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With the growth of the homeland security industry, many companies are now wondering how they can get a share of the contract and grant funds that the government is parceling out. There may be great opportunities for some businesses, but management must first understand the risks and potential pitfalls associated with bidding for federal homeland security contracts.

Security professionals can begin by educating themselves about a company’s obligations under federal acquisition rules, the process of government procurement, the types of fraud that can arise, and how a company can prevent fraudulent activity. This last concern is the focus of this article.

Types of fraud. Fraud can occur at any point during the process and can be committed by anyone. Following is a discussion of the potential pitfalls.

Before solicitation. Most of the fraud schemes that occur before a bid solicitation originate with corrupt government contracting officials. Since they control most of the information at this point, an unscrupulous official may try to gain an advantage by becoming too close to a company’s officials or employees. They will expect a quid pro quo for steering business to the company.

Employees, especially those in the accounting, purchasing, marketing, and sales departments, should be made aware of how to identify improper overtures by contracting officers. And management should make clear that the company does not view this as an acceptable way of getting business.

At this phase, some examples of schemes by government officials include giving restricted information to the company, such as advance copies of the technical specifications, or structuring the statement of work to include only a handful of preferred contractors. Any odd, improper, or questionable advances should be documented and reported to the proper company personnel for follow-up with law enforcement or a government oversight agency.

While the majority of schemes in this cycle originate with government employees, collusion between an employee and his or her private sector counterpart can also occur. Company employees can also manipulate certain schemes, with or without the assistance of a government insider, to ensure that a contract is awarded or that it is larger than necessary.

Potential indicators may include receiving restricted information on the statement of work, technical requirements, or other information not available to competitors or the public; limiting or breaking up a proposal to keep it under the monetary limit of scrutiny; and improper contact with government officials at social or professional events.

Other concerns include price fixing—setting an artificially high price or an intentionally low price with the intent of raising it after winning the bid—or bid rigging—arranging for one company to win the contract and then hiring the other companies as subcontractors. A company that does not wish to get caught up in any such fraud schemes must have appropriate internal controls and a strong audit regimen designed to send a clear message to staff and to catch any signs that such activities may be underway.

Negotiation phase. In the negotiation phase, the contract is vulnerable to exploitation by company employees. Since the government negotiates with a designated company official, this person could potentially do serious damage. Schemes may involve giving false statements about the company’s ability to perform, its financial assets, or its business status—such as misrepresenting itself as a small business or a minority-or woman-owned business.

Another scheme may include a shell company bid. This is where the company employee submits two bids—one for the company and one for his or her personal business, the shell company. Of course the employee’s personal business will have the lower bid.

Evidence of this type of fraud may include bids that are similar in appearance, name, submitter signature, or other information. Linking this information through a comprehensive investigation of local business records and computer databases will often reveal the guilty party’s involvement.

Management, with proper oversight and internal controls, can ensure that personal proposals are not submitted. The keys are to conduct spot checks and audits in addition to keeping track of employees’ side jobs.

Execution phase. Almost anyone in the company who has the knowledge, opportunity, and need can take advantage of the contract during the execution, administration, and closeout phases.

One type of fraud in this stage is defective pricing. It involves inflating costs by intentionally using old or inaccurate cost-price models. Another type of fraud involves labor costs, which generally comprise the largest part of any contract. Labor-cost mischarging occurs when time cards are altered, there is little or no supporting documentation for labor costs, or overtime is charged when employees are not working.

A third type of fraud is tied to materials to be used in the manufacture of the product being made under the terms of the contract. Materials can be altered, substituted, or bought at lower than market price.

For example, Ralph Cooper was caught and convicted for providing counterfeit and substandard parts for critical functions of aircraft, including the AWACS surveillance plane, and the F-16 and F-14 fighter jets. To manufacture a critical seal for the aircraft, Cooper’s company subcontracted with a nonapproved, foreign manufacturer in Taiwan that used a substance that would not have withstood the exposure of the extreme heat or fluids in the aircraft.

Cooper obtained these parts at a cost of $1 each. The government paid more than $54,000 for the lot—giving Cooper a profit margin of 35 times the normal amount. In addition to a nearly three-year prison term, Cooper was ordered to serve three years of probation and to pay back the money.

A fourth scheme is called stage-payment fraud. It entails lying about the percentage of work completed to obtain more money, as well as the possibility of future work.

The closeout phase of the contract is most vulnerable to fraud. A corrupt accounting employee may create a billing overcharge or a corrupt manager may try to bill for nonexistent overtime. Proper oversight and constant monitoring by both the company and the contracting agency are required. Because of the risk during this stage, contracts are under greater scrutiny by the government during closeout. Government contracts allow full audits or investigations when suspicious activity is reported.

Company response. The company’s response to an allegation of procurement fraud made by an oversight agency, whistleblower, or law enforcement entity will be essential to the successful outcome of the claim. Trying to cover up misconduct by any employee is not an acceptable option.

