Don't take this fraud for granted

The U.S. federal government disburses billions in grants annually to worthy recipients. These awards aim to make life better by promoting research and development, finding new disease treatments plus improving education, infrastructure, housing and much more. Of course, big money attracts fraudsters. Here we examine three main types of schemes and how fraud examiners can prevent and deter grant fraud. We also dissect the government’s latest anti-fraud guidance.

Vesta Brue said she wanted to develop electronic pillboxes customized for HIV and pediatric patients, among others. So, she began her companies, LifeTechniques Inc. and Care Team Solutions LLC, and applied for millions of dollars in federal grants from the National Institutes of Health (NIH). But she lied on applications to get those awards. And then she spent much of the cash on plastic surgery, jewelry, home renovations and massages. She also misused grant money for marketing and promoting her businesses — a blatant violation.

“Ms. Brue defrauded the government in two ways, each of which cost taxpayers,” said U.S. Attorney Kerry B. Harvey in July 2016. “By including false statements in grant applications, her companies received grants to which they were not entitled, thereby depriving qualified small businesses of those funds. Ms. Brue then diverted the funds — which should have been used to develop new healthcare technologies — to support herself and her businesses.”

A U.S. District Court ordered her and her companies to pay a $4.5 million civil judgment. In a related criminal case, Brue pleaded guilty to making a false claim to the U.S. in connection with grants awarded by NIH to her partner’s company, Telehealth Holdings, LLC. She was sentenced to seven months in prison and an additional seven months on home detention.

[See the U.S. Department of Justice (DOJ) release.]

Formulating an anti-fraud program for grant funding

$748,300,000,000. That’s the amount the U.S. federal government disbursed in grants and cooperative agreements in the fiscal year 2018, which dwarfs the $450 billion in federal procurements in the same year. (The government doesn’t keep figures on yearly U.S. grant fraud.)

Grant awards are one of the most potent tools available to shape society and foster innovation. Foundations, not-for-profit corporations, charities, state and county governments, municipalities, researchers, scientists, academic institutions and many more use money the U.S. federal government awards to them via some 1,800 different programs to fight some of the most intractable problems in our communities.

They tackle the opioid epidemic, gun violence, homelessness, domestic violence and environmental issues. Grants fund groundbreaking medical and scientific research, infrastructure improvements, mentoring, the arts and health care. These awards also provide international assistance to refugees, clean drinking water projects and efforts to fight disease epidemics. Approximately 40,000 entities annually receive grants.

Of course, this funding, like all programs, isn’t immune from fraud and abuse schemes. In this article, I’ll discuss the common fraud schemes that affect grant-funded activities and some anti-fraud aspects of the 2013 Uniform Grants Guidance — a set of regulations that govern these awards.

Grant fraud schemes generally fall into one, or a combination of more than one, of three categories:

1. Conflict of interest, corruption and related issues.
2. Material false statements in the application or performance phases.
3. Traditional theft or embezzlement.

Fraud examiners, especially those involved with auditing and daily management or oversight of these programs, will benefit from learning about 1) what can and does go wrong in grant-funded programs 2) some of the new anti-fraud tools and 3) some of the issues in the rule changes that might create new challenges.

The discussion focuses primarily on project grants and not individual assistance grants related to disasters and education; these programs have unique risks and regulations.

These are the rules

In December 2013, the U.S. Office of Management and Budget (OMB), an integral agency for setting policies and priorities for the executive branch of the U.S. government, published new guidance that significantly reformed the federal grant process and consolidated eight federal circulars into a single policy guide.

The final guidance, Code of Federal Regulations Title 2 Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards — commonly referred to as the Uniform Grants Guidance — includes rules related to a wide range of topics, including pre-award due diligence, grantee reporting requirements, accounting standards and cost allowability.

Most important for our discussion here, the guidance also contains several changes aimed at preventing, deterring and helping to identify fraud schemes. The Uniform Grants Guidance is applicable to all new awards made on or after Dec. 26, 2014. 

Grant Fraud 101

Grant fraud schemes generally fall into one, or a combination of more than one, of three categories: 1) conflict of interest, corruption and related issues 2) material false statements in the application or performance phases and  3) traditional theft or embezzlement.

First, both grantees and grantor agencies must avoid the appearance of — and, of course, actual — personal and organizational conflicts of interest, including corruption.

Conflict of interest rules are especially important because most federal grant dollars are awarded to state governments who then sub-grant them to subordinate units of government or other entities. These decisions must be fair and free of corruption and other unethical considerations. Grantees are also required to have and follow a procurement policy, to help ensure that every acquisition is necessary, appropriately documented and properly valued.

