Federal Fumbles - 5th Edition

Oklahoma Senator James Lankkford has released the fifth volume in his Federal Fumbles series. These publications report on specific examples of wasteful federal spending and regulations that lead to wasteful spending.

This particular edition gives a lot of coverage to the "broken budget process" and the need to end Government shutdowns once and for all. That would be a goal that any Government contractor can endorse as Government shutdowns and the threat of shutdowns play havoc with the orderly conduct of contract performance.

Not every example in Volume 5 is related to wasteful contract spending. A lot of it relates to grants for questionable research (like $1.7 million to Russia to study the Steller seal lion in Russia or $114 thousand to study corporations that existed in Russia prior to the 1917 revolution). Some of the identified waste is not exactly spending but tax loopholes where the alcohol industry, racehorses, movies, and NASCAR have tax breaks written into the tax code. And then there's the Puerto Rican death scam where beneficiaries of social security recipients keep receiving social security payments after the recipient has died because Puerto Rico will not share death information with the Social Security Administration.

On the contracting side of wasteful spending, the report identifies a number of issues related to the Government's propensity to buy COTS (commercial off-the-shelf) items. In a number of cases COTS are lower priced but also lower quality and not equipped to do their intended jobs. The report sites one example where NSSA (National Nuclear Security Agency) purchased $5 capacitors for its nuclear weapon modernization program before finding they didn't meed quality control standards. The fix? Replacing the $5 capacitor in 370 nuclear weapons at a cost of $725 million. Also cited in the report is the Air Force expenditures related to keeping decades-old aircraft flying. Many parts are not longer in production so the Air Force needed to re-engineer those parts at significant cost.

FEMA (Federal Emergency Management Agency) gets special coverage for its "promptness over integrity" behavior. Just because FEMA is efficient in getting money out the door in the aftermath of disasters, doesn't mean that the money is being spent efficiently, effectively, or economically. This report recommends more training be given to FEMA employees on ways to detect fraud, wast, abuse, and how to reduce improper payments.

You can read this latest edition of Federal Fumbles as well as the four previous editions here.

Timecard Fraud Cost the Government $1.4 Million

This fraud was allowed to go on for 17 years. How?

Michelle Holt was a DoD employee at Joint Base Langley-Eustis. She was a salaried employee and as such, was entitled to overtime pay if authorized by her employer as well as other forms of holiday and vacation pay and premium pay for holidays worked.

The fraud was first identified by the DoD-IG during a routine audit that identified anomalies in Michelle's time and attendance records. The matter was turned over to investigators (the Air Force Office of Special Investigations (AFOSI) and the Defense Criminal Investigative Service (DCIS)) who ultimately found that from December 2001 to July 2018, Michelle falsely claimed more than 42 thousand hours in unauthorized overtime for hours she did not work as well as other amounts of unauthorized holiday leave, sick leave and annual leave.

In case you're trying to do the math, 42,000 hours equates to 2,470 hours per year. When the normal worker is paid for about 2,080 hours per year (40 hours times 52 weeks), this is almost twice as much as a normal work week. Stated another way, Michelle would have to work 17 hours a day, five days a week for 11 years to book that many hours.

How is this allowed to go on for 17 years? Where was her supervisor? Where were the finance people in charge of managing budgets? Where were the controls in payroll processing? There were serious internal control deficiencies in the process.

According to the Justice Department press release, Michelle accomplished the fraud by making manual retroactive adjustments to protected computer time and attendance systems to add overtime, reverse leave taken and reverse holiday leave. In doing so, she used another employee's log-in information without that employee's knowledge or authorization.

The Government calculated that over the 17 year period, Michelle's enriched herself by $1.4 million. She has been ordered to prison for four years and has been ordered to pay restitution. Good luck getting the restitution - "she used the money she received from the fraudulently obtained overtime and leave payments to buy items for herself and for her family" - and when she's released at age 56, won't have much opportunity to earn enough to ever pay back the $1.4 million. At the court ordered payment plan of $200 per month, it will only take her 7,000 months (or 583 years) to pay it all back.

Contractors, are you vulnerable to such a scheme? Do you have internal controls in place to reduce the likelihood of something like this happening in your location?

