U4 Helpdesk Query

Content

• Illustrations presents information on areas and processes through which corruption can take place
  
• Annex I outlines risks at various stages of procurement/contracting
  
• Annex 2 outlines corruption risks at various stages of construction works

U4 helpdesk reply

This discussion will focus on most common ways that corruption can take place, in the context of potential misuse of public funds. There is a multitude of possible scenarios and opportunities for corruption to take place (see for instance U4 corruption glossary).

While creating an exhaustive list of ways that corruption can take place is out of the scope of this query, it is possible to highlight processes that are commonly regarded to be most vulnerable to corruption and which present significant opportunities for corruption to take place.

Some of the processes, such as procurement and construction /infrastructure works, are complex multi-stage processes. Therefore, a detailed breakdown with examples of corruption risks and opportunities that are present in each of the stages is provided.

In addition, as the query makes references to budget support, we would like to draw your attention to

• a U4 helpdesk answer on corruption and budget support produced earlier this year and,
• a TI discussion paper containing a section on modalities of aid and their vulnerability to corruption (available on request)

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Illustrations

Illustrations of areas and processes through which corruption, particularly in the context of misuse of public funds, can take place in many areas.

Public Procurement

As rightly pointed in the query, one such major process is procurement, which presents enormous opportunities for corruption. The problems associated with it are applicable to nearly all public sectors. Bidders and suppliers may provide kick-backs and bribes to public officials to secure awards of contracts, turn a blind eye on poor implementation of a contract, etc. This can create an incentive for public officials to allocate more and more public funds (including untied aid funds, such as budget support, etc.) to such public sectors that create opportunities for funding expensive public infrastructure and construction works and other goods.

The higher the value of the purchases of goods or works, the higher are the returns, in the form of kick-backs, for the officials.

Needless to say, this can have devastating effects on other public and social sectors, which are not deemed by officials as presenting lucrative opportunities for corruption and which, in turn, remain under-funded and under-developed.

There would also be instances, where procurement may be legitimately envisaged under the aid funds (such as purchasing necessary facilities, equipment and goods) but the issues and the scope for corruption to occur in the process will, however, remain essentially the same.

See annex I for a detailed break-down of risks associated with each stage within procurement contracting and where corruption can most commonly take place.I.

Public Works and Construction

This is another area highly vulnerable to corrupt practices. Surveys reveal corruption to be higher in construction than in any other sector of economy. The scale of corruption in construction is magnified by the size and the scope of the sector, which ranges from transport infrastructure and power stations at the larger end to domestic housing at the smaller. Construction projects usually involve a large number of participants in a complex contractual structure.

Most infrastructure projects are government-owned. Even privatised projects often require government approvals for planning or agreements to pay for end-product use. The industry tends to be heavily regulated at both national and local governmental level. Numerous permits are often required.

Where there are insufficient controls on how government officials behave, their power - combined with the structural and financial complexity of the projects - makes it relatively easy for officials to extract bribes. Corruption can occur throughout the construction project cycle - from planning and design to tendering, execution and maintenance.

See annex II for a detailed breakdown and examples of how corruption can take place in each of the construction phases.

Looting of State Assets and Funds

Another common threat, especially when discussing grand corruption, is looting of public assets and funds by top officials in power. This would most commonly imply direct transfer of funds from public monetary depositories and central banks into secret offshore bank accounts of the officials' relatives and proxies. This form of corruption is interlinked with other issues such as money-laundering, transnational crime and others.

Misappropriation of Funds through Financial Malpractices

Officials can also abuse their power and misuse public or aid funds through a variety of financial misdeeds, such as

• authorising payments of made-up invoices for goods or services and sharing the proceeds with the accomplices who act as individuals or companies that supposedly delivered these services,
• creating "ghost" employees and consultants on their payrolls and authorising their salaries, which are shared with accomplices or go to the officials' relatives and friends' accounts to be passed on to the official,
• "losing" important financial data that would confirm various forms of made-up expenditure items that they may have authorised, etc.

These forms of corruption and misuse of public funds are closely linked with various areas of financial fraud and crime.

Reallocation and Distribution of Funds

There is also scope for corruption in the process of reallocating and/or distributing funds (including funds that may have originated form budget support or other forms of aid) to various entities, such as from a central body to a local authority body, etc.

