In the Watt Tieder Fall 2015 Newsletter, we published an article entitled “DBE Contractors And Those Working With DBEs Travel A Treacherous Road On Federally-Funded Highway Projects,” which explored the background of and regulations applicable to the U.S. Department of Transportation’s Disadvantaged Business Enterprise (“DBE”) program, the common types of DBE fraud schemes, and tips for avoiding the significant consequences of noncompliance.

Since that time, the U.S. Court of Appeals for the Third Circuit issued a significant decision in what has been referred to as the largest reported DBE case in history, concerning the Pennsylvania-based company Schuylkill Products, Inc. (“SPI”), its subsidiary CDS Engineers, Inc. (“CDS”), and certified DBE Marikina Engineers and Construction Corp. (“Marikina”). The decision addresses how to calculate losses related to DBE fraud, and may pave the way for reduced criminal and civil penalties against contractors found to have run afoul of the regulations. The decision is, however, by no means an excuse to relax vigilant efforts to avoid noncompliance. Given the array of criminal, civil and administrative penalties at the government’s disposal, education and diligent compliance remains a critical component to the success of contractors working on federally-funded highway projects.

Overview Of Historic DBE Fraud Scheme

SPI was a concrete beam manufacturing company owned by Joseph Nagle and Ernest Fink. CDS was a wholly-owned subsidiary of SPI that installed SPI’s beams and other suppliers’ products on highway projects. In or about 1993, SPI entered into an arrangement with Marikina, a Connecticut construction company, to obtain work on federally-funded projects in Pennsylvania. Marikina was owned by Romeo Cruz, an American citizen of Filipino descent, and was certified as a DBE in Pennsylvania and other states.

SPI and Marikina agreed that Marikina would bid as a subcontractor for federally-funded contracts let by the Pennsylvania Department of Transportation (“PennDOT”) and the Southeastern Pennsylvania Transportation Authority (“SEPTA”). Under the arrangement, Marikina would receive the DBE contract on paper, but SPI and CDS would perform all of the work and would pay Marikina a fixed fee for the use of Marikina to obtain work otherwise intended for a legitimate DBE. SPI and CDS would retain all of the profit as is typical of a classic front scheme. Marikina would not perform any commercially useful function in complete disregard for the regulations addressed in our Fall 2015 Newsletter.

During the government’s investigation and as proven in the subsequent prosecutions, SPI identified subcontracts that SPI and CDS could fulfill, prepared the bid paperwork, and submitted the information to prime contractors in Marikina’s name. SPI and CDS went to extreme efforts to conceal the fraudulent scheme in furtherance of obtaining and performing the DBE contracts. For instance, SPI used stationery and email addresses bearing Marikina’s name to create correspondence to prime contractors. SPI also used Marikina’s log-in information to access PennDOT’s electronic contract management system. When performing Marikina’s contracts, CDS employees used vehicles with magnetic placards displaying Marikina’s logo and covering SPI’s and CDS’s logos. SPI and CDS employees went as far as using Marikina business cards and separate cell phones to disguise the fact that they were not legitimate Marikina employees. SPI even used a stamp of Cruz’s signature to endorse checks from prime contractors for deposit into SPI’s bank accounts. While Marikina’s payroll account paid CDS’s employees, CDS reimbursed Marikina for the labor costs.

In its investigation, the government demonstrated that between 1993 and 2008, Marikina was awarded contracts under the PennDOT DBE program worth more than $119 million and under the SEPTA DBE program worth more than $16 million. Between 2004 and 2008 alone, Marikina was awarded contracts under the DBE programs worth nearly $54 million.

Prosecution And Sentencing

In 2009, a federal grand jury in the United States District Court for the Middle District of Pennsylvania returned an indictment against Nagle and Fink charging each with conspiracy to defraud the United States (18 U.S.C. § 371), conspiracy to engage in unlawful monetary transactions (18 U.S.C. § 1956(h)), eleven counts of wire fraud (18 U.S.C. § 1343), six counts of mail fraud (18 U.S.C. § 1341), and eleven counts of engaging in unlawful monetary transactions (18 U.S.C. § 1957). Other participants in the scheme were indicted separately, including: Romeo Cruz, Marikina’s owner; Dennis Campbell, SPI’s Vice President in charge of sales and marketing; and Timothy Hubler, CDS’s Vice President in charge of field operations.

Cruz, Campbell and Hubler pled guilty to the charges and agreed to cooperate against Nagle and Fink. Cruz and Hubler were both sentenced to 33 months of incarceration, two years of supervised release and ordered to pay $119 million in restitution. Campbell was sentenced to 24 months of incarceration, two years of supervised release and ordered to pay $119 million in restitution. The sentences of Cruz, Campbell and Hubler were based upon the district court’s finding that the amount of loss for which they were responsible under the applicable sentencing guidelines was the face value of the contracts Marikina received.

In DBE fraud prosecutions and settlements, the government has long argued that its loss amounts to – and it is thus entitled to restitution/recoupment of – the full face value of any contract obtained improperly by way of fraud without any credit for work done on the contracts. With regard to calculating jail time for Cruz, Campbell and Hubler, the district court adopted the government’s position that the defendants were not entitled to a credit against the loss for the work performed because they had not refunded the contract price to allow a legitimate DBE to perform the work. This conclusion was significant because, under applicable sentencing guidelines, as the loss increases, the offense level increases, potentially resulting in longer incarceration time.

