Finding procurement fraud behind approved purchases

Dave Oswald CPA (CA) CA(SA), CFE, CFI
Founder and Owner of Forensic Restitution Limited

The supplier is real. The goods arrive. The invoice matches the purchase order. Someone with the right authority approves payment. Somewhere else, the purchasing manager gets a swimming pool.

Procurement fraud can survive inside a perfectly functioning approval process. A price increase is explained as a market movement, a shortage or an unavoidable supplier adjustment. The company approves it. The supplier shares the benefit with the person who helped it through.

Whistleblowers are often vital because they can reveal the private arrangement that the approved paperwork leaves out. A colleague, supplier or contractor may know who is receiving a benefit, which quotations are being manipulated, or where the real records are kept.

That is why finding procurement fraud requires more than checking signatures and matching invoices. We need to establish what the company should have paid, how the supplier secured the business, and whether someone received a concealed benefit. We also need to ask whether the people expected to investigate actually have an incentive to do so.

Dan and the supplier funded swimming pool

In one case we investigated, a man I will refer to as Dan took 20% of purchases from his suppliers. He took very little of that benefit in cash. Contractors paid for repairs to his house, a swimming pool, a sauna and other improvements.

Dan also maintained a spreadsheet of the suppliers paying him. It recorded the amounts they owed him. When a supplier performed work for his benefit, such as putting in a swimming pool, he reduced that supplier’s outstanding balance by the value of the work.

He was keeping a ledger of his kickbacks. The spreadsheet connected the suppliers, the amounts due and the benefits received. A swimming pool could therefore be recorded as settlement of a debt to Dan, with no cash payment into his personal account.

That record provided a way to test the arrangement. The supplier balances could be compared with company purchases, while reductions could be checked against invoices, work records and payments for improvements to his home. An investigator still has to establish what each entry means and corroborate it. A spreadsheet is powerful evidence when its contents can be tied to actual transactions.

His first fraud began when he joined the company. He arranged for a friend to move him and charge an excessive amount. A legitimate relocation expense provided the opportunity for an inflated bill.

The later benefits illustrate a weakness in an investigation that looks only for unexplained deposits into an employee’s bank account. A supplier can reward the employee by paying someone else. The employee receives the benefit without receiving the money.

The inquiry therefore has to follow the work as well as the cash. Who performed the renovations? Who instructed them? Where did they work? Who was invoiced, and who actually paid? Those questions can connect a corporate supplier to a private benefit.

A contractor may do good work for the company and still participate in the fraud. Quality, delivery and proper invoice processing do not establish that the purchasing relationship is honest.

Why whistleblowers matter

An employee processing invoices may see an approved price increase without knowing that the buyer is receiving a share. A contractor may know that the same buyer expects free work at home. An unsuccessful supplier may know that its quotation was never genuinely considered. Each person sees a different part of the arrangement.

A whistleblower can connect those fragments or point investigators towards the record that does. Dan’s spreadsheet illustrates the kind of evidence that an insider’s information could help locate. I am not suggesting that a whistleblower found that particular spreadsheet. The point is that a tip identifying a private ledger, a supplier-funded renovation or an undisclosed relationship can change the direction of an investigation.

The KBR case discussed below provides a documented example. Some allegations originated in Bud Conyers’ whistleblower lawsuit. His report was a route into matters that required further investigation and corroboration. [2]

A report is an investigative lead. It does not establish every allegation, identify every participant or quantify the loss. Investigators must preserve records, test explanations and distinguish first-hand knowledge from assumptions. Dismissing a report because the purchases were approved can leave the central allegation entirely unexamined.

The reporting route also matters. Staff and suppliers need a confidential channel that reaches someone independent of the purchasing decision. If the complaint is sent straight back to the person implicated, or to managers whose profits depend on the disputed costs, the organisation has created a reporting process with an obvious weakness.

Protecting a reporter’s identity, limiting disclosure and addressing retaliation are practical conditions for obtaining useful information. Someone who expects to lose their job or their supply contract may remain silent even when they know exactly where the evidence is.

When higher costs produce higher profit

A contract that reimburses costs and adds a percentage markup creates a particular problem. Higher purchasing costs can increase the intermediary’s gross profit in dollars, even when the extra cost provides no value to the customer.

Consider a simplified example. An intermediary buys goods for $100,000 and resells them at cost plus 20%. It invoices $120,000 and earns a $20,000 gross spread. If the purchasing cost is inflated to $110,000 and the same markup applies, it invoices $132,000 and earns a $22,000 spread. The customer absorbs the $10,000 excess cost and another $2,000 of markup.

