Suppliers who fraudulently substitute inferior materials to increase their profits put your company at risk of losing future federal contracts.
Uncovering product substitution is especially difficult if vendors and their suppliers conspire to conceal evidence of wrongdoing. This was the case in a scheme involving military airplane parts in which executives at a contractor engaged unauthorized manufacturers and falsified the corresponding paperwork (see “Aircraft Parts Suppliers Plead Guilty, Sentenced in Procurement Fraud” below).
There are signs, however, that suggest fraud may be happening and steps you can take to fight it. First, look for these red flags:
High Percentage of Noncompliant Returns
Pay particular attention if your business is having to send back a lot of parts that are not complying with the specs called for in the contract. This is particularly important if the terms of the contract have recently changed or there has been a significant increase in the prevailing market prices for raw materials used in the parts your business orders.
Overall keep an eye on the financial pressures that your suppliers could be facing. Those pressures are one component of the fraud triangle, and are often the triggering factor. Price and contract changes could affect your supplier’s profit margins and bottom line and temp the vendor to substitute inferior materials without telling your company.
The other points of the triangle are opportunity and rationalization. Opportunity results from weak internal controls. Rationalization lets an individual reconcile fraudulent behavior by believing the fraud is, for example,
- Helping save a family member or loved one; or
- Preventing the person from losing family, home, car or business.
Suspicious Compliance Certificates
Pay close attention to products that are sold with compliance certificates. Ideally, they should be reviewed in detail by a qualified staff member. Concerns regarding a certificate’s validity should be discussed and investigated immediately. Among the possible indications that something is amiss:
- A product’s certificate may be missing, appear altered or be inconsistent with previous certificates.
- Signatures may be illegible or contain typos. This is a possible indication that they were approved by a low-level staff member or completed in a hurry.
Reluctance to Provide Test Results
Suppliers substituting substandard materials may avoid product testing altogether. Alternatively, they may conduct limited testing and alter the results so they appear to meet your company’s standards.
Having staff members present at product tests can help. But it is important to send employees with the appropriate qualifications and seniority to be able to question the process and the results.
Take the Proactive Road
If you think a supplier may be defrauding your business or you simply want to stay on top of the quality of the parts you receive, your concern can adopt all or any of the following proactive measures to help combat product-substitution fraud:
Throw in some random inspections: If your company invests the time to conduct routine inspections, adding a few unannounced checks can reap significant benefits. As with most types of fraud, the “perception of detection” can dramatically reduce the probability the fraud will occur. If subcontractors know your enterprise conducts unannounced inspections, they may be much more reluctant to substitute substandard products.
Have a disinterested party review tests and replicate results: In order to confirm that your supplier is conducting the appropriate product testing, allow a specialist to conduct an independent review. This will not only send a strong message of the importance your organization places on quality, but it will also provide crucial documentation in the event your firm takes a supplier to court.
Add an audit clause to contracts: Put a “right to audit clause” in all supplier agreements. Refusing to comply with the clause and denying access to records doesn’t mean a supplier is substituting materials. But it is an action that should be considered in the context of all available information regarding that supplier’s conduct. If you suspect misconduct, consult your firm’s attorney before making any allegations.
Make suppliers sign a code of conduct: Regardless of the size or type of supplier, the code of conduct should include explicit examples of what your business considers violations. If product substitution is your organization’s concern, the code of conduct should reflect that and spell out the expectation that suppliers comply with your business’s standards. The code should also include information on your company’s fraud hotline and suggestions on when to use it.
Keep tabs on your suppliers: Your enterprise’s suppliers likely face pressures, just as your own business does. To be fully informed on what might affect suppliers’ behavior, keep track of who owns them, their office addresses and any pending litigation as well as their overall financial performance.
The Internet contains a number of sources to track news stories involving your suppliers and their owners. Depending on the size and importance of the supplier, you may consider engaging your accountant or lawyer to conduct a comprehensive background check.
Aircraft Parts Suppliers Plead Guilty, Sentenced in Procurement Fraud
Two Florida residents were convicted after pleading guilty to participating in a massive procurement scheme to defraud the U.S. Air Force and commercial aviation sector.
The convictions were part of Operation Wingspan, a two-year Justice Department investigation into the manufacture and sale of counterfeit military and commercial airplane parts. That probe uncovered losses estimated at more than $5 million.
The Details: Mariella Bianchi, owner of Airborne Group in Miami, and Juan Beltran, director of military sales at the military and commercial aircraft parts company, hired unauthorized manufacturers to make parts under contracts with the Air Force. That violated contract specifications that required either new surplus parts or parts manufactured by Boeing or other approved sources.
Bianchi and Beltran would sell and ship those counterfeit parts to the Air Force and others in the commercial aviation industry, creating false documents to misrepresent the origin and authenticity of the parts.
The pair was sentenced to 30 months in prison, three years supervised release and ordered to pay more than $1.9 million in restitution.
Four other Miami men were also charged in connection with the conspiracy and convicted on charges involving false paperwork and certifying the airworthiness of counterfeit parts.
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