Given the scarcity of public funds, there will almost certainly be scope for officials to make decisions on allocation priorities (as to which region or locality gets how much funding, etc). This decision can be driven by corrupt motives and be dependent on opportunities for private gains and sharing of funds though accomplices at the local levels.

The longer the chain, the easier it is to dilute the funds on the way. Reallocation or distribution of funds can also occur from the public sector to the private sector or the NGO sector, through such government schemes as micro-credit for SMEs or grants for NGOs for projects or to deliver certain social services, etc. The same opportunities for kick-backs and undue returns can also exist there.

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Annex I. Corruption risks at in stages of procurement/ contracting

Extract from a relevant TI Discussion Paper (J. Olaya, 2005)

Described below are risks that can be present in each stage of a contracting process.

Stage 1: Contracting process decision and process design

During this stage, the government decides to purchase or sell goods or services, or to outsource the management of a unit. Determines what it needs to buy or sell or privatize (technical requirements, special characteristics etc.) and how it will go about it (contracting method, agency responsible etc.)

Associated risk

• Contracts are tagged, this is, they are designed in a way that favour a specific provider
  
• Contracts are unnecessary: does not attend the public interest (the citizens or victims' needs)
  
• Contracts are over/under designed
  
• The choice of method is abused

In sum, during this first stage corruption is most common because it is difficult to see. It hides underneath the way the materials to be bought are described, or underneath the time given for bidders or contractors to present offers or to fulfil the contract. It takes an expert to realize this. In emergency situations, this is specially difficult because there is no time too look at the specifications as most procurement is performed by direct contracting.

Stage 2: Contracting process

This stage starts when the Contracting process opens. The process should take place according to what the applicable law determines for the contracting method chosen. It either starts with an invitation to present proposals (in the case of open bids, closed/limited bids, short lists) or to evaluate contractors (in the case of single source, emergency contracting, direct contracting).

Associated risk

• Opacity: information on the relevant stages of the (i.e. invitation to tender) process is not accessible, is incomplete or the timing of its publication does not allow bidders to respond.
• Privileged information. Abuse of confidentiality or lack of publicity creates unequal grounds between different bidders.
• Manipulation of prequalification or evaluation. For example, when short listing systems are used, and companies bribe their way in them, or access is manipulated in any way.
• In single source or direct contracting processes, lack of publicity or transparency leads to unjustifiable decisions.
• Bidders or contractors collude to influence prices or to share the market by artificially losing bids, or not presenting offers.

In sum, during this stage most risks are associated with limited access to information. This allows to fulfill corrupt arrangements with or between contractors and to avoid public scrutiny.

Stage 3: Contract Award

The contract process ends and a decision is taken in order to select the winning bidder (in open bids) or the contractor (in single source or direct contracting processes)

Associated risk

• Evaluation criteria were not clearly stated in tender documents, no grounds to justify the decision.
  
• Evaluation of bids are subjective or leave room for manipulation and biased assessments.
  
• Contract awards are not publicized ( nor the grounds for the decision)

In sum, most risks during this stage are associated with possibilities for manipulation. Although it is common to think that most corruption actually occurs during this stage, it is often the case that corruption here was prepared much before, or very likely that corruption at this moment won't go noticed until contract implementation, precisely because it has been the most common way.

Stage 4: Contract implementation

The contract is signed with the selected bidder or contractor who now should deliver the goods or services contracted under the terms agreed.

Associated risk

• Contract changes and renegotiations after the award are of such a nature that change the substance of the contract itself.
  
• Supervising agencies/individuals are unduly influenced to alter the contents of their reports so changes in quality, performance, equipment and characteristics go unnoticed.
  
• Contractor's claims are false or inaccurate and are protected by those in charge of revising them.

In sum, during this stage the greatest risk is associated with lack of monitoring or follow up. Most controls are active during the contracting process stage and then fade away. It is a common practice to avoid controls by an apparently transparent and perhaps correct contracting process, "counting" on the possibility of getting additional profits during contract implementation.

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Annex II - Corruption risks at various stages of construction works

Extract from a TI UK report Examples of Corruption: Preventing Corruption in Construction Projects (N. Stansbury, March 2005)

Outlined below are examples of the type of corrupt or fraudulent practices that can occur during each of the various stages of construction/infrastructure works.

