8(a) Program
The Importance of Effective Fraud Prevention Controls
Gao ID: GAO-11-440T March 3, 2011
This testimony discusses the results of our prior investigation of the Small Business Administration's (SBA) 8(a) Business Development Program. SBA's 8(a) program, named for a section of the Small Business Act, is a development program created to help small, disadvantaged businesses compete in the American economy and access the federal procurement market. To participate in the program, a firm must be certified as meeting several criteria, including: be a small business as defined by SBA; be unconditionally owned and controlled by one or more socially and economically disadvantaged individuals who are of good character and citizens of the United States; and show potential for success. Upon certification, firms can obtain federal contracts without competing fully and openly for the work. For example, agencies are permitted to enter into sole-source contracts after soliciting and negotiating with only one 8(a) company. They also can participate in restricted competitions for federal contracts, known as set-asides, open to only 8(a) companies. In March 2010, GAO issued two companion reports on the 8(a) program, one focused on internal control procedures and processes that SBA has implemented to ensure that only eligible firms participate in the program and one focused on fraud prevention. This testimony is based on the latter report, and addresses three issues: (1) whether ineligible firms were participating in the 8(a) program, (2) the results of our proactive testing of the application process, and (3) strengths and weaknesses in SBA's fraud prevention system.
This testimony summarizes our findings on each of the three issues discussed in our report. Specifically, we found that: Ineligible firms are participating in the 8(a) program. We identified 14 firms that received set-aside or sole-source 8(a) contracts worth $325 million through fraud or abuse. These 14 firms received another $1.2 billion in other federal obligations since entering the 8(a) program, including $17 million in awards through the American Recovery and Reinvestment Act of 2009. We found evidence that showed that officials at 13 of these firms misrepresented their eligibility for the program to fraudulently acquire or maintain 8(a) status and obtain federal contracts awarded with limited or no competition. Examples include underreporting adjusted net worth and serving as a "pass-through" for non-8(a) companies. In the case of a pass-through, an 8(a) firm receives the sole-source or set-aside contract, but contrary to program requirements, work is performed and managed by a non-8(a) company. We also determined that SBA staff responsible for annually assessing firm eligibility allowed 3 firms to remain in the 8(a) program and receive contracts despite clear evidence provided by company officials during annual reviews that showed they were no longer eligible. For example, SBA allowed a firm to remain certified even though the president reported a salary which substantially exceeded the threshold. SBA's application process has both strengths and weaknesses. SBA had certain strengths in its 8(a) application process that allowed the agency to correctly determine that three of the four bogus firms from our proactive testing were not eligible for the 8(a) program. We also identified vulnerabilities that demonstrate weaknesses ineligible firms could exploit to fraudulently receive program certification. In the first of our three unsuccessful applications, SBA stated that it denied our application because the firm lacked the financial capacity to perform 8(a) contracts. For the other two cases, SBA raised concerns about our eligibility based on the presidents' adjusted net worth. The agency also questioned control of one of these firms. SBA provided us with such thorough comments that we determined we could not overcome the deficiencies and eligibility issues identified in both applications, so we abandoned them. However, we obtained 8(a) certification for one bogus firm using fabricated documentation and fictitious owner information. SBA's fraud prevention system has both strengths and weaknesses. Weaknesses exist in SBA's controls for preventing, detecting, monitoring, and investigating fraud and abuse in the 8(a) program. Fraud prevention requires a system of controls which, in their aggregate, minimize the likelihood of fraud occurring while maximizing the possibility of detecting any fraudulent activity that may transpire. Fraud prevention systems set forth what actions constitute fraudulent conduct and specifically spell out who in the organization handles fraud matters under varying circumstances. A well-designed fraud prevention system should consist of three crucial elements: (1) upfront preventive controls, (2) detection and monitoring, and (3) investigations and prosecutions. For the 8(a) program this would mean effective (1) front-end controls at the application stage, (2) fraud detection and monitoring of firms already in the program, and (3) the aggressive prosecution or suspension and debarment of individuals committing fraud. In our report we describe specific strengths and weaknesses that we identified during the course of our review. For example, a strength we identified was SBA's use of certain third-party sources, such as Dun and Bradstreet and the Credit Bureaus, to verify some information about our bogus firm that was certified for the program. Nevertheless, these controls did not allow SBA to identify the fake documents we submitted.