The supplier may use some of its additional receipts to reward the buyer. The intermediary may also benefit from the increased markup. The customer carries the cost while the parties controlling the purchasing information have reasons to leave it alone.

This incentive is specific to arrangements where the fee or markup increases with reimbursable costs. Cost-plus contracts with a fixed fee, a ceiling or performance incentives do not necessarily produce the same result. A 10% kickback also does not automatically prove a 10% price inflation. The supplier might fund it from an existing margin. Each amount needs its own evidence.

The carpet importer that did not want an investigation

In another matter, a company imported carpets and resold them to Costco under a cost-plus arrangement. The company acknowledged that its purchasing manager was receiving a 10% kickback, but refused to investigate the purchases. Its stated concern was that establishing the overcharges could require it to repay Costco.

The company’s reluctance was itself an important part of the problem. An investigation could expose a customer claim and the company’s own benefit from passing inflated costs through its pricing formula.

Whether repayment was legally required would depend on the contract, the representations made to the customer and the evidence. The company’s fear of repayment was not a court determination. The practical consequence, however, was clear: management’s commercial interests discouraged it from establishing the extent of the wrongdoing.

Owners and customers cannot assume that every intermediary will investigate purchasing misconduct enthusiastically. Under a percentage markup, reducing costs may reduce the intermediary’s gross spread. Discovering historical overcharges may create an even stronger incentive to avoid scrutiny. That is a reason for independent review and effective customer audit rights.

Agrium and a purchasing relationship that changed sides

Agrium Inc. v. Chubb Insurance Company of Canada, 2007 ABQB 140, provides a detailed account of improper payments within a substantial raw material purchasing relationship. The company’s Redwater plant needed approximately one million to 1.1 million tonnes of phosphate rock each year. Wayne Pocha negotiated supply agreements with Office Togolais des Phosphates, known as OTP, in Togo. Douglas Milne, the phosphate operations manager, also participated. [1, paragraphs 10 to 12]

The purchasing relationship began with a favourable commercial agreement and a genuine supplier. The Chicago Amendment, signed on October 11, 1995, extended supply through December 1997, with an option to June 1998. It was intended to bridge the period until the company developed its own phosphate mine at Kapuskasing. The contract linked prices to a fertilizer market index and provided quality adjustments and 60 day payment terms. Management considered it a successful agreement. OTP did not, and replaced members of its negotiating team. [1, paragraphs 15 to 22]

Delays to the mine project created a genuine need for further supply negotiations. Pocha and Milne were instructed to seek a long term agreement in 1996. That commercial pressure supplied the setting for the improper approaches. [1, paragraphs 23 to 26]

The envelopes and offshore payments

At the end of an April 1996 meeting in Paris, OTP representative Patasse offered envelopes that Pocha testified he had no doubt contained money. Pocha said there were two envelopes and that he returned his. Milne said there was one and neither man took it. Neither reported the approach to Agrium. The conflicting accounts did not alter the fact that neither man disclosed the approach. [1, paragraph 27]

Milne testified that, after another Paris meeting in December 1996, Bodjona offered the two men US$400,000. He suspected that the offer concerned payment for security stock, phosphate rock already held under an arrangement deferring payment until the contract ended. Milne said they thanked the representatives and said they would respond. Pocha said he did not recall the offer. [1, paragraphs 14 and 39 to 43]

In January 1997, Pocha helped prepare a US$1,200,008.69 security stock invoice directing payment to Beechfield Trading Corporation through a Geneva bank. He and an Agrium secretary approved it. His company, Associate Management Incorporated, then arranged a Royal Bank account in Jersey in anticipation of a US$400,000 payment. Beechfield transferred that amount on February 18, 1997. Another US$350,000 reached Pocha in a different account in April, although its source was unclear. The judge rejected his explanation that the payments compensated future services. [1, paragraphs 49 to 50 and 60]

The approved contract and the private notebook

The 1997 agreement retained the US$34.40 base price per tonne but changed the index formula, removed a US$2.55 downward adjustment, altered the quality bonus calculation and reduced payment terms from 60 days to 15. These changes show why comparing headline unit prices alone can miss the commercial effect of a renegotiation. 

Drafts passed through senior management and legal review. Pocha received praise for his work, including a fax from his supervisor saying “Good job!” The agreement was signed in April 1997, effective retroactively from January 1. A US$1,532,655.60 invoice for the retroactive increase had already been approved by Pocha and the secretary in March. His supervisor did not learn of that invoice and requisition until June 1999. 

