Seven Signs of Logistics Fraud

May 07, 2008 2:58 AM  By

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.