Investigating Corruption In The Construction Industry Construction Essay

Investigating Corruption In The Construction Industry Construction Essay Corruption is a longstanding issue within the Construction Industry worldwide. What Effects have the Recent Bidding Scandals had on the UK Construction Industry and what are their Implications for the Future Worldwide, the construction sector is regularly rated as one of the most corrupt industries and the UK has not escaped these unlawful practices. In fact, in 2006 the Chartered Institute of Building (CIOB) published a survey entitled Corruption in the UK Construction Industry, which showed that corruption was present to some degree in many areas of this sector and that more should be done to tackle this issue. The industry was further rocked by the Office of Fair Tradings (OFT) Investigation into Bid Rigging in the Construction Industry. This topic is current and on-going and the main focus of my project. The aim of my project is to investigate the widespread effects and outcomes of bid rigging on the UK Construction Industry and how companies can tackle such problems. Scandals have included many large, high profile companies within the UK, damaging both reputations and trust. The project concludes that corruption in the form of bid rigging appears to be long standing and endemic in the construction industry and, often, an acceptable practice. Even though legislation against such practices exists and new legislation has/is coming on stream, this has not managed to stamp out these illegal practices. If the UK finds it difficult to control corrupt practices with legislation in place it most certainly follows that worldwide where practices are not subject to the same legislation, the problem is huge. There is a need for monitoring, greater transparency and staying within the law. Introduction (292) There are many reasons why corruption takes place including greed, a lack of transparency and accountability, bureaucracy and a lack of law enforcement. Corruption is fuelled by the enormous sums of money involved in carrying out projects and wherever money changes hands practices are open to corruption. Corruption is illegal and causes serious problems. Corruption in construction takes many different forms, from bribery or misuse of power/position to obtaining large sums of money through fraud or other dishonest behaviour. In order to win contracts companies would normally not have won, corrupt practices take place. This has an effect on the decision making and independent processes and causes costs to rise. Corruption in the construction industry is a world-wide problem; it is not just confined to developing countries, as there is extensive evidence of corruption taking place in developed industrialised countries. The United Kingdom has extensive experience of corruption in the construction industry and, as a consequence, advanced systems of corruption have evolved. High profile, leading companies have been involved in corruption scandals provided by large public sector contracts being issued to the private sector, which often means that taxpayers are likely to have been massively overcharged. Politicians have been found guilty of improperly accepting cash from businesses. Scandals such as cash for amendments and cash for favours have been uncovered in recent years. Public sector contracts and concessions are the single greatest source of corruption in the UK and the majority of corruption cases in the UK are connected to the award of contracts. The use of illegal payments for contracts is widespread. A report by Transparency International listed the construction industry as the business sector most prone to bribery ahead of even the arms, defence, oil and gas industries. Research Review (2134) This review focuses on reliable primary and secondary sources. Very little speculative information has been used in this study. Corruption is an illegal practice and by its nature is difficult to establish and to accuse companies of such practices without circumstantial evidence would likely lead to cases of slander or libel as the companys reputation would be at stake. No company is going to admit freely to adopting an illegal practice. Speculative information is therefore in short supply. What is corruption? Corruption, with reference to the construction industry, is the abuse of power or resources for personal gain by extortion or offering bribes. This includes collusion, i.e. an agreement between two or more people. It is used to limit open competition by deceiving or defrauding others of their legal rights, leading to gaining an unfair advantage. In a Global Corruption Report produced by Transparency International in 2005 it was estimated that the cost of corruption in the UK could be circa  £3.75 billion per annum, a vast sum of money. At the time they drew up an anti-corruption code for individuals in the construction and engineering industry. Tendering The main purpose for the principal contractor, the sub contractors and suppliers is to win contract work on a competitive basis and to ensure that the profit margin placed within the tender is maintained or exceeded. If the reverse occurs, where a loss is made, it can be made up during the trading period of the company with other projects; however large losses cannot be maintained indefinitely and could lead eventually to the closure of the company. Some companies will submit to tender with no intention of winning the work, solely to maintain the reputation and references of their company. This can have adverse effects on smaller companies who need the work however are beaten by larger companies. There is a cost to the contractor for tendering. Construction firms have to survive in a high risk market and losing contractors lose their costs of tendering. Illegal Practices within the Construction Industry affecting the tendering process Cartel A formal agreement among competing firms to fix prices, marketing and production. [The European Unions competition law explicitly forbids cartels and related practices. Competition Act 1998 and Article 81 of the EU Treaty] Bid Rigging Bid rigging is a form of