The Federal Government spends billions of dollars annually on infrastructure projects, including highway construction and reconstruction, approximately $40 billion of which goes to state departments of transportation. As part of the U.S. Department of Transportation’s (“DOT”) Disadvantaged Business Enterprise (“DBE”) program, each recipient of federal financial assistance, e.g., state DOTs, is required to set goals for participation of disadvantaged entrepreneurs and certify the eligibility of DBE firms to participate in DOT-assisted contracts. The Federal Government’s generosity to the states is increasingly accompanied by significant oversight and scrutiny of the DBE participation on federally-assisted projects. Importantly, that attention is focused on the contractors, subcontractors and manufacturers performing the work and less so on the state agencies setting the DBE participation goals and implementing the contracts.
The Federal Government has embarked on a journey to eradicate the “DBE Fraud” that it has found prevalent and engrained in the construction industry. As evidenced by recent federal investigations, and the resulting convictions and/or settlements, even well-established and experienced contractors have found that the climate has changed and if they do not change course they may find themselves headed for significant tolls (e.g., hefty fines, penalties and legal fees) or a dead end (i.e., suspension, debarment or jail).
This article will provide an overview of the common types of DBE fraud, pertinent regulations, and the serious risks – including civil and criminal penalties – facing contractors who fail to adhere to the rules of DBE contracting. In addition, this article will explore certain recent government investigations uncovering rampant DBE fraud within the industry. Contractors seeking to take advantage of the lucrative opportunities provided by the federal-assisted projects should institute stringent internal controls and compliance measures to avoid violations of the regulations and contract requirements applicable to DBE participation on federally-funded projects.
Overview Of The U.S. DOT DBE Program And Regulations
Since 1983, the Federal Government has earmarked certain funds authorized for highway and transit federal financial assistance programs for DBEs. Through its DBE program, the U.S. DOT has endeavored, among other objectives, to: (1) level the playing field so that DBEs can fairly compete for U.S. DOT-assisted projects; (2) ensure that only eligible firms become certified as DBEs; and (3) assist in the development of DBE firms so that they can compete outside of the U.S. DOT DBE program. The government’s primary method of achieving these objectives is the mandate to recipients of federal funds to set DBE goals in each of their federally-assisted construction contracts.
The numerous directives and mandates upon recipients of federal highway and transit funds are set out in the Code of Federal Regulations, Title 49, Part 26. The regulations can be boiled down to a few main components: (i) good faith efforts must be made to meet and maintain the stated DBE goal during the construction project; and (ii) credit toward the goal may be taken only when DBE firms perform a commercially useful function. Many contractors have found themselves on a bumpy road because they either failed to perform a commercially useful function themselves or they failed to ensure that the entity with which they contracted actually performed a commercially useful function. Failures by both groups have resulted in severe penalties, as noted below.
Contractors often ask “what is a commercially useful function in the context of DBE contracting?” This can be difficult to answer in the abstract, but the starting point has to be the DBE regulations. In that regard, 26 CFR 26.55(c)(1) advises that “[a] DBE performs a commercially useful function when it is responsible for execution of the work of the contract and is carrying out its responsibilities by actually performing, managing, and supervising the work involved.” The regulations also provide guidance for recognizing when a DBE is not performing a commercially useful function. 26 CFR 26.55(c)(2) instructs that “[a] DBE does not perform a commercially useful function if its role is limited to that of an extra participant in a transaction, contract, or project through which funds are passed in order to obtain the appearance of DBE participation.” Contractors should be aware that the specific tasks to be performed by a DBE and the associated credit that may be taken toward meeting the DBE goal vary depending on whether the DBE is acting as a subcontractor, manufacturer, trucker or supplier. As such, it is imperative for contractors performing on federally-assisted projects to be well-studied in the applicable regulations to avoid the potential for making false claims when submitting, for instance, applications for payment and related certifications.
The most common types of schemes addressed in highly publicized DBE fraud cases and investigations are the “front scheme” and the “pass-through scheme.” In both cases, a DBE does not perform a commercially useful function as required by the government in exchange for its financial assistance.
