Payne Hackenbracht & Sullivan
DOD Inspector General: Handbook on Indicators of Fraud in DoD Procurement (June 1987)
Excerpted from a Handbook by the DOD Inspector General, June 1987)
Chapter 1. Crimes Involved in Contract Fraud
Chapter 2. Fraud in Government Contracts
Chapter 4. Antitrust Violations: Collusive Bidding and Price Fixing
Chapter 6. Product Substitution
Chapter 7. Progress Payment Fraud
Chapter 9. Bribery, Gratuities, and Conflicts of Interest
Chapter 10. Commercial Bribery and Kickbacks
Chapter 11. Civil, Contractual, and Administrative Remedies for Fraud
Chapter 12. Voluntary Disclosure of Fraud
a. Fraud is characterized by acts of guile, deceit, trickery, concealment or breach of confidence which are used to gain some unfair or dishonest advantage. The objective may be to obtain money, property or services; to avoid the payment or loss of money, property or services; or to secure business or personal advantage. Fraud may occur at any stage of the Government contracting process. As discussed in Chapters 1 and 11, fraud may have criminal, civil, contractual, and administrative ramifications.
b. This chapter discusses factors which may indicate the presence of, or enhanced potential for, fraud at various stages in the procurement process. The indicators included in this chapter are not intended, each taken by themselves, to establish the existence of fraud. Rather, the presence of any of the indicators, when taken in the context of the particular procurement action being conducted, should cause DoD employees to be alert to the possibility of impropriety and take appropriate actions to ensure the integrity of the process. Three later chapters will discuss in more detail the concepts of (1) collusive bidding and price fixing; (2) defective pricing; and (3) bribery, gratuities and conflicts of interest. These activities are present in some of the indicators presented in this chapter and should be considered in light of the later explanations.
c. The motives and methods for fraud in the contract award process are varied. There are many instances where fraud is perpetrated to obtain a contract in order to create the opportunity to later engage in such activities as theft or embezzlement, product substitution, cost mischarging, fast pay or progress payment fraud. In some instances the fraud is perpetrated to obtain a contract at a higher price or with better terms than would have occurred in an award untainted by fraud. Still others commit fraud merely to obtain Government contracts because they need the business to keep their companies in operation when private sector activity is low.
d. Another factor to be considered is that frauds are sometimes committed by or with the help of DoD employees. The possibility should not be overlooked that a DoD employee has solicited or accepted bribes or gratuities or has a financial interest in a contractor. There have even been instances of DoD employees creating or participating in the ownership of outside businesses for the purpose of committing fraud through their ability to impact on or control the award process.
Chapter 1. Crimes Involved in Contract Fraud
1-1. Introduction.
When the Government and its programs have been defrauded or corrupted, Federal investigators and prosecutors will usually find that one or more Federal statutes have been violated. It is their job to develop conclusive evidence that each of the elements of a specific crime exists. This chapter discusses some of the most frequently violated statutes. The criminal penalties for violation of these statutes can result in up to 10 years imprisonment and a $1 million fine.
1-2. False Statements, 18 U.S.C. 1001.
a. This statute makes it illegal to engage in any of three types of activity in any matter within the jurisdiction of any department or agency of the United States.
(1) Falsifying, concealing, or covering up a material fact by any trick, scheme, or device;
(2) Making false, fictitious, or fraudulent statements or representations; or
(3) Making or using any false document or writing.
Any certification in a DoD contract which contains false, fictitious, or fraudulent information may be a violation of this statute.
b. The following is a typical scheme which resulted in convictions for violations of this statute. A contractor was required to provide test certifications to DoD for parts it supplied for use in the breach mechanism of a 105mm cannon. The test certifications provided by the contractor contained false representations because the tests had not been performed. The contractor was convicted of making false
statements in violation of 18 U.S.C. 1001 for that conduct. It is significant to note that the contractor was prohibited from introducing evidence that the parts would have passed the tests if they were performed. The only relevant issue was whether the tests had been performed at the time the contractor made its certification. The crime is complete upon the submission of the statement to the Government. It is not necessary to prove that the Government relied on or was harmed by the false statement.
1-3. False Claims, 18 U.S.C. 287.
a. This statute makes it illegal to present or make any false, fictitious, or fraudulent claim against any agency or department of the United States. The crime is also complete when the claim is presented. Payment of the claim is not an element of the offense and need not be proven to obtain a conviction. (In a related civil statute, 31 U.S.C. 3729, the United States can recover treble damages, plus the cost of the civil action, plus a forfeiture of $5,000 to $10,000 per false claim for any false claims against the DoD.--See Chapter 11.)
b. The following scheme is typical of false claims violations which result in convictions. A contractor altered subcontractor invoices to show inflated prices on purchases made from a subcontractor. The inflated prices were then charged to the Government resulting in a monetary loss of over $1 million. The company paid a total of $3 million in fines, penalties, and restitution. The executive vice president was sentenced to five consecutive two year prison terms.
c. Any claim for a cost which has been declared unallowable by statute or regulation is a criminal and civil violation of the False Claims Act under the Defense Procurement Improvement Act of 1985 (10 U.S.C. 2324(i)) (See Chapter 11).
d. In addition, 18 U.S.C. 286 makes it a crime for two or more persons to agree or conspire to defraud the United States by obtaining or aiding in obtaining payment or allowance of any false, fictitious or fraudulent claim.
1-4. Mail Fraud, 18 U.S.C. 1341, and Wire Fraud, 18 U.S.C. 1343.
a. These statutes make it illegal to engage in any scheme to defraud in which the mails or wire communications are utilized. Utilization of the mails or wire communications includes sending or receiving any matter through the use of these mediums. As an example, they cover receiving payment from the Government which has been sent through the mail or by wire when such occurs in connection with a scheme to defraud.
b. A Virginia based contractor defrauded the Navy in performing a contract awarded and administered in California. The scheme to defraud involved the mailing of false claims (based on false and inflated costs for direct labor and employee benefits) to the Navy. The scheme also involved cost mischarging in an attempt to recover cost overruns on a fixed price contract by concealing the costs in later claims. The corporation and its president were convicted of violating the false claims, false statements, and mail fraud statutes. The president was sentenced to five years in prison on two charges and received a five year suspended sentence and five years probation on a third charge. In addition, the president was ordered to perform 2,500 hours of community service. The corporation was fined $22,000 and ordered to make restitution in the amount of $185,000.
1-5. Bribery, Gratuities, and Conflicts of Interest, Generally, 18 U.S.C. 201-208.
a. These statutes prohibit a broad range of activities which can be described generally as corruption. Such activities include giving or receiving a bribe or gratuity, as well as engaging in a conflict of interest. (See Chapter 9) (New authority delegated by the President in November 1983, under 18 U.S.C. 218, permits agencies to rescind any contract tainted by bribery, graft, or conflict of interest after conviction for such activity.--See Chapter 11.)
(1) Bribery includes giving a Government employee something of value for the purpose of influencing the performance of an official duty.
(2) Gratuities include giving a Government employee something of value because of his official position. There is no requirement for the Government to prove that the gratuity was given for the purpose of influencing any official act.
(3) Conflicts of interest include those situations where a Government employee engages in activities which create a conflict between his personal interests and his duty to protect and serve the interests of the Government.
b. The following schemes are typical of these violations:
(1) Bribery--A base laundry, dry cleaning and clothing repair contractor offered a quality assurance inspector (QAI) a bribe in return for approval of monthly service costs to the Air Force. The QAI notified the Air Force Office of Special Investigations (AFOSI) and cooperated in an undercover investigation during which the contractor provided money, food, hotel accommodations, liquor, and other gifts to the QAI. The contractor was found guilty on two counts of bribery and two counts of false claims. He was sentenced to three years in jail, given three years probation, and fined $3,000.
(2) Gratuities--A GS-12 contracting officer's technical representative (COTR) admitted soliciting and receiving gratuities from a contractor for which he had responsibility. The gratuities consisted of video equipment, meals, and use of an automobile and a beach condominium over the course of one year. There was no evidence that the COTR did anything in return for these gratuities. The COTR was convicted of receiving gratuities in violation of 18 U.S.C. 201(g), and was sentenced to one year in jail which was suspended and two years probation. He resigned from Federal service while removal action was pending.
(3) Conflicts of Interest--A military member used the authority of his position to direct the award of a contract to a subcontracting firm. The subcontractor, in turn, was to further subcontract to a firm which was wholly owned by the military member. The estimated loss to the Government was $43,500. The member pled guilty to two counts of bribery and one count of acts affecting personal financial interests (conflict of interest). He was sentenced to two years in prison on each of the three counts. He was confined for six months and received supervised probation for two years. He was also fined $2,000 for each count.
1-6. Trade Secrets Act, 18 U.S.C. 1905.
a. This statute prohibits unauthorized release of any information relating to trade secrets or confidential business data by a Federal employee who receives such information in the course of his employment. Such information includes advance procurement information, prices, technical proposals, proprietary information,
income information, etc. (A conviction for violating this statute requires mandatory removal from employment.)
b. Criminal prosecutions under the statute are not brought frequently because it is only a misdemeanor; instead, prosecutors frequently choose to prosecute under the theft statute (see Section 1-7).
1-7. Theft, Embezzlement, or Destruction of Public Money, Property, or Records, 18 U.S.C. 641.
a. This statute prohibits intentional and unauthorized taking, destruction, or use of Government property or records. It also prohibits receiving or concealing such property or records.
b. The following is a typical case involving the theft of Government records pertaining to an upcoming solicitation. A quality assurance representative (QAR) solicited a bribe from a major electronics contractor and promised to return inside information on an upcoming bid solicitation. The QAR delivered the bid information in exchange for a $2,500 bribe. The QAR suggested a second transaction in exchange for payment of $30,000. A second meeting was scheduled and the QAR was arrested after asking for the payment again. The QAR was indicted on two counts of theft of Government property and two counts of bribery. The QAR pled guilty on the bribery counts in exchange for full cooperation with the prosecutor. The cooperation resulted in the indictment of a co-conspirator who was charged with theft of Government property and conspiracy. The QAR received a five year sentence, and the second defendant is awaiting trial.
1-8. Anti-kickback Act, 41 U.S.C. 54.
a. This Act makes it a crime for any person to provide, attempt to provide or offer any fee, commission, compensation, gift or gratuity to a prime contractor or any higher tier subcontractor, or an employee of one of these, for the purpose of improperly obtaining favorable treatment under a Government Contract.--(See Chapter 10).
b. A buyer for a major DoD contractor entered into an agreement with certain machine shops which provided that they would pay him an amount equal to five percent of the value on all contracts which he awarded to them. The Government identified $14,000 in such kickbacks to him. He was convicted on one count each of tax fraud, mail fraud, and violations of the Anti-kickback Act, and was sentenced to six months in jail and a $14,000 fine.
1-9. Sherman Antitrust Act, 15 U.S.C. 1.
a. This Act prohibits competitors from entering into any agreement to restrain trade in interstate commerce, including price fixing, bid rigging, and bid rotation schemes. (See Chapter 4)
b. The following is typical of the type of antitrust violations that can occur in connection with DoD contracts. A contractor entered into an agreement with a number of its competitors to divide the available Army Corps of Engineers dredging contracts between them. The scheme was carried out through meetings during which the competitors decided who among them would submit the low bid on any given solicitation. The president of the company was convicted for violating the Sherman Antitrust Act in connection with his activities in this regard, and was sentenced to three years in prison. The company was fined $325,000 and ordered to pay civil damages of $250,000.
