Yesterday, the Wall Street Journal reported that stepped up scrutiny by regulators is at that the top of general counsels’ list of legal concerns in 2014. In recent years, construction companies have felt this stepped up pressure, particularly if they deal with the Department of Transportation’s Disadvantaged Business Enterprise regulations. In recent years, Federal and State agencies have riveted up investigations into allege fraudulent activities involving the DBE program. Moreover, investigations from government authorities are not the only threats unscrupulous contractors face when toying with the DBE program, suits brought under the False Claims Act by private whistle-blowers involving DBE fraud are also increasing. Therefore, it is worth understanding the two most common types of DBE fraud.
Pass-Through Fraud
DBE fraud cases resulting in regulatory action or a False Claims Act claim usually result from two types of frauds: pass through or fronting. Pass through cases are are the most common type that result in prosecution. In those cases, the certified DBE firm does not actually perform any work or “commercially useful function.” Instead, a non-DBE firm actually performs the work and DBE firm collects a commission for submitting invoices or payment applications to the general contractor claiming it, rather than the non-DBE, performed the work. In turn, the general contractor (or higher tier subcontractor) gets to claim the amount of work “performed” by the DBE towards its DBE goal. In the most egregious cases, the work is performed by the general contractor itself.
A DBE firm is permitted to subcontract a portion of its work under DOT DBE regulations. However, under DOT DBE regulations only the value of the work actually performed by the DBE can be counted towards DBE goals. The value of the subcontracted work, if subcontracted to a non-DBE firm, cannot be counted towards the DBE goals. Therefore, subcontracting by a DBE does not violate the regulations per se.
Fronting
The other less common but no less severe form of DBE fraud is a scheme whereby the DBE is a front for a non-DBE firm. In this scheme, there is no allegation that the DBE’s own forces did not actually perform the work. Rather, the allegation is that the DBE is actually controlled by a non-DBE firm or individual. Under this scheme, the DBE is certified and, on paper, is owned and controlled by a socially and economically disadvantaged individual and appears to operate as an independent business with its own work force and equipment. However, in reality the DBE is “controlled” by a non-DBE or non-socially or economically disadvantaged individual. Under DOT DBE regulations, only independent business that do not depend on a non-DBE for existence can be certified as a DBE and the socially and economically disadvantaged owner must maintain ultimate control over the day-to-day affairs of the business.
Regulatory scrutiny of contractors working under the DOT DBE rules does not appear to be letting up. Whistleblower suits should continue to rise as plaintiff’s firm begin to realize the lucrative nature of the practice. For construction firms looking to avoid both, understanding the common missteps is the first right step to avoid trouble.
Wally Zimolong
Wally represents contractors (and subcontractors) and developers. His clients build and develop residential, commercial, and industrial properties nationwide. Wally enjoys working with the owners of the businesses he represents because they tend to be entrepreneurs and all around interesting people.