fraud in which a commercial contract is promised to one party even though several other parties also present a bid to make the process look acceptable. This is a form of price fixing and illegal in most countries, including the UK. Cover Pricing Cover pricing takes place when companies join together to overbid for a contract they have no intention of winning. One or more bidders tenders an inflated bid with an intention not to win the contract This is misleading to clients as it gives a false representation of the real extent of the competition as the client is unaware of the contact between the bidders and cheaper firms are less likely to be invited to tender. Often builders do this to avoid being taken off the tendering list of contractors. Compensation payments known as bungs may take place in exchange for a cover price Both these practices can have the effect of inflating the final contract price. Blacklisting A blacklist is a list or register of persons who, for one reason or another, are being denied a particular privilege, service mobility, access or recognition. SCANDALS Case Studies One very large scandal to hit the UK construction industry recently was the Office of Fair Tradings investigation into bid rigging and cover pricing. A primary source of information. The Office of Fair Trading (OFT) started one of the largest investigations in its history against the construction industry in April 2004. The investigation into the cartel behaviour which it claims artificially inflated the cost of  £3 billion of public and private sector contracts. 112 companies were accused of years of price fixing. It formally accused the industry of bid rigging and cover pricing, contrary to the Competition Act 1998. The contracts investigated included several public sector projects to build schools, hospitals, universities and social housing. This bid rigging often involved the use of false invoices. The OFT reported that in the course of its investigation it found evidence of cover pricing in thousands of tender processes in the construction industry involving many more than those named. The inquiry involved dozens of investigators and lawyers and firms had their offices raided during the process. The industry admitted privately that the practice of bid rigging and cover price fixing was widespread for some time before the OFT intervened. Among those named were large companies such as Carillion, Balfour Beatty and the Kier Group but many small family run businesses were also involved. The OFT had the power to fine the companies up to 10% of their global turnover for breaches of competition rules and several firms admitted their guilt in order to reduce their fines to 1% or 2% of turnover. The Information Commissioners Office (ICO), also a primary source of information, uncovered serious breaches of the Data Protection Act and served Enforcement Notices on 14 construction firms who had paid for illegal information on potential employees. Firms including Balfour Beatty and Laing ORourke paid annual fees of  £3,000 to obtain sensitive information on workers and over 40 construction companies were accused of flouting the law by paying for personal information on blacklisted construction workers. Construction firms would use the illegal list to vet potential new employees. The data included information on personal relationships, trade union activity and employment history. The ICO said that companies paid a  £3,000 annual fee to a firm known as the Consulting Association to use the service. Consulting Association was owned by Ian Kerr, who faced prosecution by the ICO for breaching the Data Protection Act. According to the ICO the firm operated for 15 years. Deputy Information Commissioner, David Smith, said: This is a serious breach of the Data Protection Act. Not only was personal information held on individuals without their knowledge or consent but the very existence of the database was repeatedly denied. The covert system enabled Mr Kerr to unlawfully trade personal information on workers for many years helping the construction industry to vet prospective employees. Smith said the ICO was considering what regulatory action to take against the construction firms who had paid for personal information from the blacklist. I remind business leaders that they must take their obligations under the Data Protection Act seriously. From 16 March the ICO said it will operate a dedicated enquiry system for people who believe personal information about them may be held on the database. Prosecutions for such corrupt activities are not new. A famous corruption case from the 1970s was the Poulson case, involving public works contracts, which led to the resignation of a Government Minister, the then Home Secretary, The Right Honourable Reginald Maudling. This case was very well documented legally and is a primary source of information. Architect John Poulson was jailed for five years in 1974 for corruption after being found guilty of bribing public figures to win contracts. After his business failed in 1972 an investigation showed it had been making payments to several MPs, police officers, health authorities and civil servants. This case was one of the longest for corruption in legal history. Scandal of  £19m rigged building tenders An investigation by the Office of Fair Trading found that two firms colluded with each other on tendering for the  £8.3m project to renovate Bradfords Eastbrook Hall. Bidding processes designed to ensure clients and, in many cases taxpayers, receive the best possible choice and prices were distorted, creating a real risk of increased prices. This decision sends a strong message that anti-competitive and illegal practices, including cover pricing, must cease. Five charged with corruption over  £66m engineering construction Five men have been charged with offences of conspiracy to corrupt following a two year investigation into allegations of corruption in the energy sector between January 2001 and August 2009 and it is alleged that inside information was being offered to companies bidding for contracts in high value engineering projects in return for a percentage of the contract