In our May 2023 edition of Procurement in Profile, we addressed collusion and bid-rigging in public sector tendering. The extent to which the public sector is exposed to fraud and corruption, however, goes much further than collusion and bid-rigging.
We will be taking an in-depth look into procurement fraud over a three part article series. This is the first of those articles in which we look at what procurement fraud is and why it poses should a big risk to the public sector.
What is procurement fraud?
The Fraud Act 2006 defines fraud as "a deliberate action to secure unfair or unlawful gain, or to deprive a victim of a legal right". The focus is on an individual's dishonest behaviour and their intent to make a gain or cause a loss. There are three main offences under the Fraud Act: (1) fraud by false representation (2) fraud by failing to disclosure information and (3) fraud by abuse of position.
Bribery and corruption are related criminal offences and where corrupt individuals seek advantage for themselves or others (for example, family or social connections) through actions such as bribery or favouritism in the award of public contracts. Bribery is defined in the Bribery Act 2010 as giving or offering someone a financial or other advantage to encourage them to carry out their functions of activities improperly or to reward them for having done so. Requesting, agreeing to receive or accepting the advantage offered is also bribery.
When applied to the procurement cycle, procurement fraud is, therefore, a dishonest action to deceive, with intention to influence any stage throughout the procurement cycle (up to and including a contract being awarded and in place), in order to make a financial gain or cause a loss. If proper precautions are not taken, it is possible that unlawful fraudulent activity can take place in the procurement cycle.
Procurement fraud encompasses a wide range of deceitful activities aimed at exploiting weaknesses within an organisation's procurement system. Perpetrators may be internal employees, suppliers or even collusion networks operating from both inside and outside the organisation. Their objective is to manipulate the procurement process for personal gain, which can manifest in various forms, including:
- Bribery
- Ghost of industry – this relates to employees, invoices or material / deliveries that do not exist such as extra workers (i.e. putting through costs at a day rate for people that don't exist), signing for false deliveries and duplicating invoices
- Shell companies – this is a company that has no physical presence and generates little independent economic value.A shell company scheme can be used to generate false invoices for products and services that are never delivered
- Theft – e.g. employees stealing products and selling them on for profit
- Cover pricing – this involves collusion of suppliers which then plan for specific contracts to be shared out among them all.In effect, high bids, which are not intended to be successful, make the favoured bid look more attractive
- Conspiracy
- Business email fraud (or phishing) – this is a form of cybercrime that uses email fraud to attack organisations.Criminals send an email message that appears to come from a known source making a legitimate request.This type of fraud can result in mandate fraud and identity theft
Procurement fraud is a global issue. Notable examples of procurement fraud cases over the years including:
- Petrobas Scandal (Brazil, 2014) – one of the largest procurement cases in history, the Petrobas scandal involved an extensive network of corruption within Brazil's state-controlled oil company.Executives and politicians conspired with contractors to inflate the process of construction projects and siphon off billions of dollars.
- 1MDB Scandal (Malaysia, 2015) – The 1Malaysia Development Berhad (1MDB) scandal involved the misappropriation of funds from a Malaysia government strategic investment fund.Procurement fraud was a key element of the scheme, with officials conspiring to overpay for assets and receive kickbacks.The fraud involved complex webs of offshore shell companies, money laundering and high-level corruption, resulting in billions of dollars being embezzled.
- Latvia, 2022 – more recently, four individuals in Latvia were convicted of procurement fraud in which they organised a fraudulent tendering procedure, through which they obtained €780,000 in EU funds.
The risk of procurement fraud
The procurement process involves identifying, shortlisting, selecting, and acquiring suitable goods or services or works from a third party supplier through a direct purchase, competitive bidding or tendering process – all while ensuring timely delivery in the right quality and quantity.
At every stage of the procurement cycle, there is a potential risk of fraud being committed. As the complexity of supply chains increases and procurement becomes more intricate, it is even more crucial for organisations to understand the red flags associated with procurement fraud and adopt robust preventive measures. We will be addressing these issues in the rest our article series on procurement fraud.
The likelihood that procurement fraud is being committed in your organisation should not be underestimated. The public procurement process contains one of the highest risks of illegality that can arise virtually at any stage of the process. Even before the pandemic, PwC saw a 28% rise in the number of organisations in the UK experiencing procurement fraud. Fraud risk exposure is even greater now following the pandemic with huge numbers of employees working from home and normal processes disrupted.
It is notoriously difficult to detect procurement fraud, sometimes years until a fraud is uncovered in the procurement cycle. Procurement fraud can, therefore, be very costly, particularly in procurement where losses in individual cases can run into millions of pounds over several years. Fraud in public procurement also poses a significant risk to government entities and undermines the integrity of public spending – not to mention the reputational risk that it can cause to organisations who fall victim.
Conclusion
Procurement fraud remains a significant threat to businesses, resulting in substantial financial losses and damage to organisational integrity. In part two, we look at the red flags associated with procurement fraud in relation to the procurement cycle. What should you be looking out for in order to identify procurement fraud?
