The Mugshot of Non-Compliance

Indeed, the dawn of a new day in the world of contracting on certain projects receiving federal financial assistance has arisen. And for those who choose to dwell in the days of the past and ignore the mandates of the Disadvantaged Business Enterprise (DBE) program, the consequences can be life altering.

Disadvantaged Business Enterprise (DBE) program“We’ve always done it that way.” “Everyone does it, so why would we be singled out?” “There’s no way we can comply, so there’s no way we’ll get in trouble if we don’t.”

Thus are the words of the past. Thus are the words of the uninformed. Thus are the words of the incarcerated.

Indeed, the dawn of a new day in the world of contracting on certain projects receiving federal financial assistance has arisen. And for those who choose to dwell in the days of the past and ignore the mandates of the Disadvantaged Business Enterprise (DBE) program, the consequences can be life altering.

Stated simply, and with no need for feigned sensationalism, contractors who obtain construction funding from the government through the fraudulent use of minority or women-owned businesses may find themselves in the clutches of state or federal penal systems for violating federal regulations relating to DBEs. In the past four years, there has been a proliferation of DBE fraud prosecutions by the Office of Inspector General (OIG) of the Department of Transportation (DOT).  DBE fraud prosecutions now account for approximately 29 percent of the OIG’s procurement fraud investigations,1 and the DOT is encouraging everyone — competitors, disgruntled employees and even the DBEs themselves — to report potential DBE fraud.

History of DBEs
The DBE program was created in the 1980s to increase participation among minority and women-owned businesses in DOT contracting. The goal was to provide initial assistance to traditionally disadvantaged firms so that they would eventually have the ability to compete outside the DBE program. The DOT awards more than $40 billion annually to various state and local highway agencies, airports and transit authorities, not counting supplemental letters of credit or loan guarantees.2 As a precondition to acceptance, state and local governments seeking DOT assistance must first establish certification standards for eligible minority or women-owned firms, as well as benchmarks for DBE participation. Federal regulations require the DOT to ensure that at least 10 percent of its financial assistance is expended on projects involving DBEs.3 Although the money is federally sourced, the program is implemented by these state and local governmental authorities.

Who are the DBEs and What are They Supposed to Do?

As the federal regulations currently stand, DBE eligibility requirements are as follows:
DBE Eligibility Requirements
In addition to meeting the profile requirements above, the DBE must perform a “commercially useful function” in the transaction.5 A DBE is commercially useful only when it performs, manages and supervises the work for which it was engaged. Specifically, the DBE must be responsible for: (1) negotiating prices; (2) determining the quality and quantity of materials needed; (3) ordering and installing such materials; and (4) paying for the materials without a contractor subsidy.6

Why are Contractors Being Treated to the Luxurious Lodging of State and Federal Institutions?
Ensuring DBE participation is often what stands between general contractors and lucrative government contracts. Although there is no prohibition on DBE general contracting, under most circumstances a general contractor will subcontract work to a DBE in order to receive credit toward the contractor’s DBE participation goals. Mandating DBE participation was intended to red-light the inequities of contracting for historically disadvantaged groups, but its effect has been radically different. In many instances, general contractors have become dependent on artificial DBEs in order to be “in the money” on DOT-assisted contracts. The DOT, while once complacent with respect to the true compliance of these arrangements with the mandates of the DBE program, is no longer looking the other way.

Since 2009, the DOT, acting through the OIG, the Justice Department and state and local investigative agencies, has actively cracked down on fraudulent DBE arrangements and their participants. If a contractor hires a DBE merely to satisfy its mandated benchmark without the DBE performing any commercially useful function, the contractor may be found guilty of conspiracy to knowingly and willfully defraud the United States.7 In many cases, the OIG extends the invitation to wear the ever-fashionable orange jumpsuit apparel to the entire contract team — the general contractor, the subcontractor or supplier who actually performed the work intended for the DBE, and the DBE itself.

Recent Prosecutions
Earlier this year, the CEO and part-owner of a general contractor was convicted in the largest DBE fraud prosecution to date.8 The purported scheme lasted more than 15 years and involved more than $136 million in government contracts to fund Pennsylvania highway construction. According to the prosecuting authority, in order to effectuate the scheme, the contractor used a certified DBE as a front in order to obtain the award of multiple government contracts, but none of the contracted-for work was actually completed by the DBE. The prosecuting authority also charged that the perpetrators of the fraud created the illusion that the DBE was performing services it was not by using phony time sheets, payroll records, business cards, stationery, addresses and vehicle decals. In exchange for acting as the empty vessel of the contractor, the prosecutors alleged the DBE received a small fixed fee. In addition to the CEO and part-owner of the general contractor, three of his employees and the former owner of the DBE all await sentencing.

