United States. Congress. House. Committee on Small.

The abuses in the SBA's 8(a) Procurement Program : hearing before the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, first session, Washington, DC, December 13, 1995 online

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1987. 8 employees have been convicted of felonies stemming from their abuse of the
public trust. The most notable cases included two Assistant District Directors who
accepted gratuities for awarding contracts. These cases received extensive publicity.
Because both individuals were convicted and sentenced to substantial prison terms, we
believe their experience provided an object lesson for other employees and has
deterred such activity over the past two years.

Another reason for corruption is a breakdown in management control of the
program by Agency employees and managers. In most employee corruption cases,
higher level officials were lax in their oversight of 8(a) program employees empowered
to make decisions involving millions of dollars in Federal contracts. Likewise, in cases
of participant fraud, due diligence on the part of the responsible SBA employee would
frequently have prevented the fraud, or would have contributed to discovery sooner.
We have also found, in many instances, SBA employees were informed of activity
contrary to existing policies and regulations, yet, the activity was approved or allowed to
continue. Unfortunately, this abuse of discretionary authority has resulted in fraud
referrals being declined by the Department of Justice because the Agency knowingly
permitted violations of its own policies and regulations.

The September 1995 GAO report on l-NET and TAMSCO, "8(a) Is Vulnerable to
Program and Contractor Abuse," expanded on some work performed by the OIG on



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the 8(a) company, l-NET. The OIG has not audited TAMSCO, therefore, I cannot
address the issues raised by the GAO concerning that company.

Over a decade, SBA mismanaged various aspects of l-NETs participation in the
8(a) program The veracity of l-NETs assertions at entry have been appropriately
questioned both by the OIG's auditors and GAO personnel. Faulty monitoring was
apparent in allowing at least 1 1 contracts with a related value exceeding $16 million to
be awarded to l-NET when l-NET was too large to qualify as a small business for those
contracts, and l-NET's graduation from the program was unreasonably drawn out.
Actions by SBA employees were also inappropriate and slow. It took the Agency
almost nine months to send out the initial letter of intent to graduate l-NET after the OIG
raised the graduation issue. During the 17 months it took SBA to graduate l-NET from
the 8(a) program, l-NET was awarded 19 8(a) contracts exceeding $12 million in value.
The OIG referred the possible false claims issues to the Department of Justice which
was very interested until it learned that SBA incorrectly certified that l-NET qualified for
contracts.

I will now discuss the major systemic issues (eligibility, competition, and
brokering) that I believe should be addressed to reduce abuse and improve the
effectiveness of the 8(a) program.

* Eligibility The 8(a) program is designed to assist individuals who are both
socially and economically disadvantaged. For purposes of the 8(a) program,
economically disadvantaged individuals are socially disadvantaged individuals whose
ability to compete in the free enterprise system has been impaired due to diminished



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capital and credit opportunities, as compared to others in the same or similar line of
business who are not socially disadvantaged. These diminished opportunities must
have precluded, or have likely precluded, opportunities for successful competition in the
open market.

The Office of Minority Enterprise Development (MED) is supposed to measure
economic disadvantage in one of three ways: (1) the individual's net worth, (2) the
financial condition of the individual's company, and (3) its access to credit. Individuals
who exceed certain net worth thresholds are not considered economically
disadvantaged. For entry into the program, personal adjusted net worth cannot exceed
$250,000; once in the 8(a) program, it cannot exceed $750,000. These limits exclude a
spouse's assets, and by law, the individual's equity in his or her house and any equity
he or she may have in the business.

The MED analysis of a business' financial condition is supposed to be based on
a comparison of the 8(a) company with other concerns in the same or similar lines of
business MED is supposed to consider, among others, the following factors: business
assets, revenues, pre-tax profit, working capital, and net worth.

When assessing access to credit and capital, MED is supposed to consider
access to long-term financing; access to working capital financing and equipment trade
credit; and access to raw materials, supplier trade credit, and bonding capability. While
MED employees are supposed to determine whether the firm has sufficient working
capital and access to capital and to credit during the Annual Review of 8(a) firms, no



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guidance is given as to what dollar amounts of each would make a company no longer
economically disadvantaged.

