DoD Recovers More Than $7 Billion from Procurement Fraud in a Five Year Period

The 2018 NDAA (National Defense Authorization Act) required the Defense Department to submit a report on defense contracting fraud for the previous five fiscal years (2013 through 2017). That report has not been published and shows some surprising results. We are all aware that there is significant fraud occurring in Government contracting and in DoD contracts in particular. We report on some of those on these pages from time to time. What we did not know was the magnitude of the occurrences and recoveries, until now.

The report, entitled "Report to Congress, Section 889 of the FY 2018 NDAA, Report of Defense Contracting Fraud was issued last December and reported the following:

• During the five year reporting period, there were 1,059 cases resulting in a criminal conviction of 1,087 defendants. 678 of those were individuals while the remaining 409 were business entities. As a result of these convictions, a total of $369 million was recovered in fines and penalties, $370 million was recovered through restitution, and $53 million was recovered through forfeiture of property (total: $792 million).
• Those recoveries, while impressive, pale in relation to recoveries from civil judgments and settlements. Over the same five year period, a total of $5.8 billion was recovered in civil judgments and settlements. Comprising these cases were 546 defendants (or respondents) of which 111 were individual persons and 435 were business entities.

Another interesting statistic coming from the report indicates that a handful of contractors are responsible for the majority of the fraud.  The total number of individuals or entities indicted for, settled charges of, been fine by any Federal department or agency for, or have been convicted of procurement fraud, involved 168 contractors with 16 million contract actions valued at $334 billion. Ninety-four percent of the 16 million contract actions was from a single contractor and 76 percent of the $334 billion was from two contractors.

Procurement fraud includes such things as cost and labor mischarging, defective pricing, price fixing, bid rigging, and defective and/or counterfeit parts.

Procurement Fraud Prevention Act

Senate Bill 938 would require GSA (General Services Administration) in consultation with the Office of Management and Budget (OMB), to ensure that any direct communications with small businesses about providing goods and services to the Federal Government contain a notice that technical assistance from the Federal Government on the procurement process is available to small businesses at no cost.

We explained this bill in some detail back in May (see Proposed Legislation to Notify Small Businesses of Free Procurement Assistance). The intent is to help protect small businesses from falling victim to fraud when they register to sell their products and services to the Government. We're not sure what kind of procurement fraud that SAM (System for Award Management) registrants are susceptible to. Neither of the Senate sponsors (Peters and Collins) provided any studies or anecdotal evidence of procurement fraud. We know from personal experience that SAM registration will result in many offers of assistance for a fee. Sometimes such paid assistance is no better than what is available for free through DLA's Procurement Technical Assistance Centers (PTAC) or SBA assistance. However, we would not call that procurement fraud.

The Congressional Budget Office (CBO) reported that the Bill, if enacted, would have negligible impact on spending or revenues for the next 10 years, and would impose no costs on state, local, or tribal governments. That is intuitively obvious.

The Bill took another step toward enactment earlier this month when the Senate Committee on Homeland Security and Governmental Affairs reported favorably in support of the legislation.

Finding and utilizing free resources is a good place to start for small businesses just getting started in Government contracting. The PTACs in particular have a lot of resources and a good track record in helping companies through the maze of procurement regulations.

Subcontractor Pays $235 Thousand to Settle False Claims Charges

Late last month, we wrote about a $2 million settlement involving a DOE (Department of Energy) subcontractor who subcontracted some of its work to a third company who, it turned out, was a small  woman-owned business but had no employees or equipment (see $2 Million Settlement in Small Business Subcontracting Fraud).

This week, the Justice Department announced settlement with the other company, Sage Tec LLC. Sage Tec and its owner agreed to pay $235,000 to resolve allegations that it violated the False Claims Act (FCA) in connection with two small business subcontracts.

The prime contractor, responsible for environmental remediation at Hanford, was required to award a certain percentage of subcontracts to eligible and qualified small and disadvantaged businesses, including woman-owned small businesses. The requirement flowed down to its subcontractors as well. One of the subcontractors, FE&C (Federal Engineers and Constructors) awarded two subcontracts to Sage-Tec, an entity that purported to be a small, disadvantaged business. 

Initially, a lawsuit was brought forth by a whistleblower. The Government later enjoined the suit. The basic charge was that the prime contractor, FE&C, and Sage Tec knowingly misrepresented Sage Tec to be a qualified disadvantaged small business in order to be eligible for two multi-million  dollar subcontracts that were designated for truly qualified small disadvantaged businesses. Sage Tec, it turns out, was not a legitimate small, disadvantaged business; rather it was a pass-through front company for FE&C, which performed substantially all of the work that should have been performed by Sage Tec.

