Investigators detail mismanagement, fraud in SBA set-aside program

Despite repeated assertions by officials at the Small Business Administration over the past two years that internal controls were in place to protect a federal program designed to help small businesses in poor areas, government watchdogs said Thursday that the program is riddled with fraud.

Government Accountability Office officials told lawmakers Thursday that companies ineligible to participate in the Small Business Administration's HUBZone program -- which provides assistance to small businesses in "economically distressed" areas -- had collected fraudulently billions of dollars in federal contracts. To legally participate in the HUBZone program, small businesses must locate their principal offices in one of more than 14,000 areas identified as economically distressed. In addition, at least 35 percent of the company's full-time employees must live in such HUBZones.

At a House Small Business Committee hearing, GAO officials testified that as part of the agency's investigation, four bogus companies were created that still receive HUBZone certification. One of those companies used a Starbucks coffee shop as its address.

During the hearing, SBA Acting Administrator Jovita Carranza acknowledged that the agency's management of the program "leaves considerable room for improvement."

"I am … frustrated and shocked at the depth of this issue," Carranza told the committee as she outlined a lengthy list of planned reforms.

But Carranza's frank assessment of the program's weaknesses differed considerably with the earlier posture of other top agency officials.

On March 30, 2006, Anthony Martoccia, associate deputy administrator in the SBA's Office of Government Contracting and Business Development, told House Small Business Chairwoman Nydia Velasquez, D-N.Y., that he was "not aware of any fraud involved in the program."

And as recently as February 7 of this year, then-SBA Administrator Steven Preston told Velasquez he believed the agency possessed "sufficient internal resources" to prevent fraud in the HUBZone program.

On Tuesday, Velasquez was incredulous as she peppered Carranza for an explanation.

"It is so easy to break into the HUBZone program that investigators -- using fake addresses and forged credentials -- were able to do so in a matter of weeks," Velasquez said. "The entire process was easier than getting a library card."

GAO investigators agreed with the analogy, pointing out that at least libraries typically ask applicants for valid photo identification.

Using fictitious names, bogus principal addresses and imagined employee information, GAO succeeded all four times it attempted to win HUBZone certifications. In addition to the Starbucks address, investigators claimed to be located at Post Office box addresses or in a virtual office where no actual work was conducted.

With little to no inquiry by SBA investigators, each application was approved within two to five weeks.

"Anyone with a computer and a mailbox and who is willing to lie can become a HUBZone company," said Gregory Kurtz, the GAO's managing director of forensic audits and special investigations.

Rep. Heath Shuler, a Democrat from North Carolina, said that since the focus of the fraud investigation was on just a narrow segment of the HUBZone universe, potentially billions of dollars of fraud still could exist.

"This is our tax dollars going to these programs," Shuler said. "We have a crisis on our hands."

GAO officials also testified that SBA's map for determining whether a company is located in a HUBZone is out of date by at least 18 months. The map incorrectly includes 50 metropolitan counties and excludes 27 others.

GAO found that on only 36 percent of applications were companies asked by the SBA to provide proof of their office location. And only 5 percent of certified HUBZone firms are audited for compliance by the SBA each year. Only one company out of 125 applicants examined by GAO received a site visit from an SBA inspector.

In October, the House passed a bill that would require on-site evaluations of all HUBZone firms prior to granting a second program-related contract. The Senate has not moved on the bill and the Bush administration opposes the measure, saying it "would create a large burden on the Small Business Administration, as these firms are widely distributed and often located in rural areas."

Loopholes appeared to allow at least 10 companies in the Washington, D.C. area to gain access to the program -- and to more than $100 million in contracts -- even though they did not meet program requirements.

For example, Quantum Dynamics qualified for the HUBZone program using the address of a small room above a dentist's office in McLean, Va. When investigators visited the room, they found only a computer and filing cabinet. No employees were present, and the building owner told GAO investigators that no one had worked there "for some time." The company has an Army contract worth up to $40 million.

When confronted about the irregularities, officials with many of the companies cited in the report appeared unconcerned about potential consequences, displaying an attitude that amounted to 'this is just how the game is played,' said Bruce Causseaux, GAO's senior level specialist in forensic audits and special investigations.

SBA's Carranza told the committee that such firms likely will be suspended or debarred and that the cases cited by GAO will be recommended for criminal prosecution.

Carranza also announced that SBA has moved swiftly to implement a number of other changes, including replacing the HUBZone program's leadership. The agency is recruiting additional staff and also will perform unannounced site visits at companies with HUBZone contracts. SBA is notifying companies that it may ask for documentation at any time as part of program examinations.

The agency also has awarded a contract to update and recertify its HUBZone map. The agency discovered the map problems months earlier during a congressional inquiry, Carranza said.

A contract also has been signed to assist in clearing a backlog of recertification applications and to decertify companies no longer eligible for the program.

A third contract, with an independent auditor, will focus on additional program improvements including potential policy changes, IT modernizations and improved training.

Finally, the SBA is developing an assessment methodology to measure the program's overall effectiveness and management. The methodology will be released for public comment in August.

Carranza declined a request from Velasquez to temporarily suspend all new HUBZone applications until the reforms are implemented.

"While it pains me to have to describe these problems with our HUBZone program, I am also very confident that we can solve them, and in so doing, ensure that the HUBZone program accomplishes the noble purpose for which it was established," Carranza said.

In total, nearly 13,000 firms participate in the HUBZone program. In fiscal 2007, these companies received roughly $8 billion in set-aside federal contracts.