1. Fraud and Abuse in the Construction Industry
Auditing Construction Contracts and Projects
Presenter:
William Consolie – Global Practice Leader, Construction Services

2. Objective / Introduction
Construction Project Audits
Objective / Introduction
Share construction audit knowledge and experiences regarding different types of construction contracts and risks, and identify the appropriate controls to help mitigate the risks. First Level of Control: Contract Selection/Contracting Strategy Second Level of Control: Contract Administration The Secret Weapon: Construction Audit Skills

3. Agenda Contract Selection/Contract Strategy Contract Administration
Construction Project Audits
Agenda
Contract Selection/Contract Strategy
What types of Contracts are used for construction projects and what are the risks?
Contract Administration
How do I know what to look for?
Discussion
Will solid financial controls and compliance testing destroy the relationship between the Owner and Contractor?
Can you rely on the architect to ensure cost control and quality?
Questions?

4. Contract Selection/Strategy

5. What are the Types of Contracts Used for Construction Projects?
Construction Project Audits
What are the Types of Contracts Used for Construction Projects?
Lump Sum, Fixed Cost, Stipulated Sum
Cost Reimbursable or Cost Plus
Cost Plus with Fixed or Percentage Fee
Cost Plus with Guaranteed Max (GMAX or GMP)
Cost Plus with GMAX & Shared Savings
Unit Price
Time & Material

6. Construction Project Audits

7. When do I use Lump Sum Contracts for Construction?
Construction Project Audits
When do I use Lump Sum Contracts for Construction?
Specifications and Bid Packages
Detailed Design Substantially Complete
Work Breakdown Packages
Realistic Schedule/Timeline
Delivery Dates
Milestones
Adequate Bid/Price Competition
Unit Price – Units of Measurement

8. What are the Risks Associated with Lump Sum Contracts?
Construction Project Audits
What are the Risks Associated with Lump Sum Contracts?
Bid Rigging
Material Quality Switch
Subcontractor Switch
Front-end Loading
Scope Not Performed
Work Not Complete
Insurance Not Purchased
Original Scope Presented As Change Order
Insufficient Testing
Contractor Low-balling
Contingency/Allowance Not Returned
Prevailing Wage Rate Requirements
Workmanship Issues
Fitness For Purpose

9. When do I use Cost Plus Contracts for Construction?
Fast Track Projects
State of the Art Construction
Large Dollar Contract
Completion Date in Flux
Lack of Competition

10. What are the Risks Associated with Cost Plus Contracts?
Construction Project Audits
What are the Risks Associated with Cost Plus Contracts?
Labor
Rates & Fringes (multiplier)
Uncompensated overtime
Excess reported hours
Travel & reimbursable
Union rates
Ghosts
Self-Performed work
Materials
Trade discounts
Excessive material
Scrap (attic stock) & returns
Rework
Subcontractors
Over billing

11. What are the Risks Associated with Cost Plus Contracts? (continued)
Construction Project Audits
What are the Risks Associated with Cost Plus Contracts? (continued)
Equipment
Rent to own
Charge exceeds purchase price or FMV
Excess repair costs
Sweetheart deals
Rates
Equipment not on job
Rental rebates not credited
Change orders – Pricing, OHP
Insurance – CCIP assessment
Bonds – Subguard / Payment and Performance
Home office charges - IT, check charges, infrastructure
Charging for non-reimbursable costs
Fines
Mathematical errors – Fee, CCIP, Subguard; Forecast billing

12. What Are the Risks of a Unit Price Contract?
Construction Project Audits
What Are the Risks of a Unit Price Contract?
Erroneous estimates
Mobilization/demobilization
Improper measuring/quantity verification
Re-calculation clause omitted
Quantities not delivered

13. What Are the Risks of a Time & Material Contract?
Construction Project Audits
What Are the Risks of a Time & Material Contract?
Use of incorrect labor rates
Overstated time sheets
Use of incorrect material mark ups
See Cost Plus

14. What is the Life Cycle of a Construction Project?
Construction Project Audits
What is the Life Cycle of a Construction Project?
Contract Negotiations
Construction
Retention Pay Out
Pre-Award
Contract Finalized
Contract Compliance
Close-Out
Cost Avoidance
Protective Contract Language
Process Improvement
Maintain Controls
Overcharge Identification
Establish if obligations to Subs & Suppliers have been met
Accuracy of final billing
Review back charges & buy outs
Confirm receipt of deliverables
Tax cost segregation –Tax Practice
Ensure owner favorable contract
Evaluate GC bid
Ensure adequate control structure
Tax cost segregation planning –Tax Practice
Review payment applications
Analytic review and support
Test and evaluate change orders
On-site inspections
Assess and monitor internal controls
Identify potential overcharges prior to final payment
Cost Recovery
Protective contract language recommendations
Process improvements recommendations
Tax savings (accelerated depreciation)
25%
50%
75%
100% 0%
Benefits

15. Contract Administration

16. Construction Project Audits
What are the most critical Cost Plus Contract terms in typical Construction Projects?
Right to Audit Clause
Cost of the Work
Allowance Funds
Salaried Professional Labor Rates
Contractor’s Contingency Fund
Change Orders
Bonding / Insurance
Schedule of Key Personnel
Contractor’s Fee
Retainage
Shared Savings Clause / Early Completion Bonus
Conflicts

17. Contract Terms Right to Audit Clause
Construction Project Audits
Contract Terms
Right to Audit Clause
Maintains the Owner’s right to validate costs at a later date

18. Contract Terms Cost of the Work
Construction Project Audits
Contract Terms
Cost of the Work
Establishes terms and conditions for Contractor’s reimbursable costs
Trade Costs
General Conditions (Actual costs!)