The Government continues to investigate the Prime contractor for its role in the matter. The original whistle-blower stands to make a lot of money. On this Sage Tec settlement, the whistleblower will receive $47 thousand. On the aforementioned FE&C settlement, the whistleblower earned $470 thousand. If the prime contractor settles, the whistleblower will probably get a cut of the settlement amount as well.

You can read the full Justice Department press release here.

Here's a link to a related article appearing in the local newspaper.

More on Setting Up Internal Controls Over Company-Issued Purchase Cards

Internal controls over company-issued purchase cards should be of paramount concern to Government contractors. Regular readers of this blog will recall several reports where the cost of improper purchases using company-issued purchase cards were passed along to the Government and fraud charges resulted. Its serious enough when employees defraud their employer but when those charges pass through to a Government contract, things get much more serious. A contractor cannot just let those involved slip quietly off into the night. There will be consequences for both the individual(s) and the contractor.

But purchase card fraud is not just a contractor problem. It affects the Government as well. In fact, GSA's (General Services Administration) Office of Inspector General recently (OIG) published an audit that found GSA's purchase card program is vulnerable to illegal, improper, and erroneous purchases.

The OIG reported three deficiencies, each serious enough in its own right but when viewed in their totality, leaves the Government (and taxpayers) highly vulnerable to improper, if not fraudulent, purchase card charges. These deficiencies include:

• GSA does not have assurance that purchase cards are used exclusively for approved, business-related goods and services because controls to support and review transaction documentation are not performed consistently
• GSA may not identify illegal, improper, or erroneous purchases because controls over the resolution of questionable purchase card transactions are not operating effectively
• GSA lacks controls for identifying split purchase card transactions, making GSA vulnerable to cardholders violating federal procurement regulations.

Contractors might want to assess their own purchase card policies and procedures against these reported (and common) deficiencies. Here's a few ideas you can use to enhance your own internal controls.

1. Create a formal purchase card policy. Who is authorized to have a card?. What type of purchases are allowable? 
2. Require substantiation. Require original receipts. Document business purpose to ensure purchase has a legitimate business purpose. Require formal approvals.
3. Periodic internal reviews. Require independent (skeptical) internal review to periodically review purchase card statements and supporting documentation for propriety.

Remember, "trust" is not an internal control.

Soliciting Donations for Charities - While on the Job

During sentencing, a judge questioned why a high-level civilian employee of the Federal Government, who was well compensated, felt the need to steal from the charities for who he was ostensibly raising support. A rhetorical question, of course - one for which no answer was proffered. He should have plenty of time now to mull it over, he will be spending the next year and two months in a Federal prison. He'll also need to cover a $5 thousand dollar fine and pay $50 thousand in restitution from the charities he stole from.

According to the plea agreement, this former fire chief for the U.S. Air Force, knowingly disclosed Department of Defense bid information to give a competitive advantage to a defense contractor. According the Department of Justice press release however, that was not his most serious crime. He also pocketed some money belonging to charities.

For four year leading up to 2013, this individual used his position as Chief of Air Force Fire Services to defraud approximately 25 business entities or individuals out of tens of thousands of dollars per year that was intended for charity. He organized award banquets and charity golf outings to coincide with conferences sponsored by the International Association of Fire Chiefs. He actively solicited donations for his golf outing from contractors and subcontractors who sought to do business with the Air Force and Department of Defense.

Some of the donations were forwarded to charities as intended however many donations were deposited in his personal bank account. According to the plea agreement, he used these funds to pay off credit card debt, vacations, and gambling. Sounds like he may have had a gambling problem.

The Justice Department did not disclose how either of these frauds were uncovered however it is likely that the investigation of one lead to another - because the investigations would be reviewing bank records to follow the source of funds deposited in his account.

Anyone with procurement responsibility, whether in the Government or employed by Government contractors, has no business soliciting funds for charities or for any other purpose, from firms that hope to benefit from their relationship with procurement. We don't know about the Air Force Fire Chief's department or organization, but most Government agencies have policies against such practice. We know of one Government agency that doesn't even allow parents to sell Girl Scout cookies to co-workers.

You can read the full DoJ press release here.

Feds Use Al Capone Precedent to Convict Procurement Fraudster

Al Capone is arguably one of the most notorious tax evaders in history. Although well-known as the king of Chicago gangsters, the Federal Government couldn't put together any criminal charges that would stick until they nailed Capone for failing to pay taxes in 1931. Capone was convicted of five counts of income tax evasion and sentenced to eleven years in prison.

