Investigating Conflict of Interest

Articles on Fraud Investigation

Investigating Conflict of Interest
By Mark R. Simmons, CIA CFE

As internal auditors, we are obligated to be familiar with the characteristics and warning signs of fraud. The purpose of this article is to examine a methodology for investigating criminal conflict of interest. A correspondent sent the following inquiry:

I am looking for some specific information that may not exist. We are trying to find an audit program /guide to gather evidence to determine if a conflict of interest exists. The issue concerns a procurement situation with alleged employee contacts to and prior relations with vendors in an RFP. We are looking for steps and ideas of what types of evidence can be gathered to identify and support whatever conclusion may be drawn. To date all we can come up with is reviewing long-distance phone records of the individuals in question. However, this only indicates a call was made from a phone, not by a specific individual.

Got any ideas or specifics for us?

There are several publications by the Office of the Inspector General, US Department of Defense, that address contract fraud, including conflict of interest and bribery (two sides of the same coin), and other crimes that result from conflict of interest:

Publication IG, DOD 4075.1-H, "Indicators of Fraud in DoD Procurement"
Publication IG/APO 7600.1-H, "Handbook on Scenarios of Potential Defective Pricing Fraud"
"Handbook on Fraud Indicators - Material"
" Handbook on Labor Fraud Indicators"
Publication IGDPH 4200.50 CIPO, "Criminal Defective Pricing and the Truth in Negotiations Act"

To obtain copies, contact:

Office of the Inspector General
Department of Defense
The Pentagon
Washington, D.C. 20301-1900

The US General Accounting Office has issued Publication GAO/GGD-96-15 "Government Contractors - Selected Agencies' Efforts to Identify Organizational Conflict of Interest" published in October of 1995.

Several excellent books have been written in the past ten years or so on contract procurement and the contract process:

Contracting Municipal Services, by John Marlin (John Wiley & Sons, 1984)
Purchase of Service Contracts, by Kettner and Martin (Sage Publications, Inc., 1987)
Contracting Out in Government, by John Rehfuss (Josey-Bass Publishers, 1989)

Those are pretty good starting points for general background.

As far as an actual investigation is concerned, the following are my personal opinions. They are offered for informational purposes only. They do not constitute legal advice, nor do they represent the only or best means to pursue the issue raised. I strongly recommend consulting with an appropriate attorney to identify and interpret the requirements under the state laws applicable to the particular circumstances of a given situation. I also suggest obtaining appropriate law enforcement or investigative support if you are going to conduct any type investigation that might result in civil or criminal prosecution. Having said that, let's jump right in.

If you already have strong indicators or suspicions (red flags) of conflict of interest, then a professional investigator and attorney should be brought in to supervise/develop a criminal or civil fraud case for prosecution. The approach and type of expertise required are outside the scope and training of most auditors - criminal evidence, the manner in which it is gathered, and the manner in which it is preserved, protected and presented, are very different from the evidence gathering activities and methods auditors are accustomed to using. If you represent a government entity, there are also legal land mines and considerations regarding the rights of the suspect(s) that, if not dealt with properly, can easily wreck an otherwise good case. You may already have sufficient predication to warrant a criminal investigation. To find out, consult with your attorney. If predication exists, you will probably be teamed with an investigator to develop the evidence of the conflict of interest and any associated felonies. If you do not yet have sufficient predication for an investigation, your attorney can tell you what you will need to develop, and what you can legally develop, under governing laws. Also remember that while conflict of interest may be a crime in and of itself, it is usually the tip of the iceberg, and directly connected to other more serious crimes such as bribery, bid rigging, and kickbacks. Keep your eye on the ball at all times - know exactly what it is you want (or are likely) to prove or disprove.

Here are some things to consider in the procurement phase of contracting, and, again, I caution you that getting this information should be the responsibility of one or more individuals with appropriate training and experience. Since you have an allegation of employee contacts with, and prior relations with, a vendor in an RFP process, the obvious starting point is an interview of the individual who made the allegation. You should ask:

What does the individual know;
How did the individual come to know it;
Who were the key individuals involved;
When did the incidents occur - dates, times and places (all - not just one or some of them);
What records and documents exist to corroborate the events, where are they, and how can they be accessed.
What witnesses can corroborate the events, where are they, what do they know, and how should they be approached;
Why did these incidents occur (motivation of each of the players); and
Why were the actions engaged in improper.

