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Eliminating Fraud in Small Business Contracting

By Lacie Schwarz and Will Hixson
Better Government Competition
May 20, 2013

What do the iconic brands Pepsi, Disney, Johnson & Johnson and Costco have in common? They’re amongst some of the largest companies to have developed their roots in the land of the American dream. They rose to prominence through ironclad business plans, unwavering consumer support and, oh yeah, defrauding American taxpayers and small businesses out of billions of dollars a year.


The Problem


An increasing number of small business contracts are ending up in the hands of ineligible, too-large companies to the tune of tens of billions of dollars a year. The Small Business Act of 1953 legally established that a fair portion of all federal contracts (currently 23 percent) are to be awarded to American small businesses in order to help them and, consequently, our economy grow and prosper. The Small Business Act is the number one program diverting funds to our dwindling middle class and the nation’s chief job creators, small businesses. The U.S. Census Bureau reported that small businesses are responsible for 90 percent of net new jobs in the country, 50 percent of the private sector workforce and 50 percent of the GDP; so undercutting the portion of funds that goes to these small businesses creates dire consequences for the American economy. A lack of federal funds being funneled into legitimate small businesses directly means fewer jobs are available.


The North American Industry Classification System (NAICS) outlines the size standards for each industry eligible to receive small business contracts. Some industries go by number of employees, while some go by annual revenue to determine eligibility. For industries with a size standard based on a certain number of employees, the size range varies from 500 employees or less to 1,500 employees or less. Trades with eligibility based on revenue have a set amount of maximum revenue in the range of $750,000 and $35.5 million, based on the industry.


For the last decade, extremely large companies like Pepsi, with at least $65 billion in annual revenue, continue to fraudulently receive billions of dollars in small business contracts each year. In fiscal year 2012 alone, Pepsi fraudulently received $5,690,654 in small business contracts. In order to be legitimately qualified for those contracts, a company in that industry can have no more than 500 employees, Pepsi has 278,000.


Through loopholes, a lack of oversight and what the Small Business Administration (SBA) calls “anomalies,” a company more than 550 times larger than what is allowed was able to receive millions of dollars in small business contracts that should have gone to legitimate small businesses. This is not the exception, but is fast becoming the rule. The majority of small business contracts do not go to their intended recipients, they go to large companies, many of which don’t pay their fair share of taxes.


In 2005, the Small Business Administration Office of Inspector General (SBA OIG) released Report 5-15, which described the diversion of federal small business contracts to large businesses as, “One of the most important challenges facing the Small Business Administration and the entire federal government today,” but, to date, these small business contracts are still going to ineligible companies at an alarming rate.


Oftentimes large companies receive small business contracts through their subsidiaries. Though these subsidiaries are likely to fit the NAICS standards, they still are not legally eligible for these contracts, as the size standards are meant to include not only the size of the company that received the contracts, but also the size of all affiliated companies, including any subsidiaries and parent companies. This is just one loophole large companies are using to highjack small business contracts.


Many companies also capitalize off of the lack of oversight exercised by the SBA in doling out these small business contracts. Ineligible companies self-certify as small businesses, and the SBA doesn’t verify this information. Various SBA OIG reports have shown that the diversion of small business contracts to large companies is prevalent and the SBA’s reaction to these reports show that committing this kind of fraud rarely comes with any penalties or repercussions. Participating in this kind of fraudulent activity is supposed to carry a prison sentence of 10 years and a fine of $500,000 but, very few business owners committing this type of fraud ever face charges.


The Solution

The first part of our proposed policy would make illegal the practice of labeling contracts to large corporations as small business contracts. The SBA would be responsible for going through each agency’s small business contracting records and would relabel any small business contract that went to an ineligible company. Once the relabeling occurs, further transparency would be the result. The SBA would no longer be able to count ineligible small business contracts towards their 23 percent goal, and we’d see their true numbers surface. The SBA would be held accountable for ensuring the accurate labeling of each small business contract, with harsh penalties issued for any misleading data.


Part two of our policy would enact a piece of legislation that failed to pass Congress. Nearly four years ago Congressman Henry “Hank” Johnson Jr. introduced the Fairness and Transparency in Contracting Act of 2009, a bill created by our organization, the American Small Business League (ASBL). The bill’s purpose was to amend the Small Business Act to establish additional requirements excluding publicly traded companies, subsidiaries of publicly traded companies, foreign owned firms and subsidiaries of foreign owned firms from small business contract eligibility. The bill simply directs existing federal infrastructure spending to our nation's chief job creator - the small businesses, no new taxes or spending required. Ultimately the bill lacked support and failed to be put into effect.