GAO-11-440T, 8(a) Program: The Importance of Effective Fraud Prevention Controls
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United States Government Accountability Office:
GAO:
Testimony:
Before the Committee on Small Business and Entrepreneurship, U.S.
Senate:
For Release on Delivery:
Expected at 10:00 a.m. EST:
Thursday, March 3, 2011:
8(a) Program:
The Importance of Effective Fraud Prevention Controls:
Statement of Gregory D. Kutz, Director:
Forensic Audits and Investigative Service:
GAO-11-440T:
Madam Chair, Ranking Member Snowe, and Members of the Committee:
Thank you for the opportunity to discuss the results of our prior
investigation of the Small Business Administration's (SBA) 8(a)
Business Development Program. SBA's 8(a) program, named for a section
of the Small Business Act, is a development program created to help
small, disadvantaged businesses compete in the American economy and
access the federal procurement market. To participate in the program,
a firm must be certified as meeting several criteria, including: be a
small business as defined by SBA; be unconditionally owned and
controlled by one or more socially and economically disadvantaged
individuals who are of good character and citizens of the United
States; and show potential for success. Upon certification, firms can
obtain federal contracts without competing fully and openly for the
work. For example, agencies are permitted to enter into sole-source
contracts after soliciting and negotiating with only one 8(a) company.
They also can participate in restricted competitions for federal
contracts, known as set-asides, open to only 8(a) companies. In March
2010, GAO issued two companion reports on the 8(a) program, one
focused on internal control procedures and processes that SBA has
implemented to ensure that only eligible firms participate in the
program and one focused on fraud prevention.[Footnote 1] My testimony
today is based on the latter report, and addresses three issues: (1)
whether ineligible firms were participating in the 8(a) program, (2)
the results of our proactive testing of the application process, and
(3) strengths and weaknesses in SBA's fraud prevention system.
To determine whether firms were participating in the 8(a) program
through potentially fraudulent misrepresentation, we used a risk-based
approach to identify firms that exhibited signs that they were not
qualified for the program. We also reviewed allegations of fraud and
abuse sent to our e-mail address established to receive reports about
small business contracting programs. For the firms we selected for
further investigation, we reviewed documentation available from SBA in
the firms' official 8(a) files maintained in district offices. We
conducted both announced and unannounced site visits and interviewed
firm employees and executives. The selection of the 14 firms we
investigated was not representative and the findings from these 14
cases cannot be projected beyond those cases. To proactively test
whether SBA's 8(a) application process and controls were sufficient to
prevent ineligible firms from entering into the program, we
established four bogus businesses and submitted falsified applications
and supporting documentation to SBA. To determine what strengths and
weaknesses, if any, existed in SBA's fraud prevention system, we made
observations based on our case studies and proactive testing.
Furthermore, we compared controls in place at the time of our review
of the 8(a) program to a fraud-prevention model we developed and
utilized in prior small business contracting investigations. A full
description of our scope and methodology is included in appendix I of
our report.[Footnote 2] We also requested an update from SBA on any
actions that it had taken on our recommendations. We did not validate
any representations made by SBA.
We conducted our audit work and investigation from October 2008
through January 2010 in accordance with U.S. generally accepted
government auditing standards. Those standards require that we plan
and perform the audit to obtain sufficient, appropriate evidence to
provide a reasonable basis for our findings and conclusions based on
our audit objectives. We believe that the evidence obtained provides a
reasonable basis for our findings and conclusions based on our
objectives. We performed our investigative work in accordance with the
standards prescribed by the Council of the Inspectors General on
Integrity and Efficiency (CIGIE).