The primary characteristic of the “front scheme” is typically the false representation of the ownership and/or control of a DBE firm. Under the regulations, to qualify as a DBE, the entity must be majority owned and independently controlled by a disadvantaged owner, e.g., a woman or racial minority, it must be “small” by the SBA’s size standards for the type of work to be performed, and must not have exceeded the limit on gross receipts set forth in the regulations. A classic front scheme occurs when, for example, a “women-owned business” is actually run and operated by a large company owned by the “woman’s” husband or brother. In such a case, both the woman owner of the “DBE” and the owner of the non-DBE company using the DBE as a front may be subject to prosecution.
In a “pass-through” scheme, the ownership is often not the issue, but rather the failure to perform a commercially useful function is at the fore. In this case, the pass-through or conduit company usually does little more than process paperwork, such as invoices for payment, while the work is actually performed by a non-DBE. As with the front scheme, both companies and all participants involved in a pass-through scheme may find themselves in hot water.
Contractors involved in fraudulent DBE-related schemes on U.S. DOT-assisted projects are at risk for severe consequences, including: (1) invasive, disruptive and costly investigations by numerous federal and state agencies (e.g., U.S. DOT, State DOTs, FHWA, FBI, IRS, DOL); (2) criminal prosecution (typical charges include mail and/or wire fraud, conspiracy, obstruction, false claims, and false statements); (3) civil action (e.g., civil false claims); and
(4) administrative actions that could result in suspension or debarment. Significant fines and penalties, forfeiture of contract proceeds and jail time are also real risks for contractors found in violation of the DBE regulations.
Lessons Learned From Recent DBE Fraud Case Studies
DBE fraud investigations are on the rise as DBE Fraud has become a top priority for prosecutors and government agencies. One need look no further than the myriad press releases issued by the U.S. DOT’s Office of Inspector General and/or the Department of Justice over the last three or four months to recognize the caution signs and to extrapolate several lessons for avoiding a similar fate.
• Lesson 1: Don’t Say You Paid A DBE When You Did Not
According to a government investigation, a Washington-based contractor, Tri-State Construction (“Tri-State”), bought and used a storm water treatment system on the federally-funded I-5 High Occupancy Vehicle lane project in Tacoma, Washington. Despite owning the system, the government’s investigation found that Tri-State submitted invoices to the state DOT representing that it was renting the treatment system from a DBE and that Tri-State certified that the rental costs were eligible for DBE credit on the project. Without admitting any misconduct, on June 30, 2015, Tri-State agreed to pay $142,440 to the government to settle the false claims allegations.
• Lesson 2: Don’t Say You Performed Work When You Did Not
After an investigation, the government alleged that a South Carolina based highway contractor, Premier Constructors (“Premier”), falsely certified that it had completed work as a DBE on a federally-funded road project in Greenville, South Carolina. The government further alleged that a non-DBE contractor actually performed the work and that, despite its certifications, Premier did not perform a commercially useful function. On March 25, 2015, the Federal Highway Administration (“FHWA”) suspended Premier and its President from conducting business with the Federal Government. In May 2015, Premier and its President entered into a three-year administrative settlement agreement with FHWA accepting responsibility for the alleged misconduct and agreeing to implement a corporate compliance program, among other internal controls. Thereafter, on July 7, 2015, Premier and its President entered into a civil settlement agreement with the government and agreed to repay the government $77,335 to settle the civil false claims act allegations.
• Lesson 3: You Could Be Permanently Debarred If You Engage In DBE Fraud
In November 2014, Watson Maloy (“Maloy”), the owner of WMCC, Incorporated (“WMCC”), a Pennsylvania certified DBE steel erection and precast concrete erection subcontractor, pleaded guilty to conspiracy charges and admitted that in 2012 and 2013, he and co-conspirators employed by Century Steel Erectors Co., LP (“CSE”), agreed to use WMCC as a front company to obtain profits from DBE contracts. CSE staff actually found, negotiated, coordinated, performed, managed and supervised the DBE subcontracts awarded to WMCC. Thus, WMCC failed to perform a commercially useful function. In an attempt to conceal the scheme, CSE officials used WMCC letterhead and email accounts when communicating with general contractors and PennDOT officials. Also, CSE personnel obtained WMCC business cards, t-shirts and hard hats, among other items. Maloy, WMCC’s owner, reportedly received approximately $1.8 million in illicit proceeds as a fee for his participation in the scheme. On December 12, 2014, FHWA suspended Maloy and WMCC for their roles in the DBE fraud. On June 30, 2015, PennDOT permanently debarred WMCC from state-funded contracts. Sentencing on Maloy’s criminal conviction for conspiracy to defraud the U.S. has been continued until December 2015.
