Procurement Fraud: How to Identify and Prevent

Research suggests half of businesses have experienced fraud in the past two years – with financial losses and business disruption or failure among the most common outcomes. In this guide, DeepStream looks at procurement fraud, the risk for unprepared businesses, and how to prevent it.

What Is Procurement Fraud?

Procurement fraud – also known as purchasing fraud – is the manipulation or diversion of business deals involving the acquisition of goods and services by malicious actors.

Fraud can happen when best practices aren’t followed, and typically results in significant losses of revenue, government penalties for failing to comply with trading regulations and a loss in customer support if the goods are unavailable to sell.

Another aspect of procurement fraud involves the buyer receiving an inferior product that either isn’t up to the quality advertised or doesn’t have all the features that were specified in the product’s original description.

What Are the Different Types of Procurement Fraud?

Procurement fraud covers a range of criminal activities that share a single motive – to manipulate business trade agreements for financial gain.

Some common methods of purchasing fraud include:

Invoice Scams

Invoice scams are a process by which the scammer sets up a fake company and sends an illegitimate invoice to companies for apparent goods and services that have never been agreed upon or delivered.

Imagine you owned a bakery that bought its flour and icing from various suppliers. An invoice ends up being sent to you from a supplier you’re struggling to memorise, claiming that you owe them £300 for supplies. You have no idea who this company is, but they’re invoicing for items you buy regularly – seems legitimate, right?

This is how an invoice scam works – submitting credible and convincing invoices that may end up being paid due to negligence.

Using threats like due dates expiring, or a warning about the company’s credit rating being in jeopardy to prompt quick payment are also common tactics used in invoice scams.

False Accounting Fraud

False accounting fraud refers to illegal activities concerning how a business reports its finances.

Imagine you check your business accounts, and something seems odd. The numbers don’t align or add up, assets and liabilities have been deliberately misconstrued or funds have been funnelled into an additional account.

Any actions designed to make the business’ accounting unclear and untraceable is a type of false accounting fraud – and it can be done for a multitude of purposes by a multitude of people.

An individual employee could be abusing their position to slice a cut of profits from the company, but also a company may knowingly engage in accounting fraud to avoid paying certain taxes or to inflate their share prices with false statistics about profit.

Kickbacks

A kickback is a type of purchasing fraud that sees employees use false or inflated invoices to funnel money into chosen organisations – with the intention of receiving a cut from the beneficiary.

Imagine one of the employees at our bakery develops a close friendship with a supplier. They start to win contracts from the company all while having no competitive advantage. Not only this, but the invoices seem over-inflated and have no supporting documentation.

This is an example of a kickback scam.

The cost of goods is increased or inflated in invoices to cover the amount of the payment ‘kickback’ which is often paid to the employee engaged in the scam.

Bid Rigging

Bid rigging – also known as collusive tendering – is when businesses that are typically market competitors work together to win trade.

This can be through manipulating prices – such as taking turns being the lowest bidder – eliminating competition or limiting the pool of available supplier bids to let the remaining vendors raise their prices through monopoly.

Imagine the bakery business has a problem. It seems that the number of available suppliers for ingredients is dropping, and the available suppliers decide to raise prices by 50% to take advantage of the supply and demand situation.

The business realises it has been a victim of bid rigging – with two key suppliers collaborating on the tender, minimising competition and forcing the bakery to pay over the odds for their goods. They then split the profits.

Fake Vendor

Fake vendor scams are similar to invoice scams but on a larger, long-term scale – with a series of invoicesbeing raised and paid to a vendor that is not delivering products or services.

Returning to our bakery example, the business realises a vendor is being paid for strawberries, but there is no internal record of it receiving strawberries from that vendor.

Plus, these invoices are all being processed by one or a small group of employees who seem to provide unclear, photocopied invoices from unusual addresses.

This may be a fake vendor scam, in which an employee sets up a non-existent vendor and starts funnelling money to an illegitimate account through false invoices.

How Can Organisations Detect Procurement Fraud?

Organisations can detect and prevent these procurement fraud scams by regularly and thoroughly checking all company financial accounts and vetting the employees who handle those finances.

This means checking for purchasing fraud red flags, such as:

·      Any vendor prices that are wildly higher than the market price for goods.

·      Limited market competition.

·      Suspicious patterns to winning and losing bidders – or winning bidders sub-contracting to a competitor.

·      Close relationships between procurer and winning bidder – does the same company repeatedly win bids?

·      Contracts awarded to unexpected bidders.

·      Discrepancies between contracts and delivered services.

·      A single employee being responsible for the entire contract process – from bidding to delivery of goods.

If an ethical business suspects any of these red flags may be a sign of procurement fraud, they must begin putting together a case – working with internal and external staff to review the company’s finances and investigating the suspicious vendors.

To save time and improve accuracy in reviewing this data, businesses can use a digital RFx process to ensure compliance and visibility between all parties during the entire source-to-contract process with emphasis on who is involved in each stage of the process.

DeepStream’s RFx software is packed full of features to help your company control its procurement process.

DeepStream is dedicated to an ethical and clean approach to digital procurement and protection to help your business thrive with an easy-to-read and centralized audit trail.

