The Incredible Shrinking Company

Corporate giants snag federal small business set-aside contracts.

By Christopher Moraff

Between 2002 and 2005, St. Augustine, Fla., exercise equipment vendor Raul Espinosa watched mystified as, one after another, a series of Air Force contracts he had placed bids on were given to other companies. Of the 14 bids that Espinosa has documented, his company, FitNet International, did not win one. To his surprise, Espinosa learned that some of the competitors he was losing contracts to had never even bothered to bid on them.

Espinosa was no stranger to adversity. At 14 he came to the United States alone from Cuba and managed to work his way through college and graduate school. He formed FitNet in 1995 to sell exercise equipment to the U.S. military. A certified minority-owned small business, FitNet describes itself as a purchasing alliance that represents over 400 equipment suppliers. The company has three employees and grosses under $1 million a year.

Now, Espinosa was getting a first-class lesson in corporate pandering that he'd never bargained for; it would take him three years to uncover the full story.

In June 2005, the Air Force came under scrutiny for its dealings with a company called The Corps Group (TCG), which Espinosa alleged had stolen his contracts for fitness equipment. In fact, TCG was a unit of the much larger Precor, Inc., and therefore ineligible for the small business set-asides it had received.

In a brief filed in June 2005 by the Small Business Administration's (SBA) Office of Hearings and Appeals, Administrative Judge Christopher Holleman summed up: "The Administrative Judge finds this case profoundly disturbing. The Air Force has filed two contradictory documents with this office, identifying different awardees for this contract. Other documentation the Air Force submitted to the Area Office appears to treat TCG and Precor as one entity. The Air Force is now candid that it awarded a contract designated as a small business set-aside to a large firm."

Holleman continued: "The Air Force has thus filed at least one false and misleading document with this office. This is inexcusable. The Air Force's actions here are negligent at best, at worst deliberate attempts to mislead SBA and this Office."

But Espinosa admits his is a victory in name only. "You might win the size protest, but you can't claim the contract because the agency allowed delivery to take place and what's worse, the penalties for the violations aren't enforced."

Dreaming of a Small Business

Espinosa's situation is not unusual. In June 2002, the ranking Democrat on the Senate Small Business Committee, John Kerry, acknowledged that "the federal government today is not keeping faith with America's small businesses."

Small business has been called the cornerstone of the American dream--and in the nation's early years, small enterprises predominated. Small business became largely disengaged from the gold rush of 20th century industrial capitalism. But even in an economy increasingly at the mercy of superstores and megalith corporations, many Americans still hold fiercely to the myth of the mom-and-pop establishment and what it means to our culture. Politicians recognize--and don't hesitate to play on--the special place small business holds in the ideology of U.S. capitalism. In the name of freeing small businesses from burdensome taxes and regulations, conservatives champion work-ethic individualism as a rationale for dismantling everything from welfare to environmental protections to Social Security. But their rhetoric invokes small business much more than their policies actually benefit it.

George W. Bush is no exception. Bush unveiled his small business agenda in March 2002. Among other steps, he pledged to improve the access of small businesses to federal contracting opportunities. The Bush administration has in fact modified one common practice used to disqualify small firms from federal contracts--"bundling," or consolidating several smaller contracts into one large "mega-contract" designed to exceed small business contracting requirements. But large corporations and their friends among federal procurement officials still have a range of tactics for squeezing out small businesses. For example, critics charge that the size-vetting process that certifies businesses as "small" itself serves as a vast loophole for big contractors.

At the same time, the administration has slashed the SBA's budget. The SBA is charged with ensuring that small businesses get their mandated share of federal contracts. But time and again, the agency has complained that it simply doesn't have the resources to do the job. The 2006 budget earmarks just $456.5 million for the agency--nearly 5% less than last year, and a 60% drop from the $1.1 billion the Clinton administration provided for 2001. Commenting on the 2006 budget proposal, Sen. Kerry recently remarked, "Over the last four years, President Bush has cut the SBA's budget by more than one-third, leaving our entrepreneurs struggling for access to credit, federal contracts, and adequate training."

