Vending Gender and Race to Defraud

Governmental and business entities are giving women/ minority-owned businesses chances to compete with other firms for contracts. But fraudsters can exploit regulations and diversity policies to rake in the cash. Learn how to protect your company and discover ways to deter and detect schemes that defraud taxpayers, corporations, and true W/MBEs.

Nancy thought this was her big break into the lucrative world of government contracting. As president of a small steel producing firm, she was thrilled when she got the call from the president of ABC Construction, who had won the contract to build a convention center. In its winning bid, ABC pledged to subcontract 25 percent of the business to women- and minority-owned businesses. Nancy had previously registered with the city as a woman-owned business and ABC had found her through the city’s registry. Nancy’s initial excitement turned to frustration when ABC told her they would pay her a 2 percent fee and they would do the work themselves. ABC planned on turning the fraudulent bills into the city. Nancy’s golden opportunity soon turned into a nightmare of fraud and lawsuits.

This composite case illustrates what can happen when fraud becomes part of contracting with a women/minority business enterprise.

WHAT IS A W/MBE? 

A women/minority business enterprise (W/MBE) is defined as being at least 51 percent owned, controlled, and operated by one or more members of a diverse group (for example, African-American, Hispanic, Native American, women, etc.). The terms “supplier diversity” and “vendor diversity” are used by governments and businesses that seek to incorporate W/MBEs into their supplier pipelines. The focus on supplier diversity has been steadily increasing over the past two decades. According to Purchasing magazine (Nov. 2, 2006), corporate spending with minority-owned businesses increased to $87.4 billion in 2004 from $27.3 billion in 1994.

There are generally agreed-upon criteria for status as a W/MBE; however, the qualifying and certification process varies widely depending on the entity that plans to do business with a W/MBE. In the public sector, typically each jurisdiction has its own qualifying process. For example, a city might require a W/MBE to supply only a notarized document stating it is woman- or minority-owned but a state might require the business to submit detailed bank records, incorporation filings, and photo identification. Often the criteria and paperwork change among different agencies within the same jurisdiction.

Many governmental agencies have participation targets for businesses owned by women and minorities. For example, Maryland’s minority-owned business participation goal is 25 percent, with goals within that group of 10 percent for women, and 7 percent for African-Americans.

Private companies also have goals for inclusive vendor diversity. For example, General Motors has a corporate goal to increase the company’s overall minority purchasing share to 10 percent and even asks its suppliers to make at least eight percent of their purchases from certified minority suppliers.

The time and effort required from a W/MBE to produce the required paperwork for certification has spawned an industry that compiles the information for applicants. A W/MBE often goes through third-party certification with organizations such as the Women’s Business Enterprise National Council (WBENC) or the National Minority Supplier Development Council (NMSDC).

Kate Chrisman, director of marketing and communications for WBENC, said, “Large Fortune 1000 corporations that have diversity programs facilitate the process of (W/MBEs) getting into the procurement game. Certification helps get W/MBEs to the table to hear about bid opportunities. Women- and minority-business owners view W/MBE certification as a competitive advantage. Diverse supplier status may open doors to them otherwise not available.”

WHAT TYPES OF FRAUD OCCUR? 

Several kinds of fraud occur in the supplier diversity marketplace. As Kate Chrisman puts it: “When large contracts are on the line some suppliers are willing to do whatever it takes to secure them.”

Name game. What’s in a name? With the right incentive, there could a clever deception concocted to make money.

Ashley Jimenez sounds like a Hispanic female. If the procuring company did nothing more than review names and require a notarized form, Ashley could get away with registering her business as a W/MBE. However, with a slightly more stringent review, such as requesting a copy of the birth certificate, the procuring company might find that Ashley is a Caucasian man who took his stepfather’s last name when his mother remarried.

Figurehead owner. A maze of papers including incorporation documents and checking accounts can conceal the true owner’s identity.

Patricia Duff was a busy lady. She claimed she was the owner of a janitorial company that contracted with Chicago to service the recycling center and of a trucking company that provided hauling services to the city and private companies. Her companies were awarded more than $100 million in minority set-aside contracts. The only problem was that her son, Patrick, was the true owner and operator of the companies. According to the U.S. Department of Justice, the U.S. Attorney’s office indicted Patrick Duff on charges of racketeering, six counts of money laundering, three counts of wire fraud, and 19 counts of mail fraud relating to the contract fraud scheme and a separate insurance fraud scheme.

Patricia Duff, 75, was indicted on 11 counts of mail fraud relating to the contract fraud scheme. Patrick plead guilty and was sentenced to nearly 10 years in prison and fined more than $22 million. Of that total, $10.9 million was to go to the City of Chicago to help fund minority and women business contracts. Patricia was found unfit to stand trial and another co-conspirator, William Stratton, who posed as a minority figurehead in other companies controlled by Patrick, was sentenced to 70 months in prison and ordered to pay restitution of more than $7 million.