Why the story about Al Capone? Well, the Justice Department announced that a federal jury convicted a man for omitting $56 thousand from his 2013 federal income tax return. Unfortunately, that's not really news, it happens all the time. But then we noticed that the Defense Criminal Investigative Service (DCIS, part of the DoD's Inspector General office) was involved in the investigation. That got us curious. Why would DCIS investigate income tax evasion. Upon further reading, we learned that the tax evader was a former contracting official for the U.S. Army at Redstone-Arsenal in Huntsville. Uh oh.

Digging a bit deeper, we found that this former "high level" contracting official was implicated (not charged or prosecuted) into a much larger investigation. He was suspected of helping steer helicopter contracts to a "flamboyant financier" in exchange for a lucrative consulting contract after  he retired from the Army.

The Feds probably didn't have enough information to convict the guy for taking bribes so they went after him "Al Capone" style.

Read the DOJ press release here.

Read about the underlying case here.

University Pays $20 Million to Settle Improper Charging Allegations

It was about 21 years ago that Stanford University settled a fraud case involving research expenses. The Government settled for a small fraction of of the Navy's original claim. Initially, the Office of Naval Research wanted the University to pay back more than $200 million. The parties finally settled for $1.5 million (or perhaps a bit more as the settlement included some small claims that Stanford had against the Government). It was an embarrassing time for the University and its President though. The President was dressed down before Congress trying to explain why silk sheets for his private home were charged to Government contracts among other indiscretions. And, he was forced to resign. Although the Government did not recover much money in the end, the episode brought about significant changes in the way the Government conducted oversight of university conducted research.

A couple of decades go by and once again, a prestigious university is on the hot seat for overcharging the Government for improper research expenses. In this case, the University of Florida has agreed to pay the United States about $20 million to settle allegations that it improperly charged the Department of Health and Human Services (DHHS) for salaries and administrative costs on hundreds of federal grants.

The overcharging occurred in several ways. First, the University charged the Government for salary costs of employees where it did not have documentation that the employees actually worked those hours. Secondly, the University charged costs directly to the grants that were improper under federal regulations. And finally, the University inflated costs for services performed by an affiliated entity.

As is typical in settlements by the Justice Department, the claims resolved by this settlement are only allegations and the University did not agree to any liability in the matter.

You can read the DoJ press release by clicking here.

Prison Time for Falsely Claiming "Service-Disabled" Status

Warren Parker falsely claimed to be a disabled veteran and war hero . He claimed to have been awarded three Silver Stars, four Bronze Stars, eleven Air Medals, a Presidential citation, and three Purple Hearts in the Vietnam War. Military records however showed that he only served in the Missouri National Guard and was never deployed outside of the Missouri.

Warren Parker, his wife Mary, and son Michael used this "stolen valor" to secure Veteran's Administration and Defense Department Contracts totaling $7.5 million that had been set aside for SDVOBs (Service Disabled Veteran Owned Businesses).

They were caught, plead guilty, and are now serving time in Federal prisons; Warren (who's already in his 70s) received an 87 month sentence, his wife Mary, 20 months, and his son Michael, 41 months. Its probably not where Warren and Mary expected to spend their "golden years".

In addition to the prison sentences, the Parkers will also be paying restitution of some unspecified amount. Their reputations have been destroyed - one was immediately kicked off the city planning commission. Their construction company is now referred to in the past tense.

Yet to be sentenced in the case is Thomas Whitehead who used Parker's company as an illegal pass-through for his own construction company.

Misrepresenting "status" in order to obtain Government contracts has got to be one of the dumbest procurement fraud scenarios. It seems like there is almost a 100 percent certainty of being caught. There is so much information available on the internet and in social media that it becomes difficult to maintain a ruse for any length of time. There are the unsuccessful bidders that will poke around to see if there are flaws in the procurement process so that they can appeal the award. If it involves a set-aside contract, you can be sure they will be checking up on the winning firm's qualifications. There is also risk from insiders (i.e. employees) who are ready to blow the whistle so that they can get a big payday (qui tam actions). Finally, the Government is beefing up its vetting process to reduce the occurrences of businesses falsely claiming a "status" to which they are not entitled.

As we learned from the Parker case, the consequences for falsely claiming small business, veteran-owned business, woman-owned business, minority-owned business, etc, can be swift and severe.

Contractor Employees Plead Guilty for Bribing Government Official

 The Department of Justice (DoJ) issues many press releases every week and some of them deal with contract fraud in some fashion. It is not often that we get to find out how the fraud came to light - whether it was because of Government oversight, a tip, a whistleblower, or an honest fed. Usually, the press releases say that so-and-so has been charged or has plead guilty to this or that. Last week however, the DoJ via the U.S. Attorney's Office for the District of Alaska, issued a notification that was surprisingly detailed in describing how an attempted bribe of a Government official was uncovered.