1-10. Conspiracy, 18 U.S.C. 371.
a. This statute prohibits any agreement between two or more persons to defraud the United States or to violate any Federal law or regulation when at least one act is taken in furtherance of the agreement.
b. The president and vice president of a subcontractor conspired to provide defective aluminum castings for use by prime contractors in manufacturing the Navy Phoenix missile, the Air force mobile radio tower, and the cockpit display of the F-16. The officials agreed to and did make concerted efforts that the prime contractors and the Government were deceived regarding the defective nature of the parts. This involved instructing company employees who conducted random tests of the parts to test additional parts, whenever one or more of the originally selected parts failed, until the required number of parts passed the tests. In addition, the officials instructed shipping employees to conceal obviously defective parts by stacking conforming parts on top of them. The officials pled guilty to one count of conspiracy each after being charged with three counts of conspiracy and four counts of false claims. They were sentenced to imprisonment and required to pay substantial fines.
Chapter 2. Fraud in Government Contracts
2-1. Fraud in the identification of the Government's need for goods or services.
a. Normally, procurement actions are initiated after a formal or informal determination of general requirements. The requirements consist of a brief description of the types and amounts of goods and services needed together with a justification for the need. Fraud occurring during this stage of the procurement process may result in decisions to buy goods and services in excess of those actually needed or possibly not needed at all. As an example, need determinations for items that have scheduled disposal and reprocurement or reorder levels can be manipulated by including false information. In recent cases, this type of manipulation has resulted in excessive purchases of items such as drugs or auto parts. Further examination of the cases also disclosed indications of other criminal activity such as theft or diversion of the items.
b. With respect to fraud in defining requirements and stock levels, fraud indicators include:
(1) Requiring excessively high stock levels and inventory requirements to justify continued purchasing activity from certain contractors.
(2) Declaring items which are serviceable as excess or selling them as surplus while continuing to purchase similar items. (One documented scheme involved repurchasing the same items being sold as surplus on a recurring basis.)
(3) Purchasing items, services or research projects in response to aggressive marketing efforts (and possible favors, bribes or gratuities) by contractors rather than in response to valid requirements.
(4) Defining needs improperly in ways that can be met only by certain contractors.
(5) Failing to develop "second sources" for items, spare parts, and services being continually purchased from a single source.
c. In addition to the fraud indicators listed above certain types of activity create a greater vulnerability to fraud and may enhance the potential for fraud to occur.
(1) Such a situation can occur when a needs assessment is not adequately or accurately developed or when an agency continually changes its mind about what it wants. This provides an opportunity for the unscrupulous to try and recoup losses for which they could not otherwise be compensated by falsely characterizing them as increased costs due to Government mandated changes or defective specifications.
(2) Another situation that increases the potential for fraud exists when the Government identifies the need to purchase proprietary, trade secret or other technical information without making reasonable attempts to determine if that information is already owned by the Government.
2-2. Fraud in the pre-solicitation phase.
a. Bid specifications and statements of work detailing the types and amounts of goods or services to be provided are prepared to assist in the selection process. They are intended to provide both potential bidders and the selecting officials with a firm basis for making and accepting bids. A well-written contract will have specifications, standards and statements of work which make it clear what the Government is entitled to. Sloppy or carelessly written specifications make it easy for a contractor to claim that it is entitled to more money for what the Government defines as what it really wants. Sometimes, there is deliberate collusion between Government personnel and the contractor to write vague specifications. At other times there is an agreement to amend the contract to increase the price immediately after the award. One contractor actually developed a "cost enhancement plan," identifying all of the changes he would make in order to double the cost of the contract, before it was even signed.
b. Fraud indicators include:
(1) Placing any restrictions in the solicitation documents which would tend to restrict competition.
(a) Defining statements of work and specifications to fit the products or capabilities of a single contractor.
(b) Designing "prequalification" standards or specifications to exclude otherwise qualified contractors or their products.
(2) Unnecessary sole source/noncompetitive procurement justifications:
(a) Based on falsified statements.
(b) Which are signed by unauthorized officials.
(c) For which required levels of review were deliberately bypassed.
(3) Providing contractors any advice, advance information, or release of information concerning requirements or pending purchases on a preferential or selective basis. (Applies equally, whether committed by Government personnel, consultants or contractors.)
(4) Using statements of work, specifications, or sole source justifications developed by or in consultation with a contractor who will be permitted to compete in the procurement. (Institutional conflict of interest.)
(5) Permitting contractors (architect engineers, design engineers, other firms or individuals) that participated in the development of statements of work, specifications or the preparation of the invitations for bids or request for proposals, to bid on or be involved with the prime contract or any subcontracts.
(6) Splitting requirements so that small purchase procedures can be utilized or to avoid required levels of review or approval, e.g., to keep each within the contracting authority of a particular person or activity.
c. Bid specifications or statements of work which are not consistent with the need determination, if unexplained, may indicate an attempt to steer a procurement to a preferred contractor.
(1) Splitting requirements so contractors each get a "fair share" may increase the potential for collusive bidding. (See Chapter 4)
(2) Vague specifications may inhibit the reasonable comparison of bids or proposals and facilitate steering a contract to a favored contractor.
2-3. Fraud in the solicitation phase.
a. Contractors are offered an opportunity to submit bids or proposals for the provision of goods or services that will meet the Government's needs as set forth in specifications or statements of work. This process is intended generally to maximize the use of competition and to ensure that the Government obtains goods and services which meet its needs at the best possible price.
b. Fraud indicators in this phase include:
(1) Procurements which are restricted to exclude or hamper any qualified contractor.
(2) Limiting the time for the submission of bids, thereby creating a situation where only those with advance information have an adequate time to prepare bids or proposals.
(3) Technical or contracting personnel revealing information about the procurement to one contractor which is not revealed to all. Examples of the types of information found to have been illegally disclosed in prior cases include competitor's cost or pricing data; competitor's trade secrets or proprietary information; the results of Government technical evaluations; and Government estimates.
(4) Failure to amend a solicitation to include necessary changes or clarifications. (Telling one contractor of changes that can be made afterward.)
(5) Bid solicitation which is vague as to time, place, or other requirements for submitting acceptable bids.
(6) Failure to assure that a sufficient number of potential competitors are aware of the solicitation. (Use of obscure publications, publishing in holiday seasons, providing a vague or inadequate synopsis to Commerce Business Daily, etc.)
(7) Special assistance to any contractor in preparing its bid or proposal.
(8) "Referring" a contractor to a specific subcontractor expert, or source of supply. (Express or implied that if you use the referred business, you will be more likely to get the contract.)
(9) Improper communication with contractors at trade or professional meetings or improper social contact with contractor representatives.
(10) Government personnel or their families acquiring stock or a financial interest in a contractor or subcontractor.
(11) Government personnel discussing possible employment with a contractor or subcontractor for themselves or a family member.
(12) Improper acceptance of a late bid.
(13) Falsification of documents or receipts to get a late bid accepted.
(14) Change in a bid after other bidders prices are known. This is sometimes done by mistakes deliberately planted in a bid.
(15) Withdrawal of the low bidder who later becomes a subcontractor to the higher bidder who gets the contract.
(16) Any indication of collusion or bid rigging between bidders. (See Chapter 4)
(17) False certifications by contractor.
(a) Small business certification.
(b) Minority business certification.
(c) Information provided to other agencies to support special status.
(d) Certification of independent price determination. (See Chapter 3)
(e) Buy American Act certification.
(18) Falsification of information concerning contractor qualifications, financial capability, facilities, ownership of equipment and supplies, qualifications of personnel and successful performance of previous jobs, etc.
2-4. Fraud in the award of the contract.
a. Government contracts are awarded based on the evaluation of contractor's bids and proposals. The evaluation process encompasses many factors, including price, responsiveness, and responsibility.
b. Fraud indicators during the evaluation and award process include:
(1) Deliberately discarding or losing the bid or proposal of an outsider who wants to participate. (May be part of a conspiracy between a Government official and a select contractor or group of contractors.)
(2) Improperly disqualifying the bid or proposal of a contractor.
(3) Disqualification of any qualified bidder.
(4) Accepting nonresponsive bids from preferred contractors.
(5) Seemingly unnecessary contacts with contractor personnel by persons other than the contracting officer during the solicitation, evaluation, and negotiation processes.
(6) Any unauthorized release of information to a contractor or other person.
(7) Any exercise of favoritism toward a particular contractor during the evaluation process.
(8) Using biased evaluation criteria or using biased individuals on the evaluation panel.
(9) Award of a contract to a contractor who is not the lowest responsible, responsive bidder.
(10) Allowing a low bidder to withdraw without justification.
(11) Failure to forfeit bid bonds when a contractor withdraws improperly.
(12) Material changes in the contract shortly after award.
(13) Awards made to contractors with an apparent history of poor performance.
(14) Awards made to the lowest of a very few bidders without readvertising considerations or without adequate publicity.
(15) Awards made that include items other than those contained in bid specifications.
(16) Awards made without adequate documentation of all preaward and postaward actions, including all understandings or oral agreements.
(17) Release of advance information concerning the award of a major contract. Such a release increases the potential illegal insider trading in the stock of both winning and losing contractors.
(18) Inadequate evaluation of contractor's present responsibility, including ignoring or failing to obtain information regarding a contractor's record of business ethics and integrity.
2-5. Fraud in the negotiation of a contract.
a. Negotiation occurs whenever the Government contracts without formal advertising. Negotiating permits bargaining and affords offerors an opportunity to revise their offers before award of a contract (Federal Acquisition Regulation (FAR) 15.102).
b. There are a number of abuses that can occur in the negotiation of a contract. The first stems from the assumption of many personnel that once it has been determined that negotiated procurement procedures can be used, that procurement on a sole source basis has also been justified. It is clear, however, that the FAR requires negotiated contracts to be awarded on a competitive basis unless less than full and open competition is authorized by an exception (FAR 6.301 and 15.105).
c. Fraud indicators involving negotiated contracts include:
(1) Back-dated or after-the-fact justifications in the contract file.
(2) Disclosure of information to one contractor which is not given to others, thereby giving that contractor an unfair competitive advantage.
(3) Improper release of information (e.g., prices, technical data, identity, or rank of competing proposals, proprietary data or trade secrets, or Government price estimates).
(4) Any indications that a contractor has provided false cost or pricing data. (See Chapter 3)
(5) Failure of Government personnel to obtain or rely on a Certificate of Current Cost or Pricing Data.
(6) Approval of less than full and open competition by an unauthorized person or for an improper reason (a reason other than one of the authorized exceptions to the requirement for full and open competition).
(7) Inadequate evaluation of contractor's present responsibility, including ignoring or failing to obtain information regarding a contractor's record of business ethics and integrity.
3-1. Introduction: The Truth in Negotiations Act.
In the 1950s and early 1960s, the Government Accountability Office (GAO) discovered numerous instances of overpricing by Government contractors on negotiated contracts. That is, costs quoted to the Government as those which would be incurred by the contractor in performing the work were found to be higher than the actual expenditures. At the time, however, the Government had no legal redress to reprice the contracts unless it could show fraud or deliberate misrepresentation by the contractor. In 1959, the DoD adopted regulations requiring the contractor to provide data reflecting the costs it would incur in performing the contract, called
cost and pricing data. However, GAO later found that the data were not being required or examined by the Military Departments. Consequently, in 1962, Congress passed the Truth in Negotiations Act. The Act required, among other things, submission of complete and current cost and pricing data to the Government
during pre-award negotiations for all contracts valued at more than $100,000, and thereby ensured that the Government had the information necessary to determine the reasonableness of the contractor's bid price. The law also provided Government access to contractor records for purposes of assessing the costs of the contract. When a contractor's data submission is defective, the Act permitted the Government to reduce contract payments by the amount attributable to the defective data.
