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Fraud and Loopholes Deliver Small-Business Contracts to Big Firms

By ROBB MANDELBAUM
New York Times
November 1, 2011

It’s been a busy season for combating fraud in government contracts for small business, for prosecutors enforcing the law as well as the legislators trying to improve it. But for both, it appears to be an uphill battle.

In June, the federal government charged two men with creating a fake small business to win a $100 million Defense Department contract. Two months later, a businessman pleaded guilty to obtaining to false citizenship papers, which he used to get a security clearance from the Department of Defense so that he could receive preferential small-business contracts.

In October, one man pleaded guilty to a scheme in which he and a partner vouched for the small-business status of each other’s company. That, in turn, led the Justice Department to uncover an alleged ring of bribery and kickbacks centered at Eyak Technology, or EyakTek, nominally a small business based in Virginia with a $1 billion contract to provide information and security technology to government agencies. An indictment announced on Oct. 4 claims that the company’s contracting director conspired with officials in the Army Corps of Engineers to steer federal purchases to an unnamed subcontractor. That subcontractor then inflated its bills — by $20 million, according to the indictment — and used part of the proceeds to pay off the Eyak and Army Corps officials.

The federal government is the world’s largest buyer of goods and service, and it is supposed to make sure that 23 percent of those purchases go to small businesses. In the case of economically disadvantaged businesses, government agencies can often set aside contracts and award them without putting them up for a competitive bid. The government perennially misses those goals, but most observers believe that the amount of small-business contracts the government does report masks a share that have in fact been diverted to larger companies. Fraud is an important, though unquantified, culprit.

Observers say government officials in charge of procurement are often too busy to look closely at a company’s small-business credentials. But the Small Business Administration’s inspector general, Peggy E. Gustafson, testifying in a Congressional hearing last week, said that her agency often did not effectively oversee the contracting programs and did not aggressively pursue companies that misrepresented themselves as small. The S.B.A., Ms. Gustafson said in her prepared statement, “needs to change its culture so that employees understand that their mission includes not only assisting small businesses but also ensuring accountability and integrity to prevent fraudulent and improper actions from depriving procurement opportunities for legitimate firms.”

Ms. Gustafson also said that despite the recent legal victories, seeking justice in a courtroom was difficult because a company that fraudulently identifies itself as small in order to win a federal contract usually fulfills the contract. “Without an associated and definable loss to the government, criminal prosecutors are sometimes reluctant to pursue action against these companies, or if they do pursue them, may only be able to obtain limited sentences,” she said.

That is not the case in the EyakTek case, where the government allegedly paid for the conspirators’ BMWs, first-class airfares and Cartier watches. But while the company itself was not implicated in wrongdoing — charges were only brought against its head of contracting — the allegations surrounding EyakTek raised other troubling questions about small-business contracting, because the company had a legally sanctioned leg up in the competition for small-business contracts. Eyak is what’s known as an Alaska Native Corporation, and with that designation, it is able to compete for contracts set aside for companies that participate in the S.B.A.’s 8(a) program. This is a program intended to help small, disadvantaged businesses — particularly those owned by minorities — by providing business training coupled with opportunities for no-bid contracts set aside just for them.

In the 1970s, Congress made Alaska Native Corporations a special class of 8(a) business. Unlike most businesses in the program, the Alaskan companies are not subject to a limit to the size of a no-bid contract. And while a typical 8(a) business must be managed by someone who meets the program’s definition of disadvantaged, that’s not the case with Alaska Native Corporations, which  tend to recruit executives with broad and deep ties across government agencies and pay handsomely for their experience.

These features have made Alaska Native Corporations very popular with government bureaucrats because they offer an easy way to meet small-business quotas. In 2009, according to the S.B.A.’s inspector general, Alaskan firms took in 26 percent of total 8(a) contract dollars. EyakTek and other subsidiaries of the Eyak Corporation together took in at least $338 million, according to a search of the federal contracting records performed by the American Small Business League, which lobbies for integrity in small-business contracting. (If a native company gets too big to participate in the program, the parent corporation can simply create a new company — another advantage not afforded other program participants.)

Any effort to change the rules for Alaskan companies is likely to meet stiff resistance in Congress. (Alaska’s representative, Don Young, is the second-ranked Republican in the House in terms of seniority and the sixth most senior of all representatives.)

Surprisingly, even trying to pass legislation to curb fraud is more difficult than one might expect. In her testimony, Ms. Gustafson proposed measures to make it easier to prosecute fraud and stiffen penalties for conviction, in part by defining a loss to the government as equal to the size of the contract.

A bill containing these provisions has passed the Senate, but Rep. Sam Graves, the chairman of the House Small Business Committee, faulted the Senate bill for, among other things, not including an exemption for honest errors. “The small-business affiliation rules are complex and are not intuitive, so I’m hesitant to potentially trigger jail time for companies that make a mistake,” he said in an interview with VetLikeMe, a newsletter for business owners who are wounded veterans, “although I agree that we need to more vigorously enforce the certification rules.” The House has not yet taken up the Senate bill.

Mr. Graves also expressed skepticism about a separate House bill, introduced last month, that would exclude the subsidiaries of publicly traded companies from the definition of a small-business contractor. The law already requires that recipients of small-business contracts must be independently owned and operated, but a American Small Business League spokesman, Brian Reeder, said a clarification was necessary. “Common sense says that independently owned means not publicly traded,” he said, “yet publicly traded companies and their subsidiaries receive contracts that government agencies put towards their small business goals.”

The bill was introduced by Rep. Hank Johnson, a Georgia Democrat, with support from 16 other Democrats. No Republicans sponsored the legislation, and Mr. Graves, the Small Business Committee chairman, opposes the bill “because it places further restrictions on how a small business can be organized and the source of its investment,” said a spokesman, Darrell Jordan. “At a time of record unemployment, Chairman Graves wants to support measures that help small businesses grow.”

Opposition to Mr. Johnson’s measure isn’t strictly partisan. The Georgia congressman introduced an identical bill last year, while Democrats were in charge. It died in committee.



 
 

 
 

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