Cities and Municipalities Have Contracting Problems Too

We tend to focus our blog writings on Federal Government procurement but states, counties, and municipalities and their contractors face pretty much the same contracting challenges as the Feds. In some respects, they face even more challenges since many do not have contracting professionals nor adequate resources for contract oversight. While they're not buying major weapon systems (we hope), contracted services represent a significant portion of cities' budgets.  Purchasing decisions often rest with a single person with little, if any, internal controls or checks and balances to prevent or deter fraud, waste, or abuse. The vesting of responsibility with just a few individuals and the lack of adequate oversight is why cronyism tends to fester in many localities. Here's an example of what we're talking about.

The City of San Diego has a living wage ordinance that took effect back in 2006. It requires employers working within City limits to pay a "living wage" that is adjusted annually based on inflation. The current living wage is $14.95 per hour.

Prizm Janitorial Services was pretty successful in getting Government contracts. Since 2010, the firm had been paid $3.4 million by various Government agencies and municipalities for cleaning offices, rest rooms, etc. Based on hotline complaints, the Government conducted a couple of audits in 2014 and 2016. These audits disclosed a number of repeated violations of San Diego's living wage ordinance and other labor laws, including:

1. Prizm violated the living wage law by making all of its workers independent contractors rather than employees.
2. Prizm paid some employees in cash with handmade receipts. It didn't provide itemized pay stubs as required by state labor laws
3. Prizm claimed it didn't know or employ many workers whose name were listed on signup sheets as those doing work for Prizm.
4. Prizm failed to provide requested records inviolation of a city code and interfered with the investigation.
5. Prizm's address is a mailbox at PostalAnnex.

Prizm repaid back wages and social security liabilities, refunded the City for overpayments, and paid State required sick leave.

Despite all of these issues, another city close to San Diego, the City of Carlsbad, just awarded Prizm a $2.7 million contract over six years to clean city facilities and park restrooms. When asked about the San Diego problems, Carlsbad spokesperson declined to comment. Why? San Diego reported that it does not routinely share its problems with other cities. Why? From an audit and investigative standpoint, this situation certainly raises red flags. Could there be more here than meets the eye?

$2 Million Settlement in Small Business Subcontracting Fraud

The Department of Justice (DOJ) announced last Friday a partial settlement in a case involving questionable subcontracting practices by an Energy Department contractor and one of its subcontractors. The investigation is ongoing but one of the parties agreed to pay $2 million to resolve its part of the case.

The DOJ press release can be found here while a newspaper article with more detail can be read here.

Government contracts and subcontracts contain small business subcontracting goals. Although in most cases, contractors make diligent attempts to meet those goals, there is no real penalty for not meeting them. Except in the case of some DOE contracts. DOE is known to base a portion of award fees on contractors' successes in meeting those goals.Therefore in those cases, failure to meet those goals has a direct impact on profits.

In this case, the prime contractor was Washington Closure Hanford (WCH). The Federal case against that company continues. One of its subcontractors was Federal Engineers & Constructors (FE&C). Although admitting no liability, FE&C settled with the Government for $2 million to resolve its part in the affair.

FE&C, in turn, awarded two subcontracts totaling $19.5 million to a third company called Sage Tec cleanup work at DOE's Hanford site. Sage Tec is a small, woman-owned business and awarding $20 million worth of subcontract to a small woman-owned business counted significantly toward both WCH and FE&C meeting their small-business goals.

Things began to unravel when another woman-owned small business, Savage Logistics, called foul. Its owner, Salina Savage, filed a whistleblower suit claiming that Sage Tech was a front company and had no relevant experience, no equipment, and no employees other than its owner.

Turns out that was true. When FE&C awarded the first subcontract to Sage Tec, Sage Tec had no experience, equipment, or employees. When it awarded the second subcontract three years later, Sage Tec still had no employees or equipment although by then it must have had a little bit of experience.

So how did Sage Tec pull off $20 million worth of subcontracting without any equipment or employees? Easy, it "rented" trucks from its prime contractor, FE&C, and used FE&C employees to drive those trucks. So, Sage Tec certainly looks like a front company. It probably doesn't seem helpful to know that the owner of Sage Tec was also the wife of an FE&C Vice President.

For her part in blowing the whistle, Salina Savage gets $470,000 of the $2 million settlement. Also, FE&C agreed to reimburse her for $100,000 in attorney fees.