The OIG has conducted several audits that focus on eligibility issues. We have
audited individual companies and concluded that the participant had overcome his/her
economic disadvantage and recommended termination or graduation from the program.
While MED has taken actions on these cases, the termination and graduation
processes are complex and time-consuming. I-NET is one case which illustrates this
problem In another situation, we recommended graduation or termination proceedings
on May 31,1 994, because the company had grown to the point that it was larger and
more profitable than other similar companies and the owner had withdrawn over $6
million in a two-year period. While MED has initiated appropriate actions, as of a few
days ago, the company was still in the program pending an appeal.

We also audited MED's continuing eligibility review process and evaluated the
adequacy of procedures for assuring 8(a) program participants meet continuing
eligibility requirements. Fifty larger companies were reviewed that were serviced by five
SBA District Offices in Washington, DC; Los Angeles, CA; Richmond, VA; Columbus,
OH; and Albuquerque, NM. The audit concluded that participants remained in the
program even though they had accumulated substantial wealth or had overcome
impediments to obtaining access to financing, markets, and resources. Specific
findings of the audit included the following:

• Six individuals who had overcome their economic disadvantage retained

8(a) eligibility because they understated their personal net worth or SBA's






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Business Opportunity Specialists (BOS) made errors in calculating the
individuals' personal net worth.

• Participants with substantial income remained in the program because
personal annual income was not considered when economic
disadvantage assessments were made. Of the 50 participants reviewed,
17 had compensation ranging between $500,000 to $2.5 million for a two-
year period. SBA has no definitive criteria on the maximum amount of
annual compensation that would overcome economic disadvantage.

• Continuing eligibility reviews did not include compansons of 8(a) concerns
to others in the same or similar lines of businesses that were not owned
and controlled by disadvantaged individuals. This failure allowed
participants to continue in the 8(a) program although the strong financial
condition of their companies should no longer have qualified them as
economically disadvantaged. Of the 50 companies in our sample, 32
companies exceeded the average business assets, revenue, gross profit,
working capital, and net worth of other companies in a similar line of
business.

• Wealthy individuals continued to be eligible for the 8(a) program because
the equity in their companies and primary residences and the net worth of
their spouses were not considered in determining whether they remained
economically disadvantaged due to statutory exclusions. In our sample,
35 of the 50 participants were millionaires but remained classified as



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disadvantaged when their excluded assets were deducted from personal
net worth. Of our sample of 50, 13 had more than $1 ,000,000 equity in
the 8(a) company and 5 lived in houses valued between $800,000 and
$1.4 million.

In response to this audit, MED officials agreed with the majority of
recommendations and has begun to take some steps to analyze continuing eligibility.
For example, effective May 16, 1995, BOSs are required to compare annually five
financial performance factors for 8(a) companies with the industry average for
companies in the same line of business, and if the 8(a) firm meets or exceeds three of
the averages, "graduation should be considered." While we have not reviewed the
implementation of this requirement, we consider it a positive step forward.
Unfortunately, the economic disadvantage aspect of eligibility is extremely complex,
time-consuming to administer properly, and relies on self-certification by the participant.
Therefore, simplified procedures must be instituted. I am in favor of using objective
criteria because it is much easier to administer and more difficult to circumvent. I would
like to see objective criteria established to ease the review process and to limit the need
for extensive accounting knowledge and financial analysis experience. While I am not
prepared to recommend specific net worth levels or other appropriate criteria, I find it
difficult to rationalize the notion that anyone who is a millionaire can be considered
economically disadvantaged when the median value of all American households is
significantly less than $100,000. In 1991, the median value of selected nonfinancial
assets, which includes spousal wealth, equity in the business and the personal



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residence, was $36,623 for all households and $44,408 for Caucasian households. In
1991 , the median value of households owning selected financial assets was an
additional $38,330. I believe the appropriate criteria for judging economic disadvantage
should be based on comparisons with the overall population, rigorous research on
appropriate levels of capital necessary to sustain a successful business, and strict
adherence to the mandated goals of the 8(a) program.