3-2. Cost or Pricing Data Provision: 10 U.S.C. 2306(a).
a. The cost or pricing data provisions of the Truth in Negotiations Act are contained in 10 U.S.C. 2306(a). That section provides, in part, that a prime or subcontractor shall be required to submit cost or pricing data, and shall be required to certify that, to the best of his knowledge and belief, the data submitted is accurate, complete, and current, under the following circumstances:
(1) Prior to the award of any contract other than one using sealed-bid procedures where the price is expected to exceed $100,000.
(2) Prior to pricing a change or modification of any contract if the price adjustment is expected to exceed $100,000, or any lesser amount if so prescribed by the agency head.
(3) Prior to the award of a subcontract when the subcontract price is expected to exceed $100,000 and the prime contractor and each higher tier subcontractor was required, under the contract, to submit cost or pricing data.
(4) Prior to pricing a change or modification to a subcontract covered by paragraph (3), above, for which the price adjustment is expected to exceed $100,000, or any lesser amount if so prescribed by the agency head.
The certifications are to be made to the Government contracting officer in the case of prime contractors and to the prime contractor in the case of subcontractors. The exceptions to certification of data include contracts or subcontracts for which the price is based on "adequate price competition," "established catalog or market
prices of commercial items sold in substantial quantities to the general public," "prices set by law or regulation," or, in exceptional cases, when waived by the head of the agency. Conversely, despite the above-noted provisions, the head of any agency can require submission of data if it is determined necessary for the evaluation of the reasonableness of the price of the contract or subcontract.
b. The Act also requires that each contract that falls under the Truth in Negotiations provisions contain a clause for allowing for a price reduction based on the amount of any overpricing due to defective data submissions by either the prime or any subcontractors. The reduction would include profits and fees. The Act does state, however, that if the contractor can show the Government did not rely on the data submitted, that fact can be a defense in any price reduction action.
c. As part of the 1986 Defense Authorization Act (PL 99-661), a penalty in an amount equal to the overpayment can be assessed against a contractor who knowingly submits defective cost data. In any case of overpricing, the Government is entitled to recover interest on the amount of the overpayment for the period beginning on the date of the overpayment until repayment of the sum owed (10 U.S.C. 2306a(e)--See Chapter 11).
3-3. Regulatory Requirements: Federal Acquisition Regulation (FAR).
a. Section 15.801 of the FAR defines costs or pricing data and specifies the form and language for the certificate of current cost or pricing data. Price reduction rights of the Government are found in clauses at FAR 52.214-27, 52.215-22, and 52.215-23.
b. Cost or pricing data are submitted to the DoD on DD633, Contracting Pricing Proposal Cover Sheet. Along with that form, the contractor (or offeror, if no contract award has yet been made) is required to provide a breakdown of his costs, and submit supporting documentation such as invoices or firm price quotes from his suppliers. In addition, the contractor must submit the certification as soon as practicable after agreement is reached on the contract or modification price. The certification references FAR 15.801 to specifically include vendor quotes as cost or pricing data. A knowingly false or inaccurate certification by a contractor can lead to criminal prosecution for submission of false statements in violation of 18 U.S.C. 1001. A claim which is subsequently paid based on the false statement is a false claim which can be criminally prosecuted under 18 U.S.C. 287, and can result in civil liability under the civil False Claims Act (31 U.S.C. 3729). In addition, a false statement via certification can be penalized administratively under the Program Fraud Civil Remedies Act of 1986, Chapter 38 of Title 31, U.S.C. (See Chapter 11).
3-4. Defective Pricing Indicators.
a. In September 1983, the Director of the Defense Contract Audit Agency (DCAA) issued a memorandum to DCAA auditors stating guidance in the area of defective pricing where certain conditions exist which might indicate fraud. Auditors were instructed that when indications of fraud are found, the case will be referred to
the proper investigative agency. Some of the most significant indicators include:
(1) Indications of falsification or alteration of supporting data.
(2) Failure to update cost or pricing data even though it is known that past activity showed that costs or prices have decreased.
(3) Failure to make complete disclosure of data known to responsible contractor personnel.
(4) Distortion of the overhead accounts or base line information by transferring changes or accounts that have a material impact on Government contracts.
(5) Failure to correct known system deficiencies which lead to defective pricing.
(6) Protracted delay in release of data to the Government to preclude possible price reductions.
(7) Repeated denial by the responsible contractor employees of the existence of historical records that are subsequently found.
b. As a result of increased emphasis on detection and referral of detective pricing cases, the Government, in 1986, prosecuted a major contractor and exacted the largest fraud penalty in DoD history. In July 1986, a Federal grand jury returned a 325 count indictment charging a major Defense contractor and two corporate
officers, with engaging in a scheme to defraud the DoD of approximately $6,300,000 in connection with the bidding and award of 45 prime and subcontracts between 1975 and 1984. The charges, all relating to defective pricing, included concealing and covering up material facts, racketeering, mail fraud, conspiracy, and false statements. The indictment charged that the defendants submitted false and fraudulent cost and pricing data, representing to the DoD that the contractor would be paying more for material than the company would in fact pay. The inflated submissions became known as "chicken fat" among the conspirators and were accomplished by various means, including the use of blank quotation forms obtained from material vendors, and obtaining quotations at book or catalog prices which were higher than the actual costs known to the contractor. One defendant was also charged with failing to disclose to the Government the rebates the company received from vendors on purchases, and that he also lied to an auditor from the DCAA. The contractor agreed to plead guilty to all counts set forth in the indictment and to pay approximately $15 million to the Government in criminal and civil penalties and restitution. The individual defendants likewise pled guilty and were sentenced to imprisonment (suspended in one case), five years probation, and fines of $10,000 and $10,500.
c. The fraud indicators should be used by contracting officers as well as auditors and investigators. Particular note should be made of intent indicators in defective pricing cases. These are critical to a determination of whether a criminal act occurred. The deliberate concealment or misrepresentation of a single significant cost element could constitute a prosecutable crime.
Chapter 4. Antitrust Violations: Collusive Bidding and Price Fixing
4-1. Introduction.
a. Collusive bidding, price fixing, or bid rigging are commonly used interchargeable terms that describe many forms of illegal anticompetitive activity. The common thread throughout all of the anticompetitive activities is that they involve any agreements or informal arrangements among independent competitors which limit competition. Schemes that allocate contracts and limit competition can take many forms and are only limited by the imagination of the parties. Common schemes, which will be discussed in more detail later, include bid suppression or limiting, complementary bidding, bid rotation, and market division.
b. The essential elements of a criminal antitrust offense are (1) the formulation of a contract, combination, agreement, or conspiracy, and (2) the restraint of trade or commerce among the several states. With regard to the first element, the agreement must be between two or more real competitors. The evidence must establish that the competitors had a common plan, understanding, arrangement, or agreement to fix or stabilize prices, allocate customers, or allocate territories or markets. In regard to the second element, to satisfy the interstate commerce element of the offense, the evidence must establish that the conspiracy involved goods or funds traveling in the flow of interstate commerce, e.g., materials shipped by common carrier interstate, or affected interstate commerce, e.g., Federal funds involved in the procurement. There are certain agreements or business practices that by statute are per se violations. These agreements or practices, because of their previous effect on competition and lack of any redeeming virtue, are conclusively presumed to be unreasonable and thus illegal. These types of agreements among competitors which would violate the law
include, but are not limited to, the following:
(1) Agreements to adhere to published price lists.
(2) Agreements to raise prices by a specified increment.
(3) Agreements to establish, adhere to, or eliminate discounts.
(4) Agreements not to advertise prices.
(5) Agreements to maintain specified price differentials based on quantity, type, or size of product.
c. The Antitrust Division, Department of Justice (DOJ), has primary prosecutive jurisdiction on all Federal antitrust violations. Responsible antitrust attorneys are located at the seven field office locations: Atlanta, Chicago, Cleveland, Dallas, Philadelphia, New York City, and San Francisco. The Antitrust Division has successfully prosecuted defendants who have fixed prices or rigged bids in conjunction with the award of contracts for the following types of commodities and services widely used by DoD: asphalt paving; electrical equipment; shipment of household goods; wholesale produce; retail gasoline; waste disposal; bread; milk; dredging; roofing; lumber; cigarettes; coal; and building construction. Prosecution of Sherman Antitrust Act offenses present in Defense procurement is a high priority within the DOJ Antitrust Division.
4-2. Impact on the procurement process.
a. One of the cornerstones of the Federal procurement system is the requirement that Government contracts should be awarded, to the greatest extent possible, on the basis of free and open competition. The preference for competition in the procurement of goods or services on behalf of the United States was first set by statute in 1890. That preference still remains and has been specifically expressed in statutes concerning DoD purchases and contracts. Title 10, U.S. Code, Section 2304(a), sets forth a specific requirement that, "Purchase of and contracts for property and services covered by this chapter shall be made by formal advertising, and shall be awarded on a competitive bid basis to the lowest responsible bidder, in all cases in which the use of such method is feasible and practicable under existing conditions and circumstances." In addition, 10 U.S.C. 2304(g) requires that, except in certain limited circumstances, competition must also be obtained in negotiated procurements. The requirements are also contained in DoD policy regarding competition as outlined in FAR 14.103.
b. Further evidence of the importance of competition in the DoD procurement process is provided by the requirement for Certification of Independent Price Determination, FAR 3.103-1. The regulation requires contractors to certify that they have not engaged in certain specific activities which constitute what can generally be described as collusive bidding or price fixing.
c. It should be obvious that collusive bidding or price fixing among competitors completely undermines the Government efforts to use competitive purchasing and contracting methods. The harm in this situation, however, is not limited to the mere circumvention of the important Government policies that encourage free and open competition. In fact, collusive bidding and price fixing result in increased costs, destroy public confidence in the country's economy, and undermine our system of free enterprise. To illustrate the impact of the activities on DoD procurement, consider just a few recent cases:
(1) A 1983 prosecution in the Southeastern United States resulted in the conviction and incarceration of an electrical subcontractor. Plea negotiations culminated with the defendant pleading guilty to a criminal information charging a violation of 15 U.S.C. 1 (Sherman Antitrust Act). The subcontractor was sentenced to a six and one-half month prison term for his part in a conspiracy to ". . . fix, raise, and maintain electrical subcontract work on a $455,049 Army Corps of Engineers contract . . . ."
(2) In 1983, two household goods moving and storage companies and their respective presidents, entered guilty pleas to charges of price fixing in a Federal district court in South Carolina. The contractors, serving the Army base at Fort Jackson, South Carolina, were indicted for ". . . conspiring to fix, raise, maintain, and establish the rates charged for providing non-temporary storage of household goods owned by military personnel . . . ." The two companies received respective fines of $100,000 and $25,000, and were debarred from bidding on Government contracts. The individual defendants were each fined $25,000 and $5,000, and personally debarred.