 A Tennessee company was awarded several subcontracts to install and upgrade fiber optic cables on Joint Base Elmendorf Richardson (JBER) in 2014. In June 2014, company representatives met with an Air Force official to complete quality assurance inspections on two project locations. During the inspections, the Air Force official discovered numerous discrepancies, informed the company, and requested the discrepancies be fixed.

Instead of fixing the problems, which would have cost the company $60 thousand, they offered a $10 thousand bribe to the Air Force official knowing that the Air Force official would make the final decision on whether to accept the work as complete and wanting the official to overlook the discrepancies.

The Air Force official declined the $10 thousand bribe and reported the attempt to law enforcement. When the company again offered the bribe, the Air Force official was "wired" and was meeting with the company at the direction of the Air Force Office of Special Investigations (AFOSI). This time, the entire conversation was recorded and the rest, as they say, is history. The company's representatives plead guilty and now face significant jail time.

The investigation of this case began when the public official reported to law enforcement that the subcontractor had offered him $10 thousand to look the other way on faulty work and accept their deficient work on behalf of the Air Force.

You can read further details about this case by clicking here.

Transportation's Disadvantaged Business Enterprise (DBE) Program

The Department of Transportation (DOT) has established a Disadvantaged Business Enterprise (DBE) program to provide a vehicle for increasing the participation by Minority Business Enterprises (MBEs) in state and local procurement. DOT's DBE regulations require state and local transportation agencies that receive DOT financial assistance, to establish goals for the participation of DBEs. Each DOT-assisted State and local transportation is required to establish annual DBE goals, and review the scopes of anticipated large prime contracts throughout the year and establish contract-specific DBE subcontracting goals.

In addition to establishing goals, state and local recipients also certify the eligibility of DBE firms to participate in DOT-assisted projects. Some groups are presumed to be socially and economically disadvantaged for the purposes of participation in this program. For example, women-owned businesses are presumed to be disadvantaged for the purposes of participation in this program.

To be certified as a DBE, a firm must be a small business owned and controlled by socially and economically disadvantaged individuals. Certifiers make the determinations based upon on-site visits, personal interviews, reviews of licenses, stock ownership, equipment, bonding capacity, work completed, resume of principal owners and financial capacity.

Last week, the Department of Justice announced a settlement of allegations of false claims related to this program. The company agreed to pay more than $140 thousand to settle allegations it submitted false records to the Washington State Department of Transportation related to a federally-funded interstate highway improvement project.

The contractor claimed that from 2010 to 2014, it was leasing specialized equipment used to process and clean waste water generated by construction projects from a certified DBE. In fact, the machine was owned by the contractor who used a lease/purchase agreement to make it appear, consistent with DBE set-aside requirements for federally-funded highway projects, that a subcontractor (or supplier) owned the machine.

In paying the $140 thousand to settle allegations, the contractor did not admit to misconduct. The DoJ press release did not state the source of the allegations - whether from a whistleblower or someone within a transportation agency doing their job.

National Procurement Fraud Task Force

Back in 2006, the Department of Justice established the National Procurement Fraud Task Force for the sole purpose of detecting and prosecuting fraud in government contracting. Its members include representatives of both the Criminal and Civil Divisions of the Department of Justice as well as the U.S. Attorney's Office and twenty-some agencies including the FBI, the CIA, Homeland Security, Inspector General's, GSA, SBA, and every defense-related investigative command (e.g. AFOSI, NSI, and Army CID).

Initially, the task force focused on the following areas of procurement fraud:

• Defective pricing
• Product substitution
• Misuse of classified and procurement sensitive information
• False claims
• Grant funds
• Labor mischarging
• Accounting fraud
• Fraud involving foreign military sales
• Ethics and conflict of interest violations, and
• Public corruption associated with procurement fraud.

Lately, it seems the Task Force has been working a lot of cases involving contractors misrepresenting their socio-economic status. One such case, announced yesterday, involved an individual who fraudulently obtained $2.8 million in Government contracts by representing to the U.S. Government that his business was veteran owned, a small disadvantaged business, a Hispanic-American owned business, a minority-owned business, and a service-disabled veteran owned business. In fact, the individual was not a member of any racial or ethnic minority, was not a disabled veteran and was not a member of a socially disadvantaged group. This fellow has been sentenced to 42 months in prison and must forfeit $700 thousand.

