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Procurement Contracts & Agreements

[Detection & Prevention of Fraud]

by Gursharan Singh C.M.I.I.A.

	Web www.auditnet.org

1.0  Introduction

1.1              Every individual, public and private organization is involved in procurement activities. The organizations would be governments including its agencies and those in the private sector such as commercial, manufacturing, industrial and service providers.

2.0 Definition

2.1 The common definition of procurement is the acquisition of any asset, expertise or any service through any means which could be legal or illegal.    

3.0  Opportunities, Possibilities and Preventive Measures

3.1              The monetary quantum of the procurements can be from the small values to those valued in millions & billions. Consequently there are great temptations for fraud. The procurement managements within the organizations have prescribed comprehensive procedures, internal controls and heavy penalties for provable frauds to ensure prevention and identifications of frauds. Further the government and its enforcement agencies have declared fraud as a criminal activity with heavy financial penalties and/or prison sentences or both. 

3.2 The existing measures and deterrent laws for prevention of fraud have proven to be substantially ineffective. Most organizations tend to close one eye to small value frauds that are considered to be part of costs of doing business and are generally so accounted. The ineffectiveness of the measures and laws to prevent and deter larger amount fraudulent activities is perceived to be due to two main reasons. These reasons are:

[a] Medium value frauds - Refusal by organizations to report to authorities small amount frauds due to bureaucratic processes, high costs with negligible recovery possibilities, possible negligible penalties and consequent adverse publicity; and

[b] High value frauds - High cost of prosecution [legal], time consuming, absence of evidence and witnesses that can substantiate the crime, sentences that may be ineffective and may be [negotiated] plea-bargained, negligible possibilities of quantifying the actual amount of fraud and its recovery and the adverse publicity that may not be seen in good light by investors and thus adversely impact the price of the shares and market capitalization.                                                                                                                 

3.3 It may be noted that in most high profile fraud cases where the fraudster is convicted the sentence is mainly a fine. Though the fine may be substantial and in hundreds of millions, it is very small when compared to the amount defrauded. It is a rare occurrence when a high profile convicted fraudster goes to prison. The main reason for this practice could be attributed to the reason that these high profile fraudsters are highly qualified corporate leaders with connections in corridors of power.

4.0 Creation of Fraudulent Opportunities

4.1 The procurement industry is a goldmine for fraudulent opportunities and possibilities whereas the possible profits are extremely high with chances of detection, subsequent conviction and repayment being minimal. Thus there is great motivation to create opportunities for fraud in the initial planning and commit fraud in subsequent stages.

4.2 Some examples of creation of opportunities for fraud during the planning stage and the implementation stage and physical procurement and post-procurement are listed below.

[A] Planning Stage

[a] Justification for Items & Quantities   

[b] Specifications & Standards

[c] Selection of Product and Supplier

[d] Terms and Conditions

[e] Emergency Situations 

[f] Procurement Method

[g] Packing and Deliveries

[h] Payment Mode

[i] Evaluation and Recommendations

[B] Physical Procurement Stage

[a] Non-compliance with terms & conditions

[b] Impractical Delivery Periods and Locations

[c] False Approval Certifications

[d] Non-Inspection

[C] Post Procurement Stage

[a] Storage Conditions

[b] Inventory Records

[c] Security

[d] Checking and Auditing

4.3 Similarly fraudulent opportunities can be created in the disposal of existing assets by declaring them as surplus to needs or not necessary for any future purposes and disposal methods.  

5.0 Role of Internal Audit

5.1 It is the primary responsibility of Management to prescribe comprehensive and relevant procedures pertaining to procurement of assets and services for prevention and early identification of any fraudulent practices. However It is the responsibility of the Internal Auditor to ensure the compliance of such procedures and their implementation. The Internal Auditor should ensure the audit of the procurement contracts/agreements with emphasis on internal controls compliance that would ensure the prevention of fraudulent opportunities at the planning stage and for early identification of any frauds that may be suspected at the physical procurement and post-procurement stages.

5.2 It is important that the Internal Auditor understands all aspects of procurement contacts/agreements and his officers be equipped with the relevant expertise and knowledge to be able to do an effective audit especially on the fraud aspect. Further it is important for IAD to discuss the matters with the auditee for positive results in respect of avoidance of fraudulent opportunities and early detection of frauds. This objective can be achieved only with the full co-operation of management and support of the BAC and BOD.

6.0 Role of Board Audit Committee [‘BAC’]

6.1 The BAC, with the support of Internal Audit, has a major role to play in the prevention and early identification for minimizing losses of any discovered frauds.

6.2 It is regrettable that the BAC has become ineffective due several reasons. Some of the contributory reasons could be summarized as follows:

[a] BAC members may not have the relevant knowledge and expertise about the core activities of the organizations and the contracts/agreements pertaining to the procurement relevant to such core activities;

[b] The absence of any penalties to which the BAC members may be subjected to in the event of any fraud could also contribute to their lack of interest or make the effort to posses the relevant expertise;

[c] The mandated minimum [4] membership of BAC and minimum number of meeting [4] a year could be deemed to be insufficient for the BAC to do an effective overview of the core activities; and

[d] Most BAC members may not be inclined to show the necessary attention due to their non-executive role.

7.0 Conclusion

7.1 Prevention of Fraud in any organization is mainly the responsibility of the BOD and Management. However it should be the joint responsibility of all in the organization as the victims of the fraud would be all who would include innocent officers/employees.

7.2 Procurement fraud is a growing industry with rich rewards for the fraudsters who may share their riches with those responsible for prevention of fraud. Further the fraudsters and those responsible for preventive measures and in authority for enforcement of laws may also be members of the same elite clubs and professional organizations.

GSK/Aug 06

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GURSHARAN SINGH C.M.I.I.A. [Trainer –Audit Officer]
116 Jln. Hujan Manik, O.U.G. Jln Kelang 58200 K Lumpur, Malaysia

Tel. No. [H] 603-79808549 [H/P] 019-2927178

E-mail: gursharan38@gmail.com, sharwant38@yahoo.com

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