Service center executives should be wary of their exposure to civil and criminal penalties from the misuse of Disadvantaged Business Enterprises when selling to government contractors. Regulators are cracking down on pass-through DBEs, reports the National Association of Wholesaler-Distributors in Washington.
Wholesaler-distributors, including metals service centers, often supply products and materials to contractors for use on public procurement projects funded with government dollars. Under federal, state and local regulations, a certain portion of that government contract may need to be awarded or subcontracted by the general contractor to a DBE, a business majority owned and controlled by socially and economically disadvantaged individuals such as minorities and women. The U.S. Department of Transportation, for example, spends about $50 billion per year on construction projects, and about $5 billion goes to DBEs.
Recent criminal and civil enforcement actions have involved scenarios where contractors have asked distributors to supply product on a public procurement project through a designated DBE as a conduit, rather than have the distributor sell directly to the contractor. The contractor then claims credit for the DBE’s “participation” in the project. For its role, the DBE receives a small fee for the use of its name and DBE certification. The Justice Department and other enforcement authorities have challenged these arrangements and charged the distributor and contractor with fraud because the designated DBE was a mere “pass-through” entity and did not perform any “commercially useful function.”
Generally under federal regulations a DBE performs a commercially useful function when it is responsible for execution of the contract and is carrying out its contractual responsibilities by actually performing, managing and supervising the work involved—negotiating product price with the distributor, determining quality and quantity, placing orders, receiving, warehousing and delivering the products, paying the distributor and invoicing the contractor. A DBE that acts as a mere “front” and is actually an extraneous participant in the transaction through which funds are passed in order to obtain the appearance of DBE participation does not qualify.
Criminal DBE fraud cases involving a pass-through DBE prosecuted by the U.S. Attorney’s Office have resulted in prison sentences for individuals involved ranging from three years of probation to seven years in prison. The federal government and private whistleblowers (who could be a competitor of the distributor or the DBE) may also seek substantial civil penalties in DBE fraud cases under the federal False Claims Act. Since 2011, the U.S. Department of Transportation has recovered more than $245 million in fines, restitution and forfeitures in these cases. A distributor who sells product through a pass-through DBE—even if the DBE is “certified”—is a potential target for enforcement actions. Penalties also may include debarment from future government contract work.
The Department of Transportation’s Office of the Inspector General has issued the following “red flag” indicators of DBE fraud:
- DBE owner lacking background, expertise or equipment to perform subcontract work.
- Employees shuttling back and forth between contractor and DBE payrolls.
- Business names on equipment and vehicles covered with paint or magnetic signs.
- Orders and payment for necessary supplies made by individuals not employed by the DBE.
- Contractor facilitated purchase of the DBE-owned business.
- DBE owner never present at the job site.
- Contractor always uses the same DBE.
- Financial agreements between the contractor and the DBE.
- Joint bank accounts.
- And the absence of written contracts.
metals. This information was excerpted from a recent NAW legal advisory.
Government scrutiny of contractors using pass-through DBEs is on the increase and penalties are severe. Wholesaler-distributors must exercise thorough due diligence and oversight when asked to sell products and materials for a government funded project to, or through, a DBE. Remember, the fact that a company has achieved government certification as a DBE only confirms the entity’s status. The DBE must also bring real value to the transaction. If a contractor-customer attempts to just insert a DBE into the deal for the appearance of compliance, a prudent distributor should take a pass.
[The National Association of Wholesaler-Distributors in Washington represents distributors of a wide range of products, including metals. This information was excerpted from a recent NAW legal advisory