We don't have the statistics but it does seem to us, based on the number of Justice Department press releases we read, that the Government has been cracking down on abuses in its socio-economic programs - especially by contractors who misrepresent their status. Of course, it doesn't seem to be a particularly difficult crime to uncover and prosecute, especially with lots of competitors looking for ways to appeal awards they were unsuccessful in, disgruntled insiders, and whistle-blowers hoping to make a buck by filing Qui Tam actions.

What is "Credible" Evidence of Fraud?

Yesterday we discussed a case where the President of a contractor for the State Department had credible evidence of fraud but didn't report it to the Government. According to the press release from the Justice Department, FAR (the Federal Acquisition Regulations) required the contractor (the President in this case) to report credible evidence of fraud. Someone immediately asked where that requirement was found in FAR and another asked about the definition of "credible". So, we'll answer both of those questions here.

The mandatory disclosure rule has been around since 2008 and we've written about it a few times. See for example here and here. The policy guidance is found in FAR Part 3.10, Contractor Code of Business Ethics and Conduct. (FAR Part 3 in generally is a good place for contractors to find information when developing ethics programs). The associated contract clauses are FAR 52.203-13, Contractor Code of Business Ethics and Conduct, and FAR 52.203-14, Display of Hotline Poster.

Briefly, these contract clauses require contractors (and subcontractors) to disclose to the Government whenever they have obtained "credible evidence" of criminal violations, a violation of the civil False Claims Act, or a significant overpayment in connection with the award, performance or closeout of a Government contract or subcontract. As we saw from yesterday's posting, failure to do so could land a contractor in jail or, more likely, fined.

Now for the term "credible evidence" question. FAR does not define the term "credible evidence". However, the FAR Councils have noted that the term represents a higher standard than say, "reasonable grounds to believe". To go from "reasonable grounds" to "credible evidence" means that a contractor must have time to properly investigate matters. Once the matter has reached the "credible evidence" stage however, a contractor (or subcontractor) is required to promptly notify the Government.

While the term "credible evidence" is not defined in FAR, the DoD FAR Supplement (DFARS) provides a definition for "credible information" which may be helpful. DFARS 252.246-7003, covering a contractor's affirmative duty to disclose potential safety issues to the Government, defines credible information as information that, considering its source and the surrounding circumstances, supports a reasonable belief that an event has occurred or will occur.

Boeing Employee Charged With Accepting Kickbacks

Well, we suppose that if it can happen at Boeing, it can happen anywhere.

Boeing has long been known for its exceptional Code of Conduct, not only in the words but in the implementation - setting the proper tone at the top, ensuring that all employees are routinely and frequently trained and reminded of ethical conduct, and even certifying each year that they have read and understood the code. A code of ethical conduct is integral to all internal control systems including accounting, billing, estimating, and purchasing (to name some that the Government is interested in). And the Government has reviewed these internal control systems and found them adequate ("Adequate" is the best a contractor can hope for - systems are either adequate or not adequate).

The Boeing code of conduct includes provisions such as "In conducting its business, integrity must underlie all company relationships, including those with customers, suppliers, communities and among employees." Or, how about this one; "Employees will not engage in conduct or activity that may raise questions as to the company's honesty, impartiality, reputation or otherwise cause embarrassment to the company." Employees certify annually that they will not take advantage of their Boeing position to seek personal gain through the inappropriate use of Boeing or non-public information or abuse their position.

Regarding procurement practices, Boeing likes to think that all procurement actions are based on conformance with all applicable laws, regulations and contractual obligations and all suppliers and their representatives are treated fairly and impartially. Boeing stresses the importance of competitive bidding as a good business practice and considers ability, capacity, integrity, financial status, etc in evaluating a potential supplier before and during a purchase contract.

Boeing's program of ethical conduct must be working pretty well. The Department of Justice just announced that a Boeing employee has been charged with receiving hundreds of thousands of dollars in kickbacks from suppliers in exchange for steering contracts their way (yeah, we know, the guy has only been charged and he's innocent until proven guilty but every one knows the guy's a crook - four people that paid the guy off have already plead guilty). Boeing said it discovered the scheme after receiving a tip from its internal ethics program. It launched its own investigation and later alerted the Government that it suspected the employee was receiving kickbacks. The Government investigated and sure enough, the employee was receiving kickbacks. This is a strong testimony for the effectiveness of internal hot line systems.

At the center of the scheme was a subcontractor to Boeing that specializes in machining, welding and producing sheet metal. In a classic "pay to play" scheme, the subcontractor paid kickbacks to the Boeing buyer in exchange for confidential information  that gave the subcontractor an improper advantage in bidding and ensure that it would receive a contract from Boeing.