Today, a weakened SBA that lacks the capacity for monitoring and enforcement means a culture ripe for procurement exploitation. Under current law, 23% of the estimated $270 billion in federal contracts must go to firms certified as small by the SBA. But in reality, large corporations like Raytheon, Carlyle Group, Titan, and Boeing are taking advantage of an overtaxed system, using deception, collusion, and influence to garner set-aside contracts intended to fulfill the federal government's pledge to support small business.

Serving the War Effort

Today's SBA evolved out of several older agencies originally created to help businesses of all sizes recover from the Great Depression and then to maximize the U.S. war effort in World War II and Korea.

In 1932, President Hoover formed the Reconstruction Finance Corporation (RFC), a government-assisted loan program for guiding both large and small enterprises through the post-depression years. The RFC grew significantly under Franklin Roosevelt's New Deal, and by 1939 had been merged into the Federal Loan Agency.

As the country geared up for war in 1942, the Smaller War Plants Corporation was formed which made direct loans, encouraged financial institutions to make credit available to small enterprises, and advocated small business interests to federal procurement agencies and large firms.

The SWPC was dissolved after the war, but was followed up during the Korean conflict with the Small Defense Plants Administration. The SDPA was charged with vetting small businesses for the RFC. By the 1950s, however, critics of the RFC, led by Senator J. William Fulbright, leveled charges of influence peddling--among other ethical and legal lapses--at the agency, and a subsequent investigation resulted in its dissolution.

Soon thereafter, President Eisenhower proposed the creation of a new small business agency. The Small Business Act of July 30, 1953, created the SBA to "aid, counsel, assist and protect, insofar as is possible, the interests of small business concerns" and ensure small businesses a "fair proportion" of government contracts and sales of surplus property.

Since the 1950s, the SBA boasts, it has helped supply over 20 million loans, guarantees, contracts, and counseling sessions to America's small business community. But how many of these firms are truly small is a matter for debate.

Who Defines "Small"?

A widely accepted statistic says that somewhere around 98% of all businesses in the United States employ fewer than 100 workers, yet under most SBA guidelines, any business with fewer than 500 may qualify as small.

Given the payoff in contract set-asides, what defines a company as small is a matter of no little consequence and one that has been contested and rethought for years. The government's Central Contractor Registration database has historically relied on a hodgepodge of staff-size and revenue-based indicators, creating a process that many argue is both complex and unreliable.

Until last April, companies themselves--on the honor system--supplied the information on which these classifications were made. Now, procurement offices, woefully understaffed for the job, will research and determine firms' classifications.

As far back as 1998, the SBA's own Office of Advocacy was aware that the federal contract award system was seriously flawed. That year, the agency found, small firms received just 18.3%, or $33.2 billion, of the $181.7 billion spent by the federal government in prime contracts over $25,000. But officials did little until 2002, when the SBA commissioned a landmark study from Virginia-based research firm Eagle Eye.

According to that study, at least 44 large companies erroneously received small business contracts in 2002. Meanwhile, the 44 admittedly miscoded businesses--heavy-hitters like Raytheon, Hewlett-Packard and the Carlyle Group--represented over $2 billion worth of federal contract money that year. But the SBA refused to make Eagle Eye's report public, offering an edited version instead.

A California-based small business advocacy group, the American Small Business League, cried foul. The group sued the SBA for the original document, and the administration dug in for a fight. The ASBL, led by Lloyd Chapman, charged that the SBA was attempting to whitewash the study's results.

Last spring, things began to heat up. With the ASBL lawsuit receiving increasing media attention, a federal court finally ordered the SBA to comply with the Freedom of Information Act and release the unedited report to the ASBL. A threatened SBA appeal never materialized, and on June 21, the SBA handed over the full report to Chapman's organization.

In FY2002, according to the report, the 1,000 largest "small" contractors accounted for 53% of the approximately $53 billion in total contract dollars allotted for small businesses. Among these top 1,000, $1.6 billion in contracts went to 32 firms the analysts designated as large businesses, while another $275 million went to eight firms categorized as "other." The report concluded that $4.5 billion in contracts went to a total of 167 firms "exhibiting inconsistent small business coding."

