Sentencing in DBE Front Scheme

As we have written about before, DBE fraud involving a pass-through scheme, whereby a certified DBE performs no commercially useful function but receives a a commission for allowing their status to be used by a prime contractor, is by far the most common form of DBE fraud.

While less common, but no less illegal, is a the form of DBE fraud known as a front scheme.  There a DBE is certified and performs a commercially useful function but the DBE is not actually owned and operated by a socially and economically disadvantaged individual.

A recent case from Idaho shows that federal prosecutors are just as willing to prosecute DBE front schemes as they are DBE pass-through schemes and the consequences of engaging in this type of scheme are just as severe.  Elaine Martin, former president of Marcon, Inc. a certified DBE, was sentenced to 7 years in jail, ordered to forfeit over $3 million, pay over $120,000 in fines, and pay prosecution costs of $32,575, for her role in a DBE front scheme.  Martin submitted false documents in order to become a certified DBE.  The documents submitted made it appear that Marcon was owned and controlled by Elaine Martin.  In reality, other persons and shareholders had a role in the firm that raised questions about Marcon’s independence.  Martin was also guilty of concealing her net worth for DBE and SBA purposes and tax evasion – among other transgressions.

The Hidden Dangers of Failing to Follow DBE Rules (Part 1): Bid Challenges

Criminal indictment is not the only threat to contractors who fail to follow the Department of Transportation’s Disadvantaged Business Enterprise (DBE) regulations.  While the risk of jail and civil fines is real, it is limited to those contractors that knowingly violate the DBE rules by engaging in a scheme to use the DBE program to commit fraud.  However, even contractors not knowingly engaging in a fraud scheme face a significant risk when they fail to follow the DBE regulations in the form of bid rejections and challenges.

Strict minority set asides or quotas are almost always unconstitutional.  Disadvantaged business contracting programs, like the DOT’s DBE program, are not quotas (a fact that DOT underlines in its regulations).  Rather, they are goals that contractors must use “good-faith efforts” to achieve.  In fact, many contractors would be surprised to know that a State Transportation agency cannot reject a bid because it fails to include a commitment to subcontract work that meets or exceeds the stated DBE goal.  However, for its bid to be accepted, the contractor must be able to demonstrate “good faith efforts” in attempting to meet the stated DBE contracting goal.

When contractors fail to meet DBE contracting goals, DBE regulations can collide with public procurement laws that require an award to a contractor that is the lowest responsible and responsive bidder.  Failing to document adequate good-faith efforts is grounds for a state transportation agency to reject a bid or for challenge to be filed by a disgruntled bidder on the basis that it is non-responsive.   Such was the case in M.K. Weeden Construction, Inc. v. Montana Dept. of Transportation.  That case involved bids for a $15 million project to prevent rock slides along Interstate 80.  Montana DOT established a 2% DBE participation goal for the project.  Plaintiff, M.K. Weeden, was the low bidder but it did not meet the 2% DBE participation goal.  Its bid contained only a 1.83% participation goal.  Montana DOT rejected Weeden’s bid as non-responsive.  Apparently, the only effort that Weeden made to contract with certified DBE’s was a “mass emailing to 158 DBE subcontractors without any follow up.”  The MDT administrative appeal board and then the federal district court all agreed with MDT that Weeden failed to show good-faith efforts to meet its hiring goals.  Unfortunately for Weeden, it was out of the project and out of pocket for preparing the bid and for challenging the rejection.

 Appendix A to Part 26 of the DBE regulations sets forth the types of efforts contractors can show in documenting good-faith efforts.  Among those efforts include:

1. through all reasonable means, aggressively soliciting DBE’s to perform available work;
2. breaking out contract work to increase the likelihood that DBE goals will be achieved;
3. subcontracting work to a DBE that a contractor intended to self-perform; and
4. negotiating prices with DBE firms.

Clearly mass emailing 158 DBE firms falls woefully short of these efforts.  It is unclear if Weeden was aware of what the DOT considered good faith efforts.  If it was, perhaps without much additional effort it may have been able to meet its DBE goal or at least document its good faith efforts sufficiently so that it bid would not have been rejected.

Certainly, losing a bid is not as severe as jail time, but few contractors would argue that it a lost bid is painless.  Indeed, besides the  potential profit on the project that was lost, the cost of bid preparation alone can sometime reach into the several thousands of dollars.  Bid challenges – yet another reason to make sure to follow DBE guidelines.

The DOT’s Disadvantaged Business Enterprise Program: The Huge Cost of Non-Compliance

Join us for a webinar on Mar 27, 2014 at 2:00 PM EDT.