A notebook later seized from Pocha’s home listed changes benefiting OTP and calculated additional profits to OTP of US$9,552,300 over 18 months. It also recorded the figures US$350,000 and US$400,000. Pocha said the calculation was a negotiating tool to show the supplier the benefits of the deal. It was significant evidence, but it was not a judicial finding that Agrium had lost US$9.55 million. 

Pocha left Agrium in May 1997. His company became OTP’s agent later that year, and Agrium accepted him as OTP’s Canadian liaison. He subsequently negotiated against his former employer. The 1998 amendment increased prices and imposed take or pay obligations. OTP later assigned those obligations to Pocha’s company. Correspondence discussed collecting more than US$3.2 million without shipping rock and concealing the arrangement from people in Togo. Agrium did not pay the assigned amounts. 

How the investigation developed

An early clue was a telephone message from the Royal Bank in Jersey on Pocha’s desk, coupled with an unexplained absence during a business trip. Agrium notified Chubb of its suspicions in April 1997. The first forensic inquiry found no bank account in Pocha’s or his wife’s name, but identified calls to Jersey and Togo that he had blacked out on expense records. The investigators suggested that an account might instead be held through a company, alias or number. The distinction mattered. In 1999, further investigation identified Jersey accounts belonging to his company and transfers involving Swiss and Luxembourg accounts. Investigators also examined property purchases. The first unsuccessful search for accounts in his personal name had not resolved the underlying suspicion. 

Agrium also suspected Milne was communicating with Pocha. In June 1999 it used a confidential memorandum as an investigative test, intending to see whether information would reach Pocha. After a discussion of that memorandum, Milne made a telephone call to Pocha lasting approximately one hour and 58 minutes. Agrium then confronted and interviewed Milne over June 24 to 26. Its proof of loss identified June 24 as the discovery date because Milne made significant disclosures then. 

On July 2, 1999, Agrium commenced proceedings against Pocha, his wife, his company and Milne. A court authorised civil search of Pocha’s home recovered the notebook. Investigators also found a shredder and a garbage bag of shredded material. The discovery sequence combined an incidental clue, financial tracing, communications evidence, interviews and preservation of records. 

What Agrium recovered and why the additional claim failed

Chubb paid Agrium C$926,485 in July 2000 to compensate for the improper payments received by Pocha. Agrium also received US$243,943.13 from Pocha or his company’s Channel Islands accounts in November 2003. Agrium and Milne entered into Minutes of Resolution in February 2000. The judgment records that agreement but does not set out its terms. These are documented payments and resolutions, not grounds to assume further recovery or a criminal conviction. 

The later insurance dispute concerned additional claims, including US$20,721,878 in alleged overpayments under the 1997 and 1998 amendments. Agrium’s calculation assumed that the favourable Chicago pricing would have continued across the purchasing period. The court did not accept that assumption. Market conditions, management’s decision to renegotiate and the absence of a concluded long term agreement at Chicago prices mattered. 

The court found that Pocha received bribes and Milne anticipated a future payoff. Nevertheless, Agrium failed to establish the additional insured loss. The alleged conduct did not satisfy the policy’s theft requirement for those claims, and the evidence did not prove the claimed commercial loss. Agrium’s bad faith claim against Chubb also failed. 

This case captures the central difficulty of procurement investigations. A concealed payment is evidence of corruption. Quantifying the purchaser’s loss requires a separate, defensible account of what would have happened without that corruption. The employee’s benefit, the supplier’s additional revenue and the customer’s loss cannot simply be treated as the same figure.

KBR and inflated costs passed to the customer

The KBR litigation shows how supplier misconduct can travel through an intermediary to the ultimate customer. The US government alleged that KBR employees steered subcontracts to La Nouvelle and First Kuwaiti in return for kickbacks, with inflated costs subsequently billed to the Army. 

Some allegations originated in a whistleblower lawsuit brought by Bud Conyers. Government investigation also produced criminal admissions. Anthony J. Martin pleaded guilty in 2007 to taking kickbacks and admitted including them in subcontract prices. Stephen Lowell Seamans admitted taking kickbacks in 2006. Jeff Alex Mazon pleaded guilty to making a false written statement in 2005. 

In 2022, four KBR entities agreed to a $13.67 million civil resolution, including $1.67 million previously paid as contract restitution. The allegations included truck rental charges continuing after vehicles were returned. The Justice Department expressly distinguished the settlement from a determination of liability on the settled claims. 

The detection lesson is the combination of an insider’s report, investigative evidence and operational records. Checking whether the rented trucks were still being used tested the substance of the charge beyond the invoice.

