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Protect your company from field-level fraud in the oil patch

Protect your company from field-level fraud in the oil patch

Megan McFarland, CPA, Hein & Associates LLP, Dallas

With every oil boom, comes fraud. Most of the attention centers on fraudulent stock scams, which hit the courts regularly in every state, especially those home to the big energy plays. What doesn't garner as much notice is fraud against oil and gas companies themselves.

It's not a small problem. Although we are unaware of statistics particular to the oil and gas industry, the Association of Certified Fraud Examiners estimates in its annual survey that a typical business loses five percent of its revenues to fraud each year. In the oil and gas business, reporting rules require safeguards on corporate reporting and audit of financial statements, but what about operations? For oil and gas companies, field operations are likely more vulnerable to fraud than any other part of the business.

There are enough varieties of field-level fraud that we have either heard about or experienced in our practices that could easily inspire song lyrics to dozens of "She done me bad; I done her worse," country western songs. First I'll look at some various types, and then give a typical — but mythical — example of the most prevalent types of field fraud. Finally, there are some steps companies can take to fight field-level fraud in the oil and gas business.

Two main types of field fraud

Field fraud varies significantly, but you can divide it into two main categories. The first is vendor fraud. Examples include: phony invoicing for unperformed or under-delivered goods and services; billing for undelivered rental equipment; billing ghost hours or even fabricating ghost employees; billing more than the going rate; and getting companies to commit to a high rate when there is no competition and then not re-bidding the job when more competitors come in.

The second type of fraud is more expensive because it involves collusion from employees at the oil company. Most of these frauds involve kickback schemes. The employee responsible for bidding a service or supply has the vendor charge a fictitious amount, siphon off a portion of the profit, and pay the employee. The kickback can come in different ways, and may not be in the form of cash. Gift cards are a popular way to pay a kickback, as is extravagant entertaining. Some of the craftier fraudsters set up a business and have the vendor write a check to their company. They may pay wives or girlfriends as if they had worked for them. There are even numerous instances of vendors charging the energy company for used oilfield pipe, and using that pipe to build fencing for a ranch or lot. With today's prices for pipe, those fences aren't cheap.

According to a presentation by John F. Lipka, USA security advisor for Encana Oil & Gas Inc., there are other types of non-cash kickbacks. The vendor arranges to provide services to the employee, such as pouring driveways, road work, or other heavy equipment services. It could involve home repairs or improvements such as landscaping, patios or patio covers, barbecue pits and roping arenas. Some vendors buy the employee boats, cars, trucks, airplanes, motorcycles, golf carts, travel trailers, motor homes or horse trailers. They may even buy the employee or a spouse a personal item such as jewelry, furs, clothing, liquor, golf clubs, firearms or customized cowboy boots.

In the travel and entertainment arena, kickbacks can include gambling trips; excessive or frequent restaurant and night club bills; transportation and expenses for the employee's vacation; unusual hunting, fishing, golf, or ski trips not offered by the vendor to other companies as a normal course of business; and finally it can mean the purchase of sexual favors for the employee, Lipka says.

Commonly, field fraud takes up to 18 months for companies to discover. Usually these types of thefts, once discovered, are not reported by companies to the authorities. Company officials almost always just fire the employee. They may be embarrassed by the theft or believe that it would cost more to prosecute than they would recover. The company can try and recoup losses from the vendor, but that can produce mixed results. More often than not, companies take it in the teeth and walk away. The amount of money stolen is not usually material enough to report to shareholders. However, over time, if you add all of the field fraud up, it can be significant to the company.

Field fraud continues to be a problem because finding qualified workers is tough, which leads to shortcuts in hiring. Many times, companies may not check references or call the fraudster's past employer, and if they do, that employer might be reluctant to divulge information for fear of legal trouble. The fraudulent field employee usually knows many people in the industry and can find work, because as we said, qualified employees are tough to find.

Field fraud: An example

Let's look at a typical oil and gas field fraud. Although fictional, our tale is influenced by real events we have learned of as accountants and consultants. We focus our story on Good ol' Boy, the field supervisor at a $300-million exploration company operating in the Barnett Shale.

Water used in the drilling process has to be recovered and taken to a processing site for cleaning and re-use. One day, Good ol' Boy notices that his water hauler, a guy by the name of Harry Hustler, is charging him ten loads a day, about $10,000, when Harry is really only hauling eight loads a day. This has been going on for six months. Good ol' Boy calls Harry on his cell phone, and asks him about the discrepancy. Harry immediately offers Good ol' Boy in on the action, and promises him that no one will notice such a small amount of money.

In the oil and gas business, reporting rules require safeguards on corporate reporting and audit of financial statements, but what about operations? For oil and gas companies, field operations are likely more vulnerable to fraud than any other part of the business.   In the oil and gas business, reporting rules require safeguards on corporate reporting and audit of financial statements, but what about operations? For oil and gas companies, field operations are likely more vulnerable to fraud than any other part of the business.

After thinking about it and justifying it — because Good ol' Boy thinks he should be making more money — he agrees to set up a limited partnership as a water disposal company. They create two separate invoices for the water hauling contract; one from Harry that is legit and another to Good ol' Boy Water Hauling Ltd. Now Good ol' Boy is married, but he also happens to have a girlfriend, Norma Rae. He lists Norma as the principal of the partnership and sets her up in a trailer not far from the oil fields, all at the company's expense, of course. This goes on for two years, amounting to more than $350,000 stolen from Good ol' Boy's employer. The scheme only gets discovered after Good ol' Boy's wife finds out what's going on and turns him in to his company via its fraud hotline. The fraud isn't prosecuted; Good ol' Boy is fired, but has since found new employment in Louisiana.

Steps to take to prevent field fraud

If you want to avoid the Harry Hustlers and Good ol' Boys of the world, consider the following steps:

  • Separate the bid and approval process. Be sure the person who is responsible for bidding is not also responsible for approving invoices. The purchasing department should solicit and select bids while the field supervisor approves invoices.
  • Check references when hiring. Normal job reference checks are not typically performed in this industry. Make the call, do a little homework and you might get lucky with some solid information.
  • Rotate vendors and use a disciplined, competitive bid process. Rotating vendors can be a logistical hassle, but companies should know that when you become too dependent on one vendor, relationships become too close. Going through the bidding process for each job insures you'll avoid being overcharged.
  • Compare field tickets to invoices received. This step is skipped too often. A representative of the operating company gets together with the field supervisor to compare field tickets to invoices. Don't pay invoices that aren't supported with signed field tickets.
  • Create an approved vendor list. Use a vendor application process, check the vendors with other operators to learn of their experiences, and ensure your field personnel only use vendors from this list.
  • Perform analytical reviews from a financial perspective. Internal audit staff or outside consultants compare what you are paying versus the industry norm. Additionally, perform vendor audits after the work was completed, taking into consideration price and performance.

Field fraud in the oil and gas industry is widespread and not talked about. Is it happening to you?

About the author

Megan McFarland is the National Energy Practice Leader for Hein & Associates LLP, a full-service public accounting and advisory firm with offices in Denver, Houston, Dallas and Orange County. She specializes in SEC and other complex reporting requirements and has significant experience assisting companies with the implementation and reporting of internal controls.

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