Seven Signs of Logistics Fraud May 6, 2008 5:28 PM
, By Mark Sullivan
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What do you do when you receive an anonymous tip alleging
that an executive running the transportation department is taking kickbacks?
At first such news can be hard to believe – especially when the department
performs well, maintains services in spite of shrinking budgets, and increases
savings every year. How could a department show improvement year after year and
the executive be defrauding the company at the same time?
In just such a case, an investigation revealed that cautionary flags had been
flying all along, but the company ignored them because the department continued
to perform. No one realized that while budgets and costs were reduced, they had
started from seriously overinflated levels. It’s easy to cut costs by 5% when
you’re overpaying by 25%!
Overpayment for services, one of the biggest red flags of all, tells you that the
money is there. If it is available, there’s a good chance that some people are
scheming to get their hands on it. When investigating such red flags, we’ve
found fraud in some cases and incompetence in others.
Every time, however, clients were paying millions of dollars more – usually 5%
to 25% more – than they should have for services rendered. Companies therefore
need to look for the clues that will show if something is not right.
Whether red flags are present or not, however, well-designed internal controls and
functional information systems make these frauds difficult to perpetrate. We
have yet to see fraud seep into a logistics department where strong controls
and processes are present.
Here are some of the warning signs management can watch out for in order to
minimize the risk of fraud from within:
Undocumented selection of vendors or
service providers
When a single individual selects service providers, then related, controllable,
or illicit players can be chosen. A more effective process requires competitive
bids, the oversight of a company controller, and the establishment of a cross
functional team to select carriers, third-party logistics providers, or
warehouse facilities using predefined criteria.
Rates paid are not in line with the
company’s standing in the market
Benchmark the rates you pay to service providers. It is difficult for a carrier
that earns a fair profit to distribute part of its revenues in kickbacks or
illicit payments. Even criminal carriers have to pay their drivers, purchase
gas, and provide equipment. One way to amass a slush fund is to charge slightly
above market rates on every transaction, saving these small overcharges to make
big payouts.
Payments made outside of the normal
account payable system
All payments to a vendor must first be matched to a purchase order and proof of
delivery. Progressive companies will calculate freight movement costs, create a
purchase order for the planned move, compare invoices, and insure that the delivery
took place.
Be careful if payments to service providers are: not matched to a unique
purchase order or load number; hand delivered; processed outside of the normal accounts
payable system; not accompanied by proof of delivery; paid without an automated
calculation of what the charges should be; or approved manually.
Executives with unexplained lifestyle
improvements or an extreme debt load
Some of the more common items to look for are luxury cars, trips or vacations
with representatives of the supplier, and purchases of real estate.
Business going to related parties
When a manager can choose a service provider with little scrutiny, he can take
an ownership interest in a favored carrier. For example, in an instance where
the logistics manager had sole responsibility for authorizing 100% of the
moves, matching all of the rates and invoices, and demonstrating that rates
paid were market competitive, we learned that he covertly owned part of the
sole service provider. This carrier also artificially increased its invoices to
the company by using sub-optimal equipment, raising the costs for our client by
20%.
Unusual payment patterns
Use technology to mine your own data and create exception reports. When
controls around payment matching and approvals are weak, service providers will
learn that a company does not notice when they over bill, double bill, ghost
bill, or bill for the wrong service. Falsified invoices, however, rarely follow
the same patterns as those from honest suppliers.
Any of the following might indicate fraudulent activity: a dramatic increase in
payments to one vendor; a high number of transactions under audit thresholds; consecutive
invoice numbers or multiple invoices on the same day; or payments highlighted
by exceptions to Benford’s law, which states that numbers that occur naturally
in business follow some basic patterns. Perpetrators of fraud rarely have the knowledge
or capability to fake these.
Complaints or tips
While logistics managers or executives may wield the power to navigate weak
controls to perpetrate fraud, they have a harder time fooling those working
closely with them. Eventually, they try to get rid of nonconformers or exclude
them from the “in crowd.” Paying close attention to the dynamics within a
department and the comments or complaints lodged by coworkers can provide
significant clues that things might not be what they seem.
Mark Sullivan is head of loss prevention
and managing director, Chicago, for risk consulting firm Kroll. His article originally
appeared in the Global Fraud
Report Issue 4, April 2008,
published by Kroll. He can be reached at (312) 681-1510 or msullivan@kroll.com.
Seven Signs of Logistics Fraud