My testimony today summarizes our findings on each of the three issues
discussed in our report. Specifically, we found that:
* Ineligible firms are participating in the 8(a) program. We
identified 14 firms that received set-aside or sole-source 8(a)
contracts worth $325 million through fraud or abuse. These 14 firms
received another $1.2 billion in other federal obligations since
entering the 8(a) program, including $17 million in awards through the
American Recovery and Reinvestment Act of 2009.[Footnote 3] We found
evidence that showed that officials at 13 of these firms
misrepresented their eligibility for the program to fraudulently
acquire or maintain 8(a) status and obtain federal contracts awarded
with limited or no competition. Examples include underreporting
adjusted net worth and serving as a "pass-through" for non-8(a)
companies. In the case of a pass-through, an 8(a) firm receives the
sole-source or set-aside contract, but contrary to program
requirements, work is performed and managed by a non-8(a) company. We
also determined that SBA staff responsible for annually assessing firm
eligibility allowed 3 firms to remain in the 8(a) program and receive
contracts despite clear evidence provided by company officials during
annual reviews that showed they were no longer eligible. For example,
SBA allowed a firm to remain certified even though the president
reported a salary which substantially exceeded the threshold.
Permitting ineligible firms to obtain 8(a) contracts undermines the
intent of the program and deprives qualified firms from receiving
targeted contracting opportunities. A description of all 14 case
studies is included in Table 1 of our report.[Footnote 4] Subsequent
to issuing this report, we referred all 14 cases to SBA and the
agency's Office of Inspector General.
* SBA's application process has both strengths and weaknesses. SBA had
certain strengths in its 8(a) application process that allowed the
agency to correctly determine that three of the four bogus firms from
our proactive testing were not eligible for the 8(a) program. We also
identified vulnerabilities that demonstrate weaknesses ineligible
firms could exploit to fraudulently receive program certification. In
the first of our three unsuccessful applications, SBA stated that it
denied our application because the firm lacked the financial capacity
to perform 8(a) contracts. For the other two cases, SBA raised
concerns about our eligibility based on the presidents' adjusted net
worth. The agency also questioned control of one of these firms. SBA
provided us with such thorough comments that we determined we could
not overcome the deficiencies and eligibility issues identified in
both applications, so we abandoned them. However, we obtained 8(a)
certification for one bogus firm using fabricated documentation and
fictitious owner information. We consider this a vulnerability because
unscrupulous firms could do the same to create front companies and
funnel 8(a) contracts to themselves, circumventing eligibility
requirements. A description of the scenarios and outcomes for all four
bogus firm applications is included in our report.[Footnote 5]
* SBA's fraud prevention system has both strengths and weaknesses. The
14 case studies of ineligible firms discussed above and the
certification of a bogus firm show that weaknesses exist in SBA's
controls for preventing, detecting, monitoring, and investigating
fraud and abuse in the 8(a) program. Fraud prevention requires a
system of controls which, in their aggregate, minimize the likelihood
of fraud occurring while maximizing the possibility of detecting any
fraudulent activity that may transpire. Fraud prevention systems set
forth what actions constitute fraudulent conduct and specifically
spell out who in the organization handles fraud matters under varying
circumstances. A well-designed fraud prevention system should consist
of three crucial elements: (1) upfront preventive controls, (2)
detection and monitoring, and (3) investigations and prosecutions. For
the 8(a) program this would mean effective (1) front-end controls at
the application stage, (2) fraud detection and monitoring of firms
already in the program, and (3) the aggressive prosecution or
suspension and debarment of individuals committing fraud. In our
report we describe specific strengths and weaknesses that we
identified during the course of our review. For example, a strength we
identified was SBA's use of certain third-party sources, such as Dun
and Bradstreet and the Credit Bureaus, to verify some information
about our bogus firm that was certified for the program. Nevertheless,
these controls did not allow SBA to identify the fake documents we
submitted. We also reported that based on our limited review there was
indication that SBA staff responsible for assessing firms' continued
eligibility did not always follow established program criteria during
the annual review process. As mentioned previously, some of the 14
firms were determined to be ineligible after our investigators
confirmed information that was concealed from SBA by firm presidents.
In other cases, our review of SBA's files clearly indicated that these
firms were not eligible for the 8(a) program, yet SBA failed to
terminate or graduate these firms from the program.
The consequences of these control weaknesses are substantial: in just
the 14 cases we investigated for this report, over $325 million in
sole-source and set-aside 8(a) contracts went to ineligible firms that
manipulated the current system. To a substantial degree, the steps we
took to investigate these firms could be part of an effective fraud
prevention program. Victims of the fraud and abuse in this program are
legitimate economically and socially disadvantaged small businesses.
