As with any government program, state programs for disadvantaged business enterprises, or DBEs, are vulnerable to fraud and abuse. What’s more, even ethical, law-abiding contractors can get caught in the crosshairs of state, local and federal enforcement agencies if they fail to adhere to DBE law.
To protect yourself from inadvertently becoming involved in fraudulent practices, it’s important to understand the common abuses perpetrated by those who try to skirt DBE laws. Although various schemes have been implemented, one of the most common is what’s called a “pass-through” arrangement, in which a certified MWBE subcontracts for work that it ultimately does not, and, more importantly, cannot complete.
How Pass-through Schemes Work
Many state and local governments offer preference in awarding contracts to companies that employ certified MWBEs. Others, including New York, set minimum MWBE participation goals for contractors who bid on certain types of construction jobs. Thus, it is beneficial, and in some cases essential, for prime contractors to include MWBE subcontractors in proposals for government jobs.
Although most construction firms carefully adhere to DBE law, those who wish to abuse the system will sometimes enlist a certified MWBE to participate “in name only” on a project they own (or are bidding on). These MWBEs are not in a position to perform the work because they lack the necessary expertise, equipment, labor or funds. Instead, they subcontract the work to another firm. Nevertheless, they bill the contractor and receive payment for the project in the MWBE’s name. The money paid then “passes through” the MWBE to the subcontractor who actually did the work. Typically, the MWBE receives a “mark-up” fee for participating in the scheme.
Unfortunately for those who become unwittingly involved, these schemes are illegal under federal law, which requires that any DBE participating in a government-funded project performs a “commercially useful function” on the job. This has been interpreted by the U.S. Department of Transportation to mean the the subcontractor is “responsible for execution of the work of the contract and is carrying out its responsibilities by actually performing, managing, and supervising the work involved.” Additionally, the DOT requires that the DBE is also responsible for “negotiating price, determining quality and quantity, ordering the material, and installing (where applicable) and paying for the material itself.” Obviously, a subcontractor who participates in a pass-through is doing none of these things.
Penalties Are Steep
Recent court cases involving DBE fraud show that the penalties for violating DBE law can be very steep. One DBE supplier, for example, was recently fined $5 million in a case brought by the U.S. Department of Justice for participating in a pass-through scheme. And in 2011, Balu Kamat and Carmine Desio, owners of the DBE Environmental Energy Associates, pled guilty to mail fraud charges for allowing their company to participate in a similar scheme. The two received a sentence of six months of home confinement, two years probation and a $50,000 fine each. They were also ordered to pay criminal restitution in the amount of $188,000.
State and local governments are also cracking down on those who violate DBE law. For example, in 2016, the City of New York impaneled a grand jury to investigate fraud in the city’s MWBE program. The panel concluded that the city’s construction industry had, though fraud and abuse, successfully diverted nearly $10 million from actual MWBEs over the previous 10 years. Since that time, the city (and state) have enacted policies that allow them to more aggressively prosecute contractors who engage in fraudulent practices such as pass-through schemes.
Perhaps even more concerning, those who violate DBE law are also subject to civil action brought by private citizens under the federal False Claims Act. This statute offers a reward to any individual who files suit on behalf of the federal government against a business entity that has defrauded the United States. Thanks to aggressive marketing of this program by state, local and federal governments, these suits have become more prevalent, more lucrative for whistle blowers, and more damaging to the companies that are sued. In 2016, for example, a whistle blower named Rickey Howard received $1,485,000 of a $5.4 million settlement paid by Harper Construction, Inc. to the U.S. government for participating in DBE fraud.
At The Carmoon Group, we work with minority and women owned business to help them grow and thrive. We have over 20 years experience in construction insurance and risk management, and can recommend solutions that help you protect your assets and remain within the law. Give us a call today to set up an appointment to discuss your needs. Or if you prefer, reach out online and we will get back to you right away.