(3) A 1985 prosecution in the Southeastern United States yielded the first of several significant convictions of Army Corps of Engineers dredging contractors for bid rigging. Following a guilty plea to a criminal information alleging a conspiracy to rig bids on a $1.4 million contract, a Virginia dredging company and its president received substantial sentences in a Federal district court. The company was ordered to pay a criminal fine of $200,000. The president received a two year suspended sentence and was ordered to pay a $50,000 fine. A separate administrative/civil settlement with the Army Corps of Engineers and the DOJ resulted in the payment of a $235,000 civil fine.
d. It has been demonstrated that collusive bidding and price fixing schemes cause the DoD to pay much more for goods or services than it would have if true competition existed. Even though this is the case, the bids may appear to be fair and reasonable because the Government estimate may be too high. The appearance of reasonable prices should therefore not mistakenly be construed as proof that collusive bidding and price fixing are not occurring or that a violation of law does not exist because the harm in terms of monetary loss is not apparent. In fact, when such conduct is criminally prosecuted, the defendants are prohibited from introducing any evidence to justify their conduct or to demonstrate its reasonableness.
4-3. Indicators of collusive bidding and price fixing.
a. The list of indicators below is intended to facilitate recognition of those situations which may involve collusive bidding or price fixing. In and of themselves these indicators will not prove that illegal anticompetitive activity is occurring. They are, however, sufficient to warrant referral to appropriate authorities for investigation. Use of indicators such as these to identify possible anticompetitive activity is important because schemes to restrict competition are by their very nature secret and their exact nature is not readily visible.
b. Practices or events that may evidence collusive bidding or price fixing are:
(1) Bidders who are qualified and capable of performing but who fail to bid, with no apparent reason. A situation where fewer competitors than normal submit bids typifies this situation. (This could indicate a deliberate scheme to withhold bids.)
(2) Certain contractors always bid against each other or, conversely, certain contractors do not bid against one another.
(3) The successful bidder repeatedly subcontracts work to companies that submitted higher bids or to companies that picked up bid packages and could have bid as prime contractors but did not.
(4) Different groups of contractors appear to specialize in Federal, state, or local jobs exclusively. (This might indicate a market division by class of customer.)
(5) There is an apparent pattern of low bids regularly recurring, such as corporation "x" always being the low bidder in a certain geographical area or in a fixed rotation with other bidders.
(6) Failure of original bidders to rebid, or an identical ranking of the same bidders upon rebidding, when original bids were rejected as being too far over the Government estimate.
(7) A certain company appears to be bidding substantially higher on some bids than on other bids with no logical cost difference to account for the increase, i.e., a local company is bidding higher prices for an item to be delivered locally than for delivery to points farther away.
(8) Bidders that ship their product a short distance bid more than those who must incur greater expense by shipping their product long distances.
(9) Identical bid amounts on a contract line item by two or more contractors. Some instances of identical line item bids are explainable, as suppliers often quote the same prices to several bidders. But a large number of identical bids on any service-related item should be viewed critically.
(10) Bidders frequently change prices at about the same time and to the same extent.
(11) Joint venture bids where either contractor could have bid individually as a prime. (Both had technical capability and production capacity.)
(12) Any incidents suggesting direct collusion among competitors, such as the appearance of identical calculation or spelling errors in two or more competitive bids, or the submission by one firm of bids for other firms.
(13) Competitors regularly socialize or appear to hold meetings, or otherwise get together in the vicinity of procurement offices shortly before bid filing deadlines.
(14) Assertions by employees, former employees, or competitors that an agreement to fix bids and prices or otherwise restrain trade exists.
(15) Bid prices appear to drop whenever a new or infrequent bidder submits a bid.
(16) Competitors exchange any form of price information among themselves. This may result from the existence of an "industry price list" or "price agreement" to which contractors refer in formulating their bids, or it may take other subtler forms such as discussions of the "right price."
(17) Any reference by bidders to "association price schedules," "industry price schedules," " industry suggested prices," "industry-wide prices," or "market-wide prices."
(18) A bidder's justification for a bid price or terms, offered because they follow the industry or industry leader's pricing or terms, may include a reference to following a named competitor's pricing or terms.
(19) Any statements by a representative of a contractor that his company "does not sell in a particular area" or that "only a particular firm sells in that area."
(20) Statements by a bidder that it is not their turn to receive a job or, conversely, that it is another bidder's turn.
4-4. Collusive bidding and price fixing examples.
Common collusive bidding and price fixing schemes that DoD personnel may be able to recognize are discussed below. The schemes relate to one another and overlap. Frequently, an agreement by competitors to rig bids will involve more than one of the schemes.
a. Bid suppression or limiting. In this type of scheme, one or more competitors agree with at least one other competitor to refrain from bidding or agrees to withdraw a previously submitted bid so that another competitor's bid will be accepted. Other forms of this activity involve agreements by competitors to fabricate bid protests or to coerce suppliers and subcontractors not to deal with nonconspirators who submit bids.
b. Complementary bidding. Complementary bidding (also known as "protective" or "shadow" bidding) occurs when competitors submit token bids that are too high to be accepted (or if competitive in price, then on special terms that will not be acceptable). Such bids are not intended to secure the buyer's acceptance, but are merely designed to give the appearance of genuine bidding.
c. Bid rotation. In bid rotation, all vendors participating in the scheme submit bids, but by agreement take turns being the low bidder. In its most basic form, bid rotation will consist of a cyclical pattern for submitting the low bid on certain contracts. The rotation may not be as obvious as might be expected if it is coupled with a scheme for awarding subcontracts to losing bidders, to take turns according to the size of the contract, or one of the other market division schemes explained below.
d. Market division. Market division schemes are agreements to refrain from competing in a designated portion of a market. Division of a market for this purpose may be accomplished based on the customer or geographic area involved. The result of such a division is that competing firms will not bid or will submit only complementary bids when a solicitation for bids is made by a customer or in an area not assigned to them.
5-1. Introduction.
a. One of the most common of abuses found in the procurement system is cost mischarging. This is due in large part to the fact that most high-dollar Government research and development and production contracts are awarded as cost type contracts. Because such contracts are paid on the basis of incurred costs, the
contractor may increase profits by mischarging. It is important to recognize that the impact of such mischarging is almost always far greater than the basic costs which were falsified. For example, a single hour of labor which is mischarged may result in payments of as much as three times the labor hour rate due to indirect cost allowances which are added based on that hour.
b. Mischarging can occur in a number of situations, with a variety of results. It can involve charging labor hours from one contract to another, charging at higher than allowed rates, charging to indirect accounts those charges which should be direct, or viceversa, as well as other schemes. In all cases, mischarging is a serious
matter. Even when unintentional or without a fraudulent motive, it undermines confidence in the contractor's accounting and control systems and should raise questions as to the validity of other submissions.
c. The issue of whether a mischarge was a "mistake" or a crime usually turns on the intent of the maker. Investigators should examine the issue of intent. Because intentional false submissions themselves are criminal, prosecutors may pursue those cases even though no substantial loss occurs, particularly where the contractor has actively sought to conceal costs. Additionally, to overlook situations such as mischarging from one Government contract to another on the theory that it is merely a case of "robbing Peter to pay Paul" is to ignore the serious consequences of such a scheme. Because cost estimates for future procurements rely in large part on accurate historical cost figures from similar work, the estimates for later work will be tainted by false accounting. Further, moving costs from a Government job which is tight on budget to one which is "fat" could prevent an overrun in the case of the former and thus make the contractor appear more efficient than he actually is. This could result in awarding incentive fees or follow-on contracts which would not be appropriate were the true costs known.
d. Under cost type contracts, the Government reimburses the contractor's costs which are allowable, allocable to the contract, and reasonable. Those types of contracts include cost plus fixed fee, cost plus incentive fee, cost plus award fee, cost reimbursable, and cost sharing contracts. In addition, contract changes and equitable adjustment to contracts are reimbursed on the basis of incurred costs even on fixed price contracts. Cost mischarging occurs whenever the contractor charges the Government for costs which are not allowable, not reasonable, or which cannot be directly or indirectly allocated to the contract.
5-2. Allowable Costs.
a. The FAR 31-205 identifies costs which are allowable and those which cannot be charged to Government contracts. Such costs may be direct costs, such as labor and materials used on one contract and no other, or indirect costs, which contribute to a number of different contracts. Indirect costs are placed in "cost pools" which are then allocated to contracts on some agreed basis (such as total cost or labor hours). Title 10, U.S.C., Section 2324, specifically identifies certain unallowable costs for covered DoD contracts and requires the Secretary of Defense to prescribe regulations to clarify the allowability for certain other costs. The statute also requires that a proposal for settlement of indirect costs applicable to a covered contract include a certification by a contractor official that, to the best of his knowledge, all indirect costs submitted are allowable.
b. Unallowable costs include:
(1) Advertising costs (except to obtain workers or scarce materials for a contract, or to sell surplus or byproduct materials).
(2) Bid and proposal costs in excess of a set limit.
(3) Stock options and some forms of deferred compensation.
(4) Contingencies.
(5) Contributions and donations.
(6) Entertainment costs.
(7) Costs of idle facilities except in limited circumstances.
(8) Interest.
(9) Losses on other contracts.
(10) Long-term leases of property or equipment and leases from related parties are limited to the costs of ownership.
(11) Independent research and development costs beyond set limits.
(12) Legal costs related to a contractor's defense of any civil or criminal fraud proceeding or similar proceeding (including false certifications) brought by the Government when the contractor is found liable or has pled nolocontendre.
(13) Payments of fines and penalties resulting from violations of, or failure to comply with, Federal, state, local, or foreign laws and regulations, except in cases where authorized in writing by the contracting officer or by adherence to contract specifications.
(14) Costs incurred to influence (directly or indirectly) legislative action on any matter pending before Congress or a state legislature.
(15) Costs of membership in any social, dining, or country club or organization.
(16) Costs of alcoholic beverages.
(17) Costs of promotional items and memorabilia, including models, gifts, and souvenirs.
(18) Costs for travel by commercial aircraft which exceed the amount of the standard commercial fare.
5-3. Accounting Mischarges.
a. The mischarging most frequently encountered by DCAA auditors is called an accounting mischarge. A fraudulent accounting mischarge involves knowingly charging unallowable costs to the Government, concealing or misrepresenting them as allowable costs, or hiding them in accounts (such as office supplies) which are not audited closely. Another common fraud variation involves intentionally charging types of costs which have reached their limits (such as bid and proposal costs or independent research and development costs) to other cost categories.
5-4. Material Cost Mischarges.
a. Material is physical inventory and component deliverables. Material includes raw material, purchased parts, as well as subcontractor and intercompany transfers. Like labor, material costs are sometimes mischarged, both as to their reasonableness and allocability. Numerous cases have been discovered where Government-owned material was used on a similar commercial contract but the material accountability records showed that the material was used on a Government contract. There have also been cases where Government-owned materials were stolen and the thefts were concealed by showing the materials as being issued to and used on Government contracts.
b. Mischarges of materials are usually confined to situations involving raw material or interchangeable parts. Specialized material, such as a certain type gyroscope, cannot be easily mischarged and go undetected due to its character. For example, a gyroscope for a C-130 aircraft just will not fit on a KC-135 aircraft and would be easily detected as an improper billing. An excellent guide to detecting material mischarges, Handbook on Fraud Indicators: Material, was published in July 1986 by the Office of the Inspector General, DoD, and is available through the Assistant Inspector General for Audit Policy and Oversight.