value. The case will be heard during November 2010. Local examples Last year, Regional Development Agency Advantage West Midlands withheld  £511,046 of funding from Stoke-on-Trent council due to concerns over the procurement procedures of the North Staffordshire Regeneration Partnership (NSRP), for which Stoke-on-Trent Council is the accountable body. AWM finally released the money last month after NSRP agreed to address procurement issues over the engagement of consultants identified by an audit and independent review by KPMG. The council insisted that no deliberate wrong-doing had taken place. In March this year, Staffordshire Police began an investigation into the award of the contract to  demolish the former Westcliffe Hospital site, which was re-tendered following an internal investigation which found that the correct procedures had not been followed. The meeting also heard that the council had paid a company  £3.2 million for building maintenance over the past three years without tendering for the work. The above are a few example cases of which there are many. These practices have still taken place despite the existence of laws governing conduct. It is recognised that it is up to each individual company to comply with the law and there are severe penalties in force for those that do not. The UK construction industry is committed to compliance with UK and EU competition law. Competition helps to lower prices and give more choice. There are established laws in the UK on anti-competitive behaviour. The Competition Act 1998 This law prohibits anti competitive agreements such as cartels between businesses and also anti competitive behaviour. The OFT is there to enforce competition laws but does rely on complaints to help enforcement. A wide range of information published by the OFT is available to companies on the Competition Act. Enterprise Act 2002 This is an Act passed to give legal powers to the Office of Fair Trading, the Competition Appeal Tribunal and the Competition Service. à ¢Ã¢â€š ¬Ã‚ ¦to create an offence for those entering into certain anti-competitive agreements; to provide for the disqualification of directors of companies engaging in certain anti-competitive practices à ¢Ã¢â€š ¬Ã‚ ¦.. The Serious Fraud Office (SFO) Available advice from the SFO includes a list of corruption indicators. Some of these indicators can be applied to the construction industry both in the UK and worldwide. Abnormal cash payments Pressure exerted for payments to be made urgently or ahead of schedule Payments being made through 3rd party country, e.g. goods or services supplied to country A but payment is being made, usually to shell company in country B Abnormally high commission percentage being paid to a particular agency. This may be split into 2 accounts for the same agent, often in different jurisdictions Private meetings with public contractors or companies hoping to tender for contracts Lavish gifts being received Individual never takes time off even if ill, or holidays, or insists on dealing with specific contractors him/herself Making unexpected or illogical decisions accepting projects or contracts Unusually smooth process of cases where individual does not have the expected level of knowledge or expertise Abusing decision process or delegated powers in specific cases Agreeing contracts not favourable to the organisation either with terms or time period Unexplained preference for certain contractors during tendering period Avoidance of independent checks on tendering or contracting processes Raising barriers around specific roles or departments which are key in the tendering/contracting process Bypassing normal tendering/contractors procedure Invoices being agreed in excess of contract without reasonable cause Missing documents or records regarding meetings or decisions Company procedures or guidelines not being followed The payment of or making funds available for high value expenses or school fees etc on behalf of others. Another Act coming into force in April 2011 to help clean up corruption is the UK Bribery Act which will have a significant effect on the construction industry. The UK will reinforce its reputation as one of the least corrupt countries in the world, when the Bribery Act comes into force in April 2011. Such conduct is not without significant consequences. If such practices go undetected companies can benefit from huge financial rewards at the expense of the client or tax payer; if caught, the guilty can face huge fines or even imprisonment, not to mention tarnished reputations and blacklisting for breaching trust. Discussion/Development/Analysis (2518) What Effects have the Recent Bidding Scandals had on the UK Construction Industry and what are their Implications for the Future? An internal audit of building projects commissioned by Nottingham University Hospital NHS Trust in 2004 developed into a major OFT investigation with serious implications for the Construction Industry. This became the biggest investigation the OFT had ever conducted into cartels and price fixing. The OFT focused its investigation on approximately 240 alleged infringements even though evidence was uncovered on cover pricing being undertaken by many more companies. Evidence was uncovered on cover pricing in over 4000 tenders involving over 1000 companies. The effects of the scandal resulted in one hundred and three companies being implicated in the OFTs investigation into bid rigging, including some very high profile companies. This was scandalous as many of these projects were for the public sector, involving schools and hospitals. It was all the more scandalous as the companies involved were some of the biggest names in the construction industry Carillion, Balfour Beatty, Kier Group, Interserve and many more. In some cases the winning bidder made payments of several thousand pounds, known as compensation payments (kickbacks), to the others submitting high bids. Companies were visited under the Competition Act during the investigation and several of these companies admitted breaking the law and assisted in the investigation in the hope of their fines being reduced. Fines totalling c. £129.5 