Decrypting the peculiarities of procurement frauds

ProcurementConsider this – An anonymous whistle-blowing complaint revealed a dubious nexus between a third party vendor and an employee of a manufacturing company. The whistle-blower alleged that spurious products were used in the manufacturing process but the purchase orders were made for branded products. An investigation was conducted which proved that such unethical practices were indeed taking place. Eventually, the employee as well as the vendor was dismissed. Though not an uncommon scenario, procurement fraud is perhaps one of the most complex ones to detect in an organization and often goes unnoticed.

The procurement process in most organizations involves substantial outflow of funds; so it is important to implement a robust set of internal controls and manage the workflow efficiently. Low level of staff competency increases the exposure to risks, particularly in case of supplier fraud. That said, the actual fraud may occur at any point in the supply chain cycle. It may involve procurement of services, fraud committed during the purchase of fixed assets and even construction of large assets.

So what are the key areas of concern?

  • ‘Shadow vendors’, shell companies that are set up and used for billing, may be used in such schemes
  • Vendor kickbacks, whereby the supplier or his agent, pays to a purchaser or his agent to select the supplier’s bid for product or service, often at an inflated price
  • Conflict of interest in awarding procurement contracts
  • Intentional substitution of substandard materials without the customer’s agreement
  • Awarding long term business contracts to ‘favored’ vendors

Fraud risks are unavoidable. There will always be cases where suppliers will willingly corrupt the process to unfairly deceive the company, or sabotage a fair and competitive process. So companies should understand the risks in their procurement process and monitor supply chains. This will enable them to implement targeted controls in order to mitigate risks, both those on their radar and those with minimal visibility.

The procurement process can be sliced into multiple stages – each with its own set of challenges making it vulnerable to fraud risks.

  • Demand stage – Suppliers may have the propensity to engage in fraud even before the procurement process actually commences. For instance, they can shower unprincipled employees with gifts (cash or kind). This can lead to incorrect demand signals reaching the procurement department, with colluding employees raising purchase orders for products or services that are either unnecessary or over-specified.
  • Preparation stage – Here, some of the risks include vendor nepotism, questionable tender evaluation process, ill-substantiated justifications for waivers or budgets set artificially high to cover kick-backs. In this stage, procedures can be developed to ensure that the procurement process offers value for money by encouraging competition.
  • Selection stage – The vendor selection norms/ procedures could be manipulated, either internally or even externally. There could be a restriction on the tender pool of potential suppliers, shortlisting weak vendors against a preferred one, acceptance of late bids or bidders submitting fraudulent documents.
  • Implementation stage – Post sourcing and closing a contract successfully, organizations may get complacent – but the work is still far from done. To elaborate, unscrupulous suppliers may bend the terms of the contract to suit their needs or even supply sub-standard goods.

While risks around such fraud can never be eradicated fully, organizations can undertake a number of steps to safeguard their business and reputation. Regular reports on procurement activities will help mitigate risks such as identifying illicit waivers, duplicate supplier accounts etc. But what is most important is setting the right tone at the top, communicating intent and training to build the organization’s armoury against fraud.

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