The subcontractor evidently specialized in poor quality  because Boeing fired them for poor quality and poor performance. That didn't really stop anyone - they just brought in a "front" company to take over the work. The principles remained the same. In the end, the subcontractor got $4.5 million worth of work from Boeing in exchange for $750 thousand in kickbacks.

You can read DoJ's press release here.

Government Employees Accepting Bribes from Contractors

The Department of Justice (DOJ) announced yesterday that two Government employees (most likely "former" Government employees at this point) and a Government contractor were convicted by a Federal jury of bribery and fraud charges related to military trucking contracts. The magnitude of the fraud was staggering. Over a period of less than four years, the Government employees accepted $800 thousand in bribes in exchange for steering $37 million dollars in contracts to the trucking company. The two Government employees worked for DLA (Defense Logistics Agency) at the Marine Corps Logistics Base (MCLB) - Albany. The trucking company was also based out of Albany GA.

According to the press release, the company bribed the Government workers in order to obtain commercial trucking business from MCLB-Albany. The contracts however were loaded with plenty of "extras" including premium-priced requirements, expedited services, expensive trailers, and exclusive use that required freight be shipped separately from other equipment, even if it resulted in a truck not being filled to capacity. Sometimes shipments were delayed for a period of hours or days, thereby reducing the time available to fulfill the shipping request and assuring that a local trucking company would get the job. There was even "ghost shipments" where the contractor billed the Government for shipments that were never made.

The trucking company paid another $200 thousand in bribes to Government employees who used their positions to help steal more than $1 million in surplus equipment from the base, including bulldozers, cranes and front-end loaders. The employees removed the items from the surplus inventory list and arranged to have them transported off the base by the trucking company.

Like most of these DOJ press releases, there is no mention as to how the fraud was uncovered - which is too bad because knowing how the fraud was perpetrated would help companies establish internal control systems to help detect and prevent such things from happening in the first place. Contractors (and all companies for that matter) need to diligently monitor the effectiveness of their internal control systems to ensure that they are operating at peak efficiency.

Army Civilian Charged with Extortion and Bribery

We discuss fraud quite a bit in this blog. There is no shortage of fraud cases occurring in Government contracting. Often the fraud is between Government employees and the firms that they oversee. Sometimes, the fraud is between contractors and supplies were increased costs is passed on to the Government.

The Association of Certified Fraud Examiners (ACFE) has come up with a model to help explain why fraud occurs. Its referred to as the fraud triangle. The fraud triangle is a model for explaining the factors that cause someone to commit occupational fraud. It consists of three components which, together, lead to fraudulent behavior.

• Pressure (perceived unshareable financial need)
• Opportunity (includes small likelihood of getting caught)
• Rationalization (only borrowing it, underpaid, deserved it, etc)

Consider the fraud triangle elements as it relates to allegations raised just last week.

A retired Army Sargent Major returned to the Army as a civilian senior program manager and a contracting officer's representative. Last October, he invited a couple of executives from a company that he oversaw and solicited bribes. His solicitations were somewhat comical. He invited the two representatives to lunch. When they arrived, he was wearing sunglasses and drinking a margarita. He then instructed the company representatives to turn off their cell phones. The Army guy then passed out menus to the executives and inside the plastic covering for the center section of the menus was a piece of paper which outlined a bribe and extortion solicitation. Communications were conducted by typing into a notes application on the Army guy's phone.

The Army civilian was asking for $500 thousand. In return for the $500 thousand, the Army civilian stated that he would expunge damaging information contained within Army files on the company. Additionally, he would ensure that the company received the follow-on contract to the program they were currently working. That program was estimated to total $100 million to $120 million over a five year period.

To their credit, the company executives declined the offer and then paid a visit to the FBI. The FBI opened an investigation, using the company executives to pass $50 thousand in bribes to the Army civilian. The Army civilian used most of the money to pay off family credit cards. At one meeting during the investigation, the Army guy patted down the executive looking for a recording device. He missed it and was caught on video discussing bribe money.

The Army civilian had the pressure (credit card debt) and the opportunity (oversight of a significant dollar Government contract). We don't know too much about his "rationalization" because the DOJ press release didn't provide enough information.

Contractors, do you trust your employees to do the right thing when faced with similar situations? Do you have an effective standards of conduct policy? Are you setting the proper "tone at the top"?

Forged Documents Lead to Conviction

Back in 1993, the President of a Pennsylvania machine company was convicted of paying bribes to secure Government contracts and paying hush money to the company controller in an attempt to cover it up. It was a felony conviction and he was fined $20 thousand and sentenced to four months of house arrest, 400 hours of community service, and three years probation.