Getting the answers to these questions are really the fundamental steps of the investigation, repeated over and over with each witness or piece of evidence. Think of an investigation as a group of concentric circles, each with its own set of witnesses, events and documents, each the focus of these same questions; all of which, when taken collectively, either serve to substantially support or refute the allegation made. You want to start with the outside circle of neutral or disinterested third parties who may have knowledge and who have no reason to lie, and with documents and events outside the control of the target. You work your way in toward people, events and documents in each of the succeeding inner circles, until you have enough facts to approach your target (the innermost circle) and get his/her side of the story, looking for lies, self-serving statements, mitigating circumstances and other indicators of guilt or innocence. Your objective is to determine whether the events that occurred, the actions taken, and the results achieved by the target(s) could only be the result of a willful violation of law . If you can't eliminate all other reasonable explanations, then it is not likely you will be able to establish guilt "beyond a reasonable doubt", as is necessary for a successful criminal prosecution. However, you may still be able to establish that a "preponderance of the evidence" (i.e., more than 50%) supports a civil violation that can be successfully prosecuted to recover damages, and/or to obtain successful administrative adjudication (for the employee: termination of employment, censure, demotion; for the vendor: contract termination, disqualification from future bidding, etc.).

If the "allegator" can answer some or all of the key questions, then what results are leads that should be pursued and evaluated to prove or disprove the "facts" by again using the same basic set of questions. Other individuals can be interviewed, additional records and documents can be obtained and analyzed, discovered information can be independently verified and cross-checked. However, even if you don't know the identity of the individual who made the allegation, or if the suspicion is the result of an audit, you still have to follow the same process and answer the same set of questions. But you need a starting point at the outer circle, not at one of the inner circles.

The phone usage lies in one of the inner circles because you will need to demonstrate through witnesses (coworkers, supervisors) and documents (such as time reports, business logs, computer file records, message logs, e-mail records, procurement files, etc.) that the employee was present at the work site and present at the location of the telephone, at the time the calls were made. You also have to establish that it would not be likely that others would have made use of the phone at the identified times. You might even want to ask the target (at the appropriate time) whether he/she had exclusive access to the phone, and at what times. Therefore, this is not the first step to take, because as soon as you do this, your target is sure to become aware of your investigation, and may take steps to destroy evidence or influence witnesses and events. If pursued prematurely, and depending on the outcome of this line of inquiry, you could needlessly tip your hand and damage your investigation if it turns out you can't isolate the phone access and usage.

A better place to begin is by obtaining as much background as possible on the employee and the vendor from disinterested third party sources not likely to inform the target(s) of your inquiries:

For example, you can obtain your employee's personnel file. Identify previous employers, supervisors, names and addresses of immediate family members, beneficiaries listed for health and life insurance coverage, dependents, etc. Contact your Department of State and ask for the certificate of incorporation of the vendor involved - get the names of all corporate officers, board members, and key employees, if available; look for corporate and personal addresses and phone numbers; cross match to information in your employee's personnel file; look for the employee or immediate relatives listed as corporate officers or board members; or for phone numbers or addresses common to both the vendor and the employee or immediate family members. Contact your state tax department and ask for their help in getting information filed in vendor and individual state tax returns (your hook here is that there's usually income tax fraud if bribery and kickbacks have occurred). Use information obtained to augment your knowledge of the employment history and income history of your employee and the employee's immediate family members. Conduct research at the county clerk's office, looking for real estate transactions engaged in by the employee, or in the name of immediate relatives, that are beyond the employee's income level. Look for transfers of real property at less than fair market value, and identify the parties involved. Assess the value of the employee's residence/location against known sources of income and against other homes in the area ( a cooperative real estate agent or county assessor can be helpful here). At your state department of motor vehicles - look for cars or boats registered to the employee, or in the name of immediate family members, that are beyond the apparent income level of the employee. Look for transfers of boats or vehicles at less than fair market value, and the names of the involved parties. You can't get bank records without a subpoena, but if you do get them legally, follow the money - look for unusually large, but regular, deposits and withdrawals - trace cancelled checks back to the issuing bank accounts and find out who owns those accounts. Obtain information through a credit agency - look for regular large prepayments or paydowns of mortgage debt and other large debts; look for large prepayments against credit cards. Look for large insurance policies that have a large cash surrender value - find out from the insurer who obtained the policy and who is paying the premiums. Check with other state, local, municipal or federal agencies that either have had dealings with the vendor, or that may have regulatory oversight of the vendor, like the state labor department. Ask for their records on the vendor, and about the nature of their dealings with the vendor; ask about their experience with the vendor; ask about other information they may have regarding the vendor. Ask if the name of your employee has ever come up in their dealings with the vendor, or whether the name of your employee appears in their records on the vendor. Check with law enforcement and criminal courts for on-going investigations, and/or prior criminal indictments of the vendor, or of the corporate officers/key employees/owners of the vendor company; or of your employee or the employee's immediate family members.

