Suppliers Beware: Using DBEs as Pass-Throughs

 

By Kristin Jones and Michael Schwartz

The latest enforcement trend in disadvantaged business enterprise (DBE) fraud focuses on suppliers.  Federal and state investigations are increasingly looking at pass-through arrangements where a DBE supplier performs no commercially useful function and only lends its name to the transaction so that DBE credits can be obtained. These cases should raise concerns not only for the contractors that benefit from DBE credits and the DBEs who act as pass-throughs, but also for legitimate non-DBE suppliers, which may be subject to criminal or civil liability for participating in such arrangements.

In a typical pass-through arrangement, a non-DBE supplier negotiates a subcontract for materials with a contractor bidding for a government job.  After the contractor wins the job, it informs the supplier that a DBE needs to be used on the project.  A “certified” DBE supplier is located and executes the subcontract, purchasing the materials from the non-DBE supplier, which are then delivered directly to the job site.  The contractor pays the DBE supplier, which then remits payment to the non-DBE supplier after subtracting its own percentage fee. 

The DBE supplier’s role is confined to acting as a middleman, passing invoices between the legitimate non-DBE supplier and the contractor. Recent federal criminal cases in the Northern District of Illinois and the Southern District of New York charged sham DBE suppliers for their roles in pass-through arrangements.  Although neither case ultimately indicted the non-DBE suppliers, both cases investigated them as potential co-conspirators, and other similar investigations are ongoing at the federal, state and local level in other jurisdictions. Legitimate non-DBE suppliers may also be implicated in federal civil cases brought under the False Claims Act or in state and local fraud actions, which are increasingly focusing on suppliers.

So what should a supplier do if asked to use a DBE supplier on a project? 

First, suppliers should understand the rules governing DBE programs.  A fundamental rule of every DBE program is that the DBE must perform a “commercially useful function.” According to Department of Transportation regulations, a commercially useful function means that the DBE “is responsible for execution of the work of the contract and is carrying out its responsibilities by actually performing, managing, and supervising the work involved.” It is not enough for the DBE to participate in a transaction in name only. To make sure a transaction complies with the applicable rules, suppliers should conduct some basic due diligence. 

Ask the contractor or the DBE what commercially useful function the DBE will be performing and if the transaction complies with DBE regulations. If they cannot provide satisfactory answers, the supplier should not participate.  Suppliers should also keep in mind that they may still be found liable even if they claim to be ignorant of the fraud or the DBE supplier is “certified” as a DBE by a government agency. By conducting simple due diligence and strengthening internal DBE compliance programs, legitimate suppliers will be able to better protect themselves in this heightened enforcement environment. For more information on these issues, read a full analysis at Pepper Hamilton.

Kristin H. Jones is a partner in the white collar litigation and investigations practice group of Pepper Hamilton LLP, resident in the Philadelphia office. Ms. Jones specializes in civil and white collar criminal cases arising out of allegations of fraud, false statements and bad faith. Michael A. Schwartz is a partner and co-chair of the litigation and dispute resolution department of Pepper Hamilton LLP, resident in the Philadelphia office. He is a member of the firm’s white collar litigation and investigations and media and communications practice groups. Mr. Schwartz focuses his practice in the areas of criminal defense and counseling, internal corporate investigations, corporate compliance programs, and First Amendment matters.

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