million were imposed on those companies involved in the scandal. The Kier Group received the largest fine at  £17.9 million. A table listing those involved and the amount of fines imposed is attached as Appendix 2. The construction industry showed it could not be trusted. The effect of the recent scandal has exposed high profile firms in the UK cheating. Until corruption is regulated in the UK/EU how can UK companies be expected to bid legally/successfully for overseas contracts? The companies that were found guilty of these offences also risked being barred from taking part in future contracts but Government intervention ensured that these firms were not blacklisted by the public sector and the OFT issued an information note for the guidance of those involved in procurement in the public and private sectors, which included a recommendation that these companies should not be automatically excluded from tendering in the future (see below). Extract: The OFT considers that the following factors are relevant to the above: The Parties have received significant financial penalties appropriate to the infringement findings in the Decision; It would be wrong automatically to assume that construction companies that are not named in the Decision have not also been involved in bid rigging; As a result of the OFTs investigation, the Parties can be expected to be particularly aware of the competition rules and the need for compliance and, if anything, are more likely to be compliant; and Many of the Parties have cooperated fully with the OFTs investigation and a significant proportion have taken measures to introduce or reinforce formal compliance programmes and to ensure that their staff are aware of their competition law obligations. For the avoidance of doubt, this recommendation is only intended to apply to this case. It should not be assumed that the OFT would take a similar view in future cases. Did the Government intervene due to the involvement of such high profile national companies? It certainly gave them a second chance. The fact that cover pricing has been common in the construction industry is certainly a contributory factor. The OFT operates a policy where financial incentives of up to  £100,000 are available in return for information on cartels and illegal practices. This, however, raises the issue of whistle blowing and protection for those who come forward with information. The recent bidding scandals have raised the profile of ethical conduct in the construction industry where many people did not realise that their unethical behaviour was a criminal offence which could also lead to losing their job or even their professional status. Not everyone was sympathetic to the bid rigging scandal. In 2008 Sir John Egan, who chaired the construction industry task force that produced the 1998 Egan Report (Rethinking Construction) was openly critical of the OFT investigation saying that public sector clients only had themselves to blame for the alleged bid riggings, blaming the culture of public sector lowest price procurement. I have little sympathy for government over this OFT investigation. What do they expect if they persist in procuring based on lowest price? I am very sad the public sector is still using this short cut approach. It is still procuring on lowest price and as long as this is the case, proper tendering cant happen. It is not illegal to submit an inflated bit but it is the communication between the bidder and its competitors that infringes the law. On a smaller scale following a discussion with the proprietor of a local building company, who preferred to remain anonymous, it was apparent that cover pricing was common even on a small scale. He admitted that he had obtained quotes from colleagues that enabled him to ensure he was submitting the lowest quote, usually in the case of insurance quotes or small works for local authorities and had provided quotes for colleagues in the same way.. However, in his defence, in the case of insurance claims he stated this was sometimes done on behalf of the client who wanted to ensure they secured the services of the contractor they knew and trusted by trying to ensure the preferred contractor submitted the lowest quote. It was also said that in hard times this act of cover pricing was seen as a survival technique and a way of keeping the business going. Collusion is not only confined to large companies. Small companies and the self employed are at a greater disadvantage when tendering due t o limited resources. On speaking to a Quantity Surveyor who works for a national company she told me that late bids were never considered and negotiations with tenderers was illegal. In order to achieve fair competitive tendering it is essential that any unauthorised amendments to or qualifications of the tender documents by a tenderer render the tender non-compliant and subject to rejection, although the tenderer should be given the opportunity to withdraw the amendments/qualifications and stand by his tender. It is also essential that unsolicited alternative bids, either in terms of price or time, are considered non-compliant and rejected. How might bid rigging be prevented? A tender is the construction industry method whereby clients choose the main contractor. The practice of building firms quoting for free is a problem. It takes a lot of time and effort to produce an accurate quotation. Costs for tendering for contracts that are not won have to be absorbed by the company at its own expense. Cover pricing has been seen as a means to ease the loss. For every amount lost in unsuccessful bids more work must be generated to cover those costs or the profit is lost through the lost tenders. Bid rigging has been seen as a method of compensation. Each construction project is individual and there is no guarantee to companies that they will win any work at all through the tendering process. Perhaps procurement policies and/or tendering processes are in need of overhaul as it is not the tender price that matters but the final building cost, which is subject to all manner of variations due to delays, weather, etc. The scandal of bid rigging and the subsequent