5-5. Labor Mischarges.
a. Labor costs are more susceptible to mischarging than material costs because employees' labor can be readily shifted to any contract with the stroke of a pen on their time cards. The only absolute way to assure that labor costs are charged to the correct contract is to observe the actual work of each employee to determine which contract he is working on and then determine from the accounting records that the
employee's cost is charged to the proper contract.
b. Contractors have devised a number of ways to mischarge labor costs. As in the case of material cost fraud vulnerability, the Assistant Inspector General for Audit Policy and Oversight has available a guide on the subject, titled, Handbook on Labor Fraud Indicators, dated August 1985. Labor mischarging schemes range from very crude to very sophisticated. Some of the common methods of mischarging are set forth below:
(1) Transfer of Labor Cost. This mischarge is usually made after the contractor realizes that he has suffered a loss on a fixed priced contract. To eliminate the loss, a journal entry is made to remove the labor cost from the fixed priced contract and put it on the cost type contract. This type of mischarge is very easy to detect but is difficult to prove. The contractor will contend that the labor charges to the fixed price contract were in error and the journal entry, transferring the cost to the cost type contract, was made to correct that error. Frequently the dollar amount of the transfer is estimated.
(2) Time and Charges Do Not Agree with Contractor Billing to the Government.
(a) This accounting mischarge method is probably the easiest to detect and prove. It is a simple matter of totaling the time and hours expended on the cost type contract and comparing them to the hours billed. For example, the time cards may show that 1,000 hours have been expended on the cost type contract when, in fact, the contractor has billed the Government for 2,000 hours of labor. The difference is obvious and the accounting records (time cards) will not support the billings.
(b) Contractor labor billings to the Government are normally supported by two accounting records. The source record is the individual employee time card. The other record is the labor distribution. The labor distribution is usually a computer printout that summarizes by contract the individual time card entries. The contractor will commonly use the labor distribution to support his Government billings. It is relatively easy to falsify a labor distribution but it is necessary to corrupt the entire work force to falsify the time cards. Hence, the individual time cards should be totaled and reconciled to the labor distribution at least on a test basis.
(3) Original Time Cards are Destroyed or Hidden and New Time Cards are Prepared for the Auditor's Benefit. This is a very successful method of concealing a labor mischarge. Mischarges of this nature are very difficult to detect. They are detected when:
(a) The hidden time cards are inadvertently given to the auditor.
(b) All of the old time cards are not destroyed and the auditor finds them.
(c) Employee signatures on the time cards are carbon copies because the employee's original signature has been traced.
(d) Time card entries are compared to time records maintained by individual employees (copies of time cards, logs, etc.).
(4) Changes are Made to Individual Time Cards. A frequent labor fraud encountered by the DCAA auditor involves improper changes to the original contract charge numbers on employee time cards. Some of the charges are so well done that it is difficult to tell that a change has been made. In one instance, the change was made so expertly that the auditor could not tell that a change had been made just from looking at the time sheet. The auditor detected the change by running his finger across the entry and noticed a difference in the "feel." Under magnification, the white out material used to cover the original entry could be seen. The auditors used a "light box" to determine what the original charge had been, i.e., by placing a light underneath the time sheet the auditor could read through the "white out" to determine the original charge. Just because changes are made on time cards, it does not necessarily mean that a fraud is being perpetrated. Many times innocent errors are made and corrected. In determining the possibility of fraudulent activity, one should:
(a) Determine the magnitude of the changes. If only a few changes have been made then, in all probability, the changes were made to correct errors. However, if a significant percentage of the charges have been changed, the probability of fraudulent activity is increased.
(b) A comparison of the original charge number to the revised charge number should be made. If the net effect of the changes is to increase the charges to cost reimbursable contracts, the likelihood of fraud is further increased.
(c) Make a review of the sequence of events. For example, in one case the tail number of the aircraft that the employee worked on was posted to the time card in addition to the contract charge number. The following discrepancies were noted:
1. The original contract charge number corresponded to the contract for which work was to be accomplished on a specified aircraft. The changed contract charge number was for work on another contract for an entirely different type of aircraft, i.e., the original charge was to the C-130 aircraft and the tail number was a C-130 aircraft, but the new charge was made to the KC-135 aircraft.
2. Based on the changed charge numbers, a ridiculous number of employees were working on the same aircraft during the same labor shift.
(d) Identify the employee who made the changes, find out why the changes were made and what was the employee's source of information for the changed charge number.
(5) Time Card Charges are Made by Supervisors. One should be especially skeptical of timekeeping systems where time card labor charges are posted by supervisors. Management can exert pressure and influence on supervisors to accomplish certain goals. The pressure may influence the supervisor to falsify time charges in order to keep higher level management satisfied with his performance. An even more serious situation occurs when senior level management requires the supervisor to record time charges in a manner most profitable to the company. Management might even go so far as to provide supervisors with "budgets" of how to charge the time for each job. However, if individual employees post their time cards it would be
difficult to corrupt the entire work force.
(6) Impact of Labor Mischarges. When a labor cost is mischarged, so is the associated overhead and general and administrative (G&A) expenses. Overhead costs are allocated to labor costs based on an overhead rate or percentage. Overhead costs usually exceed 100 percent of the labor cost. Therefore, any
mischarging on labor rates also impacts on overhead charges, which ultimately results in a greater than double loss to the Government. The same is true for G&A rates. In computing the dollar amount of the fraud, one must add the overhead and G&A cost because applied overhead and G&A will probably be more than the labor cost involved.
5-6. Cost Mischarging Examples.
a. An overhead audit conducted by DCAA disclosed substantial cost mischarging by a DoD accoustical research contractor. The mischarging principally involved shifting costs on both commercial and DoD contracts to the overhead category and then allocating the overhead to those contracts (principally DoD) which provided the best overhead rate. A thorough review of the audit work papers disclosed numerous examples of time sheets which had been altered by whiteouts. As a result of the audit and investigation, two senior company vice presidents were found guilty of violations of the Federal conspiracy statute and making false statements. Furthermore, the company was fined $706,000 and ordered to make restitution of approximately $2 million; the two senior vice presidents were fined $20,000 each and given six month sentences.
b. A major DoD contractor was found to have improperly shifted individual research and development costs (IR&D) to cost type contracts. The corporation was convicted and fined $30,000. An accompanying civil and administrative settlement resulted in the company paying an additional $720,000 to DoD. The corporation also agreed to major revisions in corporate contracting practices and to increased DoD audit access to contractor records. Additionally, $300,000 in legal costs were disallowed.
c. A company contracted by the Army to rewrite military technical manuals was convicted, as well as its president and vice president, of conspiracy to defraud and of submitting false statements after a seven-day jury trial which found the defendants had mischarged labor costs. The charges stemmed from a scheme where the company, whose contract with the Army was on a time and material basis of cost reimbursement, charged over $140,000 of commercial expenses against the DoD contract. The corporation was fined, and the officers were fined and sentenced to work-release and probation terms.
d. Based on information initially supplied by a Defense Logistics Agency employee who became suspicious of a price quote submitted by an Air Force parts supplier, a contractor was convicted of material mischarging and paid fines and recoveries amounting to $3 million. The contractor had altered documents to reflect greatly inflated costs of products of which it was then able to further inflate by adding on a
percentage-of-cost overhead rate.
Chapter 6. Product Substitution
6-1. Introduction.
a. The term product substitution generally refers to attempts by contractors to deliver to the Government goods or services which do not conform to contract requirements, without informing the Government of the deficiency, while seeking reimbursement based on alleged delivery of conforming products or services. It is the policy of the DoD that goods and services acquired must conform to the quality and quantity required in the contract. Goods or services which do not conform in all respects to contractual requirements are to be rejected. It is essential that this policy be strictly adhered to, as failure to do so can result in providing substandard, untested, and possibly defective material to our Armed Forces. Defective material can have a serious and detrimental impact on the safety of DoD personnel, as well as the accomplishment of important missions.
b. When a contract calls for delivery of an item produced by the original equipment manufacturer (OEM), then the contractor must furnish that item. The rule excludes even items that may be identical in all respects but are not produced by the OEM. If the contract requires the delivery of end products produced in the United States, then the contractor is obligated to supply items manufactured in the United States. This is required even though comparable or identical items are available from foreign sources at lower costs to the contractor. Further, if the contract requires that certain tests be conducted to ensure that an item is suitable for its intended use and can be relied upon to perform as expected, those tests must be conducted. The contractor's ability to produce an item that will perform within acceptable limits regardless of whether actually tested is not relevant.
c. Contractors frequently argue that substituted goods or service delivered to the Government were "just as good" as what was contracted for, even if specifications are not met, and that, therefore, no harm is done to the government. There are several important fallacies to be noted when considering this argument. First and
foremost, the substitute is usually not as good as what was contracted for. In cases of product substitution investigated to date, the substitute is usually one of inferior quality or the workmanship is extremely poor because it was done by lesser qualified and cheaper labor. Secondly, while the immediate harm that the substitute might cause or may have, in fact, caused is sometimes difficult to determine, its introduction into Defense supply channels undermines the reliability of the entire supply system. If, for example, a microchip were in use in larger components which failed, the cause of the failure might not be directly traceable to the inferior quality of the microchip. Third, even if the item is useable, there is harm to the integrity of the competitive procurement system which is based on all competitors offering to furnish the item precisely described in specifications.
6-2. Fraud potential.
a. There are a wide variety of fraudulent schemes that may involve product substitution. Many of the recent product substitution fraud allegations involve consumable or off-the-shelf items. Defense employees should be aware of similar problems that have arisen in component parts and materials used in weapon systems, ships, aircraft, and vehicles. Cases have included:
(1) The provision of inferior quality raw materials;
(2) Materials that have not been tested as required by the contract specifications;
(3) Providing foreign made products where domestic products were required; and
(4) Providing untrained workers when skilled technicians were required.
b. Product substitution cases sometimes involve Government employees. For example, gratuities and bribes have been paid to Government inspection personnel to accept items which do not conform to contract requirements.
c. The potential for a product substitution case is greatest where DoD relies on contractor integrity to ensure that the Government gets what it has paid for. For example, fast pay procedures apply to small purchases. The Government pays contractors for goods based on certification of shipment. Quality assurance is frequently limited in scope and is performed after payment has been made. Thus, small purchases are particularly susceptible to unscrupulous contractors.
d. In large dollar value procurements, Government quality personnel often rely on testing performed by the contractor. Falsification of the test documents may conceal the fact that a piece of equipment has not passed all the tests required by contract or has not been tested at all. False entries may also conceal the substitution of inferior or substandard materials in a product. When Government personnel actually witness or perform tests themselves, there is always the possibility that what they are seeing is a specifically prepared sample not representative of the contractor's actual production.
e. In August 1986, the OIG, DoD, isued a research report on Unauthorized Quality Assurance Practices by contractors. The project was conducted to identify possible systemic weaknesses in DoD quality assurance practices. The report determined Government reliance on contractor falsified documentation, inadequate
Government inspection and testing, and the lack of adequate control over end items were three conditions conducive to unauthorized quality assurance practices by contractors. The report also concluded that in 22 of 24 DoD investigation cases studied, the contractors intentionally and knowingly delivered or planned to deliver products that were not in conformance with contract requirements. Related analysis in the report disclosed predominant issues that pertained to quality assurance practices. Some of the indicators of and conditions conducive to unauthorized quality assurance practices included a history of poor performance by the contractor; negative preaward survey; awards to unusually low bidders; misuse of fast pay contracts; Government quality assurance representatives' reliance on contractor falsified documentation; and insufficient Government quality assurance practices.
f. Finally, the Buy American Act (41 U.S.C. 10) generally prohibits the use of foreign manufactured articles, materials, or supplies in Government contracts.
