Introduction and Overview
According to the World Bank, $2.7 billion a day, or more than a trillion dollars a year, is paid in bribes. These payments are a problem not just because they end up in the pockets of greedy officials, or because they are a drain on the projects” budgets, but because they set in motion a chain of events – the selection of unqualified contractors, the gross inflation of prices, the delivery of substandard goods or of nothing at all – that defeat development and add to unproductive debt. In fact, corruption and its offspring are now widely acknowledged to be the single greatest impediment to development
Based on the results of scores of investigations, this paper briefly describes how fraud and corruption schemes operate, their red flags, how they can be detected and proven and hopefully prevented, or at least deterred. It is hoped that this short introduction will suggest the real scope of the problem and motivate more concerted and practical action against it. Also included is a list of some basic countermeasures for the control of fraud and corruption.
Simply speaking, how does corruption work… how is money stolen from the projects?
Government and project officials can divert funds from projects by:
- Demanding bribes and kickbacks from contractors in exchange for contract awards and other favors. This is the most common method of siphoning funds because it is easy to accomplish, hard to detect and very lucrative: the standard 10% kickback demand on a routine $50 million road rehabilitation project, for example, would yield the dishonest officials $5 million. This is from just one project, and many officials supervise many projects.
- Secretly owning front companies that do business with the project. The profit margins are usually higher than on kickbacks, especially if the secret owners raise prices and cut back on quality, as is often the case. Corrupt officials also can profit by leasing or selling property to the projects, and by using project employees and assets in their front businesses, without, of course, paying for either.
- Converting project funds and assets to the official”s own use. These transactions usually are relatively small compared to those described above, and include:
- embezzling cash from project accounts,
- converting vehicles and computers to personal use,
- using project funds to pay for vacations, buy cars or build houses, or
- selling goods intended for the project, such as medicines, food or construction materials, for personal profit (perhaps through their front companies), and so on.
Contractors can steal from projects (and recover the cost of their bribes) by:
- Overcharging for goods and services;
- Charging for goods or services that are never delivered;
- Substituting less expensive, lower quality materials for those called for in the contract, or billing lesser-paid employees at higher rates on consulting contracts, etc.
- Many more examples are given below.
How frequently were bribes paid?
According to the investigations and a host of other sources – contractors, international aid groups and diplomatic missions, former government officials, local NGO”s, the local press – in the most corrupt environments, bribes are demanded and paid on virtually every project. African contractors in particular complained about the “System” that made them pay on every contract; several expressed dismay at the naiveté of the aid organizations and their refusal to address the problem. An employee of a US based consulting firm said their only choice in a South American country was “to pay or to protest” (the award to another).
In less corrupt areas, the frequency of payments differed depending on the type of project, the ministry involved and the level of oversight. Throughout the developing world, however, corruption is the norm and must be expected and dealt with on most projects.
What was the typical bribe amount?
The size of bribes varied, of course, and sometimes were subject to negotiation. Most often the payments were a percentage of the contract or benefit desired: usually 5% to 20% to win a contract award, and less for other favors, such as to have invoices paid or permits issued, etc. In many cases the combined payments totaled 30% to 40% of the contract value, sometimes even more. This made it impossible for the bribe payers to complete the contracts according to their specifications without significant price increases or contract amendments. More commonly, project objectives were abandoned as contractors raised prices and cut back on quality to preserve their profits.
In the worst cases (of which, unfortunately, there were many), corruption and fraud consumed virtually all of a project”s resources. In Uganda, literally 90% of a $100 million refugee resettlement project was stolen by corrupt officials and contractors. In Nigeria, Ministry officials asked an engineering company to increase its bill from about $37,000 to $640,000 (more than sixteen times), and to kickback 80% of the excess. And in Pakistan, audits revealed that 80% or more of a billion dollar social action program, and 100% of smaller study projects, had been improperly diverted.
For what purposes were bribes paid?
As noted above, corruption infected all stages of the projects, from the preplanning stage to contract award to the payment of invoices. In several cases officials tilted project design towards areas in which it was easier to collect bribes, such as increased consulting work and studies, and away from those where it was more difficult, such as the purchase of necessary scientific equipment.
Bribes also commonly were demanded and paid to be “short listed,” to approve contract amendments and extensions, to compromise auditors, to induce site inspectors and supervisors to look the other way, to avoid the cancellation of a contract for poor performance, and so on.
In several cases in Africa and elsewhere, bribes were channeled to the ruling political party to cover campaign and other expenses – inflated road projects being the most popular source for such funds. In Indonesia, bribes were relied on to cover the shortfall in official budgets. Candidates in that country for “wet” government positions (those that offered good opportunities to collect bribes) had to pay for the posts upfront and share the corrupt proceeds with their superiors.
Who received the bribes?
Also as noted above, the bribe recipients included project, government and ministry personnel at all levels (even, at the project level, clerical personnel), political parties, government and external auditors, inspectors and construction supervisors, employees of international aid agencies (to influence project design and to obtain necessary approvals), and potential competitors to dissuade them from bidding.
