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With storm clouds on the horizon, Canada’s real estate and construction companies need to refocus on fraud
Anxiety is returning to the Canadian real estate and construction sector. After years of solid growth and steady performance, companies are finding prime development opportunities in short supply. Costs are rising as provinces and municipalities raise fees and charges to help tackle their own debt challenges. Alberta, once the country’s economic engine, is reeling from the ongoing slump in the energy sector and the province’s real estate markets are caught in the eye of the storm.
As economic winds shift and business challenges grow, real estate and construction firms should take a hard look at their fraud risk. Companies need to ensure they understand their risk and ensure they have the controls and processes in place to protect against fraud — and detect and respond to it when it occurs. Because fraud will happen; what sets successful companies apart is their capacity to quickly detect fraud and take action before it spins out of control.
Every company faces a constant, ineradicable risk of fraud, from the small (e.g., theft of office supplies) to the large (e.g., embezzlement). No matter the size, each fraud goes straight to an organization’s bottom line. Whether it’s a box of paper from the supply room, a gas fireplace from a building site or several thousand dollars from accounts receivable, each is a direct, unrecoverable loss that must be replaced. The investment is gone.
One of the frustrating truths about fraud risk is that it changes constantly, in no small part to the fact that human nature plays a major role. To understand its fraud risk, a company must look at how it does business — the processes and interactions that take place each day — and ask key questions. Is there opportunity for fraud? Are their financial pressures on the people involved? Can the fraud be rationalized? Do the individuals have the capability to carry out a fraud? As these questions illustrate, understanding people is central to coming to grips with the risk of fraud at any organization.
While the potential for fraud is unique and specific to each organization, there are wider issues and concerns that can open up any construction or real estate firm to potential fraud.
Theft of supplies from building sites is a perennial concern for construction companies, and one that commonly comes to mind. Yet the processes construction firms use in working with contractors and subcontractors can open the door to potential fraud. Is every contract signed off by an appropriate individual? Is the bidding and selection process clear, transparent and independent? Are there any relationships between company personnel and contractors or subcontractors? These process issues are common to every company; whether they translate into a real fraud depends on the specific company and its people.
For real estate firms, the larger issues of housing affordability, consumer debt levels and credit risk overall are giving rise to emerging concerns over property valuations — and the processes used to determine them. We’re seeing a growing number of properties valued on the basis of other neighbourhood properties, rather than the actual property itself; as a result, mortgages are being given that simply aren’t justified by the value of the underlying asset. It’s a practice that has many worried about a U.S.-style experience should the market take a downturn. While some financial institutions are very diligent in their valuations, others, such as second-tier and private lenders, may not necessarily exercise the same level of due diligence.
Companies sometimes aren’t quite as diligent about managing fraud risk when business is booming. When revenues are growing and profits are strong, it’s easier to absorb the odd loss. But when the winds are shifting — as they are now — it’s vital that real estate and construction firms reinvigorate their attention in this area.
Addressing fraud risk is similar to managing other business risks. It requires the company to identify the potential fraud risks that exist across the entire business and determine what controls are in place to detect or prevent fraud. Companies also need to evaluate existing controls as well. Are they strong? Have they been tested? Do they perform as expected? Do they need to be changed? Are the appropriate policies and procedures in place, including those to escalate to management as necessary?
Dealing with fraud risk isn’t a one-shot deal. A company’s risk of fraud, like all the other business risks it faces, is continually shifting and evolving. Mitigation plans, processes and controls must be continually reevaluated to ensure they work as intended and adapted, changed and reworked if they aren’t. All too often, we see plans developed with great fanfare, only to be shelved and forgotten — until after a new fraud occurs.
Companies often invest enormous time and energy in put in processes and controls to mitigate fraud and other risks, only to put very little effort into training and communication. Knowledgeable employees are far better able to support a company’s fraud prevention strategy: it’s vital that companies make their employees aware what the goals are, what’s expected of them, what to look for and what to do when they encounter a questionable situation. Fraud prevention needs to be made real for people; it has to mean something to them, not just management.
As well, companies should encourage communication and information sharing across the enterprise to better understand the complete fraud risk picture. Information that never crosses the walls of an organizational silo could mean something critical gets missed, only to cause problems for the company down the road.
Every company faces the risk of fraud each day. Addressing that risk by taking steps to understand it and putting in place controls and processes to manage, mitigate and monitor it can make a real difference to a company’s bottom line and reputation. To get out in front of fraud risk, companies should begin by asking themselves a few questions.
These questions can provide a company (and its external advisor) with valuable insights that can be used to investigate and evaluate the existing fraud controls and processes in place at your organization. Gaps can be identified and enhancements put in place to strengthen what’s there and provide even more effective protection against fraud.
Canada’s real estate and construction companies are facing a less certain, more turbulent future. As business conditions grow more challenging, the potential for fraud can rise, making it more important than ever for companies to understand their fraud and other risks that could impact their business. Addressing those risks now can help prevent a business from springing an unexpected leak when business grows stormy.
This is the third in a series of MNP perspectives on risk management aimed at Canada’s real estate and construction companies. Subsequent publications will explore fraud risk and restructuring and insolvency risk.
For more information, contact Greg Draper, MBA, DIFA, FCPA, FCGA, CFE, ICD.D, Vice President - Valuations, Forensics and Litigation Support at 403.263.3385
[email protected] or your local VFLS Services advisor.
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