The legitimacy of the business’ woman-owned status first came into question in 1991 when a competitor wrote a letter to the city alleging that Patrick truly controlled the janitorial company. However, the company wasn’t finally decertified until after a five-month review by the city that was instigated by a series of articles in the Chicago Tribune that questioned the firm’s status. A federal probe didn’t find fraud until four years later. Perhaps the fraud would have been discovered sooner, if a CFE had been involved from the beginning.

Front company. This scheme is similar to the steel company example at the beginning of this article. It might include a business owned by a woman or minority but doesn’t actually do the work. The W/MBE typically receives a percentage of the bid and passes the work on to another company. In a similar fraud to win a contract, an entity uses a front company that has no real business and then passes the work to another company.

Some W/MBES end up as fronts because they’ve won contracts too large to handle. Rather than face a liquidity issue, bankruptcy, or failure to meet the contract, a W/MBE sells the contract to a non-W/MBE firm. Others might commit fraud to stay competitive. Researchers have found that when fraud penalties were lax, honest W/MBEs also acted like front companies.

Lax oversight in the diverse supplier contracting arena can create a breeding ground for bribery, corruption, kickbacks, and involvement of organized crime. The U.S. Department of Justice indicted Siemens Medical Solutions USA Inc., two of its employees, and two joint venture partners on allegations that Siemens had formed a sham joint venture with a minority business enterprise to win the Cook County, Illinois, radiology contract. The minority business owner also was indicted for allegedly paying a $20,000 bribe to a Cook County contract compliance officer. Others in the case were indicted on mail fraud, wire fraud, and perjury. Siemens Medical signed a plea agreement pleading guilty to one count of obstruction of justice and was fined $1 million and ordered to pay $1.5 million in restitution. Two Siemens executives plead guilty and admitted lying to FBI investigators. The executives are awaiting sentencing.

Governmental agencies and private companies might also fraudulently claim that they’re working with more W/MBEs than they are. Governmental agencies feel political pressure to meet diversity goals. There are many examples of agencies that failed to follow their own certification guidelines and over-credited dollars to diverse suppliers. For example, federal guidelines state that when a W/MBE business subcontracts work, only the payments actually received and kept by the minority firm can be counted towards participation goals. In the convention center example, the city counted the full value of millions of dollars of contracts that were passed on to white, male-owned firms when the W/MBE only retained a few thousand dollars as a broker fee.

The Office of the Inspector General audited the United States Postal Service’s supplier diversity program in 1999 and concluded that the “supplier diversity statistics for FY 1999 were unreliable because prime contracting dollars awarded to small, minority, and woman-owned businesses were overstated and subcontracting statistics were unsupported and unverified.” The audit also found that 48 percent of minority contracts and 31 percent of commitments to W/MBEs were inaccurate or unsupported.

The audit found unverified/unsupported claims of W/MBE status including full contract values of contracts later cancelled or reduced in dollar amount, and contract values outside of eligible date range including the maximum amount of all orders that could be made under a “basic pricing agreement” and not actual commitments.

WHO GETS HURT? 

In public contracting, W/MBE fraud hurts the taxpayer. The public ends up overpaying and perhaps suffering diminished quality or services. Landing a counterfeit certification is only the first deceptive step for a fraud-bent W/MBE. The “pass-through” scheme forwards the fee received by the fraudulent W/MBE to the government thereby increasing costs.

Kate Chrisman, of the WBENC, spoke of the federal government’s recent involvement with her organization. “The FBI asked for our files on companies to which we had denied certification to woman-owned businesses,” Chrisman said. The FBI wanted the files because a lot of federal contracting in the Gulf region was being awarded to women after Hurricane Katrina and the bureau wanted to make sure the companies were indeed woman owned. They realized it could have been a PR nightmare.”

W/MBE fraudsters can damage a corporation by exposing it to negative publicity and breach of contract lawsuits if the contract specified that W/MBEs would be used as vendors. Private companies often have the goal of using an encompassing vendor base because they feel such diversity will increase their business. If this is the private companies’ goal, the fraudulent W/MBE is hampering it.

Perhaps no one is more directly affected by imposters than the true W/MBEs. As in the case of the steel company and the radiological contract, they were shut out of an opportunity. “Sham joint ventures,” said Patrick J. Fitzgerald, U.S. Attorney for the Northern District of Illinois, “deprive legitimate minority businesses of a level playing field in seeking contracts.”