6-3. Product substitution examples.
a. A DoD contractor provided false certifications of quality testing for coating on aluminum troop backpack frames. The backpacks are intended for use by military ground troops, and the anodized coating on frames are dyed light fast olive drab to avoid enemy detection. Inferior anodizing could endanger the lives of U.S. military personnel through the exposure of reflective metal. Investigation disclosed that no testing was performed and a sample of completed units failed at a rate of 70 percent. The owner of the company, who entered a plea of guilty to false statements, was sentenced to 3 years supervised probation, fined $6,000, and required to perform 500 hours of community service.
b. A complainant alleged that a product manufacturer of parts for Army howitzers was submitting defective items which, if installed, could produce significant safety hazards. An investigation revealed that the testing certificates being submitted by the contractor were false. The investigation kept the defective parts from being installed in Army howitzers and kept howitzers from being sold under the Foreign Military Sales program. The corporate president pled guilty to making false statements to the U.S. Government and was sentenced to one year supervised probation; the company and its president have also been debarred from contracting with the Government.
c. An investigation was conducted concerning a company that had a Navy contract to install fire-retardant decorative plastic laminate throughout the enlisted dining area of a Navy ship. The contract required the company to provide certification that the laminate was a fire-retardant material. When the company installed laminate that was not fire retardant, it seriously jeopardized the lives of the ship's crew. The investigation determined and a Federal grand jury charged that the company substituted and installed laminate that was not fire retardant and that an officer and an employee of the company conspired to falsify a certification to the Navy that the material was fire retardant. As a result of the false claims, the company fraudulently received over $23,000. Both individuals pled guilty to making false statements and claims against the Government. The president was ordered to pay restitution, and the vice president was fined $1,000.
d. A DoD investigation established that a contractor had substituted inferior check valves with the potential to damage aircraft and jeopardize personnel safety. The contractor was asked to furnish specified valves manufactured by a particular company. The scheme was discovered when the contractor billed the Government for a progress payment and billed for more valves than had been delivered. A later inspection of the delivered valves found the substitute items. The president of the company was convicted of mail fraud and submitting false statements.
e. A DoD contractor devised a scheme to deliver nonconforming and defective rifle barrels for M-14 and M-21 weapons to the DoD. Under the contract, 1,800 rifle barrels were to be provided to the Department at a price of about $245,000. The DoD inspectors were shown acceptable rifle barrels during quality assurance checks. Then the contractor substituted nonconforming rifle barrels and shipped then to DoD depots. The contractor also allegedly violated contract provisions by selling rifle barrels made for the DoD to the general public. Some of the defective barrels exploded during user tests and could have caused serious injury. A joint investigation by the Army, DoD, and Department of Justice was conducted. The president and vice president were indicted on charges of racketeering, mail fraud, obstruction of justice, and perjury. The company has been fined $400,000 and suspended from receiving future contracts.
f. Three company officials pled guilty to charges of conspiracy and filing false statements on a contract after installing pipe flanges aboard nuclear submarines without making proper tests and certifications. The defective flanges, which have a critical application aboard submarines, have been removed. The corporate president and vice president were sentenced to two years imprisonment and fined $10,000 each, and a third corporate official was sentenced to six months imprisonment and ordered to perform 500 hours community service. The corporation was debarred.
g. An investigation resulted in guilty pleas by a DoD contractor to charges of submitting false claims on Government contracts to supply aircraft parts. The company was found to have either provided nonconforming parts or to have short shipped ordered parts. The company, its owner, and two other companies that participated in the fraud, in addition to other criminal sanctions and fines, including a prison term, were debarred from receiving future Government contracts.
h. A contractor provided defective foreign-made ammunition under a Foreign Military Sales contract. The contract required 15 million rounds of 5.56mm ammunition. The first shipment of approximately 2 million rounds was according to contract specifications. However, when subsequent ammunition received from the contractor caused rifles to misfire and jam, an investigation was initiated. It was determined that the defective ammunition was produced in a foreign country, and bribery payoffs were made to facilitate acceptance of the defective product. The corporate president, vice president, and a foreign national businessman who facilitated obtaining the contracts, all pled guilty to conspiracy to defraud the U.S. Government. The president and vice president were sentenced to two and three year sentences, respectively, and the foreign national businessman was sentenced to one year confinement and fined $10,000. The corporation has been recommended for debarment.
Chapter 7. Progress Payment Fraud
7-1. Introduction.
a. Progress payments are payments made as work progresses under a contract, based on the costs incurred, the percentage of work accomplished, or the attainment of a particular stage of completion. They do not include payments for partial deliveries accepted by the Government.
b. Fraud in progress payments occurs when a contractor submits a progress payment request based on falsified direct labor charges, on material costs for items not actually purchased, or on falsified certification of a stage of completion attained/work accomplished.
c. When a DoD contract contains one of the contract clauses in FAR 52.232.16, a contractor may submit monthly progress payment requests and is entitled to receive a contractually specified percentage of its total costs.
d. Requests for progress payments are made on Standard Form 1443 (FAR 53.301-1443). On the form, the contractor identifies its contract costs and certifies that the statement of costs has been prepared from the contractor's books and records and is correct. In addition, the contractor also makes a certification concerning encumbrances against the materials acquired for the contract.
e. The purpose of progress payments is to provide contractors with a continuing source of revenue throughout contract performance, and to ensure that a contractor will have the necessary financial resoures to meet its contractual obligations. Although some progress payment requests are audited before payment, for the most part DoD relies solely on a contractor's integrity in making the payments. When a contractor requests payments for costs not actually incurred, the Government is harmed in the following ways:
(1) The contractor has the interest free use of money to which it is not entitled and which the Government itself may have had to borrow from the public.
(2) The Government may lose its advances if the contractor goes out of business and there are no materials or completed products against which the Government may assert an interest.
(3) Honest contractors lose their faith in the system and others, who are less scrupulous, are encouraged to take advantage of the system.
7-2. Progress payment fraud indicators.
a. Firms with cash flow problems are the most likely to request funds in advance of being entitled to them. Progress payments which do not appear to coincide with the contractor's plan and capability to perform the contract are suspicious. This could indicate the contractor is claiming payment for work not yet done.
b. Another type of contractor fraud in this area is to submit a progress payment claim for materials that have not been purchased. The contractor may be issuing a check to the supplier, then holding it until the Government progress payment arrives. One way to confirm the irregularity is to check the cancellation dates on the contractor's checks. If the bank received the check about the same time or later than the contractor received the progress payment, the check was probably held.
7-3. Progress payment fraud examples.
a. A contractor entered into an agreement with the Government to refurbish/overhaul heavy equipment vehicles. The contractor instructed its employees to work on the company's private commercial projects but to use a United States government time card and punch that card as though working on a Government project. The contractor received large prepayment amounts from the Government in order to support its lagging private business. The Government's monies were then used for purposes other than to repair Government vehicles. Consequently, the government vehicles either were not repaired or did receive a few repairs but not of the extent indicated on the Government repair documents and were returned to the Government as totally overhauled or refurbished equipment. The company president pled guilty to one count of making false statements, was placed on probation for two years, and fined $5,000. The company was fined $1,000. The company and its president were debarred from future business with the Government.
b. A contractor was awarded a contract to manufacture locking devices for trigger mechanisms valued at $87,000. The former president of the company allegedly submitted false invoices as proof of costs incurred, thus receiving progress payments. The president subsequently pled guilty and was sentenced to 5 years
probation, fined $10,000, ordered to make restitution of $11,000, and ordered to serve 200 hours community service. The president and the company were debarred from bidding on Government contracts during his period of probation.
8-1. Introduction.
a. Fast pay is a special DoD procedure that allows certain contractors to be paid for contract work prior to receipt and inspection of the product by the Government. In general, the fast pay procedure is limited to contract orders that do not exceed $25,000. The fast payment procedure set forth in FAR 13.3 is designed to
reduce delivery times and to improve DoD relations with certain suppliers by expediting contract payments. The procedure provides for payment based on the contractor's submission of an invoice. That invoice is a representation by the contractor that the supplies have been delivered to a post office, common carrier, or
point of first receipt.
b. Fraud in fast pay occurs when a contractor submits an invoice requesting payment for supplies that have not been shipped or delivered to the Government. If the supplies are not in transit or actually delivered at the time the contractor submits his invoice, a criminal violation has occurred because the contractor submitted
a false statement. It does not matter if the supplies are subsequently delivered to the Government.
c. There are specific DoD regulations regarding fast pay. Fast pay orders are usually issued on DD Form 1155. Regardless of the contract form used for the fast pay purchase, the contract will contain the following certification clause: "The Contractor agrees that the submission of an invoice to the Government for payment is a certification that the supplies for which the Government is being billed have been shipped or delivered in accordance with shipping instructions issued by the ordering officer, in the quantities shown on the invoice, and that such supplies are in the quantity and of the quality designated by the cited purchase order."
d. The fast pay procedure benefits both the contracting community and DoD. However, contractor integrity and honesty is essential. Payments are made before DoD is in a position to verify that it has received what it bargained for. In many cases, especially where overseas deliveries are involved, it may be weeks or even months before the DoD activity that actually issued the fast pay order is advised of either a nonconforming delivery or a nonreceipt. By that time, an unscrupulous contractor may have had an opportunity to defraud the Government of thousands of dollars and to drop out of sight. Because of the potential for large losses, and the effect that such losses could have on continued use of the fast pay procedure, immediate detection of those who have abused the system is necessary.
8-2. Fast pay fraud indicators.
a. How can DoD personnel dealing with fast pay identify possible fraud? The most obvious, and sometimes most difficult, thing to do is check for the correlation between the claim for payment and the delivery of goods. Since the claim for payment and receipt of goods occurs at different locations, this will require communication between paying and receiving points. An employee who becomes suspicious should check with the receiving point to verify that the goods have arrived. Some important things to check for include: not receiving the goods at all, receiving the goods later than would be expected if they were mailed when claimed, and receiving nonconforming goods. The latter sometimes occurs because the contractor has lost the incentive to perform fully to contract specifications after it has been paid.
b. DoD personnel should also be alert for indications that the invoice submitted by the contractor is forged or altered in some way to make it appear that the goods were sent. Information on the invoice may raise questions such as shipment on a weekend or holiday.
8-3. Fast pay fraud examples.
a. A DoD supply center received a shipment of bricks instead of several electronic connection plugs allegedly shipped by the contractor. A review of 13 other contracts held by the contractor identified 8 for which payment had been made, but shipments were not received at various supply centers across the country. The value of the eight undelivered shipments was over $45,000. The contractor provided alleged proof of shipment and tracer documents which, on further investigation, were determined to be forgeries. The president of the company pled guilty to three counts each of mail fraud and false claims. He was sentenced to concurrent three year prison terms, ordered to pay $35,915 plus interest as restitution, and fined $3,000.
b. A contractor submitted fraudulent bills of lading to obtain payment for various quantities of hardware allegedly shipped to several DoD installations throughout the United States. The contractor was shipping the product at a date far after payment was received and, in some instances, never shipped the product as indicated on the bills of lading. The company, through its president, pled guilty to 93 instances of violating the provisions of the fast pay clause. The company was fined $7,500 and ordered to pay restitution of $13,753.
Chapter 9. Bribery, Gratuities, and Conflicts of Interest
9-1. Introduction.
This chapter is dedicated to the discussion of integrity awareness. It will inform managers and employees about their responsibilities to be alert for bribe offers, to avoid the acceptance of gratuities and to recognize conflicts of interest. It also calls attention to the relationship and impact of these issues in the procurement
process.
9-2. Bribery and Integrity Awareness.