Planning and Design

The following corrupt practices could occur:

a) A project owner may bribe a government or local authority official in order to obtain planning permission for a project, or to obtain approval for a design which does not meet relevant building regulations.

b) The project may, as a result of a bribe, be designed or specified by the owner or engineer in a manner, which improperly favours one bidder over the others. For example, a certain technology, which is only possessed by one of the bidders may be specified, even though other technologies may be preferable or cheaper. This would normally result in the contractors who do not possess the specified technology being kept off the pre-qualification list, or being rejected as noncompliant at tender stage. In some cases, the owner would knowingly have caused the design to be undertaken in this manner. In other cases, the owner may not be aware that the design has been undertaken in this manner (for example where the owner has appointed an architect or engineering consultant to undertake the design, or where the decision is taken corruptly by a representative of the owner).

Pre-Qualification and Tendering

The following are some examples of the circumstances in which bribes could be paid:

a) A bidder which is properly qualified may find itself being rejected at pre-qualification stage as a result of a bribe paid to a representative of the owner or engineer by another bidder. The reasons given for rejection would be artificial. Alternatively, no reasons may be given. The rejection of several potential winners could result in the favoured bidder being given an unfair advantage at tender stage.

b) There may be, in relation to a project at tender stage, confidential details such as the owner's minimum and maximum acceptable prices, or tender assessment system. Possession of this information may assist a contractor in its bid. The leaking of this information by a representative of the owner or engineer to the favoured bidder in return for a bribe may therefore give it an unfair advantage.

c) The tenders may be received by the owner and not be opened at a public opening exercise. In this case, no-one except the owner will be aware of the bidders' prices and other critical tender components. This secrecy will enable a representative of the owner to provide confidential information to the favoured bidder in return for a bribe. This bidder can then amend its tender (for example by dropping its price) so as to secure a winning position. The tenders can then be publicised, and the favoured bidder announced as the winner, and no-one will be aware that the winning bidder was given the secret opportunity to amend its tender.

d) The tender process may be corrupted by international pressure. For example, during an allegedly competitive tender process, the government of a developed country may influence the government of a developing country to make sure that a company from the developed country is awarded a project, even if it is not the cheapest or best option. Such pressure can take many forms, including the offer of aid, arms deals or agreements to support a government's application to join an international organisation. Great lengths are taken to conceal this pressure in some cases. In others, it is remarkably overt.

Some examples of fraudulent practices

a) The bidders may secretly collude with each other to share the market. This normally entails the bidders agreeing that each one of them will win a certain number of projects, or a certain amount of turnover, in a particular sector. In respect of each project, a winning bidder will be pre-selected secretly by all the bidders, and the other bidders will put in tenders at a price which is higher than that of the pre-selected bidder.

b) The bidders may agree with each other on a "losers' fee" arrangement. This normally entails the bidders agreeing that they will bid in full competition with each other (i.e. no price fixing agreement, or pre-selection of the winner). However, they agree that they will each include in their price a fixed sum representing the estimated aggregate bid costs of all the bidders. The winner will then divide this fixed sum equally between the losers. The primary reason for this arrangement is compensation for the irrecoverable bidding costs of the losing bidders.

c) A group of suppliers of materials may collude to fix the minimum price of the materials they supply. Even when there is competitive tendering, prices will be kept higher than would be the case with genuine competition.

Project Execution

The following are some examples of the circumstances in which bribes could be paid:

a) A contractor may pay a bribe to the owner's representative in return for the owner issuing a variation which materially increases the contractor's scope of work.

b) A contractor may win a contract tender as the lowest priced bidder without including a bribe in the contract price, but agree secretly with the owner's representative that a large variation including a bribe will be agreed at a later stage. Deferring a bribe until after the appointment of the contractor can be an effective means of concealment since there is normally no competitive tender for variations, and post-contract variations attract much less publicity than competitive tenders.

c) A contractor may pay a bribe to the architect/engineer in return for the architect/engineer issuing a payment certificate or an extension of time to the contractor.

d) A contractor may pay a bribe to the owner's quantity surveyor in return for the quantity surveyor approving the contractor's work schedules and time sheets.

e) A contractor may pay a bribe to the owner's works inspector in return for him approving defective or non-existent work.

f) An owner may pay a bribe to the architect/engineer in return for the architect/engineer refraining from issuing a payment certificate or an extension of time to the contractor, or for issuing a certificate entitling the deduction of liquidated damages from the contractor.

g) A contractor may require an import permit to bring equipment into the country in which the project is being constructed, and may have to pay the import clerk a bribe in order to obtain the necessary paperwork.