How Can Organisations Protect Against Procurement Fraud

It’s important to act on the first red flags of procurement fraud. However, proactively protecting against these activities can help businesses avoid costly disruption, fines and lengthy investigations.

Organisations can protect against procurement fraud in the following ways:

·     Education and Awareness: Comprehensive employee education on invoicing and financing procedures alongside a trained awareness for discrepancies and red flags can cast a wider net on potential scammers and make identifying suspicious activity easier.

·     Examine Long-Term Supplier Relationships: Often, vendors can encourage insurance fraud by working with an employee. If an employee is extremely close with a vendor, that could be a sign of collusion and may need monitoring. This can also be avoided by delegating responsibilities across vendor relationships– with all suppliers required to have multiple procurement staff assigned.

·     Regular Reviews: Frequent assessment of invoices can help lead to an effective and clear documentation process where inconsistencies and errors are detected at the earliest opportunity and expenditures can be archived and tracked seamlessly. This improves data clarity and accountability.

·     Digitize the RFx Process: With an effective digital RFx process, you can protect against fraud and save time by streamlining the procurement process flow. Maersk reaped the rewards of this process when working with DeepStream to tackle day-to-day RFx logistics.

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“It’s about DeepStream understanding the procurement process, having a system that people in the heavy industry can relate to, and the(platform’s) flexibility, so you can structure the tender how you want to –it’s just easy.”

- Sara Nandin de Carvalho, Supply Chain Manager, Maersk Decom

What Are the Legal and Financial Consequences of Procurement Fraud?

Procurement fraud doesn’t just risk the reputation of businesses and their staff – it can also lead to serious consequences for the company’s capital and ability to trade.

The most obvious consequences of procurement fraud are the financial implications, with research suggesting 40% of businesses lose between €150,000 and €400,000 each year to purchasing scams.

However, procurement fraud actors and victims also risk the legal consequences of manipulating business deals. There are various regional and international regulations in place to ensure fair and legal procurement practices, with fines and even more serious punishments for businesses that fail to comply.

For example, businesses or individuals found guilty of procurement fraud may be charged with offences under the Bribery Act 2010 – which acts to prevent instances of fraud with penalties including fines and even imprisonment.

Procurement fraud also risks public harm in some cases, with products that have been mis-sold ending up becoming available for public consumption. This also sees businesses risk financial penalties and worse.

What Are the Responsibilities of Those Working Within Procurement to Prevent Fraud?

Companies must take an ethical approach to business practices to avoid purchasing fraud and the unwanted consequences of financial losses, compliance issues and reputational damage.

It’s the responsibility of those who work within procurement to be unbiased when it comes to potential vendors while recording paper trails accurately and consistently.

This also means flagging suspicious activity such as any potential vendor bribes, unexpected bids or discrepancies between data and services at the earliest opportunity.

Using RFx software, businesses can make this process more efficient by storing it all in one place where it can be easily accessed and verified.

DeepStream prides itself on its security and using our RFx software to handle your data in not only an efficient manner but an ethical and strictly confidential one too.

How Should Organisations Best Risk Assess and Develop Effective Anti-Fraud Programs?

One word. Traceability. Traceability helps with the flow of procurement data by making it clear and easy to access down to granular information such as invoice details and key dates.

Any potential red flags in the data become easier to spot and validate and can be broken down by vendor or invoice to support critical investigations.

There are three main areas to consider when ensuring transparent procurement practices:

·       Suppliers: To protect against fraud, it’s important to research suppliers, including their client histories. Suppliers with small or non-existent histories aren’t always fraudulent, but it’s a red flag.

·       Improving Processes: Set up an effective process for anti-fraud measures. Draft regular risk assessments and make sure employees understand and recognise red flags and key next steps. The more employees trained to look for red flags, the wider net you can cast.

·       Auditability: Make sure a digital trail of data and expenditures exists and is easy to trace.The ability to swiftly check where invoices have come from and the exact financial details is an essential part of developing an effective anti-fraud strategy.

For more information on the role of traceability in procurement and how it provides valuable end-to-end visibility, check out our guide.

Frequently Asked Questions (FAQs)

·       What Are Common Frauds in Procurement?

The most common types of fraud found in procurement are False Accounting Fraud, BidRigging, Kickbacks, Invoice Scams, and Fake Vendors – each designed to manipulate business deals for the profit of malicious actors. Procurement fraud can often be hard to detect if there is no company-wide focus on spotting these common red flags.

·       What Are Procurement Fraud Risks?

The risks incurred by procurement fraud can be anything from financial loss for the company, scrutiny and sanctions of the government, reputational damage, and even health and safety risks to the public when products are procured for distribution that are significantly below the quality advertised.

·       What Are the Red Flags for Procurement Fraud?

Some of the common red flags for procurement fraud include poorly managed invoices and employees with a suspiciously close relationship with certain vendors. A sudden spike in prices when cheaper vendors are available elsewhere, and companies listed on invoices with strange or unusual addresses with next to no company history should also raise suspicion.

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For more information on how DeepStream can save you time and optimise your procurement data set-up, chat with our expert team today.