As long as the federal government has been buying munitions and other provisions to defend the country, there has been defense contractor fraud. There is no dispute that a contractor has an obligation to deal honestly with the government. Oliver Wendall Holmes, Jr., a United States Supreme Court Justice, said it best when he said, “Men must turn square corners when they deal with the Government.” Still, fraud happens.
The temptation to cheat the government to increase profits existed during the Civil War and continued well into the 1980’s. Before the False Claims Act was amended in 1986, the Department of Justice estimated that “between 1 percent and 10 percent of the entire federal budget [was] lost to fraud every year.” S. Rep. No. 345, 99th Cong., 2nd Sess. 3 (1986). Since the vast majority of government contracts related to defense, defense contractor fraud was a huge percentage of the fraud on the government. The problem still exists now even as the budgets have increased. Today, the Department of Defense accounts for 70 percent of federal contract spending, which amounts to $367 billion annually. The constant fight against fraud in defense contracts starts with identifying the most common schemes that deprive the government of the benefit of its contracts. For example:
Virtually every government contract for a product sets forth the specifications of what the government is buying. A common scheme is Product Substitution where the contractor substitutes another product for the one that the government bargained for. In these schemes, the government typically gets a lesser quality product than the one it paid for, and the contractor gets greater profits.
Another common, and sometimes related, scheme involves Worthless/Substandard Product or Service Fraud. Over the decades there have been hundreds of contracts involving worthless or substandard goods. These have ranged from faulty helicopters to defective bullet-proof vests. These frauds are especially troubling because they present risks to the armed forces personnel who must trust the quality of the products and services they use in performing their jobs.
Defense contracts are also prone to fraud because of how the government agrees to pay for what it buys. Defense contracts are usually awarded as either: (1) a “fixed-price” contract; or (2) a “cost-plus contract.” In a “fixed-price” contract, the government pays the contractor a set price for the delivery of the product, without regard for what it actually costs the contractor to make it. In essence, the “cost” is built into the total contract from the start. In a “cost-plus” contract, the government pays the contractor a set price plus a percentage of the contractor’s costs for producing the product which can only be calculated when those costs are actually incurred. Efforts to shift costs between a fixed-price and cost-plus contract, or attempts to improperly inflate costs in order to maximize profit can lead to fraud, including Cost Plus Fraud and Cross-Charging.
Product Substitution Fraud occurs when a government contractor intentionally switches a part (often one of lesser quality) for the part specified in the government’s contract. Government contractors may be tempted to use different, cheaper parts or to source them from non-American subcontractors as a way to increase profits. If a government contractor switches a part that has clear specifications without getting approval from the government, it may be in violation of the False Claims Act.
Worthless/Substandard Product or Service Fraud
Because of the sheer number of purchases the government makes, it cannot perform quality checks and testing on all its purchases; it relies on the government contractors to be truthful when they represent that the products and services provided work as promised. Unfortunately, sometimes representations that a contractor makes to the government about the quality of what is being provided are false and intended to conceal the fact that the government is not getting what it paid for. In cases where the government contractor sells a product or service to the government that it knows is not up to the standard provided for in the contract, or is of such a poor quality to be of little to no use to the government, the government contractor may be liable under the FCA.
Improper Cost-Plus Charging occurs when a government contractor improperly manipulates a cost-plus contract awarded by the government. In the government’s cost-plus contracts it agrees to pay a set price for the product (i.e. an airplane) plus a percentage of the contractor’s costs for producing the product. Since there is no negotiated amount for those costs, there is risk that improper costs will be allocated to the cost-plus contract.
Many defense contractors will have numerous contracts open with the government at any given time. Some of these may be fixed price contracts, others may be cost-plus contracts. Cross-charging may occur if the government contractor charges time and materials it spends working on a “fixed-price” contract to a “cost-plus” contract. In this kind of fraud, the government is harmed in both contracts because it did not get the fixed price it bargained for in one, and it got additional, unauthorized charges in the other.