Fraud is an ever pressing concern in federal contracts, and the federal government goes to great lengths to minimize the risks to introduce fraud into the procurement system. Unfortunately, a recent GAO report highlighted how complex ownership structures can be leveraged to obscure fraudulent contracting activities. Worse still, complex ownership structures are most frequently leveraged to perpetrate small business set-aside fraud.
GAO’s report is a direct response to concerns raised by the House Armed Services Committee. When reporting on the 2018 NDAA, the Committee noted that Department of Defense contractors could use complicated ownership structures to conceal unreasonable cost structures or create hidden monopolies. In light of these concerns, the Committee called on GAO to investigate the types of fraud that complicated ownership structures could conceal, as well as assess steps the Department of Defense has taken to mitigate these risks.
The GAO report focused on companies that utilized complicated ownership structures to make corporate ownership difficult to trace. GAO deemed these types of organizations “opaque corporate structures” and defined that term as “business governance that may conceal or obfuscate entities or individuals who own, control, or benefit financially from a business.”
With respect to methodology, GAO reviewed closed Defense Criminal Investigative Organizations cases, Department of Justice prosecutions, and GAO bid protest decisions to identify instances where contractors used opaque ownership structures to obtain federal contracts for which they were not otherwise eligible. The review was limited to cases that had been closed between the 2012 and 2018 calendar years. All told, GAO identified 32 instances where complicated ownership structures were used to mislead federal procurement officials to obtain contracts.
GAO’s report goes on to identify a number of different risks that stem from opaque ownership structures. These risks include price inflation, circumventing small business set-aside requirements, and non-domestic contract supply chain infiltration. While each of these risks is troubling, subversion of the small business set-aside requirements was far and away the most common risk associated with opaque ownership structures.
According to GAO, “[o]f the 32 cases we reviewed, we identified 20 cases in which DOD contractors or DOD contractor employees were found guilty, pled guilty, or settled with the government for representing themselves as eligible to receive set-aside contracts.” This is to say that of the 32 cases GAO identified where opaque ownership structures resulted in procurement fraud, nearly two-thirds involved small business set-aside misrepresentations.
Concerningly, GAO was able to succinctly summarize the way in which contractors were able to use ownership structures to obtain small business set-asides for which they did not qualify:
These contractors falsified self-reported information and made false certifications to the government to claim eligibility by using eligible individuals as figurehead owners. In these cases, the figurehead owners did not actually maintain the level of beneficial ownership or control of the contractor required by federal regulations, or the contractors simply used the names of eligible individuals when communicating with the government to bid on and win contracts.
Given the ease with which GAO was able to summarize how otherwise ineligible contractors were able to use ownership structures to obtain federal awards, opaque ownership structures present a significant risk to small business contracting.
In light of the potential for fraud, GAO did note that the Department of Defense has taken some proactive steps to check the risks associated with opaque ownership structures. As GAO explained, the FAR was amended in 2014 to require prospective contractors to report “immediate and highest-level entity owner, but not their beneficial owner, as part of contractors’ annual registration process in SAM.” Certain Department of Defense agencies, such as the Defense Logistics Agency, have also revised how contractor responsibility is evaluated to better capture ownership concerns.
Even with these steps, deciphering the ownership structures of defense contractors remains challenging. According to GAO, “state governments determine the type of information collected during company formation and . . . most states collect minimal ownership information as part of this process.” Additionally, “there is no centralized information source or registry on company ownership information in the United States.” As a consequence, verifying ownership representations is a time consuming process. Department of Defense officials acknowledged that due to time and resource constraints, this type of verification only occurs in procurements involving classified work or implicating national security concerns.
Despite the Department of Defense’s efforts to combat fraud in its procurement systems, GAO nevertheless concluded that work remained to be done. Specifically, while some Department of Defense offices have initiated programs designed to reduce the contracting fraud risks associated with opaque ownership structures, GAO noted that a comprehensive department wide risk assessment was likely required.
Ultimately, GAO’s report on opaque ownership highlights risks in the small business pool. Set-asides represent an exclusive pool of contract dollars available only to those business that are eligible. The exclusivity of these contract dollars and the smaller group of eligible participants can make set-asides a tempting target for ineligible contractors. As GAO’s report makes plain, complicated ownership structures can be—and have been—used by unscrupulous ineligible contractors to fraudulently obtain set-aside contracts.
One thing GAO’s report did not address is how the SBA’s size and status protest process can serve an important role in policing the integrity of small business set-asides. As a general matter, the SBA’s socioeconomic set-aside programs (other than the HUBZone program) require both unconditional control and ownership by one or more individuals. A number of the SBA’s programs offer protest options for unsuccessful offerors to challenge the set-aside status of an awardee when facts exist that reasonably demonstrate the awardee is otherwise ineligible for the procurement. As such, small businesses play an important role in policing the integrity of the set-aside system, particularly when opaque ownership structures otherwise obscure the ineligibility of an offeror.