A change of perspective, culture and value is important to support an authentic approach to diversity ©Getty Images
A change of perspective, culture and value is important to support an authentic approach to diversity ©Getty Images

How to spot the red flags of bid rigging for diversity

posted by Jeremy Hazlehurst
3 November 2022

Good intentions can be exploited and, as anyone with a passing knowledge of human nature will tell you, they often are. Bid rigging is one example, where for many years procurement has battled with cartels manipulating bids according to price.

But more recent targets are social and economic initiatives. In the past few years, many organisations have committed to diversifying their supplier base, often motivated by supply security, lowering risk, injecting money into developing a healthier economy, or to better align with a particular community. Some simply believe it’s the right thing to do, and for organisations operating in a complex social environment it can be a way of compensating for past social injustices. For instance, many governments legislate a minimum spend of public-sector funds with firms majority-owned by women, veterans, or black or First Nation people.

The US was a trailblazer in attempts to level the playing field, and over the last decade set up several schemes to help certified disadvantaged business entities (DBEs) compete for public contracts. The scheme was ripe for exploitation, with many cases of companies – most often in heavy industries such as demolition and construction – fraudulently winning work by falsely claiming to be DBEs. Occasionally cases still surface. Earlier this year, for instance, three metalworking firms in St Louis agreed to pay $440,000 to settle a case of alleged DBE fraud.

Cases have also arisen in Australia, where the Indigenous Employment Provisional Sum introduced in the Northern Territory in 2014 provided incentives to local construction firms that employed Indigenous workers. More than A$40m (US$26m) of contracts were awarded under the scheme. However, following complaints by whistleblowers, six companies were investigated for fraud and the scheme was criticised. Eventually several firms were accused of employing Indigenous people as a front for white-owned companies, in a practice known as “black cladding”. The initiative was wound up in 2017 and a corruption investigation was launched.

Although there are various approaches, these plots are generally perpetrated in one of two ways. Firstly, a company that doesn’t qualify for diversity criteria may create a new company to tick all the boxes as a “front”. The shell company will bid for contracts then divert work and profits to the parent firm. The other method is to pay a genuine diverse organisation to act as a “pass through”, so it can win bids then pass the majority of the work on to the non-qualifying firm and charge a fee for the service, usually in the region of 3%. Some reports of fraud have been extremely brazen, such as non-qualifying firms sending blank invoices to the pass-through agent to simply tape its logo over the top, add its own mark-up fee and forward it directly to the end-client. In some cases, the mark-up has even been handwritten on to prepared invoices.

Actively seek out genuine suppliers 

For procurement teams seeking legitimate companies that meet their diversity criteria, it is important to ensure workers at all levels are aware of the potential for fraud and can spot the signs – because it may not be as obvious as a taped over invoice.

The vetting process should start before sending out requests for bids, says CIPS: “Procurement teams should research the market in advance of issuing tenders to have an idea of the suppliers likely to submit a bid, including research on suppliers’ ethical and sustainable credentials, as well as their ability to deliver and any risk criteria you have identified.” CIPS also warns to keep bid requests “reasonable and achievable”, because “if your expectations are too high or unrealistic this could lead to suppliers overstating what they do”, or even fabricating information. Bids from firms that did not come up in the initial market research should always attract closer scrutiny.

So what should a procurement professional do to minimise the risk of diversity and inclusion bid rigging? It helps to look out for red flags and, if necessary, request evidence of a firm’s claims, including holding interviews with staff and suppliers. US law firm Cohen Seglias, which specialises in the construction industry, says when working with a company under a government scheme, contractors and suppliers should carry out stringent due diligence to assess the firm in question against the current threshold and standards. They should determine whether the company owner has the background and expertise one would expect, as well as the equipment to perform the sub-contracted work by requesting references, past-project lists or equipment inventories. Also to check that the company owner is regularly present at the work site.

More forensically, the procurer should review the contractor’s payroll to determine whether any employees are regularly working for another company, especially the prime contractor if the minority is a subcontractor. Reviewing goods orders to determine whether they are being made by the diverse or the main contractor, and asking to see contracts between the primary client and sub-contractor may be insightful. The absence of a written contract is common in cases of fraud. It is also recommended to check that sub-contractors have their own storage or warehouse facilities where the suppliers’ goods are maintained, and to visit the qualifying firm’s sub-contractor facilities to ensure they have an observable inventory of goods and own their own equipment.

It may seem like a lot of work, but the investigative element is only one aspect. In the longer term, it pays to be proactive and put time in to engaging and building relationships with diverse-led businesses in general, outside of the bidding process.

Does legislation help or attract fraud?

Many confirmed cases of this fraud have occurred where the work involves multiple small sub-contractors or where there is a government programme in place, and some believe these very initiatives unintentionally cause challenges. For example, bid rigging is a problem in the US where money is reserved for minority groups and veterans, and in Australia where funds are allocated for Indigenous people. It is less apparent in the UK, which some argue is due to the lighter-touch legislation.

One source with over 20 years’ experience in the UK construction sector says cost is an overwhelming driver, and he could not imagine a scenario where shareholders or taxpayers accept diversity criteria trumping value for money. “It’s fair to say the industry could do better on diversity, but all the big contractors have their own D&I targets and are regularly audited on these. I think most people would say that is the best mechanism for achieving these sorts of goals,” he says.

MSDUK, a body that helps connect ethnic minority-owned businesses (EMBs) with corporates looking to improve diversity in their supply chains, agrees this is less apparent in the UK, possibly due to the rules. “In our history of 16 years, MSDUK has not come across any front companies”, says founder and CEO Mayank Shah. “In the UK, with no legal requirements or quotas, chances of front companies are extremely low,” he says. Rather than laws, Shah believes the best way to stamp out this fraud is by establishing a third-party, independent certifying body with clear criteria across the board for any industry or organisation.

Going beyond governance, a change of perspective, culture and value is important to support an authentic approach to diversity. Rather than viewing ring-fenced funds as a source to be tapped by any means necessary, organisations would profit from understanding the business case for pursuing a diverse supplier base and the wider benefits this brings. MSDUK says: “Diversity helps supply chains become more competitive, agile and profitable. The under-representation of EMBs in both the public and private sectors not only hinders inclusive growth, it deprives large organisations of an alternate supply chain option. Diverse supply chains bring new ideas and benefit the bottom line.”

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