Vendor fraud: Know the warning signs
Published November 11, 2019
When fraud strikes, the culprit might be sitting in your purchasing department. This department is particularly vulnerable to fraud because of the volume of transactions it processes and the varying pricing and billing policies that vendors use. Here’s a close-up of common vendor fraud scams and ways to lower your risks.
A common type of purchasing scheme involves fictitious vendors. Here, an employee in the purchasing department might set up a bogus supplier in the accounting system and then deposit payments to the supplier into his or her personal checking account.
Warnings of fictitious vendors include invoices that are photocopied, sequentially numbered, and from companies that have post-office box addresses or addresses that match an employee’s home address. Also be wary of invoices with amounts that consistently fall just below sums that require approval for payment and, depending on your business, invoices for round dollar amounts.
Bogus invoices with real vendors
Some purchasing scams require collusion between an employee in the purchasing department and someone at the vendor’s office. For example, a vendor might submit falsified invoices, and then an employee in the purchasing department will deposit refunds into his or her personal account or split duplicate payments with his or her accomplice at the supply company.
Connections between procurement staff and suppliers may provide clues to these types of schemes. Is an employee related to, or otherwise linked with, the owner or management of a supplier? If so, that employee shouldn’t make purchasing decisions that involve the vendor.
If you perform contract work, you also might be susceptible to kickbacks. That is, the person who approves the contracts could be receiving kickbacks from vendors. Red flags include fewer bids than expected or required, widely divergent bids on the same projects and unexplained deadline changes.
Kickbacks also might occur if it seems like you’re paying higher prices for lower quality products. Cash payments to employees can be difficult to detect because those payments aren’t reflected in the company’s books. They probably are, however, reflected in higher pricing from the vendor. Even fraudulent vendors must cover their costs.
Companies should look for consistent shortages, informal communication (such as mobile phone calls or personal emails) between purchasing staff and suppliers, and poor record-keeping.
You can prevent vendor fraud by targeting one of the legs of the fraud triangle: motive, opportunity and rationalization. Many preventive measures strengthen internal controls and develop policies and procedures to prevent theft, thereby reducing the opportunity to commit fraud.
For example, no employee should be authorized to handle most or all of your purchasing procedures. The person who orders supplies and materials, for example, shouldn’t check shipments or approve invoices. Consider separating these functions or rotating who’s responsible for them on a quarterly basis.
Also consider performing background checks on new vendors. Such checks can provide information on the vendors’ affiliations, ownership, litigation, regulatory or legal violations or suspensions and financial standing. This can help you weed out vendors with dubious histories.
Companies also should state in writing how they expect employees — and vendors — to conduct business. This code of ethics should be reviewed and updated annually, and employees and vendors should be required to sign it every year, even if nothing changes. Annual reminders will reinforce the idea that the company considers ethical, professional business practices a priority.
Anonymous hotlines — one for employees and a separate one for vendors — can be an effective way to detect purchasing frauds, especially those involving collusion. Giving vendors a separate hotline makes them more comfortable sharing concerns, and allows them to ask questions about the business’s ethics practices.
To catch a thief
If you notice the warning signs of vendor fraud or need assistance with reinforcing your controls, contact your MCM professional or reach out to Assurance Manager Kyle Jenkins via e-mail (firstname.lastname@example.org) or phone (812.670.3414). We can help unearth the cause of any anomalies, quantify your losses, build a defensible case (if you decide to prosecute the thief) and fortify your defenses against future scams.