigging, where collusion occurs to manipulate bidding outcomes. Engaging in procurement fraud can result in criminal charges and legal repercussions.

What Is Procurement Theft?

Procurement theft is the fraudulent acquisition of goods, materials, or services through procurement. It typically involves employees misusing their positions or authority to obtain goods or divert resources for personal gain unlawfully. Procurement theft can lead to financial losses for the organization and undermine the procurement process’s integrity.

When Should Preventing Procurement Fraud Become A Priority For Organizations?

Preventing procurement fraud should be a priority for organizations from the outset. When an organization engages in procurement activities, it becomes susceptible to fraud risks.

Organizations should proactively assess their major fraud risk by conducting regular risk assessments, implementing control measures, and establishing a whistleblowing policy.

Periodic audits should also be conducted to ensure compliance and identify any potential fraudulent activities. Organizations can safeguard their resources, reputation, and overall financial well-being by addressing these risks early on.

Remember, prevention is key when it comes to procurement fraud. By being vigilant, implementing appropriate control measures, and fostering a culture of ethics and integrity, organizations can effectively mitigate the risks associated with procurement fraud and protect themselves from potential financial and reputational harm.