Poor Internal Controls Leads to Theft of Government Property

All Native Group (ANG) is the federal contracting division of Ho-Chunk, Inc, the economic development corporation of the Winnebago Tribe of Nebraska. Besides being tribally owned, ANG carries SBA 8(a) certifiication, small disadvantaged, and a HUBZone status. They provide a wide range of services to the Government including staff augmentation, editorial services, IT, logistics, and professional services. One of ANG's contracts is with the Department of State (DoS) to provide training at the State Departments Diplomatic Security Interim Training Facility in Summit Point, West Virginia.

In 2011, All Native Group hired Richard Millette to be a "special-skills tactics instructor. Earlier this month, Mr. Millette was indicted by a Federal Grand Jury on theft charges (an indictment, of course, is only an accusation. A defendant is presumed innocent unless and until proven guilty). It seems that Mr. Millette was stealing (i) ballistic vests and (ii) combat helmets from the State Department's inventory and selling them online and trading them for other items. The thefts occurred in 2016.

The stolen equipment was found posted for sale on a Facebook private-group page titled "Shooters Lounge". The name on the Facebook account used to post the items for sale was not Mr. Millette's but an investigation determined that the photos accompanying the listings were taken from Mr. Millette's office desk. Additionally, the items were marked with the State Department's information tags.

State Department special agents obtained a search warrant and went to Mr. Millette's house and found the stolen equipment - equipment that had been used by instructors for training exercises and safety demonstrations. One of the ballistic vests contained the identification of a former State Department employee.

Initially, Mr. Millette claimed that he obtained some of the equipment from the company that produced it because he was trying to start his own self-defense company. The equipment manufacturer however refuted that claim.

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. These three components include (i) perceived unshareable financial need, (ii) perceived opportunity, and (iii) rationalization. We don't know enough of the facts of Mr. Millette's case to frame it against the fraud triangle. However, one thing is clear - there was opportunity and that opportunity was no doubt a result of poor internal controls over the accountability of Government property by All Native Group. Good internal controls would have reduced the "opportunity" risk.

Reducing Fines for Contract Fraud

We discuss fraud, waste, and abuse here on this blog quite a bit as well as the ensuing investigations and punishments. Most of the time, when fraud involves a contractor without a specific tie in to an individual, there is a fine imposed. The determination of the amount of the fine is rarely given although it is almost always significantly less than the maximum fine for the criminal or civil crime.

There are guidelines that allow for credit in the calculation of a fine if the organization has in place an effective program to detect and prevent violations of law. Such a program must be one that is reasonably designed, implemented, and enforced so that it generally will be effective in preventing and detecting criminal conduct. A contractor must use due diligence in seeking to prevent and detect criminal conduct by its employees.

A contractor must take at least seven minimum steps to meet the requirement of due diligence:

1. Implement policies defining standards and procedures to be followed by the organization's agents and employees
2. Assign specific high-level personnel ultimate responsibility to ensure compliance
3. Use due care not to delegate significant discretionary authority to persons whom the organization knows or should have known had a propensity to engage in illegal activities.
4. Communicate standards and procedures to all agents and employees and require participation in training programs
5. Take reasonable steps to achieve compliance (e.g. by the use of monitoring and auditing systems and by hiving and publicizing a reporting system where employees can refer criminal conduct without fear of retributyion - hotline or ombudsman program.)
6. Consistently enforce standards through appropriate discipline ranging from reprimand to dismissal
7. After detection of an offence, the organization must take all reasonable steps to respond appropriately to the offense and to prevent further similar offenses, including modifying its program and appropriate discipline for the individuals responsible for the offense and for those who failed to detect it.

Fraud, waste, and abuse will always be with us. No system of detecting and preventing it will be perfect. But if a contractor exercises due diligence in prevention and detection activities as enumerated above, it stands a good chance of reduced fines should fraud, waste, and/or abuse come calling.

Embezzlement through Corporate Credit Card Purchases

Here's a fraud case that should prompt companies to review their own internal control systems for preventing employee  fraud, waste, and abuse.

Stuart Teshima, the former CFO of Epsilon Systems Solutions (a Government contractor headquartered in the San Diego area) pleaded guilty last Tuesday to embezzling $825 thousand from his company over an eight year period. He did this from his trusted positions of Vice President, Senior Vice President, and Chief Financial Officer of the company.

How did he do it? According to the Department of Justice Press Release, Teshima used the company credit card to pay for personal expenses including airfare and other personal travel, jewelry, gifts for family members, furniture, lavish dinners, and even his personal income tax bill. Then, before submitting invoices for reimbursement, Teshima would conceal the personal spending by altering his account statements to replace the personal items with fictitious business expenses. He then falsely reported to company representatives that the statements he submitted were generated directly from his credit card account, when in fact he altered the records himself before submitting them for reimbursement.

