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Governments need better methods to identify fraudsters before they start operating

Close the gap by fighting vendor fraud with accurate upfront identification and mitigation solutions

Governments from the city to the federal level are the prey of fraudulent vendors. As government audits usually aren’t a real-time process, this gap can give fraudulent vendors a substantial head-start to bilk governments for possibly millions of dollars. 

Governments from the city to the federal level are the prey of fraudulent vendors. As government audits usually aren’t a real-time process, this gap can give fraudulent vendors a substantial head-start to bilk governments for possibly millions of dollars. In the 2018 report on occupational fraud and abuse, the Association of Certified Fraud Examiners (ACFE) found that nearly 1 in 5 of all organizational fraud victims are governments. “Government and public administration” was second only to “banking and financial services” in terms of fraud cases reported by industry. In cases involving government victims, median reported losses were $200,000 (federal), $110,000 (state), and $92,000 (local).

Dollars lost to government vendor fraud can add up quickly – a 2011 Department of Defense report to Congress on contracting fraud (the most recent such study) detailed hundreds of billions of dollars in criminal fines and civil sanctions against U.S. defense industry contractors.

How best to combat this? Governments need better methods to identify fraudsters before they start operating. This is a challenge for a number of reasons:

  1. Governments may not budget enough resources for fraud prevention, whether engaging vendors or in adopting prevention technology.
  2. Government offices may have archaic billing procedures that a skilled fraudsters can readily exploit, possibly with inside help.
  3. Governments are a uniquely open target. As many government vendor contracts are a matter of public records, contact information like email addresses, phone and mailing addresses are easily found online.

For example, government agencies are often required to publicly post meeting minutes. If a road repair project is discussed at a public meeting, the minutes could list vendor names, project statuses and allocated budgets. It’s not difficult for a criminal to determine when a payment is due to a vendor, and who to contact at the government about it.

An ongoing problem
While there are a variety of ways through which governments are affected by fraudsters, vendor fraud can be generally classified into two types:
Vendor impersonators. Criminals can pose as legitimate vendors, usually by initiating email or phone contact with government officials. They often aim to divert the vendor’s payments to themselves via methods like sending duplicate invoices or requesting billing address changes.

Examples: Could you be at risk?
In September 2016, the finance department of Sedgwick County, Kansas, got an email from a vendor asking to change its bank account information. It was an older ACH form purportedly signed by the vendor’s owner. The department complied. But when they sent an electronic payment of $566,000 to the vendor (a construction company performing road maintenance), the vendor never received the funds –they vanished into the fraudster’s account. The fraudster, a man from Georgia, was eventually arrested. A similar scam hit El Paso’s city government in the same period. Again, a fraudster posing as a vendor convinced the government’s finance office to change the vendor’s banking account number, and so managed to nab $2.9 million in state funds earmarked for a downtown streetcar project. 

Fraudulent vendors. Rather than impersonate legitimate vendors, some fraudsters will masquerade as a legitimate business. They’ll set up a front company, seek to get a license if one’s required, try to win government contracts and once they do, attempt to defraud the government through methods including double-billing, inflating expenses or serial overcharging.

Detecting fraud strategies: planting red flags
To reduce its chances of being hit by a fraudster, a government’s finance and fraud protection officials need to better determine what to be on the lookout for. The use of search technologies like Thomson Reuters CLEAR® offers governments a potentially major advantage in their seemingly endless fight against vendor fraud. The more access that government officials have to multiple databases, the greater their chances of detecting a fraudulent vendor. Governments will benefit from accessing as many sources of information as possible. But they also need the means to efficiently find patterns in multiple data streams, and the ability to create profiles and procedures to automatically flag any problematic vendors.

For example, the ACFE’s recent profile data found that fraudsters are most commonly:

But far beyond these basic parameters, there are multiple searches that a government office could run to better assess its current and prospective vendors. Using technology can help agencies:

Unearth personal histories. Doing property searches and even viewing social media profiles could help determine if vendor owners or top officials seem to be living beyond their means. Do they own multiple properties in various high-end locations? Do they own multiple cars in different states? Any of these situations could raise red flags for suspicious activity.

Trace debt trails. By searching for liens filed by governments or outstanding claims pursued by collectors, governments could pinpoint individuals with large amounts of personal debt, as well as those with histories of dodging claims, or filing for bankruptcy multiple times.

