Monitoring fraud risks in the supply chain

By Sabine Vollmer

Nearly one-third of about 2,600 supply chain professionals said their companies experienced supply chain fraud, waste, or abuse the previous year, but only 40% had a program in place to detect or prevent these issues, according to a 2014 Deloitte poll. Mark Pearson, who works in supply chain forensics for Deloitte, explains how companies can probe one of the top risks—third-party expense categories—and avoid overpaying:

Track labor unit data in the smallest increments practical. Fraudulent labor charges include overtime paid for regular time worked and charges for people who are not on the payroll. Individual fraudulent labor charges can add up, especially in a large organization, because more people are involved in incurring, approving, and invoicing labor charges. Signs of potential tampering on paper time sheets include corrections, even if they are initialed; the use of correction fluid; and entries made in a different color of ink on the same day. Verify digital reports with the help of secondary or tertiary records—for example, a payroll master file that lists hire and termination dates of a vendor’s employees.

Ask vendors to account in as much detail as practical for indirect charges and to submit source documentation. Services resulting in indirect charges include professional and consulting fees and marketing and advertising expenses. These deliverables are often undefined, and it can be difficult to inventory them upon completion or to perform an analysis of the invoiced expenditures after the payment. To find potential overcharges, reconcile a vendor’s source documentation for expenses with the vendor’s bill. Start with vendors deemed most likely to be problematic. To rank risks of vendors and classes of indirect charges, follow a list of identifiable evaluation criteria, such as where the vendor is domiciled, what the dollar amount of an indirect expense is, or how long a vendor has been providing services. Work from top to bottom of the risk ranking step by step, and use the results to help establish a robust supplier evaluation framework that can be fine-tuned.

Understand the formula a vendor uses to allocate charges for services you share with others. Such charges include a vendor’s overhead or fees for storage space in a vendor’s warehouse. These charges should be written in the contract. Verify the formula with the vendor and estimate what your share or allocation should be. If your estimate is much lower than the actual bill, take the potential overcharge to the vendor and negotiate a settlement.

Define clearly what is “cost” in cost-plus contracts with vendors. This can limit inflated bills under cost-plus agreements, which tend to set charges at a vendor’s cost plus a certain percentage. Aim for contract requirements that include documentation to verify defined ingredients of cost, especially with vendors identified as high-risk in the evaluation framework.

Ask vendors to provide documents that back up their costs from outsourcing part of the job to a subcontractor. Third-party passthrough charges can add up in a supply chain, especially when subcontractors hold a partial ownership interest or another undisclosed relationship with a primary vendor, creating a potential conflict of interest if the primary vendor doesn’t closely monitor the provision of the goods or services.

Take an especially close look at one-time suppliers, even if they were procured properly. Use public records to verify the vendors’ legitimacy and identify their officers, owners, and registered agents. Also, compare the charges with those of key vendors in the industry.

—By Sabine Vollmer, a JofA senior editor.

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