There are obvious internal control weaknesses in Epsilon's system. First of all, it appears that the company was paying its credit card balances without any support in the form of source documents. It merely relied on the signature of a trusted employee. Second, Epsilon was paying based on a "downloaded" statement which, of course, can be easily altered. It should have been paying based on printed statements received by mail that were reviewed and approved by a independent party. The independent reviewer should have insisted that charges be supported by original receipts.

It should not be surprising that auditors (both financial auditors and contract auditors) ask for original source documents. They are not trying to be obnoxious but when they put their name on a report asserting that the financial representations fairly present the objective of their audit, they need to be certain, beyond a reasonable doubt, that the company's representations are not misleading (or worse).

Epsilon has 1,000 employees and its not unlikely that with this many employees, there will be plenty of opportunities for those so bent, to poke around and find internal control weaknesses. Companies need to stay one step ahead of the fraudsters.

Teshima pleaded guilty but has not been sentenced. He has agreed to pay restitution for the amount embezzled. In addition, he faces probable fines and possible imprisonment.

Why Contractors and Grantees Need Government Oversight

A professor of civil and environmental engineering from Washington State University (WSU) was arrested and charged with defrauding the Government out of $8 million in federal research fund last February. He has been charged with fabricating letters of support and investment, providing false information in research grant proposals and reports, and providing falsified reports and emails regarding how federal research funds were spent.

WSU, for its part, have initiated its own review of the evidence and will use that information to determine any disciplinary action it will pursue in this case. WSU officials said they were cooperating with federal investigators and working to help gather evidence for the investigators.

This professor received about 30 grants from the National Science Foundation (NSF) and the Energy, Transportation, and Agriculture Departments, to develop asphalt-composition technologies. The grant money was deposited into bank accounts and subsequently distributed for the professor's personal use, and not the technology development represented in their grant applications.

Grants and certain types of contracts such as research and development (e.g. Small Business Innovative Research), seem to be at risk for this type of fraud. The Government gives money to individuals or businesses with the hope of advancing the state of the art in various fields. Many times, the "experiments" fail or do not produce the intended result. That happens in research. The "deliverable" for these types of grants/contracts is typically a report summarizing the results of the research. If individuals or businesses are so inclined, it is easy to perpetrate fraud in these programs, especially if there is lax oversight.

Universities like grants for many reasons including financial reasons where the work on the grant helps absorb some of the overhead. WSU pulls in $330 million in grants every year. Universities sponsoring these grant-wielding professors however have a fiduciary duty to provide a certain level of oversight into what their staffs are doing and how they are performing,

You can read the full Department of Justice press release here.

Government Files False Claim Action Against DOE Contractor

The U.S. Government has filed a civil action against the contractor in charge of its Savannah River cleanup operations (Savannah River Nuclear Solutions, LLC or SRNS) and its parent company Fluor Federal Services, Inc. (FFS) for making false and fraudulent claims and statements to the Government and for knowingly including unallowable costs in inflated claims to the Department of Energy.

The contractor operates under a DOE (Department of Energy) M&O contract (Maintenance and Operations). These M&O contracts are designed to operated by stand-alone entities and therefore any cost allocations from a home office are not allowable under the contract. Any costs that may be allocable to the M&O contract from a home office are covered by the fee that the contractor earns.

The M&O contractor often "borrows" personnel from the parent company. These loaned employees are now commonly referred to as "corporate reachback" employees because employees are loaned from the M&O contractor's owners to conduct work directly for the M&O contractor. The M&O contract makes it clear that while the reachback program is fine, the costs allocated to the M&O contractor for reachback labor cannot include any home office allocations.

The problem from the Government's point of view was that the cost of reachback labor transferred from the SRNS's owner did include home office allocations. The Government's filing goes to great lengths in chronicling the contractor's duplicity in telling the Government one thing but doing quite another. In fact, the filing describes a "secret" modification to the cost transfer agreement between SRNS and FFS that deleted the phrase "For the term of this Agreement and any extensions thereof, allocations of home office expenses to FFS loaned employee costs are unallowable in accordance with the provisions of the SRNS Contract ..." to "For the term of this Agreement and extensions thereof, allocations of home office expenses to the SRNS segment costs are unallowable in accordance with the provisions of the SRNS Contract ..." That change is no small matter. Between 2008 and 2015, the amount of home office allocations on reachback labor ultimately billed to DOE totaled $5.2 million.