In establishing simple, objective criteria. Congress could eliminate the exclusions
in determining net worth SBA could establish other definitive thresholds, e.g., the
amount of maximum annual compensation, that would make it easier to judge whether
a participant had exceeded a reasonable threshold. The current analytical construct
relies, however, on a self-certification and requires extensive financial analysis to arrive
at a net worth figure. The MED program has neither the numbers of staff nor the
expertise to conduct this function. Moreover, the OIG also lacks sufficient staff to
conduct detailed audits of participants' eligibility.

There is a corollary issue related to the lack of enforcement of the economic
disadvantage criteria. I believe that SBA's inability (or unwillingness) to identify and
graduate those 8(a) companies that are successful is a contributing factor to the
concentration in the award of contracts. There are approximately 5,700 companies in
the 8(a) program; 2,735 of these companies had active 8(a) contracts at December 4,
1 995. Of those that receive contracts, the majority are awarded to a small number of
8(a) companies, thereby limiting opportunity for Federal contracting by other 8(a)
companies Based on a computer run of 8(a) companies with active contracts as of



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December 1995, the largest 200 companies commanded 50.4 percent of the contracts
in terms of dollar value. These contracts total over $14 billion, or an average of $70
million in active contracts for each of the top 200 companies. It should be noted that
these figures only include active contracts; these companies may have had other
contracts that have been closed out, or they may still hold options for future contracts
that have yet to be exercised.

Because the most successful companies obtain contracts amounting to
hundreds of millions of dollars, they accumulate substantial wealth and overcome their
economic disadvantage. Given their expanded resources, success in recruiting
personnel with excellent technical knowledge, ability to acquire expert 8(a) procedural
advice from attorneys and consultants who specialize in 8(a) procurement procedure,
and growing experience, they are able to dominate both the sole source and
competitive 8(a) markets. I cannot believe that this was the original intent of the
Congress In fact, Senate Report No. 100-394 relating to the Business Opportunity
Development Reform Act of 1988 stated:

The important public purpose of the 8(a) program is severely undermined
when individuals who are not socially and economically disadvantaged
are permitted to participate. Such participation by non-disadvantaged
individuals reduces the amount of benefits available to those who are
disadvantaged, diverts the energy and efforts of the SBA, and undermines
support for the program.



Ill



1 fully concur with the Senate report's conclusion.

Any change to the 8(a) program should also address the issue of concentration.
There are measures that could both reduce concentration and simplify the continuing
eligibility process. The OIG has recommended that MED establish a ceiling on the
dollar amount of sole source contracts that a participating company could receive. This
recommendation, as well as others, is currently under consideration by MED.

* Competition of 8(a) Awards. One of the requirements of the 1 988
amendments was to establish dollar thresholds for competitive procurement. Service
contracts over S3 million and manufacturing contracts exceeding $5 million are
supposed to be competed among all eligible 8(a) companies. Congress believed dollar
thresholds would reduce the temptation to resort to bribery attempts to obtain large
dollar value contracts, as occurred in the WEDTECH case. These thresholds would
also help prepare 8(a) participants for the market competition that they will face upon
graduation from the program.

Since January 1 , 1989, there have been 696 competitive 8(a) awards resulting in
contracts totaling about $2.4 billion. In contrast, there have been approximately 32,000
sole source awards resulting in contracts totaling about $19 billion. In other words, only

2 percent of the 8(a) contracts have been competed, and being high dollar awards, they
represent 1 1 percent of all 8(a) contract dollars. One reason there have been so few
competitive awards is that there was a major loophole that allowed Federal
departments and agencies and 8(a) companies to circumvent the competitive
thresholds This loophole was the use of the indefinite delivery/indefinite quantity



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contract, otherwise known as an ID/IQ contract. Under an ID/IQ contract, there is a
range of goods or services that can be provided, with a guaranteed minimum. The
mandated thresholds were applied against the minimum value, not the maximum value.
It was not uncommon to see minimum values established at $2.9 million and maximum
values at $10 million or more.

