Contractors Use Shell Games to Hide Owners, Cheat Taxpayers

Contractors using shell companies to hide their ownership are ripping off the Pentagon and endangering national security, according to a sobering report the Government Accountability Office (GAO) released last month.

The report’s focus is U.S. defense contracting, but it deals with a subject that has become a worldwide concern. The problem of companies using what the report calls “opaque ownership” schemes to hide their beneficial owners (the people who actually benefit financially from the company) is an international problem. Opaque, or anonymous, corporate ownership facilitates not only government contracting fraud, but also money laundering, human trafficking, and terrorism financing.

The GAO reviewed 32 court cases resolved between 2012 and 2018 in which Department of Defense contractors provided false information about their ownership or corporate structure and were accused or found guilty of a litany of misdeeds: price gouging; providing poor-quality goods and services; abusing programs intended for small businesses owned by “service-disabled veterans, women, minorities, or economically and socially disadvantaged individuals;” and improperly disseminating sensitive military information. In typical GAO fashion, the report doesn’t name names. However, from the details it provides, the Project On Government Oversight (POGO) was able to track down what appear to be the companies and individuals involved in 21 of the 32 cases. With this information, POGO annotated the case summary table featured in the report:

For instance, one case the report looks at is that of an “ineligible foreign manufacturer that illegally exported sensitive military data and provided defective and nonconforming parts that led to the grounding of at least 47 fighter aircraft.” This appears to reference Allied Components LCC, a military hardware supplier whose owner pleaded guilty in 2013 to providing F-15 fighter aircraft parts that were not only defective but also made in India even though the contract required the parts to be U.S.-made, and to passing along information about nuclear-powered submarines to India without the required government approval.

Altogether, four of the 32 cases involved contractors using U.S.-based shell companies to conceal that the work was really being done by a foreign-based company. Concealing beneficial ownership in this manner increases the chance that “adversaries seeking to act against the government’s interests” will gain access to sensitive government information or installations, according to the report.

A case the GAO cited as an example of contractors inflating prices by concealing their ownership and control of subcontractors is apparently that of Supreme Foodservice, which pleaded guilty in 2014 to major fraud against the United States and paid a total of $434 million in penalties. And the unnamed contractor executives who admitted to “creating fictitious, inflated bids that were not from actual businesses” and fraudulently inflating invoices is an unmistakable reference to Glenn Defense Marine Asia and the massive “Fat Leonard” Navy contract corruption scandal.

The most rampant form of abuse documented in the report—accounting for 20 of the 32 cases—is contractors falsely posing as being eligible for contracts set aside for small businesses owned by “service-disabled veterans, women, minorities, or economically and socially disadvantaged individuals.” The report describes what POGO determined is likely a recent case involving a Kansas City, Missouri-area construction company owner who was sentenced to 18 months in prison last year for falsely claiming the company was managed by a service-disabled veteran in order to win more than $13.7 million in contracts.

And in one instance, an individual debarred from federal contracting got around his debarment by creating shell companies under the names of relatives and fictitious people. He was convicted of fraud and sent to prison, but not before selling the Pentagon $2.8 million in defective parts for airplanes. Suspended and debarred contractors getting around their bans through opaque ownership structures has long been an area of concern for POGO.

The GAO estimates the government’s losses from the 32 cases total over $875 million ($200 million of which comes from just one small business set-aside fraud case). In addition, there is the potential nonmonetary harm to U.S. national security, and all of this could be just the tip of the iceberg. As the report states, “There may be additional fraud or other risks and cases related to contractor ownership that are presently undiscovered fraud and are not identified in our report.”

The problem of opaque contractor ownership structures can be addressed by a series of common sense reforms. The easiest one, which the GAO recommends, is for the Pentagon to conduct a systematic “department-wide assessment of risks posed by contractor ownership.”

“DOD has not historically considered contractor ownership structures in the responsibility determination process, nor has the agency been aware of the extent to which such structures could pose a range of risks,” the report explains. Performing this assessment would give the Pentagon and the other agencies a greater awareness of the potential harms of anonymous company ownership, which would hopefully cause contracting officials to more carefully vet contractors’ ownership and financial structures during the pre-award evaluation process.

POGO has two additional reform recommendations that will be a much heavier lift. First, the government must revamp the system for reporting contractor ownership information. Companies wishing to do business with the government register in a database called the System for Award Management. However, the system currently doesn’t require the disclosure of beneficial owners; instead, contractors are only required under law to disclose their “highest-level” and “immediate” owners. Subcontractors are not required to register. Any company that receives federal funds—from a prime contractor to the lowest-tier subcontractor—should be required to register and disclose their beneficial owners. And the system must be audited periodically to ensure the data is timely and accurate.

Second, a centralized database of corporate beneficial ownership information would greatly help government contracting officials identify and verify contractors’ real owners. There is currently an effort underway to lay the groundwork for such a database as part of a growing worldwide campaign to impose greater transparency on corporations. The government should do all it can to support this effort.