GAO Urges DOD To Systematically Assess Fraud Risks Related to Contractor Ownership

On November 25, 2019, the Government Accountability Office (“GAO”) published a report examining the financial and nonfinancial fraud and national security risks to the Department of Defense (“DoD”) when contractors employ “opaque ownership structures.” GAO defined opaque ownership structures as those that conceal or obfuscate entities or individuals who own, control, or benefit financially from the contractor. GAO’s report responds to Congressional concerns DoD contractors may disguise their identities and cost structures from procurement officers, “in effect acting as hidden monopolies with unreasonable prices or establishing opaque ownership structures for benefits that are contrary to the government’s interest.”

GAO researched cases from 2012–2018 where contractors may have concealed or failed to disclose ownership information and identified multiple types of fraud and national security risks associated with opaque ownership structures. According to GAO’s report, these risks include:

• Concealing relationship with subcontractor to inflate prices or bill for work not performed. If one individual or entity maintains ownership over both a subcontractor and a DoD prime contractor, the subcontractor may fraudulently inflate its prices to the DoD contractor, which in turn allows the DoD contractor to pass on those inflated prices to DoD. Similarly, a subcontractor may create its own invoices for work that other companies performed, allowing the subcontractor to add additional costs to the work, and then pass the invoices along to the DoD contractor, which would in turn be passed to DoD.
• Disguising conflicts of interest. When the same individuals or entities have ownership interests in various companies, they may obscure their actual ownership interests to avoid revealing the conflicts of interest. For example, an employee of a DoD prime contractor may conceal his or her ownership in a subcontractor in order to funnel work to the subcontractor through his or her role as an employee of the DoD contractor.
• Creating the appearance of competition on a contract to inflate prices. Individuals and entities that have ownership in or support a genuine DoD contractor may create fictitious shell companies to submit bids in response to a solicitation in order to ensure that their company will be awarded a contract. The fictitious companies may submit inflated bids designed to position the genuine company as the lowest bidder.
• Misrepresenting set-aside contract eligibility. DoD contractors and their employees may misrepresent themselves as eligible to receive set-aside contracts reserved for specific types of businesses, such as those owned by service-disabled veterans, women, minorities, or economically and socially disadvantaged persons. A contractor might, for example, be owned by a figurehead individual who does not actually maintain the required level of control or beneficial ownership required for the set-asides.
• Misrepresenting domestic contractor eligibility. Individuals who are not U.S. citizens or entities that are not based in the United States may obscure their ownership interest in domestic shell companies in order to bid on contracts for which only domestic companies are eligible. For example, a shell company may falsely claim U.S. ownership, while significant parts of the business, such as manufacturing, may be taking place by foreign companies.
• Circumventing debarment. Individuals and entities that have been debarred or otherwise prohibited from doing business with the federal government may attempt to conceal their ownership in shell companies to bid on government contracting opportunities. This allows the shell companies to compete for contracts without the debarment or prohibition being recognized.
• Accessing sensitive information and infiltrating supply chains. Adversarial foreign governments or other malicious individuals and entities may conceal their ownership interest in companies bidding on contract opportunities with the goal of being awarded the contract to access sensitive national security information or disrupt DoD’s supply chain.

GAO’s report urges DoD to include a further assessment of risks related to contractor ownership as part of DoD’s ongoing, department-wide fraud risk assessment. GAO’s report indicates that DoD has concurred with this recommendation.

What This Means For You

Contractors should be sensitive to Congressional and Executive agency concerns regarding contractor ownership and should be prepared to report and explain a contracting entity’s corporate affiliations and ownership structure. Many procurement officials are not familiar with the myriad ways that commercial firms organize and structure their operations, and GAO’s report suggests that the government may be increasingly inclined to “assume the worst” when a contractor’s affiliations and ownership are not readily apparent. In the wake of GAO’s report, DoD contractors in particular should expect more requests for ownership and affiliation information and should consider proactively submitting that information or having it ready to submit upon request. Ultimately, however, it is uncertain when and how DoD will respond. DoD could adopt formal changes to contractor ownership structure reporting, whether in proposals or otherwise. Any new requirements could formally supplement those of the government-wide System for Award Management (“SAM”) database, which only requires the reporting of immediate ownership and highest level ownership. DoD could also respond more informally; for example, procurement officials may start more closely scrutinizing contractor ownership information on a case-by-case basis and asking more questions about a contractor’s ownership structure.