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https://attendee.gotowebinar.com/register/5788498068269059073

On January 13, 2014, the Department of Justice announced that two former executives of Schuylkill Products, Inc. had each been sentenced to 2 years in federal prison and forced to pay $119 million is restitution because of their role in what the FBI called the largest ever fraud involving the Department of Transportation’s (DOT) DBE Program

In recent years, federal prosecutors and the DOT’s Inspector General have significantly stepped up enforcement of the DOT’s DBE Program and have brought several high profile cases resulting in civil penalties and jail time. Additionally, contractors who fail to understand the DOT’s DBE rules can see bids challenged and lost and be forced to defend costly whistleblower lawsuits. Moreover, contractors that operate under a State or Local DBE program are not immune to risk.

Construction attorney Wally Zimolong, Esq., will lead a program that will discuss best practices for contractors and subcontractors in complying with the DOT’s DBE program and how to avoiding government investigations, bid challenges, and whistleblower lawsuits related to non-compliance. Wally counsels clients throughout the nation on issues related to compliance with federal, state, and local D/M/WBE programs.

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Why You Need A DBE Compliance Audit

THE RISK IS REAL: On January 13, 2014, the Department of Justice announced that two former executives of Schuylkill Products, Inc. had each been sentenced to 2 years in federal prison and forced to pay $119 million is restitution because of their role in what the FBI called the largest ever fraud involving the Department of Transportation’s (DOT) Disadvantaged Business Enterprise (DBE) Program. A third individual, the owner of the firm that was used as a “front” or “pass through” firm, Marikina Construction Corp., in the scheme received a prison sentence of nearly three years.

The sentencing of these individuals is not the result of an isolated incident. In recent years, we have become aware that federal prosecutors and the DOT Inspector General have significantly stepped up enforcement of the DOT’s DBE Program and have brought several high profile cases resulting in civil penalties and jail time.

The stakes are indeed high for contractors that do not abide by the DOT’s DBE rules. In addition to facing a federal investigation for violating DBE rules, contractors who flout the rules can see bids challenged and lost and be forced to defend costly whistleblower lawsuits. Furthermore, contractors that operate under a State or Local DBE program are not immune to risk.

You can help protect your firm from these avoidable problems by having a cost effective DBE Compliance Audit performed. We assist firms throughout the country in identifying potential DBE Program compliance issues and assist them in implementing changes to their standard operating procedures so that they can avoid criminal investigations and expensive lawsuits. The DBE Rules are complex and a DBE Compliance Audit is one way your firm can help avoid the cross hairs of the prosecutor’s gunsight.

To learn more on how we can help assure that your company complies with Federal, State, or Local DBE rules, please email Wally Zimolong at wally@zimolonglaw.com or call at (215) 665-0842.

The Two Most Common Types of DBE Fraud

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.

Terminating a DBE Subcontractor? Not So Fast My Friend

Fans of ESPN’s iconic program College GameDay are probably familiar with host Lee Corso’s catchphrase “No So Fast My Friend.”  For the uninitiated, the phrase is usually used to preface Mr. Corso’s disagreement directed towards another host’s seemingly obvious prediction about a game.  The phrase is also an apt preface to describe what transportation contractors should do before terminating a DBE subcontractor.

Like any other non-performing subcontractor, you may need to terminate or replace a non-performing DBE subcontractor.  However, on transportation projects receiving federal funding, Department of Transportation regulations state that you cannot terminate a DBE subcontractor without prior consent of your state transportation agency and you must give notice to the effected DBE of your intent to terminate.

First and foremost you need to give the DBE subcontractor that you intend to terminate written notice setting forth the reason for the termination.  You must copy your state transportation agency with the termination notice and the DBE has five days to respond to the notice.

Second, you must get consent of your state agency by demonstrating good cause for the termination.  According to the DOT, examples of good cause are:

• The listed DBE subcontractor fails or refuses to execute a written contract;

• The listed DBE subcontractor fails or refuses to perform the work of its subcontract in a way consistent with normal industry standards. Provided, however, that good cause does not exist if the failure or refusal of the DBE subcontractor to perform its work on the subcontract results from the bad faith or discriminatory action of the prime contractor;

• The listed DBE subcontractor fails or refuses to meet the prime contractor’s reasonable, nondisrciminatory bond requirements;

• The listed DBE subcontractor becomes bankrupt, insolvent, or exhibits credit unworthiness;