A few years later, this person with a felony conviction on his record was at it again. He bought a defunct division from his old company and soon began winning millions of dollars in Government contracts to produce critical hardware components used in military helicopters and other aircraft. These contracts allowed the company to receive progress payments based on cost incurred.

In 2011, the Defense Contract Audit Agency (DCAA) performed an audit of a progress payment submitted by the company. During the audit, the owner directed two employees to present a copy of a altered cancelled check to a subcontractor in the amount of $69,000. The the true amount of the check was $25,000. The auditor accepted the falsified documentation as authentic, obviously failing to observe actual documentation or otherwise corroborating the information, wrote up a clean report, and the contractor went on to receive additional progress payments.

One of the employees who was asked to provide falsified documentation to the auditor subsequently blew the whistle and the Justice Department opened a criminal investigation. Ultimately, the investigation revealed that the contractor had diverted $1.2 million of progress payments to other uses. Subcontractors were not getting paid so they stopped work. This caused delivery delays under the contracts and quality concerns. Some of the items paid for by the Government were never delivered.

On December 17, 2014, a federal judge entered a $3.6 million civil judgment against the company and its owner. The owner agreed to the orders and did not dispute his liability.

There are a couple of obvious points that arise from this incident. First, the Government's system for dealing only with reputable contractors is broken. A man with a felony conviction was able to get right back into Government contracting and win millions in Government contracts. Second, the DCAA auditors were easily duped.  They relied on forged documentation to support their audit objectives. This embarrassment ultimately led to changes in the way that DCAA looks at supporting data. Auditors are now more likely to insist on viewing "original", rather than copies of documentation - invoices, purchase orders, cancelled checks, etc. - when performing their audits.

Closure to the Largest Bribery and Kickback Scheme in the History of Federal Contracting

Monday of this week, the Department of Justice announced that Eyak Technology LLC and Eyak Services LLC (related companies) agreed to pay $2.5 million and relinquish any rights to additional payments from the United States Government, to resolve allegations that the companies submitted false claims to the Corps of Engineers. These companies are subsidiaries of Eyak Corporation, an Alaska Native Corporation (ANC). When the fraud was first exposed, the Corps of Engineers stopped payment on all of Eyak's invoices. Eyak has agreed not to pursue those payment requests.

You may remember this case that first came to light in 2011. Eyak had a $1 billion contract with the Corps of Engineers to provide and install high-tech equipment. Between 2007 and 2011, Eyak's director of contracts accepted kickbacks from several subcontractors. The  kickbacks were included in billings from the subcontractors and subsequently passed along to the Government. In many cases, work was never performed. The Justice Department emphasized also that Eyak lacked the internal controls to detect the improper charges and that's where the Corporation got in trouble. Yes, there were rogue employees but the lack of adequate internal controls allowed the fraud to occur and fester for so many years.

The main contractor employee in the scheme is now serving a seven year prison sentence and was forced to pay $9 million in restitution. A Corps of Engineers participant is serving a 19 year sentence. So far, more than 20 people and businesses have been convicted of charges related to their involvement in the contract fraud scheme.

This case should be a reminder to all Government contractors of the importance of implementing effective internal controls, ethics, and compliance programs. This case also illustrates what can happen when the Government purchases commercially - there is no Government oversight of the contractor.

You can read the Department of Justice press release here.

Employee Fraud - Directing Subcontractors to Use Designated Lower-Tier Subcontractors

Whenever we read of a fraud case, our interest goes immediately to questioning what went wrong - what internal control system did not exist or was not adequate to prevent it from occurring. According to the Fraud Triangle model, there are three factors that, when taken together, lead to fraudulent behavior. These three factors are (i) perceived unshareable financial need, (ii) perceived opportunity, and (iii) rationalization. Take away any of these three conditions and you will reduce the likelihood of occupational fraud occurring in your organization. Internal control systems fall within the "opportunity" condition - good internal control systems should decrease the opportunity for someone to commit fraud against your organization.

Yesterday, the Department of Justice publicized the results of a jury trial where an employee of a large, multi-national construction and engineering firm was convicted of fraud. In this case, the employee was able to direct the recipients of subcontracts he had awarded, to hire certain other companies as lower-tier subcontractors. Directing a subcontractor to award lower-tiered subcontracts to specific firms would be inappropriate in any purchasing system. But to compound the problem, these lower-tiered subcontractors happened to be companies he himself controlled. In one case, he owned a shell company with no employees had the employees of the prime contractor - his co-workers - perform the work. In the other case, he owned 51 percent of the shell company but it also had no employees to perform the construction work.