How the Most Common Schemes – Bribery and Kickbacks, Bid Rigging and Fraude – Operate
Most of the bribery schemes began with demands from government or project officials, rather than offers from contractors, although the latter occurred, as did cases of both sides conspiring to loot a project. In some places corruption was so ingrained that no demands were necessary and the standard payments were automatically built into bid prices.
The cases often started with the demand or offer of relatively small favors. Several contractors offered to pay for “plant or study tours” for project personnel and their spouses, which were really vacations and shopping expeditions, other contractors “rented” office space or living quarters, some of which were never occupied, from project officials at exorbitant rates. Other companies were asked, or offered, to pay for the education of project officials” children, or to employ their relatives. One consulting firm provided several years of free lodging to an international aid agency employee.
As the schemes progressed, smaller bribes often were paid in cash in local currency, as were some very large bribes (several installments of $75,000 or more), but the risk of loss and the awkwardness of such transactions usually led to other means of payment. In the West African case the bribe recipient, an employee of an international development agency, began by insisting on cash (which filled many large card board boxes), and then switched to travelers” checks, in the apparent but mistaken belief that such instruments were not traceable.
An Australian consulting firm, active in South Asia, generated cash for bribes by asking cooperative suppliers to submit fictitious invoices for slightly more than the amount needed. The firm would pay by check or wire transfer, which it recorded as a legitimate expense. The supplier would cash the payment and return the proceeds to the consulting firm, minus a 5% commission, providing the anonymity of cash as well as the benefits of a tax-deduction. In Africa, many small companies were willing to sell fictitious invoices to be used for such purposes.
Larger bribes were paid by check or wire transfer, recorded on the payer”s books as a fee to a middleman, a local agent, a subcontractor, or a “local partner.” The latter was the preferred method in Africa and Indonesia. Under this device, the host government would require that a certain percentage, usually about 10%, of the contract price of an international company, be set aside for local firms, ostensibly to promote “technology transfer” or “capacity building.” The local firms usually were mere shell companies, owned by project or government officials, their spouses, children or relatives. In some cases, all of the funds paid to them were diverted.
Bribe recipients usually wanted their payments to be made in foreign currency to an account in a developed country where they could travel on business or holiday, speak the language, had property or relatives, or their children studied. Traditional bank secrecy jurisdictions, such as Switzerland, are still popular, but more often the payments followed the paths cited above. Bribe recipients in former French and Portuguese colonies in West Africa tended to deposit funds or acquire properties in France and Portugal, those in English-peaking East Africa favored the UK. Cyprus in the Eastern Mediterranean was popular with the Russians and others in the Middle East; Dubai attracted funds from the Subcontinent. Hong Kong and Singapore were the places of choice in the Far East. Corrupt funds from Latin America, the Soviet Republics and Nigeria were found in accounts in the US and the Caribbean.
The need to pay 10%, 20%, 30% or even more of a contract in bribes required many payers to spend considerable time and effort to prepare and submit fictitious expenses, supported by false supporting documents, to generate the bribe funds, and two sets of books – one to show the project, auditors and lenders, which falsely reflected that all of the funds were applied legitimately, and the other, for internal use, which showed the amounts paid in bribes, the actual funds available for project work, and the real profits. In one Indonesian case, the contractor employed four persons full time whose sole function was to prepare fictitious invoices and false and counterfeit documents – airline tickets, hotel and rental car receipts – to cover the bribe expenses.
From Kickbacks to Hidden Interests: the Use of Front Companies
Many dishonest officials discovered they could generate larger profits by secretly owning a contractor or subcontractor of their own than by demanding kickbacks from others. Such front companies ranged from firms that actually provided goods or services (usually at greatly inflated prices) and earned millions of dollars, to empty shells that subbed out all of the work, or billed for work never done.
In a former Soviet Republic, a project supervisor set up a construction company that used state employees and assets, and hired it on his projects; in West Africa, a project manager used his project employees to staff his engineering company, which he imposed as a subcontractor on international contractors. In other cases in Russia and the former Soviet Republics, project managers purchased hundreds of thousands of dollars in office supplies, vehicles and computers through a series of front companies that they owned, and resold them to the project at several times their actual value. They compounded the fraud by delivering defective, used or inoperable equipment. Foreign suppliers were pleased to do business through the front companies because it relieved them of dealing with the otherwise inevitable bribe demands.
“Loan brokers” – professional, full-service corrupt middlemen who represent dishonest project personnel, usually in the guise of legitimate “procurement advisers,” were discovered on a number of projects in the former Soviet Republics, Africa, and South East Asia. The brokers typically were émigrés from those regions who resided in the UK or US who, acting on behalf of their client officials, helped rig bids, solicited bribes, set up front companies to hide the payments and took a cut for themselves.