The core of our proposed policy would be increased enforcement of regulation on contracting fraud. While this practice is already illegal under the Small Business Act, our policy would strictly enforce the law as described in section 16(d) of the act, which states:


“Any person or entity that intentionally misrepresents the status of any concern or person as a “small business concern”…in order to obtain for him/ herself or another any of the contracting opportunities…will be subject to the penalties set forth…Any person who violates shall be punished by a fine of not more than $500,000 or by imprisonment for not more than 10 years, or both.”


Our policy would clearly define what a small business is and which types of companies are eligible for small business contracts. No longer would the SBA’s explanations of “human error” or “anomalies” be accepted. The SBA, contractors and companies receiving contracts would all be held accountable when this fraudulent activity occurs.


Funding


The Small Business Administration was created to aid, counsel, assist and protect the interests of small businesses. One of the intended functions of the SBA is to ensure that legitimate small businesses are receiving their fair portion of all federal contracts. The SBA needs to be reformed to ensure that small business contracts land in the right hands and the 23 percent goal is consistently met. Funding for the proposed policy would come from the SBA’s budget, which is nearly $1 billion per year. Because regulating small business contracting should be a main function of the SBA, no further funding would be provided.


Outcome

We are still feeling the pain of the worst economic downturn since the great depression. Though the unemployment rate continues to shrink, it’s partially due to the fact that more and more Americans are giving up on looking for work or they are retiring.


According to Senator Mary Landrieu of Louisiana, for every one percent increase in federal contracts to small businesses, more than 100,000 jobs would be created. U.S. Rep. Steve LaTourette says $1 billion in infrastructure investment translates to 42,000 jobs.


Of the top 100 companies receiving the highest volume in small business contracts in fiscal 2012, in terms of dollar amount, 71 of them were determined to be too big to be eligible for small business contracts. That means that nearly three fourths of the top small business contracts went to non-small, non-eligible companies that did not fit the federally mandated size standards (NAICS codes). If we use this sample as a representative of the whole, that would mean, approximately 70 percent of small business contracts are ending up in the hands of non-eligible, too-big companies. Each percentage point of the small business contracting goal achieved, according to Senator Landrieu, means 100,000 jobs are created.


According to our sample size, a mere 6.9 percent of federal contracting dollars are going to legitimate small businesses. That leaves an additional 16.1 percent of these contracts being diverted to non-eligible companies. That means, according to our sample size, Americans lost out on approximately 1.61 million jobs being created because the SBA allowed small business contracts to be intercepted by ineligible companies.


The federal acquisition budget is listed as being anywhere from $500 billion to $600 billion annually, so we average the two and used $550 billion as the acquisition budget. According to our sample size, only about 30 percent of the 23 percent procurement goal of contracts are actually set aside for small businesses.


To find out what percentage of contracts are actually going to legitimate small businesses, we found out what 23 percent of the total acquisition budget would be, multiplied 23 percent by $550 billion and came up with $126.5 billion - which would be the total dollar amount small business would get if they received their federally mandated portion of the acquisition budget. We then determined that 30 percent (referenced above, based on our sample size) of $126.5 billion is $37.95 billion. This means that, according to our sample size, legitimate small businesses are only getting approximately $37.95 billion of the $126.5 billion they are lawfully entitled to.


According to the Bureau of Labor Statistics, the unemployment rate is holding steady at 7.7 percent, or 12 million people. If we could add these 1.61 million jobs, the number of individuals that are unemployed would drop to about 10.39 million or by 13.42 percent. 13.42 percent of the total unemployment rate, 7.7 percent, is 1.74 percent. So total unemployment rate, 7.7 percent minus 1.74 percent (the percentage of people that would be taken out of the unemployment rate if small businesses had their rightful share of small business contracts) would leave the unemployment rate at approximately 5.96 percent, the lowest it’s been since July of 2008.


Ending the diversion of small business contracts to large corporations would not only give the economy a much needed boost, it would send a message to the public that the government is willing to fight fraud and increase transparency. Last year, the Pew Research Center for the People & the Press released results from a study indicating that 54 percent of Americans believe the government is mostly corrupt. Acknowledging and reversing the rampant abuse in contracting fraud would be a step in the right direction to minimize to perception of our government as corrupt.


New legislation, such as the Fairness and Transparency in Contracting Act, will be required to address the problem. This would clearly define a small business as one that is independently owned. The majority of our proposed policy would come in the form of regulatory change. The legislation crucial to the success of our proposed policy was already passed, sixty years ago.