Some examples of fraudulent practices

a) A contractor may submit a claim for payment for a variation to the owner, when the contractor knows that, or is reckless as to whether, the amount claimed is greater than the amount allowed to the contractor under the contract or by law.

b) A contractor may make a claim against the owner for an extension of time based on an alleged cause for which the owner is responsible, when the contractor knows that, or is reckless as to whether, the actual delay was due to a cause for which the contractor is responsible

c) A contractor may make a claim against the owner for an extension of time, when the contractor knows that, or is reckless as to whether, the claim is for a period greater than the actual delay caused to the contractor by the event on which the claim is based.

d) A contractor may submit a loss and expense claim to the owner which is based on an extension of time claim, when the contractor knows that, or is reckless as to whether, the extension of time claim is false or exaggerated.

e) A contractor may submit falsified records to support a claim (e.g. false programmes, invoices, timesheets etc.) whether or not the claim itself is genuine.

f) A contractor may submit a loss and expense claim to the owner based on an allegation that the owner is responsible for a particular event, while concealing from the owner records which would prejudice the contractor's claim (e.g. letters from the contractor to a sub-contractor which attribute blame for the claimed event to the sub-contractor rather than to the owner).

g) An architect/engineer may know that a variation should properly be issued to a contractor, yet refuse to issue the variation, as it fears that issuing the variation could expose the architect/engineer to a claim for breach of contract (e.g. design error) by the owner.

h) An architect/engineer may know that an extension of time should properly be granted to a contractor, yet refuse the extension of time as a result of pressure from the owner not to grant it, or in the hope of gaining future work from the owner.

i) An owner may submit false or exaggerated claims against the contractor alleging that the contractor has delayed the project, or that the contractor's works are defective. In many cases, the owner will use these false or exaggerated claims as a pretext to draw down on the contractor's performance bond, deduct liquidated damages, or withhold the retention.

j) A joint venture partner of the owner may falsely claim that its project expenses are higher than they actually are.

k) A scaffolding sub-contractor may exaggerate the amount of scaffolding on site, or the number of men used to put it in place.

l) An earth-works sub-contractor may falsify the amount of earth removed.

m) A claimant may add a significant amount of false extra cost to a contract claim as a 'negotiation margin'. The claimant's logic in including this margin is that it believes that the opponent will attempt to reduce the claim, and so a sufficient margin must be added to enable negotiations to arrive at the 'correct' figure.

n) Employees, consultants or independent experts may give evidence in a court or arbitration hearing which they do not believe to be true in order to support their employer's false claim.

o) Lawyers and other professional advisors working on a contract dispute may dishonestly allocate too many staff to work on a claim, charge for too many hours of work, or give their owner overoptimistic advice as to the likelihood of a claim's success.

Operation and Maintenance

The following are some corrupt practices that could occur:

a) Bribes can be paid to win operation and maintenance contracts, and fraudulent practices can lead to inflated operation and maintenance costs, in just the same way as during the tender and project execution phases referred to above. In many projects, the cost of operation and maintenance will exceed the actual capital cost of constructing the project. As a result, the opportunities for bribery and fraud may be greater.

b) Sometimes the same contractors that built the project will also operate and maintain it, and so the bribe paid to win the construction contract may also cover operation and maintenance. In other cases, a separate bribe may be paid to cover operation and maintenance phase.

c) Public/private projects, where a private consortium builds, owns and operates a project and then supplies the government or local utility with the end product (e.g. electricity), provide substantial opportunities for bribery in relation to agreeing the price that will be paid for the end product.

d) In high technology projects, the contractor that built the project may be the only company capable of maintaining it. As a result, it will have a monopoly of supply during the operation and maintenance period. This monopoly makes it difficult to compare costs and increases the opportunities for concealing bribes and inflating claims.