We are not Government contract attorneys but on the surface, it seems like the Government has made a very compelling case against the actions of SRNS. You can read the Government's complaint here.

Contractors Are Responsible for the Actions of Their Employees

During the wars in Iraq and Afghanistan, the military and its contractors disposed of garbage and anything it didn't want to ship back to the States, in open-air burn pits. According to the GAO (Government Accountability Office) there were at least 230 burn pits in Iraq and Afghanistan. It wasn't too long before veterans were claiming health issues as a result of inhaling smoke and fumes from the fires. They have now begun suing contractors alleging that the smoke from the burn pits was toxic and made them sick. Today the Department of Veterans Affairs is tracking veteran's exposures to burn pit dust, fumes and other pollution generated from the use of burn pits. Some are calling it the new "agent orange".

ERKA Construction was a Turkish company who was awarded a contract in 2007 to operate one of the burn pits in Iraq. The contract provided for the government to furnish ERKA fuel to perform contract work. Fuel was provided on the honor system because there was no oversight to ensure that ERKA took only the amount reasonably required to perform their contract work. In 2009, the AFOSI (Air Force Office of Special Investigations) was alerted through a contract fraud tip line that theft was occurring at the fuel farm.

An investigation ensued. Ultimately the AFOSI proved that contractor employees, with or without the contractor's knowledge, were systematically stealing fuel and taking it off base. The Government calculated that about $480 thousand worth of fuel was lost and demanded repayment. ERKA filed an appeal with the ASBCA.

Although the Air Force had not proven whether the fuel theft scheme was an enterprise that benefited ERKA or simply the people who were involved, it had little difficulty in determining the ERKA's project level management staff had knowledge of the theft. And because a Government contractor must adequately staff a project and supervise its employees, ERKA's claim of innocence didn't work.

Ultimately, the Board ruled that the responsibility should fall on ERKA for the stolen fuel. ERKA put in place people who were dishonest, and whose general manager failed to stop the theft even after it was brought to his attention.

The full text of the case can be found under ASBCA Nos. 57618, 58515.

Big Payday for Whistleblowers

The Natural Resources Defense Council and several former employees of Lockheed Martin filed a lawsuit under the qui tam, or whistleblower, provision of the False Claims Act (FCA) alleging that Lockheed misrepresented its compliance with the Resource Conservation and Recovery Act (RCRA) to the Department of Energy and as a result, knowingly submitted false claims for payment under its contracts with DOE. The whistleblower provision of the FCA permits private parties to file suit on behalf of the United States for false claims and obtain a portion of the Government's recovery. In this case, the Government recovered $5 million and the whistleblowers will collectively receive $920 thousand.

The lawsuit alleged that Lockheed violated the statute that establishes how hazardous wastes must be managed, by failing to identify and report hazardous waste produced and stored at the facility, and failing to properly handle and dispose of the waste.

Lockheed operated the Paducah Gaseous Diffusion Plant under contracts with DOE from 1984 to 1999. During that time, Lockheed was responsible for the facility's uranium enrichment operations and for environmental restoration, waste management, and custodial care at the site.

In announcing the settlement, the U.S. Attorney stated:

Government contractors are required to follow the same federal laws that apply to everyone else. These companies do not get a pass on compliance, especially when their responsibilities include managing and disposing of hazardous waste. Today's settlement should serve as a reminder that ...the Department of Justice will pursue all credible allegations of false claims and of environmental regulatory violations.

Whistleblowers provide a valuable service in ferreting out fraud, waste, and abuse. Whistleblowing is not the mother lode however. Relatively few whistleblower cases are enjoined by the Government (based on our anecdotal evidence) which means the whistleblower, if he/she wants to proceed, must go it alone. That cost money and many attorneys are unwilling to take such cases on contingencies and as a result, the law suits simply die.

You can read the full DoJ press release on this case by clicking here.