To address the vulnerabilities we identified, our report provided six
recommendations to improve SBA's ability to screen and monitor fraud
and abuse within the 8(a) program. SBA agreed with five
recommendations and stated that it would evaluate our sixth
recommendation related to how family members' assets are included in
the assets of the 8(a) participant based upon the comments received as
a result of the proposed 8(a) rule change.[Footnote 6] Although SBA
needs time to implement these changes, and we have not done a
comprehensive follow-up on their actions, SBA has taken action on some
recommendations, while according to SBA, implementation of others is
in progress. For example, SBA enacted final regulation changes on
February 14, 2011 which address three recommendations relating to firm
eligibility requirements. The regulations provide more clarification
on factors that determine economic disadvantage as it relates to total
assets, gross income, retirement accounts and a spouse of an 8(a)
company owner when determining the owner's ability to access capital
and credit. These changes take effect on March 14, 2011. In addition,
SBA officials told us that they have been evaluating the use of third-
party data systems to verify firm information when conducting initial
certification reviews. SBA officials also stated that they have
provided forensic accounting training to all SBA staff responsible for
conducting these initial certification reviews, and the agency plans
to expand this training in fiscal year 2011 to all SBA field staff
responsible for annual reviews. SBA officials also stated that they
will revise the program's standard operating procedures to reflect the
regulatory changes, to increase certain reporting requirements and to
provide more detailed and concrete guidance on initiating suspensions
and debarments. In addition, according to SBA, the agency has taken
steps to terminate some of the firms identified in our report, and has
referred other cases to the SBA Office of Inspector General.
Madam Chair, and Ranking Member Snowe, this concludes my statement. I
would be pleased to respond to any questions you or other Members of
the Committee may have.
Contacts and Acknowledgments:
For additional information about this testimony, please contact
Gregory D. Kutz at (202) 512-6722 or kutzg@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this statement.
[End of section]
Footnotes:
[1] GAO, Small Business Administration: Steps Have Been Taken to
Improve Administration of the 8(a) Program, but Key Controls for
Continued Eligibility Need Strengthening, [hyperlink,
http://www.gao.gov/products/GAO-10-353], (Washington, D.C. Mar. 30,
2010) and GAO, 8(a) Program: Fourteen Ineligible Firms Received
$325 Million in Sole-Source and Set-Aside Contracts, [hyperlink,
http://www.gao.gov/products/GAO-10-425] (Washington, D.C.: Mar. 30,
2010).
[2] GAO, 8(a) Program: Fourteen Ineligible Firms Received $325 Million
in Sole-Source and Set-Aside Contracts, [hyperlink,
http://www.gao.gov/products/GAO-10-425] (Washington, D.C.: Mar. 30,
2010).
[3] This $1.2 billion includes both non-8(a) awards, as well as 8(a)
awards that these firms were eligible to receive.
[4] GAO, 8(a) Program: Fourteen Ineligible Firms Received $325 Million
in Sole-Source and Set-Aside Contracts, [hyperlink,
http://www.gao.gov/products/GAO-10-425] (Washington, D.C.: Mar. 30,
2010).
[5] GAO, 8(a) Program: Fourteen Ineligible Firms Received $325 Million
in Sole-Source and Set-Aside Contracts, [hyperlink,
http://www.gao.gov/products/GAO-10-425] (Washington, D.C.: Mar. 30,
2010).
[6] Our companion report on the 8(a) program's internal controls also
contained six recommendations to SBA that included providing more
guidance to help ensure staff more consistently follow procedures,
reassessing certain staff workload distribution, and developing more
standard processes for documenting and analyzing certain program data.
SBA agreed with each of the six recommendations. See, GAO, Small
Business Administration: Steps Have Been Taken to Improve
Administration of the 8(a) Program, but Key Controls for Continued
Eligibility Need Strengthening, [hyperlink,
http://www.gao.gov/products/GAO-10-353], (Washington, D.C. Mar. 30,
2010).
[End of section]
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