The most common fraud issues in this category relate to corruption or other ethics issues in the grant award process; grantees that hire relatives or buy goods or services from related parties, such as a nonprofit board member; and procurement issues such as unjustified sole source contracts, questionable consultant contracts or traditional vendor procurement fraud schemes. In some of these schemes, the grantee can be part of the wrongdoing or strictly a victim.

For example, in 2016, former U.S. Congressman Chakah Fattah and others were found guilty by a federal jury of engaging in racketeering fraud schemes related to grant-funded entities. One scheme involved Fattah directing a nonprofit entity, which he’d created and had control over, to use $600,000 in grant funds to repay a campaign loan. To conceal the contribution and repayment scheme, the defendants and others created sham contracts and made false entries in accounting records, tax returns and campaign finance disclosure statements. (See the DOJ release.)

Second, grantees must accurately represent themselves when they apply for and accept grant awards.

Chief among these representations and promises are that they’re telling the truth about their backgrounds and experience, will use funds for the purposes stated in the award, and will maintain adequate books and records for subsequent audits. The most common issues are inaccurate, unreliable or nonexistent records related to individual time and effort.

Grantees also promise to tell the truth about their progress, discoveries and use of funds, and agree to follow all applicable laws and regulations, including ethical research protocols related to human and animal subjects. They also agree to have and maintain an adequate accounting system to track their use of public funds.

An example of this type of grant fraud scheme is the March 21, 2018, False Claims Act settlement between the U.S. and a University of Pittsburgh professor in which the professor agreed to pay $132,000. An investigation by the National Science Foundation (NSF) Office of Inspector General found that the professor submitted forged institutional review board documents to the NSF.

A condition of the grant award was that the recipient would abide by ethical research practices, including receiving the appropriate approvals to conduct research on human subjects. “Federally-funded research involving human subjects requires IRB [institutional review board] approval to ensure that the research is conducted safely, appropriately, and consensually,” said NSF Inspector General Allison Lerner in a DOJ release. 

In another example, in September 2015, a U.S. court sentenced Mahmoud Aldissi and Anastassia Bogomolova to 15 and 13 years of incarceration, respectively, for grant fraud schemes that cost taxpayers some $10.6 million. Aldissi and Bogomolova used two entities they controlled, Fractal Systems Inc. and Smart Polymers Research Corp., to fraudulently obtain federal research grants.

As part of their scheme they submitted proposals using the stolen identities of real people to create false endorsements of and for their proposed contracts. In the proposals, they also lied about their facilities, costs, the principal investigator on some of the contracts and certifications in the proposals. (See the DOJ release.)

Third, and by far the most common grant fraud scheme, is the direct theft of funds.

Virtually anyone can commit these schemes including bookkeepers, nonprofit executive directors, municipal employees and university professors. In most embezzlement schemes, fraudsters are incredibly creative, bold and intelligent in finding ways to exploit internal control weaknesses.

For example, in 2016, a CPA, who served as the chief executive of a nonprofit organization funded by grants, was sentenced to four years in prison for stealing more than $2 million. He created false emails and invoices under the ruse that the money was being used for research fellowships and medical studies. (See the DOJ release.)

In another example, on Feb. 6, a husband and wife were sentenced in federal court to 33 months in prison and five years of probation, respectively, and ordered to repay $5.5 million for their roles in schemes to defraud multiple government research grant programs. “A substantial amount of the fraudulently obtained money went toward the personal use and benefit of the defendants,” according to a DOJ release. 

Highlighted provisions in Uniform Grants Guidance

The federal grants process, overhauled in 2013 to streamline regulations, now has provisions in the Uniform Grants Guidance that hopefully will help prevent, deter and aid in the early detection of fraud issues. (The OMB doesn’t yet have statistics on how the revised guidance has affected grant fraud.)

Mandatory Disclosure clause

This clause, found at §200.113, directs that federal funds recipients “must disclose, in a timely manner, in writing to the Federal awarding agency or pass-through entity all violations of Federal criminal law involving fraud, bribery, or gratuity violations potentially affecting the Federal award.”

Modeled broadly on the 2008 Federal Acquisition Regulation (FAR) rule related to contracts, this grants provision hopefully will encourage recipients to be more proactive about fraud prevention and detection. As stipulated in the guidance, recipients’ failure to make required disclosures can result in a variety of enforcement actions, including suspension or debarment.

The FAR language and the current Uniform Grants Guidance language have some significant differences. Namely, the Uniform Grants Guidance focuses exclusively on violations of criminal law, but it doesn’t mention the False Claims Act and doesn’t mandate reporting to cognizant federal offices of inspectors general — all issues that some might argue could result in reducing the effectiveness of this rule.

The Single Audit Act requires recipients who meet certain spending thresholds to undergo an independent financial audit.

