SBA under pressure to probe contracting issues

Amid controversy over accusations that large contractors are eating up contracts reserved for small businesses, the Small Business Administration is scrambling to address a senator's request for the agency to perform an independent audit and punish rule breakers.

Sen. John Kerry, D-Mass., ranking member of the Senate Small Business and Entrepreneurship Committee, sent a letter to SBA Administrator Hector Barreto Tuesday citing the agency's "failure to effectively advocate on behalf of small businesses." He asked Barreto to explain how SBA will increase its monitoring of small business contracts.

Kerry sent a separate letter to SBA Inspector General Harold Damelin asking him to enforce criminal penalties, which can include fines up to $500,000 and 10 years in prison, if large companies are found to have misrepresented themselves as small businesses.

"By failing to enforce the law and the penalties it affords, the SBA is fostering an atmosphere that encourages widespread fraud and abuse in small business contracting," Kerry wrote.

Raul Cisneros, a spokesman for SBA, said he had not yet seen Kerry's letter, but the department had received it. "It will be worked out," he said.

The agency has been under fire since December to show that it does stand by its mission of protecting small businesses. At that time the agency's Office of Advocacy issued a report that found $2 billion worth of fiscal 2002 contracts thought to be awarded to small businesses were actually awarded to large corporations, including defense giants Raytheon Co. and Northrop Grumman Corp.

Governmentwide, agencies are supposed to award 23 percent of contracts to small businesses, which are defined by annual revenue and number of employees.

Shortly after the report's release, SBA issued a fact sheet outlining steps it has taken to "ensure that all of the dollars awarded in the name of small business go to small business." It includes a Dec. 21 policy change that requires small businesses to recertify their size when their contracts are transferred to a new company, which often happens when a small business is acquired by a large business.

Cisneros said in many cases, small companies grew and were acquired by larger companies, which were then miscoded as small businesses.

John McDowell, spokesman for the Office of Advocacy, said the report did not seek to determine whether companies acted illegally. "Our report is not talking about right or wrong….people were taking advantage of what was legal at the time," he said.

Companies named in the report denied any wrongdoing. "We have done an internal audit and we're in full compliance, so you need to talk to the government about that," said Jim Fetig, spokesman for Raytheon.

"Any error occurred on the government side, certainly not on the contractors' side," said Randy Belote, spokesman for Northrop Grumman. "We're waiting for direction by the government to resolve any discrepancies in coding."

Prior to the December report, SBA was already considering simplifying its small business size standards. Last week, SBA extended its deadline for comments on how it should set up its new rules. The Office of Advocacy submitted a public comment Jan. 13, urging SBA to listen to diverse perspectives and to consider the economic impact, including potential job loss, to any new rules.

In an interview earlier this month, David Safavian, head of the Office of Management and Budget's Office of Federal Procurement Policy said the Office of Advocacy's findings were an indication of the agency's success with its mission.

"We are seeing small companies graduate to a larger size because they are growing, and that is a tribute to the Small Business Administration's efforts. Another part of the success story is we have small companies that are profitable enough to be bought out by large companies," he said.

He added that letting companies self-report their size "allowed for some of these cases to sneak through the process," but that he has seen no evidence that companies are purposely lying.

The solution to the size problem is not as simple as accurate labeling. A company may be small at the time of the contract award and then grow, either temporarily to fill a contract's demands or permanently. A small business may be bought by a larger company and have ongoing government contracts. Government regulations that put a cap on size may cause companies to limit their growth in order to maintain their eligibility for small business contracts.

If small businesses are forced to give up their status on existing contracts because of growth, "then the contracting officer will be reluctant to give them a contract," said Cathy Garman, senior vice president of public policy at the Contract Services Association, an industry group.

The Dec. 21 policy change addresses the confusion that comes from small companies that are acquired by larger ones. In certain situations, a small business is required to transfer its existing contracts to its new owner, and the contract can no longer be counted toward an agency's small business contracts. The small business would be allowed to complete its existing contracts, but could not call itself small in any new contracts, explained Gary Jackson, SBA's assistant administrator for size standards.

That situation has become increasingly common lately, as mergers and acquisitions picked up speed, according to a report by Grant Thornton LLP. The company surveyed 120 government contractors and found 42 percent had been approached about selling their company during the previous year. The survey also found that in 2003, there were 147 mergers of service and technology companies.

Because value is based largely on relationships and existing contracts, any rule change that affects how contracts are counted has a potential impact on whether or not small businesses appeal to large companies looking to buy them.

"You're buying the relationships they've established over the years and the contracts they're working on," said Kerry Hall, a partner at Grant Thornton.