Disadvantaged Business Enterprise Fraud: New Trends
Lane F. Kelman contributed to this post.
A recent increase in fraud investigations relating to disadvantaged business enterprises (DBEs) has caused companies to revisit the qualifications of the DBEs they work with. Two recent investigations in New York State resulted in multimillion dollar settlements after investigators determined two companies were using DBEs as so-called “pass-through” entities. These pass-through entities were retained to perform certain work on projects, but performed none of the work and instead allowed other entities to fulfill the contractual requirements. Unfortunately, this scenario is not uncommon.
DBE Fraud
The reality is that some general contractors will use a DBE firm solely as a pass-through entity. In other cases, the DBE firm should never have received certification at all, or changes in ownership and management have caused the company to lose its qualification while maintaining certification. In October 2009, The U.S. Government Accountability Office, the investigative arm of Congress, conducted a detailed study on the use of DBEs in order to determine whether ineligible firms certified as DBEs were being awarded contracting opportunities, thus taking opportunities from legitimate DBEs. The study’s authors concluded that the unqualified DBEs were benefiting by obtaining contracting opportunities with federal government entities and the DBE certification system was vulnerable to fraud.
Additionally, DBE fraud can occur over decades. In a recent case, an officer of Perini Corporation pled guilty to conducting DBE fraud from 1988 through 2001, using several pass-through DBE entities to obtain contracting opportunities and paying the entities 3% to 5% of the subcontract value as a fee to run payroll. The officer pled guilty to criminal charges of money laundering and conspiracy, and the company paid several million dollars to settle the civil suit against it stemming from the fraud.
Who Qualifies as a DBE?
DBEs include women-owned businesses, minority-owned businesses, small businesses who qualify through the Small Business Administration, service-disabled veteran-owned businesses, and HUBZone businesses, which are located in historically economically disadvantaged areas and employ persons residing in such areas. Though requirements differ slightly among states and governmental organizations, the following requirements generally apply:
- The firm must be at least 51% owned by disadvantaged individuals, whether they be women, minorities, or other disadvantaged individuals;
- Those individuals must have managerial control and operational control over the business’s activities; and
- The individual disadvantaged owners’ net worth cannot exceed a certain amount (generally, $750,000, but this amount varies).
Managerial and operational control means, in a practical sense, that the individuals must have sufficient functional knowledge of the business so that they can successfully manage it. For example, though a woman owner of a plumbing business need not be a plumber, she must be able to effectively direct the work of the plumbers working under her, as well as to determine the equipment, man-hours, and materials required to complete any particular job, without relying on any other person to advise her.
Bid Protests
With the current highly competitive climate, competitors are seeking to use every advantage to obtain contracting opportunities, including using the bid protest process to question the legitimacy of a DBE entity, whether that entity is a prime contractor or a subcontractor. For example, a general contractor submitting an unsuccessful bid may challenge the awardee’s bid on the basis that the DBE firms which the successful bidder proposes to use (or the DBE proposing to act as general contractor) are either not legitimate DBE firms, or do not have the capability to perform the work proposed.
In order to protect against such an investigation, before submitting a bid using a DBE subcontractor, it is critical to examine the DBE entity in light of the work that must be done before submitting a bid. Do the disadvantaged owners have the requisite knowledge to plan the project, direct the work, and ensure its completion? Will the DBE be capable of performing the work it proposes to do? Will the DBE need to obtain additional employees or subcontract part of the work to another entity? Performing this type of preliminary investigation prior to submitting a bid could save a company millions of dollars, as well as avoid criminal liability for the use of a fraudulent DBE.
and units priced from $600,000 to $15 million, recently 