W/MBE FRAUD DETECTION 

The fraud in a certified but crooked W/MBE is often discovered as part of a larger scam. Traditional auditing and fraud detection tools in contracting will turn up red flags. If contracting red flags such as vague invoices, inconsistent addresses, or over-billing are discovered at a W/MBE registered firm, the legitimacy of the certification should be investigated.

A whistle-blower often will identify a W/MBE fraud. In the case of the steel company, Nancy told the city of the scheme and filed a federal civil RICO lawsuit. Similarly, the radiological front company scheme was discovered by a competitor bidding on the project who also filed suit. The state of Maryland implemented a toll-free number specifically for the reporting of MBE fraud. Corporations and governments that have general whistle-blower hot lines can advertise that the lines also accept reports of fraudulent W/MBEs.

If an application for certification is suspicious, determine if the owner has the knowledge and ability to run the daily operations, shares in the risk of profit commensurate to ownership, and has operational control and signatory control over the books.

Conduct a thorough background examination of the suspected company. Inspect public records such as incorporation filings and lawsuit records. See if the company shares an address with another uncertified firm. Examine address records versus non-minority owned firms or firms owned by relatives (such as husbands, brothers, and sons). Search the Internet and business directories, and check references. Verify any claimed certifications. Determine if other agencies have certified the company, if the company has ever failed certification, or has had its certification revoked.

DETERRING W/MBE FRAUD  

Timothy Bates and Darrell William, the researchers for the Center for Economic Studies, found that W/MBE front companies can be decreased by heavily penalizing fraudulent activity. Some jurisdictions, such as Pennsylvania, have passed strong regulations criminalizing W/MBE fraud and creating civil penalties. Federal crimes are usually pursued under money laundering, wire fraud, and mail fraud violations.

Of course, an effective way to inhibit W/MBE fraud is to prevent non-W/MBEs from being certified in the first place. Most private companies have turned to third-party certifying agencies to conduct thorough and standardized assessments. For instance, the WBENC certification requires periodic on-site visits, interviews with employees and reviews of cancelled checks, and loan documents to verify that the purported owner has a financial stake in the business.

Still, many government jurisdictions verify W/MBE status in-house. According to Zach Patton, author of “The Set Aside Syndrome,” in Governing Magazine (July 2005), the biggest factor that allowed sham minority companies to proliferate “was lack of staff to oversee the (W/MBE) program.”

This is not to say that all government agencies are lax. For example, after a contract is awarded, the Maryland Department of Transportation W/MBE program staff reviews the subcontract financials and visits the job site to verify the actual work is being performed by the W/MBE. Maryland also has escalating administrative sanctions if a contractor is found to have abused the W/MBE program including suspension of work, withholding a percentage of payment, default of contract and/or referral to the attorney general for criminal investigation.

W/MBE fraudsters seek the path of least resistance by looking for diverse supplier contracts that receive little scrutiny and have lax oversight. The imposters obtain government and corporate contracts by disguising the company’s true ownership. Supplier diversity fraud can be prevented by strong laws and civil penalties, stringent certifying processes, and encouraging whistle-blowers to come forward.

Supplier diversity fraud is, in essence, a type of procurement fraud. Thomas Caulfield, CFE, spoke about procurement fraud in his 15th Annual ACFE Fraud Conference seminar, “Protecting the Public Interest: Fraud in the Government.”

Caulfield writes that procurement fraud is designed to improperly enrich the fraudster, is an intentional misrepresentation of the truth involving guile and deception, and designed to gain an unfair advantage over another.

He writes that CFEs can educate the players in the certification and purchasing arenas of the types and methods of fraud. CFEs, Caulfield writes, also can help establish policies and controls that will help prevent fraud from occurring. Preventative measures include structuring contracts so that W/MBE subcontractors are paid directly by the firm (not by the primary contractor) and unbundling large contracts so that smaller firms have a chance to compete and less incentive to participate in a pass-through scheme. Audit the supplier diversity program to ensure that certification guidelines are being followed and the diversity spending is being properly tracked. A publicized audit could deter a fraudster.

A CFE can help determine if a purported owner has the knowledge and ability to run a firm and if he or she is the true owner or is acting as a front. After a contract has been awarded but falls under suspicion, a CFE can investigate invoices to determine if they match up with the vendors’ addresses. Also, a CFE can investigate whether a suspected fraudulent W/MBE was colluding with a procurement official or with a primary contractor.

W/MBE fraud negatively affects business owners, corporations, governments and society. Through vigilant efforts of supplier diversity personnel, purchasing officials, auditors, and CFEs much of W/MBE fraud can be avoided and detected. 

Alison K. Jimenez, Associate Member, is president of Dynamic Securities Analytics in Tampa, Fla. 

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