Krahl and home improvements concealed in project costs

Krahl Construction provides another documented example of private benefits tied to corporate purchasing. Its executives and employees inflated renovation costs and created false supporting documents. Employees of two customers received kickbacks and home improvements in exchange for favourable treatment. 

Scott Solano received approximately US$500,000 in payments and US$125,000 in home renovations. Timothy Scannell received approximately US$100,000 and US$19,500 in renovations. Both pleaded guilty. 

The published account records an FBI search in January 2010, but does not identify the original tip or detection trigger. In 2013, former president John Paderta received five years in prison and former executive vice president Doug Harner received four. Restitution and forfeiture orders followed. Krahl’s Chicago office closed shortly after the search, and 180 employees lost their jobs. 

The similarity to Dan’s case is direct. Some of the reward existed in a private home rather than an employee’s bank balance. The harm also reached employees and subcontractors who had no part in the scheme.

How to investigate an approved purchase

Start with a manageable selection of purchases that can be reconstructed properly. High value transactions, unexplained price increases and changes in supplier selection are useful starting points. A company wide spreadsheet can identify patterns, but the evidence is usually developed transaction by transaction.

First, establish a defensible comparable price at the time of purchase. Match the actual specification, quantity, delivery location, availability, currency and payment terms. For resin, comparing everything labelled LDPE is inadequate. Grade, manufacturer, food contact requirements and prime versus off-spec material may materially affect value. For carpets, composition, weight, dimensions, backing and quality matter.

Second, reconstruct the decision. Obtain original quotations and correspondence, identify who invited suppliers, and establish why alternatives were rejected. Speak to unsuccessful suppliers directly. A competing quotation supplied by the buyer is not independent evidence merely because another company’s name appears on it.

Third, test the delivery and use. Were the quantities received? Did the material match the specification? Were hired assets still on site? Were purchases necessary? A genuine delivery can conceal overpricing, substitution or an unnecessary order.

Fourth, investigate the relationships and benefits within the authorised scope. Examine relevant corporate communications, supplier ownership, intermediaries, rebates and credits. Look for private work performed by corporate contractors. Personal financial records and supplier bank records require appropriate consent or lawful authority. Their absence must not be filled with assumptions.

Preserve relevant records before confronting the people involved. An early interview may provide an explanation, but it can also give participants time to align their accounts or remove evidence. Plan interviews around records that can test the answers.

Measure the loss separately from the kickback

Keep separate calculations for the employee’s benefit, the purchaser’s excess cost and any amount passed on to the customer. They may overlap, but they are not interchangeable.

Suppose a company pays $1.65 per kilogram when reliable evidence supports a comparable delivered price of $1.50. Across two million kilograms, the potential excess cost is $300,000. That calculation does not establish how much the buyer received. A 20% kickback does not necessarily mean prices were inflated by 20%, either. The percentage base and funding arrangement must be established.

Under a percentage markup, the customer’s overcharge may include both the inflated input cost and the markup applied to it. The intermediary’s own loss, benefit and potential liability need separate analysis. Avoid counting the same amount twice or treating a possible recovery as money already recovered.

Make independent scrutiny part of the contract

For customers using cost reimbursement or open-book pricing, the contract should define allowable costs, treatment of rebates and discounts, record retention and audit access. Review rights should reach the supporting purchasing records and subcontractor information needed to verify the charge, subject to the agreed terms.

Within the business, separate purchasing decisions from independent price verification. Approval by a second person adds little if that person relies entirely on the buyer’s account of market conditions. Give unsuccessful suppliers and staff a confidential way to raise concerns, and route serious allegations to someone who does not benefit from the purchasing arrangement.

A purchase can pass every internal approval and still be dishonest. The useful question is whether the company received what it paid for, at a commercially justified price, without someone secretly collecting a share. If nobody asks that question, the fraud can continue with a full set of signatures.

Sources and editorial notes
[1] Agrium Inc. et al. v. Chubb Insurance Co. of Canada, 2007 ABQB 140, February 28, 2007. Full trial judgment supplied by Dave Oswald. Paragraph references identify the evidence and findings used in the article. Read source

[2] US Department of Justice, United States Government Sues Kellogg Brown and Root Services Inc. and Two Foreign Companies, January 23, 2014. Read source

[3] US Department of Justice, KBR Defendants Agree to Settle Kickback and False Claims Allegations, June 14, 2022. Read source

[4] US Attorney’s Office, Northern District of Illinois, Two Former Krahl Construction Executives Sentenced to Prison Terms for Billing Fraud and Kickback Scheme, February 12, 2013. Read source