Contractor Employee Indicted in $1.9 Million Kickback Scheme

The Department of Justice released a press release earlier this month noting the Federal Grand Jury indictment of a contractor employee accused of accepting kickbacks (and tax evasion). The company he worked for (identified as Company A) furnished supplies, materials, equipment, and services to the Government. He approached a subcontractor to Company A and solicited kickbacks in exchange for:

1. Refrain from conduct that would unfavorably affect the subcontractor's business relationship with Company A, and
2. Help ensure that the subcontractor obtained additional subcontracting business.

Between June 2009 and December 2014, the employee accepted 57 kickbacks totaling $1.9 million. That might not have been the extent of the kickbacks - it only represents the amount that the Government investigators found.

In January and February of this year, the employee met with the subcontractor and accepted two more kickbacks totaling $30,000. However, by this time, the Government was on to the scheme and the transaction was "documented".

The contractor employee, whose title is Logistics Manager, maintains his innocence.

I've never done anything illegal in my life. I have a clear record, education wise, work wise, I give 100 percent to everything I do. I wouldn't do something stupid to jeopardize my family.

This is a reminder to contractors that according to the Anti-Kickback Act of 1986, there is a requirement to have in-place, policies and procedures to detect and prevent kickbacks. Read more about the Anti-Kickback Act here.

What are "Fraud Indicators"

Following our posting on Courtesy Bids last week and how such bids might be considered a fraud indicator to a contract auditor, the Inspector General (IG) or the General Accountability Office (GAO), we were reminded that a fraud indicator does not necessarily lead to a fraud referral or an investigation. According to the DoD-IG who publishes listings of fraud indicators tailored to the type of audit being performed or the nature of the cost incurred, fraud indicators are designed to get auditors thinking - thinking for one, about the circumstances under which a fraud referral may be made.

Why do auditors concern themselves so much with fraud when fraud is not the objective of their audit? Generally Accepted Government Auditing Standards (GAGAS) require them to do so. It is "baked" into the auditing standards (a.k.a Yellow Book). In fact, the word "fraud" shows up 117 times in the GAO Yellow Book. GAGAS requires the following:

when performing a GAGAS examination engagement, auditors should design the engagement to detect instances of fraud and noncompliance with provisions of laws, regulations, contracts, and grant agreements that may have a material effect on the subject matter or the assertion thereon of the examination engagement. Auditors should assess the risk and possible effects of fraud and noncompliance with provisions of laws, regulations, contracts, and grant agreements that could have a material effect on the subject matter or an assertion about the subject matter of the examination engagement. When risk factors are identified, auditors should document the risk factors identified, the auditors’ response to those risk factors individually or in combination, and the auditors' conclusion.

In other words, auditors cannot perform an audit that is compliant with Generally Accepted Government Auditing Standards without considering the potential for fraud and the impact of fraud on the audit subject.. To assist contract auditors in fulfilling its responsibilities, the DoD Inspector General's Office (DoD-IG) has published a listing of fraud indicators to help auditors understand the risks. According to the DoD-IG,

Auditors should familiarize themselves with the basic knowledge provided by the scenarios and creatively use it while performing any audit or review. ... auditors should review the full scenarios at least initially as they provide other valuable information such as examples of analytical procedures, management inquiries, and audit procedures and/or expanded audit procedures to address potential fraud indicators.

Built into every one of DCAA's standard audit programs is a requirement for the auditor to affirmatively consider and document the potential or existence of fraud. For example, the standard audit program for audits of incurred costs, states:

Based on the team's understanding of the criteria, subject matter, and the contractor and its environment, hold a planning meeting with the audit team (at a minimum, Supervisor and Auditor) to discuss and identify potential noncompliances, due to error or fraud, that could materially affect the subject matter. The discussion should include: 

• relevant prior audit experience (e.g., questioned cost, relevant reported estimating or accounting system deficiencies)

• relevant aspects of the contractor and its environment

• risk of material noncompliance due to fraud (e.g., the extent of incentives, pressures and opportunities to commit and conceal fraud, and the propensity to rationalize misstatements)

• other known risk factors

• the audit team’s understanding of relevant internal controls. 

Document fraud risk factors/indicators that are present and could materially affect the subject matter. If fraud risk factors are present, document specific audit procedures designed to address the increased risk of material noncompliance due to fraud. Communication among audit team members about the risk of material misstatement due to error or fraud should continue as needed throughout the audit.

Back in the day, auditors did not specifically look for or consider fraud. If they stumbled across fraud during the course of their work, they were encouraged to report it as a suspected irregularity. Now however, they must affirmatively design audit procedures to detect fraud.