The Department of Defense OIG issued a report dated November 25, 1992,
describing the abuse of the ID/IQ type contract at the Defense Department. On
January 19, 1993, we issued a report that also addressed this issue. On August 7,
1995, SBA amended the regulation closing the ID/IQ loophole.

Another loophole permitted splitting of one proposed $9 million contract into
three contracts, each with a value under the $3 million threshold. In a May 16, 1994,
audit report, we recommended that the 8(a) program office implement procedures to
preclude such contract splitting in these awards. While the 8(a) program office agrees
with the recommendation and stated that they have initiated action to implement the
recommendation, as of a few days ago, the procedure has not been implemented.

The 1 988 8(a) amendments also required 8(a) companies to obtain certain levels
of non-8(a) business to learn how to survive in a truly competitive business
environment. This requirement is known as competitive mix . While this requirement
resulted in competitive mix targets for companies in the transitional stage of the
program, MED has not effectively enforced competitive mix requirements and many
companies are not in compliance with these requirements. In a September 29, 1995,
audit report, we noted that over one-third of 8(a) companies (in the transitional stage



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with 8(a) revenue) were out of compliance with the program's competitive mix
requirements. More significantly, 63 percent of the 8(a) revenues awarded to
transitional stage companies (in the last financial period reported) went to companies
that were not in compliance. We believe this situation has developed because MED
has attempted to enforce this requirement largely through voluntary methods. The OIG
recommended that mandatory limits be placed on the dollar value of 8(a) contracts
awarded when 8(a) companies do not meet their competitive mix requirement. In
response to the recommendation, MED agreed. We have recently consulted with MED
officials on an appropriate formula for use in calculating the mandatory limits.

* Excessive Subcontracting/Brokering . A major concern throughout the 8(a)
program has been that the benefits would not accrue to the disadvantaged participants.
In extreme cases, this would occur where a minority "fronts" for a non-minority owner.
Other situations that allow significant pass-throughs of benefits would be through
excessive subcontracting and brokering or packaging arrangements Consequently,
SBA's regulations have strict standards relating to ownership and the simple, classic
"fronts" do not seem to be a problem. The more complex arrangements involving joint
ownership and control issues, such as those pointed out in the GAO report, will,
however, always be elusive. SBA also has regulations on the allowable levels of
subcontracting; a requirement that supplies furnished through an 8(a) contract be
manufactured by either the 8(a) company or a small business, if a small manufacturer
exists (known as the non-manufacturer rule); and a prohibition on brokering and
packaging These regulations, however, have not been effective in preventing



114



substantial percentages of 8(a) funding from ending up in the hands of large
businesses.

Audits performed by the OIG and other Federal agencies have disclosed a
number of instances in which 8(a) contractors provided significant amounts (more than
50 per cent of the total contract value) of equipment on contracts awarded under
Standard Industrial Classification codes for services. These 8(a) contractors, however,
were not manufacturers or regular dealers in the equipment, as required by SBA's
regulations.

These same audits also disclosed that much of the equipment was obtained from
large manufacturers, a violation of SBA's non-manufacturer regulations. This improper
subcontracting occurred because SBA did not apply the subcontracting, brokering or
non-manufacturer requirements to contracts which are classified as services type
contracts. MED officials initially disagreed with our audit on this subject, stating that
subcontracting, brokering or non-manufacturer requirements did not apply to contracts
classified as service type contracts. After much negotiation, the former Associate
Administrator for MED agreed to study this situation and take appropriate actions. To
date, nothing has been done on this important issue.

