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Steven Hazel
Steven Hazel
 

CPAs Take On Russian Roulette

Detecting and preventing fraud on the Vegas strip.

February 22, 2010
by Steven Hazel, CPA, ABV

Forensic accountants are often retained to support special investigations related to a broad range of subjects. A number of skills and techniques are required to investigate and reconstruct facts, which are especially helpful in litigation assignments.

In September, I wrote about a construction fraud case that involved the use of forensics in a litigation environment. The focus of that article was how a subcontractor manipulated timesheets to his own financial advantage. This article focuses on another scheme discovered while working on that same case — the perpetration of a fraud involving both the General Contractor (GC) and a Subcontractor (Sub). 

Case Study

RGL Forensics was engaged to perform a cost audit of a large resort under construction in Las Vegas. The project consisted of a large hotel and casino, including a spa, fitness center and convention facilities. When we were hired by the resort owner’s attorney, the project was substantially over budget. We were brought in to provide the owner with a clear financial picture of how and where the money was going — a typical cost-and-schedule verification.

Background

As part of the engagement, RGL requested the standard construction cost overrun contractual and financial documentation. We began with a review of the construction contract between the owner and the GC. The GC is responsible for all of the work to be completed, but assigns various tasks to Subs for completion of the work. Each individual Sub has a contract with the GC.

In addition to the construction contract itself, the second most important document we review in these matters is the GC’s and underlying Subs’ cost reports, which detail all costs for the construction project. My previous article concentrated on the labor portion of the cost report; this article focuses on the material charges.  Most of the materials recorded on the cost report are submitted and paid invoices related to the project. Other materials charges are intercompany entries. Upon review of the materials charged to this job, some charges appeared suspect, so we requested the invoice support for each one of the charges on the cost report. In addition to the materials, other pass-through charges included supplies, travel, subsistence, overhead, etc. We will not discuss these other charges in this article.

Investigation

Multiple boxes of hardcopy invoices — enough to fill an entire room — were delivered for us to review.  As we poured over the materials portion of the charges on the cost report, we looked at vendor names, amounts and any patterns of the invoices that appeared unusual or extraordinary. On the identified suspect invoices determined to be anomalies, we analyzed vendor names, appearance of the invoices, invoice dates, description of items provided, invoice and ship-to addresses, authorizing person(s), billed amounts, etc. After extensive review, we were able to identify and prove that multiple invoices were “bogus” or false, and came from fictitious vendors. In fact, there were so many “bogus” invoices that we actually used that word in our professional report to the client, since we could not come up with a more descriptive term to document our findings.

Detection

After an exhaustive review, we determined that the main reason these fictitious vendors were needed was to fund a huge fraud between the GC and the Sub. The proceeds from the fraudulent invoices were used to bribe various people, including critical individuals such as the Sub’s project manager and the GC’s construction manager. This type of fraud requires multiple people to be successfully executed, including a “bagman” who owns the fictitious vendor(s). Many bagmen have multiple companies, with multiple clients. While we were not able to catch the bagman in this case, upon subpoena of his bank records, we found over $7 million worth of deposits in his accounts over a one-year period. We even found an invoice for a new boat purchased by the GC’s construction manager, which was accidentally included in the Sub’s production of documents.  Many other items of interest were also discovered. Armed with this evidence, we ultimately quantified an estimate of the overstatement of the direct materials the construction project owner and his attorney had charged to the job.

Conclusion

As part of this standard litigation engagement, RGL Forensics could have accepted historical financial information available without further investigation. However, a forensic accountant‘s job is to investigate and analyze all available financial information to determine its accuracy and completeness.

Additional Resources:   Antifraud/Forensic Accounting
    Business Valuation
    Document Retention and Electronic Discovery
    Laws, Rules, Standards, and Other Guidance
    Practice Aids and Special Reports
    Practice Management

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Steven J. Hazel, CPA, ABV, CFF, ASA, CVA, CMC, is a partner in the Denver office of RGL Forensics.