Comfort is not to be found in the allegedly extravagant nature of the sins in the case cited above. The OIG frequently prosecutes for much less. In December 2012, for example, two contractors and the owner of a DBE pled guilty to using the DBE as a mere pass-through while obtaining more than $9.5 million of Federal Aviation Administration contracts.9 To perpetrate the fraud, the contractors allegedly negotiated the purchase and delivery of windows and doors directly from a manufacturer, but without any participation by the DBE. As alleged by the prosecuting authority, after a final price was agreed upon, a small mark-up was incorporated into the contract and the invoices were altered so that the DBE, and not the prime contractor, appeared to be the direct purchaser. For allowing the use of its name in the transaction, the government contended, the DBE received the aforementioned mark-up, despite performing no commercially useful function in the transaction.

It Ain’t Just the Orange Jumpsuit: The Not-So-Civil Remedies
Liability for engaging in DBE fraud is not limited to criminal prosecution. Under the federal regulations, businesses that engage in DBE fraud can be tagged with exorbitant fines and become subject to suspension and even debarment from further DOT-assisted contracts. In March 2011, a subsidiary of one of the nation’s largest construction companies entered into a nonprosecution agreement to settle allegations that it engaged in DBE fraud during a string of New York City public works projects.10 The subsidiary was required to pay $19.6 million in fines after contracting with a DBE for millions of dollars of work, although the DBE allegedly had no employees, owned no equipment and performed none of the contracted-for work.

How to Avoid Involuntary Transportation Work?
There are two things every contractor should be doing to ensure compliance with DBE regulations. First, when approached with a situation that doesn’t pass the smell test, contracting entities should just say no. The risks of participating in a potentially fraudulent DBE scheme far outweigh any benefits. More than half of DOT criminal convictions have resulted in prison terms.11 Accompanying civil penalties have the potential to be even greater — fines and forfeitures are often in excess of $100,000.  Furthermore, many of the companies and individuals involved in DBE cases face the imposition of partial or permanent bans from future participation in transportation projects receiving federal funding or support.

Second, contractors need to institute a DBE compliance program. This includes identifying a point-person for the management of DBE subcontracting. This person should be responsible for identifying and screening certified and capable DBEs, as well as subsequent oversight and documentation of their work performance. Any work performed by the DBE should be documented in a written contract. The compliance program should also include specific procedures for the DBE to follow with regard to estimating and bidding, contract negotiation and performance accountability. Before contracting any work to a DBE, the contractor needs to conduct a thorough investigation of its capabilities. The contractor must reasonably conclude that the DBE can perform the work it has been subcontracted without subsidy or assistance.

Finally, contractors need to avoid exclusivity arrangements with any DBEs. These types of agreements reflect poorly on the DBE’s ability to independently conduct the work it has been contracted to perform. The chart below should prove helpful in successfully navigating the minefield of DBE compliance penalties.

Conclusion
The old business-as-usual approach toward DBE participation has become a recipe for criminal and civil prosecution. Contractors should seek ongoing education on the regulatory requirements and abide by both the letter and the spirit of the law when bidding on federally-backed projects. While the DOT may not have expressed much interest in DBE compliance for the first 25 years of the program’s existence, it is now intent upon achieving its objective of greater participation by minority and women-owned businesses in federal contracting. Those who have paid only lip service to DBE regulations in the past face greater penalties today than ever before.

John H. Dannecker is a Board Certified Construction Trial Attorney specializing in construction defects and delays. He has been practicing for more than 25 years representing contractors, suppliers and manufacturers and is the statewide practice group leader of the construction practice group of Shutts & Bowen LLP, a statewide firm in Florida founded in 1910. Dannecker can be reached at jdannecker@shutts.com. For more information on Shutts & Bowen LLP, visit www.shutts.com.

1Office of Inspector General, Weaknesses in the Department’s Disadvantaged Business Enterprise Program Limit Achievement of Its Objectives, Audit Report (April 23, 2013).
2Id. The three major DOT operating administrations that trigger DBE compliance are the Federal Highway Administration, the Federal Aviation Administration and the Federal Transit Administration.
349 CFR § 26.41(a).
449 CFR Part 26, Subpart D.
549 CFR § 26.55(c).
649 CFR § 26.55(c)(1).
7See 18 U.S.C. § 371.
8See United States v. Joseph Nagle and Ernest Fink, Case No. 1:09-cr-00384-SHR (M.D. Pa.).
9See United States v. Dennis Degrazia, Case No. 1:11-cr-10213-WGY-2; United States v. David Hebert, Case No. 1:11-cr-10213-WGY-3; United States v. Robert Dickerson, Case No. 1:11-cr-10213-WGY-1 (D. Mass.).
10William K. Rashbaum, Contractor Agrees to Pay $19.6 Million in Fraud Case, New York Times (March 31, 2011).
11See Kristin H. Jones & Michael A. Schwartz, Enforcement Trends in DBE Fraud Cases, Construction Today (Fall 2012).

Ensuring Compliance

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