Construct with Caution: Beware of Fraud 2017 Business & Financial Conference September 18, 2017 | Nashville, TN

Presenters Reena Panchal Senior Manager (312) 879-5491 reena.panchal@ey.com Carlos Zapata Manager (914) 960-7659 carlos.zapata@ey.com 18 September 2017 Mitigating Fraud During Construction

Agenda Why is this important? Prevalence of fraud in construction Construction is often funded by external sources Prevention and detection are possible 18 September 2017 Mitigating Fraud During Construction

Prevalence of fraud in construction 18 September 2017 Mitigating Fraud During Construction

Construction industry fraud schemes Percent of Cases Corruption 36.00% Billing 27.90% Non-Cash 22.10% Expense Reimbursements 20.90% Financial Statement Fraud 17.40% Payroll 16.30% Skimming 15.10% Check Tampering 10.50% Cash Larceny 8.10% Cash on Hand 7.00% Register Disbursements 1.20% Source: ACFE 2016 Report to the Nations on Occupational Fraud and Abuse 18 September 2017 Mitigating Fraud During Construction

Factors leading to fraud Economic pressure and project overruns Lack of internal controls Lengthy process for permits / licenses Joint-ventures and other forms of partnerships Factors leading to fraud Project financing Use of contractors and consultants or agents Changing conditions Material procurement Management of labor force Complex payment process Competition for contracts Bid Plan Design Procure Build 18 September 2017 Mitigating Fraud During Construction

Top construction fraud schemes Bribery and corruption False representations including financial statement fraud Top construction fraud schemes Phantom subcontractors or vendors Falsifying payment applications Diverting purchases or stealing / substituting material Overbilling Change order manipulation Payroll and labor fraud Manipulating SOV and contingency accounts Diverting lump-sum cost to time and material cost Bid rigging and collusion Bid rigging and collusion Bid Plan Design Procure Build 18 September 2017 Mitigating Fraud During Construction

Case study – Skanska Overview: A subsidiary of one of the nation’s largest construction companies paid $19.6 million to settle criminal allegations that it committed fraud against government programs on more than a decade’s worth of public works projects. Investigation: The Skanska investigation was conducted by the inspectors general from the Metropolitan Transportation Authority, the Port Authority of New York and New Jersey, the federal Transportation Department’s Office of Inspector General and the federal Labor Department’s Office of Labor Racketeering and Fraud Investigation. Findings: While Skanska and other companies paid an MWBE subcontractor tens of millions of dollars, the subcontractor had no employees or equipment and did no work. The actual work was performed either by the general contractor or third-party companies. Skanska was the general contractor on 10 projects, and six other Metropolitan Transportation Authority projects for which it hired Environmental Energy Associates to evade the minority requirements. 18 September 2017 Mitigating Fraud During Construction

Case study – ABC Cooperative Overview: An electrical contractor, his wife and the General Manager of a Utility company were sentenced to federal prison and fined for an attempt to siphon off FEMA disaster relief funding. In 2005, ABC Cooperative (ABC) received a FEMA Public Assistance grant totaling $2.9 million for straightening damaged utility poles following Hurricane Wilma. ABC then sole sourced with Utilities Services, Inc. (USI), a company it owned, to complete the utility work. The General Manager of USI subcontracted the work to a local company owned by his relatives. Investigation: The investigation was conducted by United States Attorney for the Southern District of Florida, Internal Revenue Service Criminal Investigation Division, Department of Homeland Security Office of Inspector General and the Highlands County Sheriff’s Office. Findings: The DHS OIG discovered that the General Manager and his relatives had agreed to a kickback scheme for the sole-sourced work. As the relatives received payments totaling $992,700 for the FEMA work, they paid the General Manager over $200,000 in kickbacks. 18 September 2017 Mitigating Fraud During Construction

Construction is often funded by external sources 18 September 2017 Mitigating Fraud During Construction

Financial Recovery Funding Sources Commercial Property Insurance FEMA Public Assistance Other (HUD CDBG-DR, FEMA 404 etc.) 18 September 2017 Mitigating Fraud During Construction

Property Insurance Building, Equipment, Supplies, Leased/ Consigned Items, Employee Property - Replacement vs ACV Extra Expense Business Interruption 18 September 2017 Mitigating Fraud During Construction

FEMA Public Assistance Governed by Stafford Act Property only Same “design, function, and capacity” Grantee (State) and Subgrantee relationship Pays only after Insurance Project worksheets Procurement considerations Force account labor and equipment Oversight – OIG audits 18 September 2017 Mitigating Fraud During Construction

Key risks Large amounts of recovery work not reimbursed through insurance or Federal grants Temporary withholding of cash payments and severe cash flow issues Deobligation of funding State and federal investigations Negative publicity Mistrust with constituents 18 September 2017 Mitigating Fraud During Construction

Top Audit Issues Duplication of billings Reconciliation of billings not performed (incorrect rates for equipment, labor, and benefits) Questionable costs Ineligible expenses, work performed, claimed Ineligible contract method used Failure to follow procurement procedures Cost/price analysis not performed Did not clearly define required services or performance standards of contractor Did not document the basis for the contract award Use of non-capped time and material contracts for extended period of time without proper justification 18 September 2017 Mitigating Fraud During Construction

Case study – City of San Diego Overview: The DHS OIG recommended that FEMA disallow $1.2 million of $6 million in Public Assistance Program Grant Funds awarded to the City of San Diego Investigation: Audited $4 million of the $6 million of FEMA Public Assistance Grant Funds awarded to the City of San Diego for damages resulting from heavy rainfall and flooding Findings: $654,348 in excessive landfill costs Misclassified the debris as a type for which the City’s landfill charges a higher rate $393,704 in fees unrelated to the disaster Ineligible recycling fees $112,279 in costs related to preexisting damages $2,894 in excessive equipment costs Used higher rates without documenting/explaining why rates were more appropriate 18 September 2017 Mitigating Fraud During Construction

Prevention and detection are possible 18 September 2017 Mitigating Fraud During Construction

Controls/Best Practices - Procurement Segregation of duties for bidding and evaluation processes Fair and open procurement (for FEMA grants) Clear scope of work Independent price/cost estimate Clear bid evaluation criteria Documentation and monitoring of authorization procedures for purchase orders, invoicing, and payments 18 September 2017 Mitigating Fraud During Construction

Controls/Best Practices – Accounting & Documentation Segregation of duties for: Bidding and evaluation processes Invoice review and approval processes Payroll processes Contemporaneous review of invoices Reconciliation of invoices to contractual documents Reconciliation of invoices to underlying support (timesheets, receipts) Processes to identify duplicate invoices and purchase order numbers Documentation and monitoring of authorization procedures for purchase orders, invoicing, and payments Bank reconciliation and review procedures to check for out-of-place vendors and endorsements 18 September 2017 Mitigating Fraud During Construction

Best practices – Grant & Insurance Recovery Have policies and procedures in place to handle federal grant funding and insurance recovery requirements Provide relevant training to all departments which could potentially be involved in the recovery process Ensure that the final claim made for each project is supported by amounts recorded in the accounting system Ensure that each expenditure is recorded in the accounting books and is referenced to supporting source documentation (checks, invoices, etc.) that can be readily retrieved Ensure that expenditures claimed under the FEMA project are reasonable and necessary, are authorized under the scope of work, and directly benefit the project Ensure that required records are retained for three years after closeout of the disaster 18 September 2017 Mitigating Fraud During Construction

Questions? 18 September 2017 Mitigating Fraud During Construction