In the midst of continuous construction in Austin, Texas I have been hired to investigate the misappropriation of construction funds by contractors. Where do I start? I start with this checklist of things for investigators and attorneys to consider when investigating fraud.
1. Meet with the client
Your investigation begins with a client meeting. Thoroughly interview the client and any co-workers or support staff with relevant knowledge about the suspected fraud. Clarify exactly what they suspect and why. This is the time to define the scope of the investigation and secure a signed contract and a retainer. \
2. Obtain records
Obtain and review the contract made between the client and the contractor to determine the agreed upon terms and conditions, including the required periodic financial reporting and the accessibility of financial records by the client. Determine how many properties are being constructed and the estimated cost of each. This is important because contractors often fail to allocate materials and labor per project, opting instead to take draws, which is a dangerous and nebulous scenario for the client. Secure any reports made by the contractor to the client and if there are none, determine why. Most contractors tell their clients they are too busy to maintain accounting, which creates confusion and increases risk for the client.
3. Determine funding sources
Funds are generally received from invested capital contributed by the client of the entity and/or bank construction loans. For all funds contributed or loaned secure records that show dates and amounts of funds and where they were deposited.
4. Gather and review additional records
Secure all relevant client records, including bank statements and canceled checks or evidence of wire transfers. This will provide a lead to the contractor’s bank account. Ask the contractor for his records (bank records, invoices, etc.); if necessary, obtain a power of attorney from the contractor to obtain the records. The client may need to have his attorney file a lawsuit and subpoena records from all known banks. The bank accounts will allow a determination of the amount received and disposition of the funds and allow the identification of other bank accounts. If necessary, subpoena the contractor for invoices for construction materials in an attempt to determine the particular job to which the materials were delivered.
Additional records to secure and review include:
- Settlement statements for the purchase of the land (reflecting the property loan)
- Bank loan documents
- Bank loan history (reflecting loan advances and payments)
- Draw requests – Comparing the allocations on the draw requests with the checks drawn during the draw period will allow you to determine if the money was spent for the stated purpose or if the contractor used the funds in another way.
- Checks or Electronic Funds Transfers (EFTs) – Use these to determine when funds were deposited. Identify and interview the bank officer who inspects the progress of the project and signs off on the draw requests. 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. Beware of potential negligence on the part of the banker when inspecting the construction site and authorizing construction draws.
5. Solve the financial puzzle
Use DIO financial investigative technology to analyze the bank loan and bank account records. Pay particular attention to transfers between accounts. Generally, the lending bank will require that the loan funds be deposited to a bank account within their bank. However, funds may then be transferred to other bank accounts and expended for unauthorized purposes. The DOI analysis will “purify” the records and enable a focus on the actual disposition of the funds.
Enlist the client’s help to establish a timeline for expenditures and the contractor’s to establish a typical construction sequence. This will inform a reasonable benchmark allocation of expenditures. The goal of your analysis is to determine how much money was received, how much was expended for construction, and how much the contractor received directly or to his benefit.
Potential outcome 1:
You may determine that the funds were transferred to the account of the contractor and the check notated as “Supervisor Draw.” If this is authorized in the contract, the money has been traced to the contractor and the investigation ends there.
Potential outcome 2:
You may determine that the funds were used to pay for materials and labor costs for other jobs the contractor has or other unauthorized expenses. The burden of proof will be on the contractor to justify his actions. With a business litigation attorney and a prepared investigator, the contractor will have to reach a compromise to benefit your client.
Recommendations to clients
Many talented contractors lack cash management and accounting skills, and sometimes innocently set into motion a negative spiral of poor recordkeeping, inefficient or nonexistent accounting systems, haphazard tracking of allocations, and lost invoices. When cash is tight they “rob Peter to pay Paul,” which results in commingling of funds and spending one client’s money on another client’s job.
Online accounting and banking tools are ubiquitous today. 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. Clients should insist on full access to view the account activity at any time. This simple step of client oversight is a strong deterrent to any “hanky-panky” by the contractor.