Identifying and Combating Construction Change Order Fraud
In part I of our series, How to Spot Construction Change Order Fraud, we highlighted examples of change order abuse. In this post, we will dig deeper into ways to identify threatening behavior ahead of time and ways to prevent change fraud.
There are a variety of red flags to look for when trying to determine if someone is trying to commit fraud with a change order. Some of the more common conditions that can lead to or be indicators of change order fraud include:
- Lack of segregation of duties or lack of dual authorization requirements among project officials or other weak controls and procedures over the review and approval of change orders
- The winning bid is just under the next lowest bid or the apparent winning bidder is disqualified subjectively
- Late bids are accepted or extensions are granted without merit
- Poorly documented or unjustified change order requests and approvals
- When a low bid contract is awarded then followed up with a change order, significantly increasing the contract price
- A sole source contract that has been awarded below the competitive bidding threshold that is now receiving change orders which push the price above said threshold
- A contractor who receives a suspiciously high number of change orders
- Known culture of corruption among project officials, contractors, and/or design team
Combating Change Order Fraud
Now that we have discussed why change orders are susceptible to fraud and how to identify change order abuse, let's discuss a few tips and techniques to deter and detect these situations.
Studies have shown that people often do not report fraudulent behavior for fear of retribution or simply because of apathy. One remedy for this issue is to establish an anonymous project 'hotline' to report fraud. This outlet should be made available to all project stakeholders, including project officials, the design team, general and trade contractors, and even material suppliers and other vendors.
This information should be made readily available and instructions made clear to potential informants to provide specific information and the ability to be contacted anonymously if necessary:
- Provide basic information such as names, titles, and contacts of those involved…the 'who, what, when, and why.'
- The potential magnitude of the loss
- Instruct how to provide any records or documents that support the allegations
In addition, it is important to evaluate the internal controls and processes over the change order management process. Again, it is imperative that there is an appropriate level of segregation of duties and a requirement for multiple contracting officials to approve change orders, particularly those over a certain dollar threshold.
These individuals must have the necessary level of experience and understanding of the construction and change order process or otherwise must obtain these resources by employing the services of professionals such as a certified construction industry financial professional (CCIFP) and/or architects/engineers, who are independent of other project stakeholders.
For project owners who are involved in numerous and/or recurring construction projects, an analytical approach may also prove beneficial in preventing and detecting change order fraud.
This includes the review and evaluation of the following factors and documents:
- Unusually high number and/or value of change orders awarded to each contractor
- Change orders that promptly follow contract awards
- Change orders that extend the quantities of the high-priced line items
- Change orders that reduce or eliminate the low-priced line items
- Review contract documents for red flags of abuse:
- Requests for bids
- Bid evaluation reports
- Change order requests, approvals, and payments
To learn more about change order fraud and how to combat it, click on the button to download Meaden & Moore’s presentation. You can also reach out to a Meaden & Moore representative in the event you have additional questions.