Other subcontracting problems noted include the lack of notification to SBA for
increasing subcontracting subsequent to contract award, the lack of monitoring of
excessive subcontracting, and the difficulty in measuring whether a company has
subcontracted too much. These are important considerations that preclude fronting or
brokering, help ensure that 8(a) participants receive their fair share of business, and



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contribute to 8(a) companies' development through their experience in fulfilling contract
requirements. Again, no new actions have been initiated by SBA to address these
issues.

To correct these problems, there needs to be enhanced control over the
subcontracting activities of 8(a) companies. This will require careful consideration of
the concept of delegating 8(a) contract administration to other agencies, which has
been discussed frequently as a way to streamline the 8(a) program. In my judgement,
such a broad delegation will only result in increased problems. Unfortunately, we
believe some abuse in subcontracting occurs with the full knowledge of the Federal
procuring entity. Under current procedures, the SBA has some opportunity to monitor
subcontracting because all subcontracting arrangements have to be approved by the
Agency Under the delegation proposal, SBA would be removed entirely from the
contract award and administration process; consequently, SBA will have little
opportunity for determining whether abuse is occurring

Lastly, SBA referred to the Walsh-Healey Act for definitions of "manufacturer"
and "regular dealer" to prevent brokering, the prevention of brokering in federal
contracting was one of the purposes of the Walsh-Healey Act Now that the relevant
portion of the Walsh-Healey Act has been repealed, SBA may have difficulty with the
definitions by which to judge 8(a) firms because the references to these definitions will
be removed from the Federal Acquisition Regulations and case decisions relating to
interpretations of Walsh-Healey will be obsolete.



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In conclusion, I would like to respond to the four questions posed in your letter
requesting me to testify:

1. What explanations for thftse abuses were offered bv either the SBA program
staff or the 8(a) participants involved? Given the wide-spread problems and number of
different situations, this question has many answers. In general, however, SBA
program officials stated that many of the problems pointed out were not really problems
and the OIG was off-base. In addition, MED officials believed that resources to
administer this program were insufficient, both in terms of numbers of staff and resident
expertise. I would like to emphasize, however, current management recognizes that
these are problems and appears committed to changing the program.

The most common response from 8(a) participants is that they were unaware
that they were doing anything improper. SBA and the procuring agencies rarely pointed
out any problems, therefore the participants believed they were operating properly.

2. Was there evidence of further abuse of the eligibility standards of the 8(a)
program or were these isolated incidents? As pointed out, there is potential for
substantial abuse in the continuing eligibility area, especially relating to the more
successful companies. Because of both the statutory exclusions and the complexities
of the law and regulations, continuing eligibility is difficult to administer and, therefore,
subject to abuse. The OIG has not reviewed the initial eligibility process in detail,
therefore, I cannot comment on its operation.

3. Do these abuses stem from poor management practices or is there an inherent
flaw in the makeup of the 8(a) program? The abuses stem from both. In theory, the



117



current legal and regulatory structure, if property administered, could preclude much of
the abuse. As I have mentioned, the laws and regulations are too complex for both the
level and technical sophistication of the SBA staff.

There also has been an institutional mind set in the MED program that led to
weak enforcement of regulations and approvals of questionable practices. This stems
from SBA's legitimate advocacy role for 8(a) companies and a history of lax
management of the program. I have seen, however, a change in attitude over the past
two years Based on discussions with the current program managers, I believe the
program can be reformed significantly.

The greatest inherent flaw in the program is that there are almost no boundaries
on the amount of contracting a company can do and remain disadvantaged. When any
Federal program allows a company to receive a half-billion dollars in contracts, while
others receive none, some blame must be placed on the program's policy and
procedures The 8(a) program could be restructured to provide assistance to a much
larger universe of disadvantaged companies, be easier to administer, and reduce the
attraction of abuse by establishing a cap on the amount of assistance any one
participant could receive.

4 What explanations were offered bv the various contracting officials for their


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Online LibraryUnited States. Congress. House. Committee on SmallThe abuses in the SBA's 8(a) Procurement Program : hearing before the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, first session, Washington, DC, December 13, 1995 → online text (page 10 of 20)