Friday, February 10, 2012

Avoiding Equipment Fraud

By James S. Peet, Ph.D., CFE

In December 2010, Maritime Safety and Security News published an article about fake bomb detectors being used in a variety of countries by numerous private and public organizations (including a national military force). Not only were the “bomb detectors” not functional, but those purchasing them had never verified if they worked. If your organization was relying on these bomb detectors, how effective do you think it would be at preventing a terrorist attack? The key point to take away from this event is to verify that your organization is actually getting what it paid for.

Does the Equipment Work?
If you or your organization is purchasing equipment from an outside vendor, you should strive to ensure that you’re actually getting what you pay for. With most equipment, it’s as simple as starting it or turning it on, and then testing it. Does the equipment function as it is designed to? If not, immediately return it to the manufacturer and have it repaired or replaced. In the maritime industry, equipment that fails to meet operational standards can be a matter of life and death. Who wants to operate a crane that malfunctions or fails to lift to its rated capacity, or install a safety valve that doesn’t function properly?

It’s not just shipboard and safety equipment that should be considered, but almost all equipment, including computer hardware and software.

Supplier and Manufacturer Due Diligence
One way to ensure that equipment you purchase is of a good quality is to purchase it from a reputable company. This doesn’t mean the company has to be a Fortune 500 company or have been around for decades (although this usually indicates a quality company, it’s not always the case). The company can be relatively new or even a start-up, but due diligence on the company and its officers can provide some insight into the character of the company and whether or not they have a strong commitment to quality products.

For example, if a company has a host of unresolved complaints or a bad rating by the Better Business Bureau, there might a problem with that company. Another red flag is if a company has gone through several name change and restructuring over the years. That usually indicates sufficient complaints through the courts or government agencies that the company decided to shut down to avoid further actions, and then started up again under another name.

Bankruptcy issues might also be a concern. If a company is in bankruptcy, will the support be there for your equipment when needed, or will the company go the way of the sailing cargo ship? This is an important matter, particularly when it comes to safety related equipment and essential software.

The company’s officers are important people to consider, particularly in new and start-up enterprises. Start off with some basic due diligence of the company’s officers by reviewing court records and doing some simple Internet searches on them. A history of arrests and convictions (particularly for fraud, theft, or drugs) is important to know, as are issues related to bankruptcy or civil actions (i.e., lawsuits). A lawsuit, bankruptcy, or even a divorce may mean the officer may be financial straits and might not provide the best quality product or service in an effort to cut costs and increase profits.

Equipment reviews are also an essential component of due diligence when purchasing equipment. If possible, always conduct at least a quick Internet search of the product and reviews (naturally, this is not something that can be done with special one off items). If a simple search on the Internet turns up a host of negative reviews from a variety of sources, then there might be a problem. If all the reviews are from a single unfamiliar source, delve deeper - it might be the competition trying to discredit the product.

Along with looking at the reviews to determine if the equipment works as stated, you should also look to see what actions have been taken by the company as it relates to negative reviews. If you see phrases such as “issues with earlier models have been corrected in the latest model” it shows that the company is striving to provide a quality product. But, if you see things such as “all attempts to contact the manufacturer have been ignored” or “problems that plagued the earlier models continue in this latest version” then you have a problem with the product and the company.

Don’t Overlook Internal Corruption
It isn’t just the supplier that could be defrauding your organization with poor quality equipment; it could also be an employee of your organization in cahoots with the supplier. According to the 2010 Report to the Nation, issued by the Association of Certified Fraud Examiners, corruption accounts for almost 22 percent of all fraud events, costing, on average, $175,000 per event.

When purchasing materials and equipment, an employee could be involved in a kickback scheme. This is a case where the employee uses his or her authority to purchase materials or equipment, but rather than purchase what is expected, a lower quality product is actually purchased, but at the higher quality price. The purchaser and seller collude to do this, and the purchasing employee receives a kickback from the seller.

Another opportunity for employee fraud is when one is authorized to purchase and receive property. Often, the employee will purchase more equipment than necessary, and when it arrives, return a portion of it and have the supplier refund the difference. Where the real fraud takes place is if the employee (or family member or close friend) has developed a shell company with a naming convention similar to your organization’s name. For example, if your company’s name is Pacific Maritime Shippers Co., (this name is made up by the author for example purposes only, and was not identified as a real company), an employee might open up a shell company named PMS. The employee can then deposit the refund check from the unwitting supplier into a business checking account that has been specifically set up to cash fraudulently issued check.

Ways to Prevent Fraud
Following some of the tips presented here and having a fraud prevention policy (and the will to enforce it) are the best ways to prevent these types of fraud from affecting your company. Look for things out of the ordinary with your employees (such as excessive vacations, jewelry, new cars, etc.), and, when necessary, do your due diligence. If there are signs of any of the red flags discussed here, you might wish to conduct an internal investigation to resolve the matter.

James Peet, a Certified Fraud Examiner (CFE), is the principle manager of Peet & Associates, LLC, a fraud examination business located just outside Enumclaw, Washington. He is a graduate of two law enforcement academies and has earned a BA at the University of Miami, an MA from California State University, Hayward and the Global Trade, Transportation, and Logistics Certificate, as well as a Ph.D. from the University of Washington.