In these cases, the subcontractors who agreed to the conditions were partly to blame. They probably knew what was going on but perhaps they figured that it was just the cost of doing business. If they didn't play, they wouldn't get the work. Kickbacks are difficult to detect but there are some red flags that contractors should be aware of.

• Lack of competitive bidding procedures
• Poor supervision of the purchasing function
• Prices of goods or services appear to be higher than market value
• Employees promote or lobby for a vendor who others in the industry shun
• Employees appear to be unusually chummy with a particular vendor
• Management applies inordinate pressure on purchasing employees to use a particular vendor
• The vendor is in a highly competitive industry where kickbacks and bribery are connonplace

Contractors need to be cognizant of conditions within their organization that would allow opportunities for fraud to occur. Once identified then, contractors need to develop and implement control systems that will prevent and detect fraud from occurring.

Dept of Justice Intervenes in a Whistleblower Suit Alleging False HUBZone Certification

Historically Underutilized Business Zones (HUBZones) are areas that have historically had trouble attracting business. Companies who have their primary place of business inside a HUBZone, often receive preferential treatment when competing for Government contracts. Some Government contracts are exclusively set aside, or reserved, for HUBZone companies.

To find out whether your primary business location is situated in a HUBZone, refer to the SBA's HUBZone map.

The primary purpose in SBA's HUBZone program is to help create jobs in areas that historically, have had trouble attracting business. Companies that maintain their principal office in a zone (and meet certain other requirements) can apply to the SBA for certification as a HUBZone small business company.

As one might expect, this program is sometimes abused by companies that seek the preferential treatment but do not maintain their businesses in a HUBZone area. Such is the complaint filed yesterday involving a contractor making false statements to the SBA to obtain HUBZone certification.

The complaint alleges that the company first applied to the HUBZone program in 2010 by claiming that its principal office was located in a designated HUBZone. The complaint further alleges that the office was a "virtual office" where no employees worked - the real office was in a non-HUBZone location. The company also falsified a lease agreement for its purported HUBZone office.

After obtaining the HUBZone certification, the company then used the certification to obtain contracts from the Corps of Engineers, the Coast Guard, and the Interior Department worth millions of dollars. One contract alone was worth $11 million.

The scheme might have continued indefinitely if it were not for a whistleblower. The whistleblower, in fact, was an employee of a competitor whose duties included monitoring competitors' bidding activity. While doing so, she learned that the company had listed an Orlando, Florida address for HUBZone certification when she knew that it was actually located in Chuluota, Florida, a non-HUBZone area.

If you want to read the entire Department of Justice press release, click here.

Purchasing Systems and Their High Propensity for Fraud

According to the 2014 Association for Financial Professionals Payments Fraud and Control Survey, a staggering 60 percent of businesses were exposed to actual or attempted payments fraud in 2013. The typical fraud-related loss experienced by businesses was $23 thousand. Ten percent of businesses recovered the full amount of money defrauded from them. Thirty percent of those impacted by fraud recovered nothing.

Not surprisingly, small businesses are more susceptible to fraud than larger firms. Many small businesses do not have internal control systems, they're disorganized, they do not perform business fundamentals like reconciling checkbooks regularly, and they put a lot of trust in their employees.

There are many ways to defraud. If the fraud is the accounts receivable clerk kiting checks, the resolution is between the clerk, the company, and perhaps local law enforcement. But woe to the company where the impact of fraud is passed along to the Government through a contract or grant. That company will feel the immense weight of the Government investigative and judicial juggernaut as they pursue prosecution and/or settlement.

Consider the Department of Justice press release from yesterday. Sevenson was a company founded in 1917 by one man. The company was passed on in the 1940s to the man's sons and from the sons to the grandsons in the 1970s. Here was a nearly 100 year old environmental remediation company that became quite successful by any standard - except for one detail. They had some employees who exploited weak internal controls.

These employees accepted kickbacks, rigged bids, and passed inflated charges to the Government. The DOJ press release stated that the employees accepted more than $1.6 million in kickbacks from six companies in exchange for the award of subcontracts for work at a EPA clean-up site. Then, those employees conspired with the subcontractors to pass the majority of those kickbacks to the EPA through inflated charges.

Obviously, this kind of fraud is perpetrated through a contractor's purchasing system and that is one reason why the adequate purchasing system are so important to the Government (e.g. DCMA performs periodic Contractor Purchasing Reviews (CPSR) at larger contractors). Internal controls can be devised to prevent fraud. Contractors should implement sound policies, procedures, and practices before its too late.