Look for cross-jurisdictional similarities. People who commit fraud often change locations in search for new hunting ground. Here’s where cross-jurisdictional searches are effective. A simple news search for a person’s name could turn up past activity or even convictions in another county or state. Does the vendor company have a similar name as a discredited company in another state? Are there any similar phone numbers, employee names, banking records? By creating a graphical analysis of links between business owners, their entities and any known associates can help government researchers cast a wider net.

Dig deeper into vendor histories. Criminals often establish business fronts to try and receive tax incentives, such as creating non-profit or minority-owned businesses. These fronts can mask the true identity of their company. Making dedicated searches into company histories could turn up an owner who’s on a government debarment list, for example. And having access to real-time geographic data means a government researcher can perform most investigative tasks at their desktop. This can greatly reduce investigative costs by minimizing costly field trips by management or investigators.

Beefing up prevention strategies
Improving fraud prevention systems also goes a long way in reducing the chances of being hit by criminals. The ACFE found that having anti-fraud controls correlates with reduced losses and quicker fraud detection. In its most recent survey, it found that where controls were present, fraud losses were up to 54% lower and detected up to 50% faster than in those victims without controls. So even if a fraudulent vendor slips through a government’s initial screening methods, having consistent internal fraud-detection processes serves as a radar system to detect a fraudster’s actions quickly. Speed is crucial. The longer that a fraud goes on, the higher the losses stack up. The ACFE survey found that frauds lasting more than five years caused a median loss of $715,000. These practices include:

Check for possible employee culpability. Sometimes fraudsters work with an inside source to help them bilk governments. Running routine searches for any personal or professional connections between government employees and contracted vendors lessens the chances of this situation.

Standardize verification of vendor accounts. Internal systems should determine that any vendor has a legitimate address, not just a PO Box or an out-of-state location that hasn’t been verified by the government’s office. Vendors should have a legitimate EIN and any other tax forms should be up-to-date. Vendor ownership should be double-checked against business registration databases and state licensing boards.

Set up triggers for payment deviations. Governments could set up systems to automatically trigger a vendor review in the case of the following:

  • Changes from past payment routines (for example, asking for a printed check instead of ACH or vice versa). 
  • New banking account information. 
  • Invoices in unusual dollar amounts. 
  • Invoice numbers out of sequence or with subtle alterations. 
  • Billing address being different from vendor address in government records.

Take advantage of technology
A great advantage that many fraudsters have had over governments in the past is speed. Their ability to rapidly change jurisdictions and shift schemes from one state to another has made tracking them a difficult task, particularly for an overworked government finance office. That’s why the use of sophisticated search technologies and efficiency optimizing solutions could be a way to better level the playing field between governments and fraudsters. Growing advances in the breadth and range of investigative tools will bolster the ability of governments to detect and prevent fraud. And as government vendor fraud continues to plague everyone from city councils to cabinet secretaries, governments of any scale should consider increasing their arsenal of protections.

About the author

Carl R. Knudson, CFE, PI, Owner/Operator, Knudson and associates, Thousand Oaks, CA, has over 40 years of fraud investigative experience at the highest level of government and the private sector. He has been a PI and CFE since 1995, and worked in the Office of Naval Intelligence and Central Intelligence Agency prior to his 23-year career as an IRS special agent in the Criminal Investigation Division. As an IRS special agent, Knudson investigated complex white-collar crime cases, including tax evasion, money laundering, drug traffickers, and organized crime syndicates. Some of his drug trafficking cases were chronicled in the books Washed in Gold and Dark Alliance. Upon retiring from the IRS, Knudson was hired as a Director in the Dispute Analysis and Investigative practice at Price Waterhouse. As a Director at PW, Knudson led several international fraud investigations involving overbilling schemes perpetrated against a large computer manufacturing company. He subsequently was hired as a Director at KPMG where he led several large fraud investigations involving internal embezzlement schemes. Knudson started his own business in November of 2000 and has specialized in forensic accounting and fraud investigations for his private and government clients. During this time, he has testified as a Certified Fraud Examiner expert in more than 50 federal and state court proceedings and trials. Most recently, Knudson co-authored two books entitled Bribery and Corruption, Casebook (2012) and Insurance Fraud Casebook (2013).

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