From the viewpoint of a security manager, the probable response will include some type of internal investigation. The allegation should also be reported immediately to the appropriate authorities at DHS (or the contracting agency) to ensure that if the allegation goes to court, the company can be guarded against allegations of conspiracy. Management should take note that under corporate charging guidelines from the U.S. Department of Justice, credit is given to companies that voluntarily disclose problems and cooperate with the investigation.

Prevention. Ideally, a company will never find itself in need of cooperating in a fraud investigation. To achieve that goal, the company must have a prevention program designed to identify potential areas of concern, potential people of interest, and operations that should be continually monitored. Once these vulnerabilities are identified, the company can establish internal controls and audit procedures to reduce the opportunity for fraud and to ensure that any attempts to circumvent protocols will be detected quickly.

A close working relationship between the audit department and the security department will increase the company’s chances of detecting fraud early and of conducting a successful investigation if fraud is suspected. Security and audit personnel may want to collaborate on spot audits and other regular investigative actions as well. The company must show staff that it is serious about prevention and detection of fraud.

Awareness training. Another element of a prevention program is a strong employee-awareness program. It is important to educate all employees on the basic signs of procurement fraud and on the penalties for engaging in any such activity. This can often be done with the help of the human resources or the legal department.

When employees are required to attend workshops and continuing education on how to detect and prevent fraud, they will get the message that criminal or unethical behavior will be punished and reported to the authorities. A fringe benefit to educating the workforce on procurement fraud from insiders is that it also helps prevent the company from falling victim to a purchasing or acquisition scheme by a subcontractor or supplier.

This educational process will also show the authorities that the company is making a good faith effort to detect and deter any fraud. The training should be well documented so that a record of it exists should legal action be brought against the company.

Code of ethics. The company should already have a code of business conduct or a code of ethics. If it does not, one should be developed before training begins. The code can serve as a deterrent in itself, especially when employees are required to read, understand, and sign it.

Corporate culture plays a big part in prevention. Employees won’t take a talk on ethics seriously if the company’s practices show that management really believes in a win-at-any-cost approach. It’s important that employees see strong management support for honesty. Employees must feel empowered to report misconduct without fear of retaliation.

The security manager should take steps to find out what is occurring in the company that may require inquiry: key personnel defecting to other companies, or improper contact with competitors or government officials. An anonymous fraud and misconduct hotline is recommended as a way to ensure that the security department will be able to receive key information on suspicious activity from people who may see it every day. Security should encourage employees to report behavior that is criminal or violates the company’s code of conduct.

The law. The government is serious about prosecuting corporations and people who commit procurement fraud. To effectively guard against procurement fraud when bidding for homeland security contracts, a security professional must have a basic understanding of the legal ramifications surrounding the procurement process. While this article is not intended to be legal advice, it could be used as a starting place for discussion with in-house counsel, investigators, and audit staff.

The Procurement Integrity Act of 1988 is designed to prevent the improper disclosure of information related to bids, bidders, and sensitive information that could be used by a company to win a contract. These postemployment restrictions regulate the ability of government personnel in the purchasing function to secure post-government employment at companies they have been negotiating with on the government’s behalf.

In the last two years, the case of Darleen Druyan has prompted a review of the hiring practices by government contractors. Druyan, who was a former principal deputy assistant secretary of the Air Force for acquisition and management for nearly ten years, was sentenced to nine months in prison for her misconduct with the Boeing Corporation.

While in her position with the government, she negotiated a contract with Boeing for $20 billion to lease 100 tanker aircraft. At the same time, she was negotiating postretirement employment with Boeing, a violation of federal law. After the scandal broke, several officials at Boeing resigned or were fired, including the chief financial officer and the CEO.

This scandal has heightened corporate awareness of when and how employees are hired, especially when they come directly from the government sector or major competitors. Comprehensive background investigations should be conducted on those employees, especially senior employees, to verify past relationships and to ensure that there was no improper conduct while they were with their prior employer.

The Civil False Claims Act of 1986 is designed to allow the government to pursue contract fraud cases in civil court. The Qui Tam provision of the act allows a private citizen to bring civil action in the name of the government against a contractor. The government may choose to join the lawsuit, in which the citizen is awarded a percentage of the final case settlement. There is also a criminal version of the False Claims Act, which punishes any fictitious, false, or fraudulent claim against the government.

Familiarity with the criminal statutes the U.S. Attorney General enforces, such as mail and wire fraud, false statements given to federal investigators, and major procurement fraud statutes, will be beneficial to a security manager. It is also important to fully understand possible punishments for a company, which could include suspension, debarment, fines, or jail time for certain employees.

Suspension is a temporary disqualification for a limited, specific time period issued when there is adequate evidence of any offenses that indicates a lack of integrity or business honesty. Debarment is much more serious and is a total ban on applying for or being awarded contracts. It generally lasts three years or less and is issued for violations of terms of a contract, willful failure to perform, or any serious misconduct by the contractor.

Dire situations could result from procurement fraud in homeland security contracts. People could die and buildings, neighborhoods, or even cities could be ruined. Prevention, investigation, and reporting by corporate security professionals are the front line of defense in the war against contract fraud, which will also help to further the war on terrorism.

Colin A. May works for a law enforcement association in Alexandria, Virginia. He is a member of the Association of Certified Fraud Examiners.