Product substitution refers to the knowing and willful substitution, without the purchaser’s knowledge or consent, of sub-standard, used, outdated or counterfeit products or materials for those specified in the contract or purchase order. Substitution is particularly common and damaging in contracts calling for expensive, high grade materials that can be replaced by less expensive, similar appearing products.
Improper substitution can occur in a wide variety of circumstances: examples have included the substitution of counterfeit electronic components in navigation equipment and cheaper, inferior base materials in road construction contracts.
The illegal substitutions can be made by the contractor acting alone or in collusion with corrupt inspectors or project officials. Corruption should be suspected when wide-spread product substitution occurs without detection or objection by inspectors or project officials.
RED FLAGS OF PRODUCT SUBSTITUTION
- Apparent substandard goods or works
- Early failure of products or materials
- High number of test or operational failures
- Early or frequent repairs or replacements
- High maintenance and repair costs
- Discrepancy between a product’s specification and actual appearance (e.g., “new” product appears to be used)
- Generic or unusual product packaging, without normal inserts, such as warranty cards
- Inadequate testing procedures; contractor conducts it own tests
- Contractor’s records indicate it purchased product or raw material that was not compliant with specifications
CASE EXAMPLES OF PRODUCT SUBSTITUTION
See actual case examples of product substitution from investigated cases.
BASIC STEPS TO DETECT AND PROVE PRODUCT SUBSTITUTION
- Identify and interview all complainants to obtain further detail.
- Obtain the following documents and examine them for the red flags listed above:
- Requests for bids
- Contract specifications
- Contract and change orders
- Invoices and supporting documents
- Received product
- Test and inspection reports
- Physically inspect or independently test questioned goods or materials; note indicators of substitution, e.g., inappropriate packaging, early failures, etc.
- Do a due diligence background check on the suspect firm to determine if it previously had been investigated or sanctioned for fraud or product substitution.
- Test and inspect questioned product and materials, look for visual defects e.g., used product delivered as new and inappropriate packaging
- Contact the contractor’s suppliers to confirm that they delivered the specified product or materials
- Interview users, former employees and inspectors regarding product failures, improper payments to inspectors, etc.
- Look for evidence of fraudulent knowledge and intent; e.g. relabeled items, apparently altered or forged manufacturer’s certificates, etc.
- Exercise contract audit rights to review the contractor’s books for additional evidence of product substation, e.g., purchase of substandard components and materials and improper gifts, entertainment or payments to inspectors.
- Interview the responsible contractor personnel to obtain admissions or identify defenses; continue investigation to rebut defenses.
Product substitution constitutes a fraudulent practice.