high profile media coverage has undoubtedly affected client thinking. Firms should now be more aware that suspicion and whistleblowing has been made easier to act on, which may act as a deterrent. There are measures which can be promoted to try to combat the perceived need for bid rigging, although there is probably none so attractive as financial gain! One of the most obvious measures is regular and appropriate training which can be used on a local and national scale so awareness is raised as to what types of behaviour are illegal. This can also be used to reinforce moral obligation to do what is correct. Again, the self employed small contractor is highly unlikely to be able to afford the time or the additional cost for training. It maybe that small firms cannot bypass bid rigging. Where firms are able to employ professionals to prepare bids and tenders the likelihood of bid rigging reduces as they would run the risk of losing their professional status if found to be undertaking illegal practices. Practical steps can be taken to help reduce the risks, such as the use of non-collusion clauses and careful design of procurement processes. In 2009 the National Federation of Builders (NFB) and the UK contractors Group launched a competition law code of conduct (see extract below). This highlighted the need for construction companies to establish internal procedures to prevent anti-competitive practices. It remains to be seen whether this Code will have a lasting effect on contract practices. Codes have to be adopted together with training and evaluation on a continuing basis and made an integral part of the companys culture. The Competition Law Code of Conduct Extract The UK construction industry is committed to compliance with UK and EU competition law. The industry understands that the purpose of competition law is to preserve free, fair and efficient competition for the benefit of all companies operating in the industry and their clients. The industry agrees at all times to commit to ensuring the highest standards of competition law compliance within the sector by adhering in all of its business practices to the principle of fair competition and to ensure that construction companies do not engage in conduct which is anti-competitive. Construction companies must: not restrain competition amongst themselves through agreements, arrangements or understandings that restrict competition; bid for contracts and tenders independently from and without any agreement or arrangement with their competitors; or not exchange competitively sensitive information or engage in discussions that may lead to the co-ordination of competitive behaviour and, in particular, must not share information about current or future pricing intentions for tenders, or any element that might affect prices or pricing practices, including the exchange of cover prices. Construction companies understand that co-operation with a competitor is justified only under the exceptions permitted by the competition rules or where they have been expressly required to enter into such arrangements by the client, for example, certain joint ventures and framework agreements, in which case such arrangements will be fully disclosed to the client. The industry understands that each individual construction company is responsible for its own compliance with competition law and that the consequences of breaching competition law are severe including possible penalties, director disqualification, criminal sanctions and damages actions. Construction companies will therefore endeavour to: ensure that competition law compliance will be achieved through implementing effective competition compliance policies and guidelines throughout their businesses; and promote an understanding of and compliance with competition law throughout their supply chains, including with their sub-contractors. This may or may not prove to be effective in cleaning up the industry as it is non-binding. In the light of recent problems clients may not be happy with verbal reassurances on competition law compliance. An overhaul of tendering processes in light of new regulations could help to avoid bid rigging. The Organisation for Economic Cooperation and Development (OECD), together with the assistance of the OFT has issued the following best practice guidelines: Guidelines for Fighting Bid Rigging in Public Procurement Designing Tenders to reduce bid rigging Detecting bid rigging in public procurement A checklist includes: Bids received at the same time or containing similar or unusual wording. Identical prices. Bids containing less detail than expected. The likely bidder failing to submit a bid. The lowest bidder not taking the contract. Bids that drop on the entry of a new or infrequent bidder. The successful bidder later subcontracting work to a supplier that submitted a higher bid. Expected discounts suddenly vanishing or other last minute changes. Suspiciously high bids without logical cost differences (e.g. delivery distances). A bidder betraying discussions with others or with knowledge of previous bids. The construction industry has been badly affected by the recession and competition is fierce. It has put itself in the spotlight and faces further scrutiny. It may be sensible for companies to carry out their own evaluation of project procurement to check for any anti-competitive behaviour. Corruption has a cost both in terms of reputation and uneconomic projects, raising the cost to the client. The Future The OFT also published a report in June of this year on the evaluation of the impact of its investigation into bid rigging in the construction industry. The research was based on surveys of construction contractors and procurers; first phase 2008 and second phase 2010. Nine in 10 construction firms now recognise that bid rigging, including cover pricing, is a serious breach of competition law with associated penalties. Approximately two in three procurers have introduced a new mechanism in the last two years to detect or prevent anti-competitive practices. A recognised way forward is the adoption of a company competition compliance policy to minimise risk, together wit