Insights & Reports > Kroll Global Fraud Report

In 1998, as part of the investigation into the metropolitan area’s interior construction industry by the New York County District Attorney’s Office, I cooperated one of the largest general contractors (CI) in the United States. The CI was a participant in the biggest kickback and bid-rigging cartel in the history of the New York City construction industry. He, along with approximately forty other individuals and companies, subsequently pled guilty to various felony crimes, including commercial bribery, after the inquiry uncovered pervasive bid-rigging on billions of dollars worth of private and public contracts.

During one of the initial debriefings of the CI, he explained the circumstances under which his participation in the cartel began.
The dialogue went something like this:

Coppotelli: What brought about the bid-rigging?

CI: In 1989, the United States real estate market crashed. From 1989 through 1991 the opportunities dried up, but the competition remained the same. The larger firms were competing for practically no work, and struggling to win enough work to stay afloat, make payroll, and maintain our standard of living. We had to do something, so some of us decided to make sure that we won what work was out there.

Coppotelli: How did you do that?

CI: We contacted people who worked with and for our clients, and who were responsible for procuring contracts – project consultants and managers, designers, architects, engineers, and facility managers within our potential customer base. We talked to anyone who could steer the award of a contract and we offered to give them a cut of the action. We also hedged our bets and beat up on subcontractors to kick us back about 10 percent of their contracts enabling us, among other things, to reduce our pricing. It was easy. Everyone was in the same boat because of the collapse. Almost no one refused.

Over the course of the investigation, we negotiated the cooperation of over a dozen high level industry executives. Each told the same story. Most provided the following additional guidance, “You should also be focusing on the unions and organized crime. They have been affected just as much by the collapse of the market, and they have been hammering us. They are the ones controlling the labor costs. If organized crime controlled companies can cut their labor costs, it won’t matter what we are doing, and they can do it easily by controlling, threatening or greasing the unions.”

The investigation confirmed one critical fact: once the structure of fraud was in place, the criminal activity continued well past 1991 in spite of a market recovery. The schemes did not stop until they were uncovered by the investigation.

Since October, 2008, public and private construction around the world has suffered in unparalleled ways due to the global financial crisis. By January, 2009, the American Institute of Architects Consensus Nonresidential Construction Forecast Panel predicted that office, hotel, and retail projects would decrease over the next two years by 28.8, 25.8, and 32.4 percent respectively. Global Insight said that the same sectors over the next two years would decline by 38.1, 40.0, and 34.1 percent. Moody’s Economy.Com put the expected drops at 45.6, 21.5, and 35.7 percent, and FMI at 36.3, 31.8, and 56.7 percent. All four have increased their pessimism in one sector or another as the year has progressed. These numbers reflect the condition and future of the United States construction industry. Clearly, its current state has eclipsed that of the 1989 to 1991 collapse, and looks set to worsen in the years to come.

So, what can history teach us? Here are three predictions for the next three years:

Fraud will increase dramatically in the private commercial construction industry. Collusive bidding, bid-rigging, kick-backs, and billing schemes for core and shell and interiors work will increase significantly by necessity. There will be a resurgence of “pay to play” practices or companies will be forced out of business.

Fraud will increase substantially on public contracts, particularly infrastructure projects. The federal stimulus package will act like a magnet, drawing ethical and corrupt alike, and will favor the dishonest as political and public corruption, collusive bidding, bid-rigging, and prevailing wage violations flourish.

Labor Racketeering and organized crime activities will rise sharply on both public and private contracts. Unscrupulous union representatives and/or organized crime controlled unions will increase their activities, allowing corrupt and/or organized crime controlled companies to violate their collective bargaining agreements, particularly their union wage rates, or prevailing wage requirements, so that they can lower their labor costs and underbid honest competitors.

Make no mistake. Consistent with historical precedent, corrupt contractors, labor officials, and organized crime have spent the past nine months planning, organizing, and coordinating their activities to survive the current economic downturn. These players look to government stimulus contracts as a vital source of revenue, a once in a decade opportunity that they will seize at any cost. They have been actively planning and coordinating their efforts, and cultivating political connections. Their tactics and planning place them well ahead of their competition’s legitimate business initiatives. What is more, federal and state law enforcement efforts currently in place to combat this behavior as well as the accountability initiatives of the federal and state agencies overseeing the distribution and use of the stimulus funds are outdated and arguably inadequate.

So, what recourse is there? Federal and state agencies need to do more than just institute the safeguards promulgated by the Recovery Accountability and Transparency Board. Those requirements, and the Board’s checklist, will not prevent collusive bidding, kickbacks, public corruption, and labor or material misusage abuses. These agencies and the private sector need to supplement their current resources and enlist or employ construction fraud experts to:

• monitor procurement proactively;
• forensically analyze the scope of work and costs submitted in bids;
• conduct detailed anti-fraud related background investigations on vendors and their principles or key managerial agents;
• forensically examine the legitimacy of costs in all requisitions or invoices as well as of those underlying change orders and “time and material” work;
• institute investigative oversight of work performed, including the integrity of labor and materials used on the project;
• require complete transparency in the disclosure and tracking of all vendor costs;
• enhance intra- and inter-agency communication to facilitate the sharing of critical information related to vendors and, to the extent possible, information related to active or planned criminal investigations.

Agencies and the private sector should not rely on project auditors, project consultants, or construction managers to conduct this work. Although they say that they provide integrity monitoring services, project auditors reconcile contracts against work completed and costs incurred, and do not conduct fraud analysis. Construction managers and project consultants have numerous conflicts of interest in handling these anti-fraud tasks, do not have any fraud detection or prevention expertise, and potentially should be part of the group monitored.

The message, then, is “praemonitus, praemunitus,” forewarned is forearmed.

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