Next, zero in on the RFP process and outcome, essentially looking for evidence of improper influence. First, understand what a legitimate procurement process should entail. Then, look for weak or inadequate control processes and procedures; weak or inadequate management oversight of the procurement process; circumvention of normal control processes, procedures and requirements; and form over substance in the documentation of processes, events and transactions. Look for a bending of the procurement rules in favor of the vendor; restriction of notification about the RFP; instructions to procurement personnel and bid reviewers that they are not comfortable with; RFP specifications that seem to point to only one possible vendor, or that vary significantly from past or typical procurements of the same product or service. Look for unusual timing of bid submissions; unreasonably short deadlines for bid submission; acceptance of bids after submission deadlines; vague (or no) predefined bid evaluation standards or criteria; unusually low or high bids that are not rejected as unreasonable; unbalanced bids that are not rejected; post-award "changes" to the awarded bid proposal that significantly alter the nature, substance or value of the award; restriction of competition or "sole-sourcing"; socializing with, preferential contact with or preferential treatment of the vendor prior to bid submission; frequent or regular presence of, or visits by, the vendor's principals or key employees at the offices or work site; and other breaches of "normal" procedure or practice. Look for evidence of "arm-twisting" to get "official" favors performed by the vendor on behalf of the employee; and for evidence of "official" favors performed by the employee for the vendor (such favors can be very creative - special assistance with a thorny fiscal or payment problem; picking up the tab for an office party or picnic; "loaning" contractor staff or equipment, to name just a few). These tend to be common knowledge among the staff, and can usually be picked up in casual conversation with contract managers, secretaries, etc.

Through discreet interviews with former coworkers/supervisors/associates, find out if the employee has taken any expensive vacations; whether any of the employee's immediate family is enrolled in college, and if so, how the tuition, room and board is being paid (contact the college registrar). Try to elicit other information about lifestyle, such as drug or gambling addictions; expensive hobbies, extra-marital liaisons, etc. Identify possible political, social, civic or trade organizations that your employee might belong to. Through discreet interviews of former coworkers/supervisors/associates, and inquiries to the organizations, find out whether your employee belongs to any of the organizations; then find out if any corporate officers or key employees of the vendor are also members. If dues are involved, try to find out how they are paid, and by whom. Discretely interview competitors and other customers of the vendor as to the vendor's business practices and reputation. (A word of warning: exercise extreme caution should you decide to conduct interviews of the nature described in this paragraph - you could be talking to a co-conspirator, or a loyal friend who will warn the target(s); or you could impart misleading/erroneous impressions that could result in a slander law suit against you in civil court - an experienced investigator will know who to talk to, what to ask, and how to ask it so that these risks are minimized).

Why do you need all this? So that when you ultimately approach your target(s), which could include the vendor, and ask for a reasonable explanation about any unusual or irregular items you've discovered, you'll have a pretty good chance of distinguishing truth from self-serving fiction. If your target(s) start making false exculpatories (i.e., start lying to you - itself a strong indicator of guilt) you will be in a position to effectively use that to get a voluntary confession (if you go about it the right way - and there are plenty of WRONG ways to do it that can totally wreck your case - so be very careful here also!). Ultimately, the best evidence will be the voluntarily made and signed confession of guilt. Yes, it is possible - some people are ashamed of what they've done and will tell all if approached the right way. Others will talk with the investigator to find out how much is known, and try to brazen his/her way out of the situation, which usually only gets them in deeper. A third type will "lawyer up" immediately upon learning you want to talk with them - another reason for approaching your target last. Once legal counsel is retained, your ability to collect evidence may be impaired.

This is by no means an all inclusive list of the issues of concern, or types of evidence to pursue, or steps you can take to resolve the allegation of conflict of interest and the possible crimes associated with conflict of interest. As I said at the begriming, these are my opinions. They are offered for informational purposes only, and they do not constitute legal advice. If you're pretty sure a crime has occurred, you really should talk to an attorney, and seek out the assistance of a qualified investigator, rather than playing "Dick Tracy" yourself.

This article is offered for informational purposes only so that we can better meet our responsibilities to understand the characteristics and warning signs of fraudulent activity. The content represents informed opinion - not legal advice. A qualified attorney should be sought out to identify and interpret any circumstances involving a potential breech of civil or criminal law. Comments, criticisms, and differing opinions are welcome in the spirit of furthering our knowledge and understanding.

The opinions and interpretations presented here are those of the author.

Internal Auditing and Fraud Investigation

Mark R. Simmons, CIA, CFE

Articles on Fraud Investigation