Vendor Fraud: Read the Warning Signs

Vendor fraud can be one of the worst violations of a business owner’s trust because it involves the collusion of an employee with an outside party or a conspiracy between two or more — often longtime — suppliers. Such collusion can be costly. According to the Association of Certified Fraud Examiners, the median loss in a fraud committed by a single person was $80,000, but when incidents involved two perpetrators, the median loss jumped to $200,000. When four or more perpetrators were involved, the median loss exceeded $500,000.

So it’s important that organizations know how to spot vendor fraud. Here are summaries of two common schemes.

Fix, Rig and Divide

Most people are at least somewhat familiar with the concept of price fixing. But contrary to popular belief, price fixing isn’t only an agreement among competitors to set the same price for goods or services. It also refers to competitors jointly establishing a price range or minimum price.

A similar fraud scheme is bid rigging, which involves collusion, where two or more vendors agree to steer a company’s purchase of goods or services. A bid-rotation scheme calls for all participating vendors to submit bids while taking turns as the low bidder. Under a bid-suppression scheme, two or more vendors illegally agree that at least one of the participants will withdraw a previously submitted bid or not bid at all. The intent is to ensure acceptance of one particular bid. Complementary bidding is marked by competing vendors submitting token bids with a high price or special terms that will make them unacceptable to the company.

Another way vendors cheat is through market division. This occurs when competitors agree not to compete in a specific segment of a market — whether based on geography or customer type. If bids are solicited by a customer in that segment of the market, the competitors either won’t bid or will submit complementary bids. A lack of competitive bidding functions to drive up the price for the soliciting company.

Overcharging Tricks

Vendors might involve an employee on the inside by paying that person kickbacks to facilitate his or her employer’s payment of a fraudulent invoice. The vendor typically incorporates the kickback amount in the price charged, thereby compounding the amount the company is overbilled.

Kickbacks aren’t the only vehicle for overbilling a company. Vendors can submit invoices for their goods and services that are inflated in several subtle ways. The price charged may exceed the prices agreed upon in the related contract. In other cases, the invoice might reflect charges for more goods than the customer actually received. Or a vendor could alter the date on a genuine invoice and submit for duplicate payment.

To Catch a Scheme

Train your management team about the types of vendor fraud that could be occurring in the organization. Although it’s difficult to recover damages once an incident has occurred, catching a scheme early can help limit losses. They might consider, for example, hiring an expert to conduct an analysis of vendor payments (broadly), often referred to as an integrity analysis. The analysis can focus on pre-selected vendors that represent a heightened risk whether by virtue of purchasing volume, relationships with organization management or tips received.

Better yet, encourage companies to put strong internal controls in place that will discourage their employees from attempting this type of theft. Further, organizations may consider instituting a bribery prevention policy, including prohibiting the acceptance of vendor gifts to employees and their families, or designing reporting and monitoring processes for any gifts or discounts received from a vendor.

Please contact us if you or a client may need such an analysis.


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