Fraud Investigation by the Numbers

by Fraud Expert, Ed Martin

With continuous construction in Austin, Texas you may be hired to investigate the misappropriation of construction funds by their contractor. The investigator will ask himself / herself, where do I start? The following will act as a checklist of things to do if faced with this type of investigation.

Meet with the Client:
Remember to take care of yourself by securing a signed contract with the client defining the scope of your investigation and secure a retainer. Thoroughly interview the client and any secretary or bookkeeper about what they suspect and why.

Records are everything:
Obtain the contract between the partners and the contractor to determine the terms and conditions, including the required periodic financial reporting

and the accessibility of financial records by the member. Determine how many properties are being constructed and the estimated cost of each. Most of the time contractors get in trouble by failing to allocate materials and labor per job. This scenario is dangerous for the client. Secure any reports made by the contractor to the client and if none, determine why. Most contractors tell their employers that they are too busy to maintain an accounting. Obtain from the client all the written information possible.

Determine what are the funding sources?
Generally, the funding sources are received from invested capital contributed by the members of the entity, and / or bank construction loans. Secure records that show how much and when funds were contributed or loaned and where they were deposited.

Gather the available records:
Initially secure the records of the members including canceled checks or evidence of wire transfers; this will give the investigator a lead to the contractor’s bank account. Ask the contractor for his records, obtain a power of attorney from the contractor to obtain the records or if necessary, the client will have his attorney file a lawsuit. Have the attorney subpoena records from all known banks. This will allow you to determine the amount received and disposition of the funds and secondarily will allow you to identify leads to other bank accounts and to the ultimate disposition of the money. Subpoena the contractor for invoices for construction materials in an attempt to determine the particular job to which the materials were delivered.

Secure the settlement statements for the purchase of the land reflecting the property loan; secure bank loan documents, a bank loan history reflecting loan advances and payments. Also, review the construction draw requests, and determine the allocation of the funds expended. (Review the allocations on the draw requests and compare to the checks drawn during the draw period. This will allow you to determine if the money went for the stated purpose or if the contractor used the funds in another way.) Also obtain the checks or Electronic Funds Transfers (EFTs) notice to determine when the funds were transfers or deposited. Determine the name of the bank officer that signed off on the draw requests. Interview the officer, he / she could become an important witness. He / she may have further records of the allocation of expenditures for the construction project as represented in the draw requests and a computation of the percentage of completion.

How to solve the financial puzzle and determine if the contractor really absconded with the funds:
Analyze the bank loan records and the bank account records on spreadsheets. Be aware of transfers between accounts. Generally, the lending bank will require that the loan funds be transferred to a bank account within their bank. Unfortunately, funds are then transferred to other bank accounts and expended, possibly for the purpose on the draw requests and at times not. The analysis of the bank loan records and bank account records will allow the purification of the records and the elimination of the transferred funds to allow a focus on the actual disposition of the funds. At times, it will be determined that the funds were transferred to the account of the contractor and the check notated as “Supervisor Draw.” A review of the contract will clarify if this is authorized or not. Therefore the money has been traced to the contractor and ends there. At times, it will be determined that the funds were used to pay for materials and labor cost on other properties of the partners or of other jobs the contractor has in progress for another group of partners. These funds must also be considered as traced to the contractor and due by the contractor to the client’s job. The goal of any analysis is to determine how much money was received overall from contributed funds or bank loans, how much was expended for construction, and how much money did the contractor receive directly or to his benefit. Once the analysis it complete, the burden of proof will be on the contractor to clarify the amount he received. With a competent business litigation attorney and a prepared investigator, the contractor will have to reach a compromise to benefit your client. At that point the investigator has done his or her job.

Recommendations to Client:
Unfortunately, in my experience a number of contractors are good with their hands but lack the skill it takes to maintain financial records and the cash management skills to timely complete a job at the estimated cost. When the money starts to run out, they resort to “Robbing Peter to pay Paul.” Poor recordkeeping starts with the lack of an accounting system, a lack of notations as to the allocation of the expenditures, lost invoices, commingling of funds received and expenditures, and the payment of materials and labor on another job. With the assistance of an active member of the entity, the investigator can put together a timeline for expenditures and can be established the normal construction sequence during the construction period. This sequence will allow a reasonable allocation of expenditures if none is available.

With today’s internet access to bank accounts, individuals that employ contractors should require all funds to be deposited in the construction account and paid out of the account directly for materials and labor. They should require that they be allowed access to view the account activity over the Internet. This would allow the partners to monitor the funds received from the draw requests from the bank, the use of the funds in the bank account and would act as a deterrent to any “hanky-panky” by the contractor.

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P.O. Box 160161 • Austin, TX 78716
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