Contractors should be aware that every time an auditor steps through the door of their facility, they are actively engaged in considering whether fraud is occurring or has occurred.

Internal Controls Over Approving and Issuing Company Credit Cards

How are your internal controls over the issuance of company credit cards? Does it rest with a single company employee or are there approvals required by someone higher up in the organization. We're reminded to consider these questions after learning of a scheme within the Drug Enforcement Agency (DEA) where an employee had too much power and authority over the approval and issuance of credit cards to DEA employees and abused it.

According to a plea agreement, the DEA employee was a program manager and responsible for the approval and issuance of government credit cards to DEA employees. She admitted that while serving in that position, she submitted dozens of fake credit card applications for fictitious DEA employees, using names and identifying information of individuals who did not work at the DEA. Through this scheme, she obtained at least 32 fraudulent credit cards which she then used to withdraw more than $113 thousand from ATMs. What was she thinking? The chances of getting caught is likely to be 100%. The common denominator of these credit card bills, the phony employees and the approval thereof points right back to the DEA employee.

The (former) employee will now serve two years in prison and must repay the $113 thousand. (Something tells us there was a lot more money involved than just what the Government happened to catch). You can read more about the case here.

This was not a very sophisticated fraud scheme but if the DEA had instituted even the most rudimentary internal controls, it should never have happened. How about verifying the application to a current listing of employees? How about verifying that the employee needed the card? How about a supervisor approving his/her subordinate's need for a card. Nothing fancy, just some common sense controls.

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.

Do You Allow Employees to Carry On Side Businesses?

Do you allow your employees to carry on side businesses or moonlight with another company? Some companies specifically prohibit such activity, some allow it, while most do not have a position one way or another. Side businesses can and have run afoul of ethics violations. We recall one instance where a DoD contract auditor was caught advising her husband's company on proposal preparation and indirect rate development for a DoD contract. She didn't last long in her position. A recent Department of Justice press release illustrates another potential problem when it comes to employees doing a little business on the side.

The case involved a State Department contracting officer's representative (Chandler) and a contractor employee (Halsey). Halsey had a little business going on the side, selling nutritional supplements (a multi-level marketing company) to other contractor employees under his supervision. The sweet part of this deal was that the employees were reimbursed for their purchases by their employer, the State Department contractor. Halsey then conspired with Chandler (the State Department employee) to approve the billings that contained the reimbursements.

Before this scheme was disrupted, reimbursements totaling $170 thousand had been billed to the State Department and reimbursed to the contractor. For his part, Halsey earned more than $25 thousand in commissions. The State Department guy (Chandler) knew that Halsey was personally profiting but approved the billings anyway. There was no mention in the press release whether Chandler profited but he did plead guilty to charges of conspiracy to commit wire fraud and a conflict of interest related to his conduct as a State Department employee.

There was also another side to this story. The president of the contractor learned about the scheme and tried to cover it up. He know that he had a responsibility under the Federal Acquisition Regulations to timely disclose to the Government, credible evidence of fraud, but failed to do so. For his failure, he now faces a maximum penalty of five years in prison, if convicted. That will never happen, of course. He will probably face a nominal fine.

If you have credible evidence that fraud is going on in your organization, you have an affirmative duty to disclose it to the Government.

Abusing the SDVOSB Program

The Department of Justice issued a press release late last week announcing a Grand Jury indictment of three people for abusing the SDVOSB (Service-Disabled Veteran-Owned Small Business) program in Puerto Rico. The press release calls it a multi-million dollar fraud against the U.S. Government but it provides no further specifics on the magnitude of the fraud (or alleged fraud, at this point).

There was this man who owned a construction company called IRC Air Contractors. He had a brother who was a Service Disabled Veteran. Together they decided to take advantage of the disabled brother's status so they created a new company called Belko General Contractors. Turns out however that Belko was just a front company for IRC Air Contractors, created solely to obtain contracts that were set-aside for SDVOSBs.

This went on for quite some time. Between 2007 and 2014 Belko received a bunch of non-competitive, set-aside and sole-source government contracts. All of these were awarded to Belko under false pretense.

Here's something interesting. The disabled brother was also a full-time letter carrier for the U.S. Postal Service which calls into question the severity of his disability in the first place. Additionally, the disabled brother was not in charge of day to day operations and really had no role in anything connected to Belko or IRC Air Contractors. He was simply, as Justice put it, a "rent-a-vet".