• The listed DBE subcontractor is ineligible to work on public works projects because of suspension and debarment proceedings pursuant to 2 CFR Parts 180, 215 and 1,200 or applicable state law;

• You have determined that the listed DBE subcontractor is not a responsible contractor;

• The listed DBE subcontractor voluntarily withdraws from the project and provides to you written notice of its withdrawal;

• The listed DBE is ineligible to receive DBE credit for the type of work required;

• A DBE owner dies or becomes disabled with the result that the listed DBE contractor is unable to complete its work on the contract;

• Other documented good cause that you determine compels the termination of the DBE subcontractor. Provided, that good cause does not exist if the prime contractor seeks to terminate a DBE it relied upon to obtain the contract so that the prime contractor can self-perform the work for which the DBE contractor was engaged or so that the prime contractor can substitute another DBE or non–DBE contractor after contract award.

Finally, DOT guidelines require you to utilize the same good-faith efforts in replacing the terminated DBE with another DBE as you did when you solicited DBE bids.

What does this all mean?  Document, document, document.  Document the reasons that giving rise to the need to terminate the DBE. Document the notices you gave to the DBE and the state agency of your intention to terminate (while the regulations only require one notice, several notices is recommended.  We also recommend that you involve your state agency early if it appears that terminating a DBE will become necessary).  Document your good faith efforts in trying to obtain a replacement DBE to complete the terminated DBE’s work.

Is America’s Biggest Construction Project Unconstitutional?

(This is a guest blog post from guest blogger John Sullivan, Esquire, a lawyer who focuses his practice on DBE disparity studies.  He can be reached at jcharlessullivan@yahoo.com)

Last month ground was broken on the first high speed rail system in the United States. The California High Speed Rail will run from Los Angeles to San Francisco, with trains traveling at speeds exceeding 200 miles per hour. Eventually the system will total 800 miles with two dozen stations.

Not surprisingly the project will not be cheap. Presently the price tag is over $91 billion. But that $91 billion is nearly triple the original estimate of only five years ago, so the price tag will quite possibly climb into twelve figures. It’s the biggest construction project in America.

Also unsurprisingly, the project is generating lawsuits. The lawsuit most likely to enjoy a quick victory, however, has not been filed. That would be a challenge to the California High Speed Rail Authority’s race-based set aside.

30% of every contract dollar (at the current estimated cost of $91 billion that would be $27 billion) must go to businesses certified in four groups. The constitutionality of preferences benefitting three of these groups is clear: small businesses, disabled veteran businesses enterprises, and micro businesses.

Preferences benefitting a fourth group, though, are just as clearly unconstitutional. The California High Speed Rail Authority has a 10% goal for Disadvantaged Business Enterprises (DBEs). White males are not presumed disadvantaged for the purposes of becoming certified as a DBE. Women, as well as all other races and ethnicities, are presumed disadvantaged. That makes DBEs a racial preference.

Racial preferences in public contracts like the California High Speed Rail are only allowed if discrimination in the market area has been identified. This is done with a disparity study. This has been required since the US Supreme Court decided Croson 25 years ago. Across the country more than 200 disparity studies have been completed. There is no disparity study for the California High Speed Rail and so no evidence of discrimination.

There is not even an explanation why the DBE goal is 10%. The California High Speed Rail Authority is a recipient of federal Department of Transportation funds and as such must set goals based on the level of DBE participation expected “absent the effects of discrimination.” (49 Code of Federal Regulations sec. 26.45 (b)) The 10% figure seems to have been picked out of the air.

The biggest construction project in America is awarding contracts unconstitutionally.

A Reminder Not to Commit DBE Fraud

As has been discussed on this blog, the most common form of fraud involving the Department of Transportation’s disadvantaged business enterprise program, involves a “pass through” entity that performs little or no actual work on the construction project.  Under this common scheme, a general contractor hires a subcontractor that has been certified a DBE and uses the value of the work subcontracted towards the percentage of work it has agreed to perform using DBE firms, however, in reality, the DBE does not perform a “commercially useful function.”  Instead, the work is performed by a non-DBE firm or even the general contractor’s own employees.

Sometimes the fraud is one of willful ignorance of the scheme by the general contractor, who knows the pass through scheme is happening and simply winks, nods, and looks the other way.  Other times the scheme is more blatant and the firm guilty of DBE fraud willfully engages in the pass through scheme, like the one announced yesterday by the U.S. Attorneys Office in North Carolina.  There the U.S. Attorney filed a 29 count indictment against a North Carolina highway construction firm and its executives for taking part in a massive and complex DBE fraud scheme involving a pass through entity.  The case is troubling because of extent of the actions the firm and individuals involved took to try covering up the pass through scheme.