There will be no more sweeping this issue under the rug or claiming it’s unintentional. The SBA administrator will be responsible for regulating his or her agency to ensure that small businesses are receiving the contracts they are legally entitled to. The agency will also be responsible for accurately reporting their numbers, rather than including billions of dollars in fraudulent contracts towards their small business procurement goals. Each agency of the government will need to be regulated to ensure they are meeting their contracting goals and not falsifying them. The presidential administration would need to oversee each federal agency’s contracting to ensure the fraud does not persist. State and local governments could regulate contracting fraud in their areas. Massachusetts has numerous large corporations receiving small business contracts fraudulently. State authorities could be doing their own regulation on contracting fraud.


Applicability to Massachusetts


Massachusetts is the hub of a great deal of small business contracting fraud. Eight out of the 11 Fortune 500 companies based in Massachusetts received small business contracts in FY 2012. Companies throughout the state are actively defrauding small businesses out of at least hundreds of millions of dollars a year. Acambis Inc. (Sanofi Pasteur Biologics) located in Cambridge, MA received $35,370,000 in small business contracts in fiscal year 2012. The problem is, Acambis is an extremely large business, that should not have been allowed to receive these contracts.The company has listed itself, on various federal databases as having $43,722,680,000 in annual revenue. In order to legally receive the small business contracts that went to Acambis, a company can have no more than 500 employees. Acambis has 107,647 employees. Acambis received the highest dollar amount in small business contracts doled out by the Health and Human Services agency in Massachusetts for fiscal year 2012. Had the SBA properly implemented the small business contracting policies, those funds would have gone to legitimate small businesses in Massachusetts.


Another culprit within the Massachusetts area is the company, P&S Construction, Inc. in North Chelmsford, MA. With 80 employees and $55,633,911 in annual revenue, they far surpass the $33.5 million annual revenue limitation for the $38,139,237 in small business contracts that they received. P&S Construction, Inc. received the second largest dollar amount worth of contracts given out by the Navy in Massachusetts for fiscal year 2012.


A company called Quantech Services, based in Lexington, MA, received the fifth largest dollar amount in small business contracts awarded by the Defense agency in Massachusetts for fiscal year 2012. They are another Massachusetts-based company that’s continued to fraudulently receive small business contracts that they are clearly not eligible for. The company with 350 employees received $55,170,270 in small business contracts for fiscal year 2012. For a company to legitimately receive these contracts they cannot have more than $14 million in annual revenue, Quantech Services has $55,248,000 in annual revenue.


These are just a select few companies that received small business contracts that they were not eligible for. The diversion of these small business contracts to large businesses is directly costing Massachusetts’s small business owners the ability to grow and hire more people, which means less available jobs for the people of Massachusetts. There are numerous examples like these for every state in the country.


Goals


In order to incite change, the public needs to be made aware of the scope of this issue. Releasing press releases, blog posts, doing interviews on news programs and contacting our chambers and elected officials has proven not to be enough to convince the SBA that this is a major problem that needs serious and immediate attention. We are in the planning stages of creating a documentary highlighting the fraud and corruption present within the SBA’s small business contracting programs. We are confident that if the American people knew that their tax dollars were being put towards fraudulent endeavors, they would demand change. How would the average American person feel if they found out companies like Johnson and Johnson and Disney were stealing funds from dime stores and mom and pop shops?


In order to make this information more readily available to American taxpayers who are footing the bill for these fraudulent acquisitions, we think creating a documentary is the most effective way to get this issue into the hands of the American public. The only way to halt this detrimental practice is to hold the responsible people accountable.


The SBA has previously released press releases claiming that these fraudulent acquisitions are mere computer glitches, anomalies or the result of human error. These claims are simply preposterous and aid in absolving the SBA from their responsibility over the issue. By interviewing legitimate small business owners that have lost out on contracts to ineligible companies, presenting the fraudulent small business contracting acquisitions spanning the last 10 years, naming the officials who have continued to let this practice happen and introducing simple steps to correct this issue through a documentary we can then educate the American people and have a firmer support group that will call for the SBA to take action and correct the way they run their small business contracting programs.


Conclusion


America is built on a society that roots for the underdog. What draws people from around the world to our country is the idea of the American dream; the hope that with hard work and dedication, great things are possible. What the SBA is doing is robbing people of their ability to reach their goals. Funds secured by the Small Business Act that are meant to help hard-working individuals with solid business plans start their business are instead being put towards already-established, oftentimes multi-million and even multi-billion dollar, companies. To change this, the SBA needs to be held accountable. Once this issue is corrected, billions of dollars will be funneled back into American small businesses and the dwindling middle class.



 
 

 
 

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