These type of schemes are really not too hard to uncover. It just takes someone within the Government to be observant or a whistle-blower from inside the company. Based on the limited amount of detail presented in the press release, we don't know whether the Government was overcharged for the work performed. We do know that programs designed to benefit service-disabled veterans was abused and the awards did not benefit the targeted beneficiaries.

Man Convicted of Time-card Fraud Going to Prision

We were planning to continue our series on BBP 3.0 (Better Buying Power) today but have chosen instead to highlight an news article appearing in yesterday's Tri-City Herald about an individual going to jail on account of timecard fraud. Its not that this particular employee engaged in timecard fraud mind you - the Judge stated his crime was one of omission, not commission. He was in a position where he should have known that timecard fraud was occurring and he had a responsibility to report it, but didn't.

This case is an old one involving a lot of employees working for a contractor performing cleanup work at one of DOE's clean-up sites. We've reported on it several times as individual cases have moved through the legal system. The essence of matter was employees charging overtime for hours never worked. One of the most troubling aspects of this case, in our mind, was that Government investigators installed GPS devices on employee vehicles to track where their actual locations when they should have been at their work site. It is somewhat surprising to us that the Government's GPS caper hasn't gotten more publicity.

In any event, according to the news article, one of the supervisors of the 10 defendants who have pleaded guilty and awaiting sentencing was sentenced to 30 days in prison, three months of home detention and a fine of $34 thousand after pleading guilty to timecard fraud.

The Judge in the case said she was surprised that the Justice Department reduced its recommendation from the federal sentencing range of eight to 14 months. Then she added that the supervisor's crime was one of omission rather than commission. He know there was a high probability of timecard fraud occurring at the Hanford tank farms. Workers are required to report suspected fraud involving federal funding.

Last December, the Justice Department dropped criminal charges on another manager at this contractor in a plea deal where he agreed to pay $44 thousand in civil penalties.

Contractors need to understand that the Government can be very serious about timecard accuracy - especially when it comes to large dollar cost-type contracts. Costs under those contracts are passed right along to the Government so the expectation is that contractors will have robust internal controls, policies, procedures, practices, and monitoring to preclude this type of fraud, and other types of irregularities from occurring in the first place.

Read more here: http://www.tri-cityherald.com/2015/04/14/3511162_former-hanford-supervisor-sentenced.html?rh=1#storylink=cpy

DoD Prohibition on Confidentiality Agreements Designed to Cover Up Fraud, Waste, and Abuse

Some companies have required employees to sign confidentiality statements as a way of preventing (or at least discouraging) employees from reporting fraud, waste, and abuse to Federal investigators. Contractor employees, like Government employees are protected under various whistle-blower statutes yet some companies are taking the position that disclosures of fraud, waste, and abuse are tantamount to disclosing, reporting, or disseminating insider or company proprietary information. Also, most companies, when made aware of fraud, waste or abuse within their organization, would prefer to resolve the issue internally rather than having it drug through the public square. To forestall or prevent that from happening, there have been reported instances where contractors have required employees to sign non-disclosure to Federal investigative agencies of instances of fraud, waste, and abuse.

That is about to change for Defense contractors. Yesterday, the Director of Defense Procurement and Acquisition Policy announced that effectively immediately, no DoD funds will go to contracts with companies requiring its employees, seeking to report fraud, waste, or abuse, to sign internal confidentiality agreements or statements prohibiting or otherwise restricting such employees or contractors from lawfully reporting such wste, fraud, or abuse to a designated investigative or law enforcement representative of a Federal department or agency authorized to receive such information.

Specifically, the prohibition, now codified in DFARS (DoD FAR Supplement) at 252.203-7998 and 252-203-7999 state:

The Contractor shall not require employees or subcontractors seeking to report fraud, waste, or abuse to sign or comply with internal confidentiality agreements or statements prohibiting or otherwise restricting such employees or contractors from lawfully reporting such waste, fraud, or abuse to a designated investigative or law enforcement representative of a Federal department or agency authorized to receive such information.

And, if the contractor has already made its employees or subcontractors sign such confidentiality agreements, it must advise everyone that the agreements are no longer in effect.

The Contractor shall notify employees that the prohibitions and restrictions of any internal confidentiality prohibitions and restrictions of any internal confidentiality agreements covered by this clause are no longer in effect.

You can read more of the new DoD policy by clicking here.

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.