The indictment alleges that Boggs Paving, it’s President, Vice-President, CFO, and Chief Estimator violated federal mail fraud, wire fraud, and money laundering laws, by engaging in a massive scheme to obtain contracts through the North Carolina DOT by using a pass through scheme involving a DBE trucking firm.  (The DBE firm and its principal were also indicted.)

It is not criminal per se to violate the DOT’s DBE program.  What makes the violating the DBE program criminal is that it invariably involves violating federal mail and wire fraud laws.  An individual or corporation commits mail fraud when the U.S. mail is used in furtherance of a fraud scheme.  Likewise, wire fraud occurs when a telephone or the internet (i.e. the wires) are used in a scheme to obtain money from a person or entity through false or fraudulent pretense.  Mail and wire fraud occurs in the context of DBE fraud because mail, telephones, and the internet are used in submitting bids, payment applications, and DBE compliance reports all of which make false statements about the level of participation by DBE firms.  Moreover, because it is the use of the mail and wires that is the violation, firms and individuals can be indicted even though the DBE fraud involved a county or municipal DBE program.  Each mail and wire fraud count carries a maximum sentence of 20 years in federal prison.

Because all the government must show in a mail or wire fraud case is that the mail or wire was used in “furtherance of the scheme,” it is hard to imagine what defense the indicted individuals in this case will have to the government’s claims.  Here, without falsely claiming the level of DBE participation in writing there could be no DBE fraud because the NCDOT would never have paid Boggs for its work.

This case is a reminder that federal authorities are on the lookout for DBE fraud and the consequences for construction firms and their executives violating DBE rules.

Will the Supreme Court’s Fisher Decision Impact the DOT DBE Programs?

(This post is a guest blog post from John Sullivan, Esquire.  John specializes in DBE issues and disparity studies.  His website is www.crosonlegalservices.com and his he can be reached via email at jcharlessullivan@yahoo.com)

During the last week of its just-concluded term, the United States Supreme Court ruled on the constitutionality of racial preferences at the University of Texas. The impact of Fisher v. Texas is not limited to preferences in public education. Fisher poses a serious threat to the USDOT Disadvantaged Business Enterprise program.

Why does Fisher threaten the constitutionality of the DBE program? In Fisher the Supreme Court ruled that any race conscious preferences, like those benefitting DBEs on USDOT contracts, are permissible only if the government has shown that “workable race-neutral alternatives do not suffice.”

Very few state DOTs have invested much effort in evaluating the race neutral parts of their DBE programs. It’s true that USDOT regulations require every state DOT to maximize the race neutral portion of its annual DBE goal. In reality, state DOTs seldom do what Fisher insists on: “serious, good faith consideration of workable race-neutral alternatives.”

For instance: it is often suggested that the largest USDOT projects like interstate construction and tunnel work be unbundled. This would allow smaller firms – both DBEs and non-DBEs – to effectively compete for these otherwise prohibitively large contracts. How often does unbundling happen? Is the effectiveness of doing so ever examined with any care?

There are probably dozens of state DOTs with bonding assistance programs. How often are these programs given “good faith consideration” of their effectiveness? If the programs aren’t evaluated, how can the agency know that workable race neutral alternatives do not exist?

Fisher may impact DBE preferences on construction contract with particular force. Certain industries get hit hardest by the DBE goals: guardrails and fencing, signage, and landscaping are examples. DBEs inevitably gravitate to these fields as subcontractors. That’s understandable; DBEs are more likely to be selected by the prime when a DBE goal has to be met and these are the specialties where goals are most often set.

In those specialties where DBE subs thrive, non-DBE subs struggle. Current court challenges to the constitutionality of state DBE programs reflect this: Geyer Signal v. Minnesota DOT and Midwest Fence v. Illinois DOT.

USDOT regs anticipate this result by prohibiting an over-concentration of DBEs in any specialty. To date, no court has struck down a DBE program due to over-concentration of DBEs.  After Fisher, with its insistence on good faith consideration of race neutral alternatives, that may be changing.

Another DBE Fraud Case from the Southern District of New York

The United States Attorneys Office for the Southern District of New York has taken the lead in the growing national trend of prosecuting fraud involving the Department of Transportation’s Disadvantaged Business Enterprise program.   Today bring the announcement of another DBE fraud prosecution by the Southern District.  Once again, the fraud committed involved a contractor that was not performing a “commercially useful” function.