• Lesson 4: Government Investigations May Not Be Limited To A Single Project
On June 16, 2015, the owners of Carl M. Weber Steel Service, Inc. (“Weber Steel”), a Pennsylvania bridge and highway contractor, and Judy Noll (“Noll”) were charged with conspiracy to commit wire fraud related to a DBE fraud scheme that allegedly ran for over 16 years and totaled almost $19 million. The government alleged that since Weber Steel was not a certified DBE, its owners set up Karen Construction, Inc. (“Karen”), a sham DBE owned by Noll to obtain DBE subcontracts throughout Pennsylvania. According to the government’s investigation, Weber Steel’s owners were in control of Karen’s sales, marketing, project selection, price estimating, purchasing, project supervision and hiring. In addition, Karen and Weber Steel shared a computer network, office space, equipment, fuel, materials, an office manager and a labor pool of construction employees – all classic “red flags.” This case is ongoing.
• Lesson 5: You Could Be Guilty of Fraud If You “Knew Or Should Have Known…”
Between 2006 and 2007, C.W. Matthews, a Georgia-based construction firm, was awarded several construction contracts on federally-funded highway projects that required them to subcontract a certain percentage of the work to a qualifying DBE. In its bids and contracts, C.W. Matthews promised to subcontract with a DBE firm called Longoria Trucking (“Longoria”) to satisfy the contracts’ DBE goals. According to the government’s investigation, a non-DBE trucking firm called G.E. Robinson – not Longoria – performed most of the work and received most of the payments. The government’s investigation revealed that G.E. Robinson used Longoria as a “front” to obtain and receive payment under the federally-funded contracts. The government concluded that C.W. Matthews either knew, or should have known, of the scheme between its subcontractor Longoria, and third-party G.E. Robinson. More specifically, the government contended that in certifying that Longoria was performing work under the contracts, despite clear signs that the work was actually being performed by G.E. Robinson, C.W. Matthews, at a minimum, was either reckless or deliberately indifferent. In April 2015, C.W. Matthews agreed to pay $1 million to settle the false claim allegations against it and also agreed to adopt an ethics code and corporate compliance program, appoint a compliance officer and retain an independent monitor to assess C.W. Matthews’ performance.
As discussed above, the Federal Government has begun zealously investigating and prosecuting DBE fraud in the construction industry. Contractors involved in such a scheme, or those that knew or should have known of such a scheme, may become targets of the government’s attention and may, ultimately, face charges, jail time, and/or significant fines and other penalties. In light of the severe consequences of non-compliance, DBE and non-DBE contractors on federally-assisted road and highway projects must be familiar and ensure compliance with the DBE regulations from the beginning to the end of their projects. The following are some helpful tips and suggestions for ensuring compliance with the regulations and avoiding the consequences faced by the contractors mentioned above.
o Contractors should carefully study the DBE program requirements and regulations;
o Contractors should require DBE subcontractors to certify that they will perform a commercially useful function as required by the DBE regulations;
o Contractors should ensure that all staff are able to recognize “red flags” and report them to management or a compliance officer;
o DBE contractors should avoid accepting too much assistance from non-DBE entities in performing work on federally-funded projects;
o Contractors should implement a compliance program;
o Contractors should document the performance and provision of a commercially useful function by DBEs;
o Contractors should conduct internal audits to ensure continuing compliance with DBE program requirements;
o Contractors should implement in-house training for employees, including estimating and project management staff, to ensure compliance with DBE program requirements.
The best way to avoid an investigation or a finding of involvement in a DBE-related fraud scheme is to be educated, vigilant and proactive, much like a highway sign I drove past a few years ago that read: “Stop Accidents Before They Stop You.”