Standards for Documentation of Personnel Expenses

The standards in §200.430(i) no longer explicitly requires personnel activity reports or other timekeeping reports as prescribed in the previous circulars but rather allows recipients to rely on their own written policies and procedures.

The guidance states in §200.430(i)(1) that “[c]harges to Federal awards for salaries and wages must be based on records that accurately reflect the work performed” and goes on to explain that these records must be supported by internal controls and other requirements.

Section 200.430(i)(1)(viii) states that the use of budget estimates might be used for interim accounting purposes, but the provision specifies that “[a]ll necessary adjustment must be made such that the final amount charged to the Federal award is accurate, allowable, and properly allocated.”

However, §200.430(i)(8) adds: “For a non-Federal entity where the records do not meet the standards described in this section, the Federal government may require personnel activity reports, including prescribed certifications, or equivalent documentation that support the records as required in this section.”

Finally, §200.430(i)(2) states that if the personnel expense records meet the documentation standards in the regulation, then the “non-Federal entity will not be required to provide additional support or documentation for the work performed” other than in accordance with Fair Labor Standards Act requirements.

Personnel costs are the single most significant expenditure for most grant programs. Therefore, fraud examiners should closely scrutinize these records and processes.

Single Audit Act

The Single Audit Act requires recipients who meet certain spending thresholds to undergo an independent financial audit. The new guidance raised the federal funds expenditure threshold for such audits from $500,000 to $750,000. This change reduces some administrative burden for grantees that spend less than $750,000 in a year, but it also reduces oversight because many small grantees will be exempt from these types of audits.

Indirect cost rate rules

These rules, outlined in §200.414, added a new option for indirect cost rates: Recipients who have never had a negotiated indirect rate can now use a 10 percent de minimis rate. Indirect rates have always presented unique challenges in the grants context because rate calculations, their application and adjustments are all prone to errors, misunderstandings and ignorance — sometimes purposefully.

Use of ‘fixed-price’ grant agreements

The rule § 200.201 provides for the use of “fixed-price” grant awards by federal awarding agencies and fixed-priced subawards that pass-through entities might use with written approval from the federal awarding agency (§200.332).

The rule dictates the specific parameters in which fixed-price awards can be used and explains the documentation, negotiation and payment requirements. The rule also states: “Except in the case of termination before completion of the Federal award, there is no governmental review of the actual costs incurred by the non-Federal entity in performance of the award.” Accountability is based primarily on performance and results.

One fraud-related concern is that if a fixed price award isn’t properly negotiated it might be difficult to determine if the award amount was appropriate. This could create scenarios where a grant was “defectively priced”— an issue normally found in the contract fraud arena.

The OMB also added clear language prohibiting profit unless expressly authorized by the award.

Prohibiting profit, conflict of interest policies and home rental

The OMB also added clear language prohibiting profit unless expressly authorized by the award, requiring federal agencies to create conflict of interest disclosure policies and mandating that grantees disclose any potential conflict of interest and prohibiting the use of federal funds to pay rent for purposes of home-office space owned by individuals/entities affiliated with the grantee.

Classification of computing devices

The OMB guidance also changes the classification of certain computing devices to “supplies” rather than “equipment.” Rule § 200.94, on supplies, states, “A computing device is a supply if the acquisition cost is less than the lesser of the capitalization level established by the non-Federal entity for financial statement purposes or $5,000, regardless of the length of its useful life.”

Many federal awards specifically enable entities to purchase laptop computers and other electronic devices. Classifying computers as supplies means they might not be subject to basic inventory controls even though the risk of misappropriation and misuse of these devices is high. By classifying these devices as supplies, federal awarding agencies and oversight entities might lose the ability to track whether grantees are using the devices for the awards.

Making sure grant cash ends up with the good guys

The hundreds of billions of dollars dispersed annually by the U.S. federal government via grants and cooperative agreements are critical to communities across the country and around the world. These awards aim to make life better by promoting research and development, finding new disease treatments, improving education, infrastructure and housing, and aiding those most in need. However, fraud can and does occur in these programs. These fraud schemes can generally be categorized into one of three (or often more than one) categories: conflict of interest, corruption and other related issues, material false statements in the application or performance phases, and traditional theft or embezzlement.

The 2013 Uniform Grants Guidance provides some fraud prevention tools and potential oversight challenges.

The opinions expressed in this article are those of the author and aren’t necessarily those of the U.S. Department of Justice or any other part of the federal government.

Ken Dieffenbach, CFE, is an assistant special agent in charge in the Office of Inspector General of the U.S. Department of Justice. He also coordinates DOJ’s Grant Fraud Working Group, a consortium of federal agencies focused on ways to better prevent, mitigate, investigate and prosecute the misuse of federal grant dollars. Contact him at kenneth.r.dieffenbach@usdoj.gov.