Federal law prohibits both the giving or offering of anything of value to influence official actions and the acceptance of such items by Government officials. The crime is complete on making the offer to a Government employee. Acceptance of the bribe does not have to be proven. In addition to being a crime, contractors who resort to bribery and gratuities in their dealings with the Government also change the nature of their business relationships with the Government. Such unethical business practices certainly bear on the issue of contractor responsibility and possibly the retention of security clearances. Much of the government procurement system relies on contractor integrity. The corruption of the procurement system by bribery is particularly damaging. Both Federal regulations and common sense dictate that the Government avoid business dealings with contractors who do not have a satisfactory record of integrity and business ethics.
a. Manager responsibilities.
(1) Managers have many responsibilities in the area of integrity awareness. They must set examples, not only of personal integrity and high ethical standards, but also of a willingness to participate in the referral and investigation process. Too often employees are discouraged from paying attention to or reporting possible
bribe situations because it is thought that subsequent actions are time-consuming and disliked by managers because of the work involved. Instead of giving any impressions that they are unsympathetic to this process, managers should actively encourage their employees to be acutely aware of potential bribe overtures,
encourage their employees to report bribe attempts immediately, and indicate to their employees that they will have full support from management in any efforts to assist investigators in obtaining evidence of the offense.
(2) The tendency to treat less blatant attempts at bribery as ordinary occupational hazards or as routine innuendos which can easily be ignored or dismissed is another reason that many bribes are not reported. Another reason might include the sentiment that refusal of a bribe offer is deterrent enough. It is part of a manager's job to ensure that these conditions are not impediments to rapid, timely, and efficient reporting of attempted bribes.
b. Employee responsibilities. There are some primary areas that should be focused on in discussing bribery awareness with employees. The areas of concern can be grouped into several questions.
(1) What constitutes a bribe? A bribe is an offer to employees of something of value to (a) do something they should not do, or (b) fail to do something they should do, in their official duties. The something of value need not be money, it can be anything of value.
(2) When is a bribe being offered?
(a) People who offer bribes are generally astute and aware individuals. A blatant offer is a rarity. Generally, the party offering a bribe will make subtle overtures in a conventional fashion. They may begin by discussing the employee's life style, family, or salary. They are looking for a vulnerable area where they can exploit the employee. They may seek to establish that the employee has college age children and begin discussing the high cost of education. They may learn that the employee is a new homeowner and discuss high mortgage payments and the expenses of fixing up a new home. If unable to detect an area in which the employee is particularly vulnerable, they may move to more glamorous and alluring areas; cash, cars, and travel. In summary, if the employee feels the individual is getting beyond mere civility and the professional purpose for the meeting, the employee should be alert to the possibility of a bribe attempt.
(b) The preliminary conversation may be an attempt to feel the employee out. The person attempting the bribe knows that bribe offers are illegal. They also know that an employee has an obligation to report the attempted bribe. Most importantly, the offeror of the bribe does not want to get caught. If the employee is not receptive to subtle overtures and alternative attempts fail, the person may not make any overt bribe offer. An employee has an obligation to determine the nature of the person's remarks. The very subtlety of preliminary overtures makes the employee's job of detecting a bribe a delicate one.
(3) Why not accept a bribe?
(a) The clear answer to this question is that the acceptance of a bribe is a criminal act that can result in prosecution, dismissal, fines, and embarrassment to the family and friends of the employee.
(b) In addition, accepting a bribe leaves one at the mercy of the person who paid it. There is no such thing as a one-time favor for one who accepts a bribe. Since the employee has committed a crime, the briber can ask anything later on under the threat of reporting the bribe, claiming it was solicited, and threatening exposure.
(4) Why not just refuse a bribe without reporting it?
(a) When an employee rejects a bribe, the offeror of the bribe may become concerned that the employee will report the attempt. He may decide that the best way to deal with the situation is to report that the employee tried to solicit a bribe and offer to cooperate in having the employee prosecuted or dismissed. If the employee has not reported the attempt, it would give credence to the offeror's allegation. Even though the employee has done nothing wrong, the allegation would have to be investigated and could cause undue problems and time to resolve.
(b) Furthermore, since the attempt to bribe a government official is in itself a crime, failure to report an attempted bribe, as well as other crimes, leaves the employee open to possible prosecution.
(c) The failure to report a bribe attempt also leaves the offeror free to try again with another employee of the Government. The next employee may not be able to resist the offer. Further, there is no deterrent effect in refusal of an attempt. The offeror is free to try again without fear of the potential consequences. Investigation and prosecution of those who would try to corrupt our employees and our system of Government is the only way to deter others from believing that this is the way to do business with the DoD.
c. Bribes are a reality. As a demonstration that the foregoing discussion relates to a very real problem, a few examples of recent DoD bribery cases follow:
(1) A Navy contracting officer at a Navy supply depot was found guilty of conspiracy to defraud the Government in connection with his receipt of approximately $21,000 in cash and other gifts in exchange for awarding Navy contracts. He was sentenced to two years confinement and fined $10,000.
(2) An Army contracting officer's technical representative was sentenced to five years in prison and fined $20,000 in connection with his receipt of over $3,000 in bribes from a contractor performing in excess of $3 million in Army contracts.
(3) An Air Force inventory management specialist was fined $1,000 and required to pay $13,500 in restitution as a result of his pleading guilty to federal charges relating to his receipt of bribes to assist a contractor in transporting material unrelated to Government contracts from the United States to a foreign country at Government expense. The contractor was also convicted of Federal charges, sentenced to six years in jail, and required to pay $40,000 in restitution.
(4) A corporate sales manager was sentenced to ten years in prison, fined $1,000, and ordered to make nearly $10,000 in restitution after conviction on multiple charges of bribing a DoD civilian employee relating to a scheme of false and inflated billings.
(5) A GS-4 file clerk was convicted of receiving approximately $50,000 in bribes from various contractors to provide them inside information used to enhance their bid packages.
9-3. Gratuities.
a. Gratuities are generally distinguished from bribery in that there is usually no request for specific improper action in exchange for what is being given. Gratuities are generally given to assist in enhancing the "relationship" between the offeror and the Government employee. This "more favorable atmosphere" in which to do business may later move the employee to lean in the contractor's favor if needed. Some contractors have actually gone so far in providing gratuities as to budget substantial sums (in excess of $150,000 for a project in one case) to create a favorable atmosphere for their dealings with Government employees.
b. Dealings with those who seek to and who do business with the Government should be conducted in an objective manner, above reproach, and avoiding even the appearance of favoritism or other impropriety. Acceptance of gratuities of any kind should be avoided in order to maintain both the form and the substance of objectivity in official dealings. It should also be remembered that the offer or acceptance of a gratuity is a felony. Furthermore, the provision of a gratuity is in violation of a standard clause in DoD contracts (FAR 52.203), and any claim by a contractor for reimbursement of expenses of a gratuity is a civil and criminal violation of the False Claims Act (10 U.S.C. 2324(i)).
c. An example of illegal gratuities can be seen in the case of a Navy commander who was responsible for keeping track of Navy flight hours used in support of the filming of a commercial movie. During the filming, the commander received over $5,500 from the movie company through the payment of a bogus invoice for set materials. Ultimately, the commander understated the number of hours flown in support of the movie, which resulted in over $600,000 in lost reimbursement from the movie company. The commander was later convicted of receiving an illegal gratuity, fined $5,000, and placed on three years probation. The commander and the movie company were sued in Federal court and later settled with the repayment of $400,000 in civil damages. It was also determined that the captain of the carrier had repeatedly accepted gratuities from the producer during filming of the movie. The gratuities included a $1,300 hang glider and over $400 in meals, accommodations, and transportation expenses for his family to watch the filming of the movie. The captain received a letter of caution and was required to repay all gratuities.
9-4. Conflicts of Interest.
Employees of DoD are generally prohibited by both criminal laws and Standards of Conduct requirements from taking official actions that deal with businesses in which they or their immediate families have a direct financial interest. In addition to the general prohibition, 10 U.S.C. 2397 (as amended by the DoD Authorization Act, P.L. 99-661), imposes other post employment restrictions on certain procurement officials, grades GS-13 or O-4 and above. Any DoD employee who is unsure of the conflict of interest statutes and their personal application should consult with their organization's ethics official for guidance.
In dealing with contractors, the Government may terminate for default any contract that was obtained as a result of a conflict of interest. Even the appearance of a conflict of interest, although not proven in court, has been held to be sufficient to disqualify an otherwise eligible bidder on a contract and, by extension, may be sufficient to terminate such a contract after award (See Chapter 11).
All DoD employees should be alert to situations in which they suspect a possible conflict of interest and report them to appropriate authorities. The following recent cases are reflective of situations to which all DoD employees should be sensitive.
a. A buyer with the Defense Electronics Supply Center (DESC), along with his wife and sister-in-law, formed a company to represent various electronics companies in their efforts to obtain contracts with DESC. On numerous occasions, the buyer, who was responsible for bid solicitation and price determination for a selected series of electronic items, recommended awards of Government contracts to those same companies. The buyer also used an affiliate of the company he had formed to sell solenoids to DESC under approximately 50 contracts with the Government. As a DESC employee, he personally participated in the award of the contracts to his own company. No disclosure of his interest in the company was made to DESC. The buyer charged DESC over $70,000 as a result of the contracts. Based on a complaint from a co-worker at DESC, the buyer was convicted under the Federal conflict of interest statute.
b. A senior medical officer, who served as a consultant to the Surgeon General of a Military Department, recommended that DoD procure an item of medical equipment on a sole source basis from one company. At no time did the officer disclose that he was a director and major stockholder in the company. When the Surgeon General agreed to the recommendation, the officer sought to recapitalize the company in anticipation of receiving a large amount of new orders. When the officer learned that he was suspected of conflict of interest, he denied his ownership in the company and had the company prepare false and backdated documents to show that he had no involvement with the company. In addition, the officer improperly received payments from various drug companies for drug tests performed at a military hospital, but failed to disclose to the hospital the receipt of that money. The allegations in this case were made by two doctors at the hospital who became aware of the medical officer's conflicts of interest. The medical officer was convicted of Federal violations of unlawfully supplementing his income.
Chapter 10. Commercial Bribery and Kickbacks
10-1. Introduction.
The payment of bribes and kickbacks by subcontractors to DoD prime contractors or higher tier subcontractors, in connection with work on Defense contracts, constitutes a serious problem. While it is similar in many ways to the bribery of a Government official, until recently commercial bribery had not had the focus of public attention and little had been done to address the problem. However, Congress recently addressed the problem, and through the passage of the Anti-Kickback Enforcement Act of 1986 has now strengthened the law in this area. The DoD is also focusing on the problem by conducting more aggressive investigations and by working with the business community for the establishment of effective company ethics programs. However, commercial bribery and kickbacks remain a problem which is not easily detected and controlled. The courts have established the presumption that the cost of any kickback activity is always passed on to the Government.
10-2. Anti-Kickback Enforcement Act of 1986.
a. With the passage of the Anti-Kickback Enforcement Act of 1986 (PL 99-634), it is illegal for any person to provide, attempt to provide, or offer any kickback to a Government contractor or contractor employee for the purpose of improperly obtaining any favorable treatment under a Government contract. The prohibition
covers any money, commission, gratuity, or any other things of value, whether provided directly or indirectly, and applies equally to persons who solicit, accept, or attempt to accept kickbacks. The legislation further prohibits the inclusion of any kickback amounts in the contract price charged by a contractor.
b. In addition to providing criminal penalties, which include imprisonment for up to 10 years, the legislation also provides for civil action and administrative offsets when illegal kickbacks are involved. In a civil action, the United States may recover a penalty of twice the amount of the kickback plus $10,000 for each kickback payment. The Government contracting officer may also administratively offset the amount of any kickback against any moneys owed by the United States under the contract.
c. The Act also requires contractors to establish internal programs to detect and prevent kickback activity. Contractors are required to report any kickback activity to the Inspector General, DoD, and to cooperate fully in any investigation regarding kickbacks. Contractors are also required to allow the Inspector General, DoD,
access to facilities and to audit books and records in order to determine compliance with the Act.