As discussed above, corruption usually led to some form of bid rigging, as disreputable contractors and officials tried to eliminate honest competitors. The most common bid rigging schemes were relatively straightforward, and included:
- Drafting unreasonably narrow specifications. This was quite common, especially in IT contracts, and included specifying products by brand name, or requiring that a bidder have been selected an excessive number of times before (25 times in one India case, which excluded all competitors but one);
- Secret promises by project officials to approve later “contract amendments” to increase the price or scope of work after the contract award. This also was widespread, and is known as “buying in;”
- A variation of the above, in which the favored bidder alone is told that certain components in the request for bids will not be called for, allowing the insider to low ball that line item – a form of a scheme known as “unbalanced bidding”;
- By far the most common method of avoiding competitive bidding, however, was simply to sole source contracts to favored contractors or consultants, often accomplished by artificially splitting procurements into several separate components to avoid reaching competitive bidding levels
Collusive bidding by contractors
Secret agreements by bidders to divide markets and submit inflated bids were common in all regions. In several cases across Asia, groups of local construction companies colluded with senior government and project officials to rig the award of road construction contracts. Project officials deliberately failed to announce or publicize requests for bids in a timely manner, refused to sell bid documents to outside companies, or found trivial or invented reasons to disqualify outside companies – known as “divers” – that submitted legitimate bids. Ministry officials designated the winning bidder, or “champion,” before the requests for bids were even announced. The winner was often a shell company which the officials owned or held an interest. The winner would subcontract all of the work to smaller firms, or losing bidders, at far lower prices. The designated losing bidders submitted complementary bids – higher priced or deliberately non-responsive bids – that allowed the winner to inflate its prices sufficiently to pay off the government and project officials and the losing bidders.
The schemes were detected when it was discovered that all of the bid securities submitted by the different bidders were purchased at the same bank on the same day. That was because the designated winner was tasked to purchase all of the securities and to distribute them to the other bidders. Other indicators included losing bids that were an exact percentage apart, because they were all generated by the winning bidder by multiplying its winning bid. There was also a pattern of the winning bids falling just under the threshold of acceptable bids, with the losers being over the thresholds.
Some contractors eliminated their competitors by paying them not to compete, offering to employ them as subcontractors, or entering into collusive bidding arrangements and dividing the available work at inflated prices. Contractors and project personnel in India collaborated to file bogus bid protests, or cited contrived “pre-qualification” requirements to get rid of international firms that threatened local cartels.
Fraud by Contractors
Fraudulent practices by contractors were common, even the norm, particularly in Africa, Indonesia and the Subcontinent. The schemes were, of course, facilitated by the bribes paid to the officials who were supposed to supervise the project, and were motivated in part by the need to recover these funds. The schemes included, among many others:
- Billing for works never performed, or consultants never employed, or expenses never incurred (This is how it is possible to steal 90% of a project;
- Failing to meet contract specifications, particularly on the construction of roads (failing to lay the proper foundation, or to include drainage, or to use the proper materials);
- Delivering substandard or defective product; e.g., used vehicles or computers for new (quite common), expired or adulterated medicines, and so on;
- Billing for engineering or consulting studies at inflated rates, and delivering boilerplate or product copied from other sources at virtually no expense (also quite common);
- Overcharging for goods and civil works, often by a factor of three or four, or even more;
- Obtaining fraudulent contract amendments to increase the price of the contract;
- Submitting false or exaggerated CV”s for personnel, and billing less-qualified, lower paid staff as higher-level personnel
Common frauds by local project officials included:
- Diverting project assets – from computers to automobiles to heavy road grading equipment – to private use. Even such petty abuses can seriously disrupt a project: four-wheel drive vehicles stripped of tires, batteries and other parts become unavailable for visits to project sites, leading to deterioration and delays in the project
- Unnecessary or padded foreign travel for supposed meetings with suppliers, study tours or training;
- Creating “ghost employees” and fictitious expenses and diverting the payments.
- Leasing warehouses, equipment, or “office space” to the project or contractors.
Basic Countermeasures to Deter Fraud and Corruption
Countermeasures that can be employed by contractors that are susceptible to bribe demands include:
- Develop corporate ethics programs for employees
- Adopt strict policies controlling gifts, entertainment and travel expenses; carefully scrutinize such requests
- Conduct a thorough due diligence inquiry on prospective agents, consultants and subcontractors;
- Adopt a “Know your Business Partner” policy, and train employees to recognize and look for the red flags of corruption
- Require close scrutiny and upper-level approval of local agent, consulting or supply contracts signed in the field
- Include business integrity and broad audit clauses in all local contracts, subcontracts and consulting agreements
- Thoroughly inspect and test all goods and works received from suppliers
- Report suspected corruption, bid rigging or fraud to the organization financing the project
Countermeasures that can be employed by host government agencies and lenders include:
- Establish independent fraud and corruption investigation units
- Install and publicize confidential hotlines and other confidential reporting systems
- Establish contractor compliance and voluntary disclosure programs
- Require contractors and subcontractors to disclose all fees and commissions
- Publicize contracting and payment information, audit and investigation results on the internet and elsewhere
- Use independent inspectors to closely test and inspect goods, services and works received
- Require annual financial disclosure by all project and government officials involved in procurement or other high-risk corruption areas, such as award of licenses, permits or inspections
- Include anti-corruption warranties, business integrity and audit clauses in all contracts, subcontracts and large purchase orders.
- Audit clause inspection rights should extend to financial records to reach evidence of bribes, and be effective for at least five years after the contract closes
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