Fink ultimately pled guilty to one count of conspiracy to defraud the United States in violation of 18 U.S.C. § 1957 and, in July 2014, was sentenced to 51 months of incarceration, among other penalties. Importantly, Fink’s sentence was based upon the previous loss opinion in the Cruz, Campbell and Hubler sentencing. In that regard, Fink was held responsible for the face value of the PennDOT and SEPTA contracts that Marikina received while he was an executive, totaling $135.8 million. Under the sentencing guidelines, this amounted to a twenty-six-level increase in Fink’s offense level.

Nagle did not plead guilty and, instead, went to trial. On April 5, 2012, a jury found Nagle guilty on all of the charges presented in the indictment, except for four of the wire fraud charges. In June 2014, Nagle was sentenced to 84 months of imprisonment, among other penalties. Consistent with the other sentencing processes, Nagle was held responsible for the face value of the PennDOT and SEPTA contracts that Marikina received while Nagle was involved in the scheme, which amounted to $53.9 million. This finding amounted to a twenty-four-level increase in Nagle’s offense level under the sentencing guidelines.

Although the district court calculated incarceration time for Fink and Nagle similarly to how it did for the other defendants, the district court took a different approach with respect to calculating restitution. More specifically, the district court rejected the government’s argument that the appropriate amount of restitution was the same as the amount of loss under the sentencing guidelines. The district court reasoned that SPI and CDS fully performed the contracts, so the government received what it paid for and, as such, the government was entitled only to the difference between the face value of the contracts and what it would have paid SPI and CDS knowing that they were not DBEs. Since the government failed to prove the difference in payment, the district court found that no amount of restitution could be assessed.

Nevertheless, both Nagle and Fink appealed to challenge the calculation of the amount of incarceration time because the district court used the full face value of the fraudulently obtained DBE contracts as the basis to apply the sentencing guidelines and to calculate incarceration time.

The Third Circuit’s Loss Calculation For Incarceration Time

In a thorough and well-reasoned opinion, the Third Circuit Court of Appeals departed from the district court’s opinion, finding that under the applicable notes to the sentencing guidelines, for purposes of calculating jail time, the amount of loss that Nagle and Fink were responsible for was the face value of the contracts Marikina received minus the fair market value of the services they provided under the contracts.

The Third Circuit noted that in normal fraud cases, the victim’s loss is computed as the difference between the value he or she gave up and the value he or she received. The court also considered procurement fraud cases where the amount of loss was calculated by offsetting the contract price by the actual value of the components provided. Analogizing the Nagle and Fink scheme to the other fraud cases in the Third Circuit, the court found that the defrauded parties before the court, i.e., PennDOT and SEPTA, gave up the price of the contracts and received the performance on those contracts. This reasoning was consistent with and supported by the court’s reading of Application Note 3(E)(i) to Section 2B1.1 of the sentencing guidelines, which states that: “’the fair market value of the property returned and the services rendered, by the defendant or other persons acting jointly with the defendant, to the victim before the offense was detected’ shall be credited against the loss.” The Third Circuit found that the existing law on fraud recovery and the applicable sentencing guidelines required the subtraction of the fair market value of the services rendered by SPI and CDS on the contracts before arriving at a final loss value for the Nagle and Fink sentences.

The Third Circuit expressly rejected as unpersuasive the government’s argument that because Nagle and Fink were not DBEs, they did not render any valuable services. In that regard, while the court recognized that the transportation agencies did not receive the entire benefit of their bargain, in that their interest in having a DBE perform the work was not fulfilled, the court, nonetheless, affirmed that PennDOT and SEPTA did receive the benefit of having the building materials provided and assembled, which must be given credit.

Ultimately, the Third Circuit made clear that:

[I]n a DBE fraud case, regardless of which application note is used, the District Court should calculate the amount of loss under [the sentencing guidelines] by taking the face value of the contracts and subtracting the fair market value of the services rendered under those contracts. This includes, for example, the fair market value of the materials supplied, the fair market cost of the labor necessary to assemble the materials, and the fair market value of transporting and storing the materials.

As such, the Third Circuit’s directive is clear for purposes of calculating jail time – contractors must be given credit for the work performed and materials supplied, even when the contract is improperly obtained. Less than clear, however, is the court’s final instruction in the above-quoted paragraph that “[i]f possible and when relevant, the District Court should keep in mind the goals of the DBE program that have been frustrated by the fraud.”

Conclusion

Though the Third Circuit’s directive regarding the appropriate calculation of loss in DBE fraud cases is admittedly limited to the context of applying criminal sentencing guidelines, the analysis and sentiment is useful (as is the district court’s ruling on the restitution calculation) for any contractor facing a criminal investigation or negotiating a settlement concerning allegations of DBE fraud. As noted above, the Third Circuit’s decision may pave the way for reduced criminal and civil penalties to contractors found to have run afoul of the regulations. What this means for Nagle and Fink’s sentences remains to be seen. In addition, how the district court will interpret and implement the Third Circuit’s suggestion that the lower court keep in mind the goals of the DBE program that Nagle and Fink frustrated is yet to be determined. It may not bode well for Nagle and Fink that the district court, during the original sentencing of Fink, declared that “DBE fraud is pervasive in the construction industry and persons so inclined to commit the same kind of fraud need to be aware that they face serious consequences from DBE fraud.”

While helpful, the Third Circuit’s ruling is by no means an excuse for noncompliance. DBE fraud remains a priority of the U.S. Department of Transportation and investigations and prosecutions are unlikely to wane as a result of the decision discussed above. Finally, it should be noted that in addition to the criminal consequences faced by the parties referenced above, the companies and individuals involved in the fraudulent scheme were each previously debarred by the Federal Highway Administration and PennDOT and, as such, they have essentially “hit a dead end.”