19. Contract Terms Allowance Funds
Construction Project Audits
Contract Terms
Allowance Funds
Establishes guidelines for in-scope items with unknown costs

20. Contract Terms Salaried Professional Labor Rates
Construction Project Audits
Contract Terms
Salaried Professional Labor Rates
Determines the cost and profit of Contractor’s resources

21. Contract Terms Salaried Professional Labor Rates
Construction Project Audits
Contract Terms
Salaried Professional Labor Rates
Issue: Contractor’s salaried employee labor rates (labor burden multiplier)
Risk: Contractor’s hidden profit center – overstated costs typically passed on to Owner
Solution:
Cost Avoidance: Validate Contractor labor rates & burden multiplier at contract negotiation phase, maintaining right to audit throughout project
Cost Recovery (Compliance): Validate CM labor rates & burden multiplier during construction

22. Examples of hourly labor rate overcharges:
Construction Project Audits
Examples of hourly labor rate overcharges:
Classification
Comment
Deferred Compensation
Contractor did not pay at rate used in multiplier
Paid Time Off
Sometimes not included in multiplier – charged directly to project in addition to multiplier
401K (Retirement Plan)
Easily overstated (averaged) – new employees?
Stock Option Plan
Not all employees participate
Employee Incentives
Contractor did not pay at all or at rate used
Safety/Education
Component of overhead
Small Tools
Contractor did not provide / overhead
FICA/SUTA/FUTA
Statutory Limitations excluded
Workers/Compensation
Supervision rate lower then trade labor (OCIP /CCIP may be utilized)

23. Contract Terms Contractor’s Contingency Fund
Construction Project Audits
Contract Terms
Contractor’s Contingency Fund
Establishes guidelines for draw down of Contractor’s contingency

24. Contract Terms Change Orders
Construction Project Audits
Contract Terms
Change Orders
Specifies overhead and profit markups for Contractor and Subcontractors

25. Contract Terms Change Orders
Construction Project Audits
Contract Terms
Change Orders
Specifies overhead and profit markups for Contractor and Subcontractors

26. Contract Terms Change Orders
Construction Project Audits
Contract Terms
Change Orders
Issue: Change Orders are new scope and new billing opportunity for trades resulting in an increase to the GMP
Risk: Change order costs are often overstated, with pricing that does not comply with the contract terms and conditions resulting in added costs to the Owner
Solution:
Cost Avoidance: Validate change order pricing at receipt of COR, maintaining right to audit throughout project
Cost Recovery (Compliance): Validate change order pricing at a later date during the construction phase

27. Contract Terms Bonding / Insurance
Construction Project Audits
Contract Terms
Bonding / Insurance
Specifies the type and limits for required insurance coverages

28. Contract Terms Schedule of Key Personnel
Construction Project Audits
Contract Terms
Schedule of Key Personnel
Determines who the Contractor assigns to the construction project

29. Contract Terms Schedule of Key Personnel
Construction Project Audits
Contract Terms
Schedule of Key Personnel
Determines who the Contractor assigns to the construction project

30. Contract Terms Contractor’s Fee
Construction Project Audits
Contract Terms
Contractor’s Fee
Determines when and where the Contractor can charge fee

31. Contract Terms Contractor’s Fee
Construction Project Audits
Contract Terms
Contractor’s Fee
Determines when and where the Contractor can charge fee

32. Contract Terms Retainage
Construction Project Audits
Contract Terms
Retainage
Specifies when the Owner should withhold payments to the Contractor

33. Contract Terms Shared Savings Clause / Early Completion Bonus
Construction Project Audits
Contract Terms
Shared Savings Clause / Early Completion Bonus
Details incentives to Contractor for reducing cost or finishing early

34. Contract Terms Shared Savings Clause / Early Completion Bonus
Construction Project Audits
Contract Terms
Shared Savings Clause / Early Completion Bonus
Details incentives to Contractor for reducing cost or finishing early

35. Contract Terms Conflicts
Construction Project Audits
Contract Terms
Conflicts
Dictates order of preference in event of contract conflict

36. Fraud Case Studies

37. Hospital System Kickback Scheme
A large hospital system called Experis in to investigate a recently discharged Sr. Project Manager. While reviewing the PM’s files they noticed unusual job cost activity.
Experis uncovered $1 Million in fraudulent invoices billed and paid with over $600K going into fraudster controlled bank accounts via several contractors :
Invoices for work not performed
Ghost projects set up
Cost shifting without proper authorization
Lack of internal control
Lack of proper supervision
Documented policies not adhered to

38. From the Headlines:

39. From the Headlines:

40. From the Headlines:

41. The Scam Unworked Labor Days Added
Daily Labor Hours Added
Unworked Labor Days Added
Billing of Sick Days, Vacation, etc.
Lump Sum Stipend Payments
MBE Fraud

42. From the Headlines:

43. From the Headlines:

44. From the Headlines:

45. From the Headlines:

46. Discussion

47. Construction Project Audits
Will solid financial controls and compliance testing destroy the relationship between the Owner and Contractor?
Trust but verify
The financial controls and compliance testing should confirm the choice of contractor not destroy a relationship

48. Can you rely on the Architect to ensure cost control and quality?
Construction Project Audits
Can you rely on the Architect to ensure cost control and quality?
The cost of that degree of service can be very high
The A&E firm would incur additional liability which they may not want
This is similar to relying on a Construction Manager or General Contractor to protect your interests. The architect has interests that compete with the owner and because they completed the design may incur liability. As one architect explained, “if we did what owners think we do, they couldn’t afford us”.

49. Questions?
Presenter:
Bill Consolie – Global Practice Leader, Construction Services
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