10-3. Other Considerations.
a. In addition to the Anti-Kickback Enforcement Act, instances of commercial bribery may also involve various other criminal statutes. The individuals paying and/or receiving the bribes may be in violation of the statute dealing with conspiracy to defraud the Government (18 U.S.C. 371), may have made false statements or
certifications under the contract (18 U.S.C. 1001), or violated various other Federal or state statutes.
b. The illegal kickbacks not only affect the integrity of the procurement process and inflate Government costs, but, in some instances, the kickbacks paid may be so significant they affect the subcontractor's performance. In such cases, contract specifications may not be met or there are other performance failures due
to underfunding, which results in deliveries being delayed or prevented and the ultimate user being deprived of the contracted items.
10-4. Kickback Case Examples.
A quick look at some case examples provides a clear picture of the extent to which the payments affect DoD contracts.
a. Six officials of a DoD subcontractor pled guilty to Federal charges in connection with kickback schemes involving an executive vice president of a major Defense prime contractor who, along with his assistant, received approximately $5 million in kickbacks. The corporate officer fled the country following his indictment
and remains a fugitive from justice.
b. In another case, 26 people were convicted in connection with a kickback scheme operated within a major shipbuilding contractor. The scheme involved approximately $1 million in kickbacks.
c. A vice president of an advertising firm in New York City pled guilty to receiving illegal kickbacks of $60,000 in connection with the company's contract to provide national advertising for the United States Army.
d. In the aerospace industry, investigations have resulted in multiple convictions of prime contractor employees who have received kickbacks. The investigations, which developed evidence of over 70 companies where buyers for the prime contractor had received kickbacks, led the United States Attorney controlling the investigation to testify before Congress that, "It is my opinion that kickbacks on defense subcontracts are a pervasive longstanding practice which has corrupted the subcontracting process at most, if not all, defense contractors . . . ."
Chapter 11. Civil, Contractual, and Administrative Remedies for Fraud
11-1. Introduction.
a. Traditionally, Government contracting officials have relied on the criminal justice system to police fraud by DoD contractors. The reliance included forbearance from certain administrative and contractual actions until the criminal case was completed. However, the reliance was often misplaced for a number of reasons.
b. First, criminal cases must be proven beyond a reasonable doubt. While there may be insufficient information to warrant a criminal conviction, contracting officials do not need the level of proof in order to take administrative and contractual actions.
c. Second, even if criminal action is taken, many cases are plea bargained to lesser offenses. This tends to mislead people into believing that a less serious offense was proven, or that less fraudulent activity took place than really did. An example of the confusion comes from one documented case in which four nonappropriated fund officials pled guilty to accepting bribes from a contractor. The contractor, however, pled guilty to only a misdemeanor for trespassing on a Federal reservation. Contracting officials, when confronted with the fact that the contractor had been convicted of only a misdemeanor, believed that the contractor's actions had not been very serious in nature. The facts showed the seriousness of the actions despite the plea to only a minor infraction of the law.
d. Third, many contracting officials are not aware of the fact that prosecutors must set priorities for the use of their resources, and, in doing so, they are not able to prosecute every case that is brought to their attention by investigators. The decision not to prosecute a case is not always based on the failure to establish that wrongdoing has taken place. There are instances when the investigators prove a crime took place, but the circumstances do not warrant taking judicial action at that time. When a case has been declined for prosecution, contracting officials should consider the facts established by the proof the investigator has gathered to determine whether alternative action is warranted by them.
e. Fourth, the criminal justice system does not have as one of its functions the recoupment of assets lost during a fraud, or the protection of the procurement system from future dealings with the contractors who practice deception. Although a company might be convicted of or plead guilty to a crime, this does not, without action by contracting officials, prevent the company from obtaining future contracts, recoup monies paid to the contractor due to fraud, or obtain the desired or intended performance under the contract.
f. Finally, DoD officials and not the DOJ are responsible for the integrity of the DoD contracting and procurement process. The FAR and DoD implementing regulations require contracting officials to take positive action on any evidence of contractor impropriety and nonresponsibility. Therefore, it is necessary for managers and contracting officials to be aware of and effectively use the civil, administrative, and contractual powers and remedies which are available to protect the Government, to prevent further loss to the Government, and to recover Government assets and funds lost through fraud.
11-2. Coordinated approach to remedies.
a. Officials of DoD are responsible for the integrity of DoD contracts and must be prepared to take immediate action to protect the Government. This often includes positive action while a criminal investigation is under way and before an indictment or conviction has been obtained. Criminal cases often take years to complete and DoD can take many contractual and administrative actions on evidence less than that necessary for a conviction. Timely action by a contracting official, such as pre-indictment suspension or a contract default termination, will aid the Government by precluding the contractor from continuing to benefit while an investigation is under way.
b. By taking a coordinated approach to criminal, civil, contractual, and administrative actions, the Government is often able to induce guilty contractors into pleading guilty more quickly. Simultaneous consideration of all remedies available to DoD and DOJ also enables the Government and the court to fashion a single comprehensive remedy package that will punish the contractor, protect the Government from further harm, and make the Government whole from any losses suffered.
c. Early action by contracting officials is important. The action must be coordinated with a variety of officials in both DoD and DOJ. The coordination is essential to ensure that none of the actions taken will adversely affect the ability of the Government to pursue any of the other actions available. An example of how the coordination of remedies process can work is demonstrated by a recent case involving a major DoD contractor who was investigated for engaging in product substitution, cost mischarging, and defective pricing. As a result of coordinated efforts by contracting officials, investigators, the DOJ, and other DoD officials, the following results were achieved:
(1) Suspension of the contractor during the investigation to prevent the award of additional or follow-on contracts (which would have required a finding of responsibility and putting additional funds at risk).
(2) Guilty plea by the contractor to numerous felonies, resulting in criminal fines of $380,000 being paid by the contractor.
(3) Agreement by the contractor to pay restitution of over $160,000 and civil damages of over $1.6 million.
(4) Agreement by the contractor to make significant changes in its cost accounting and quality assurance procedures.
(5) Dismissal of numerous employees by the contractor for their participation in the fraud, helping to assure the Government that a repeat of the fraud was unlikely.
d. The Secretary of Defense issued DoD Directive 7050.5, Coordination of Remedies for Fraud and Corruption Related to Procurement Activities, dated June 28, 1985, to ensure that the type of coordination discussed above takes place. The Directive requires that each Military Department and Defense Agency establish a centralized point of coordination for criminal, civil, contractual, and administrative actions in contract fraud and corruption cases. The following are some of the centralized points of coordination established under that Directive:
(1) Army--Office of the Judge Advocate General, Procurement Fraud Division. (Army Regulation 27-21)
(2) Navy--Office of the Naval Inspector General, Investigative Oversight Division (NOP-81).
(3) Air Force--Office of the Inspector General of the Air Force, Office of Review and Oversight. (Air Force Regulation 123-2)
(4) Defense Logistics Agency--Office of the General Counsel, Associate Counsel Logistics Services.
e. The Directive mentioned above requires that the centralized points of coordination be informed by the Defense criminal investigative organizations each time they open a significant investigation involving fraud or corruption in procurement or procurement related activities. The centralized point of coordination is then responsible for ensuring that a remedies plan is prepared, and updated as needed, taking into account the available remedies and the timing of their use. The coordination will involve communication between the centralized point of coordination and various officials in the investigative, prosecutive, program, and procurement areas of concern to balance the needs of each and foster communication between them. Through this process, the Government will be able to use fully the variety of remedies available for fraud and do so in a more efficient and effective manner.
f. The following segments contain a brief discussion of the many remedies for fraud that can be used by the Government. A number of these remedies have been created or changed by recent legislative action.
11-3. Available remedies.
The Government has the right to take action against contractors who engage in fraudulent activities. The Government right is based on several statutory grounds. Many of the civil actions taken based on those statutes are filed by the DOJ and may be filed in conjunction with, after, or instead of a criminal prosecution.
Under contract law and principles, the Government has the right to insist on certain standards of responsibility and business integrity from its contractors. The violation of any of those principles gives the Government the right to take a variety of actions. These actions may also be taken in conjunction with, after, or instead of a criminal prosecution.
a. Civil False Claims Act.
(1) The submission of a false claim to the Government can make a contractor liable to the Government, both criminally and civilly. The Civil False Claims Act, 31 U.S.C. 3729-3731, establishes liability for false claims. The law provides for the Government to be able to recover penalties and damages for false claims in addition to or instead of any criminal sanctions. Through such actions, the Government can recover assets lost through fraud.
(2) The statute, as recently amended, provides for penalties of $5,000 to $10,000 per false claim (previously the penalty was $2,000 per claim). Each invoice submitted by a contractor could, under appropriate circumstances, be considered as a false claim for purposes of the statute. The Government can also recover treble damages (previously it was double damages) or three times the amount of a false claim. The Government must actually suffer monetary damages to collect under that portion of the statute but not to have the civil penalties assessed. The Government is precluded from intentionally paying a claim it knows is false merely to activate the damages portion of the statute.
(3) The Government must prove, by a preponderance of the evidence, that the contractor knowingly submitted a false claim. Knowing submission means actual knowledge or deliberate ignorance of the truth (failure to take reasonable steps to find out if the claim is truthful) or reckless disregard of the truth (failure to pursue indications of falsity to find out the truth). It is not necessary to show that the contractor acted with the specific intention to defraud the Government.
b. Program Fraud Civil Remedies Act.
(1) This recently enacted law allows Federal agencies to impose administratively penalties and damages for all false claims where the damages are under $150,000, and all false statements. Government agencies are, at this writing, in the process of establishing administrative procedures to implement the provisions of the law.
The procedures will be designed to protect the interests and rights of both the contractors and the Government in the determination of liability and the amount of any penalties and damages assessed against a contractor.
(2) The law provides for a penalty of $5,000 per false claim or false statement. Damages for false claims are double the amount of the provable loss (rather than the treble damages of the Civil False Claims Act which requires judicial action to obtain). The standard of proof which must be met by the Government in establishing the liability of a contractor under this law is the same as that under the Civil False Claims Act, a knowing submission of the false claim or statement.
c. Contract Disputes Act. Under the Civil False Claims Act and the Program Fraud Civil Remedies Act, the Government may only recover damages when they have actually been suffered, e.g., when a false claim is paid. The Government is limited to the assertion of the appropriate penalty if an audit or investigation determines that a claim or statement is false and no payment is made. Under the Contract Disputes Act, 41 U.S.C. 604, a contractor is liable to the Government for the amount of any unsupported part of a claim plus the costs of reviewing the claim, if the claim is based even in part on fraud or misrepresentation of fact. The Government does not have to pay the claim in order to recover.
d. Forfeiture of Fraudulent Claims. The U.S. Court of Claims can, under 27 U.S.C. 2514, order the forfeiture of the entire amount of a claim in which it judges the proof, statement, establishment, or allowance thereof is based on a fraud or attempted fraud by a contractor. The Government does not have to pay a claim first for the statute to be operative. A contractor making a claim, which the contracting officer denies, risks losing the entire claim by going to the Court of Claims if the claim is based even in part on fraud.
e. Termination for Default.
(1) The sub