The researchers listed eight possible reasons for the errors, ranging from the innocuous (firms outgrowing their size class during the year) to the illegal ("vendor deception").

The SBA's edited version of the report omits the reference to vendor deception. Still, SBA spokesperson John McDowell defended the SBA's decision to release an edited version. "There is nothing sensational about the draft as compared to the final product," McDowell said. "All of our edits were designed to eliminate speculation and produce a quality report that was grounded in sound data."

But ASBL's Chapman says he believes the SBA still isn't coming clean and asserts that the real number is closer to 400 miscoded companies and $40 billion in lost contracts.

"I suspect if I can get a full list of those companies that were coded as small businesses that year, I'll be able to prove that the SBA deliberately withheld information," Chapman told me. But the SBA isn't budging.

In the meantime, if it can't get the full list of small business names, the ASBL hopes to at least get access to documents detailing protests filed against the large firms that falsely claimed to be small businesses. He says the SBA is refusing to provide those reports too, and so just before Thanksgiving the ASBL filed another Freedom of Information Act suit against the SBA. The ASBL hopes the documents will be the first step in the process of eventually bringing the culprits to justice.

Currently, size standards are only enforced if a contracting officer, another bidder, or the SBA itself protests a company's classification. Successful protests are rare. In 2002, for example, the SBA processed 383 of these protests, 29% of which were dismissed on procedural grounds. Of the remainder, 85 firms were found to be misclassified.

Nonetheless, no company has ever been prosecuted for intentionally falsifying its status, an offense punishable under the Small Business Act by up to 10 years in prison. Despite court findings to the contrary, the SBA argues that it has been unable to prove any fraud took place--a primary component of any action.

"It's time for the Attorney General to stop helping the SBA withhold information on contracting abuse and begin investigating which federal officials have been involved in allowing federal small business contracts to be awarded illegally to large corporations," Chapman said in a statement announcing the latest ASBL suit.

It's All Politics

Olympia Snowe (R-Maine), who chairs the Senate Committee on Small Business and Entrepreneurship, toes a fine line between praising and openly criticizing the SBA and its efforts. One of her first actions as incoming chair in 2003 was to ask the Government Accounting Office to investigate irregularities in the Department of Energy's contract awarding process.

The GAO found that between 2001 and 2004, the Energy Department vastly overestimated the number of contracts it was awarding to small businesses, leading to accusations of a cover-up. The findings showed that 13 large contractors overstated their subcontracts to small businesses, in violation of SBA guidelines. Twelve of the 13 reported meeting or exceeding their small business subcontracting goals, while only four actually did.

Commenting on the report, Snowe said, "The combination of misleading reporting by large contractors and lax oversight by Energy Department officials is unacceptable. The integrity of the subcontracting process must be restored immediately." She went on to say that small business owners have little assurance that the department complies with the Small Business Act.

In response, the department agreed to better police itself, prompting Snowe to declare a victory--even though, according to the Eagle Eye report, the department accounted for less than half of one percent of miscoded contracts government-wide.

On October 20, Democrats on the House Small Business Committee released their sixth annual scorecard on small business contracting. The scorecard, which measures how well 22 federal agencies are meeting small business contracting goals, found that while the federal marketplace grew by 3% to nearly $295 billion in FY2004, contracts to small businesses declined by 31%--costing small firms an estimated $1.6 billion in contracting opportunities.

The scorecard singled out contracts for post-Katrina rebuilding efforts in the Gulf Coast as especially worrisome. It seems things are not getting better. Commenting on the report, Rep. Nydia M. Velazquez (D-N.Y.), ranking Democrat on the committee, remarked, "It makes absolutely no sense that small business opportunity is declining while this nation's federal marketplace is simply flourishing."

Last May, the top procurement official in the Bush administration since 2003, David Safavian, speaking at a National Small Business Association conference, admitted that there are agencies that "aren't even trying" to achieve their mandated small-business procurement levels, and that the government's data on the matter are flawed. Safavian pledged to do better.

Now he will not get the chance. On September 19, federal authorities arrested Safavian on charges of making false statements and obstructing justice, related to his role in the Indian gaming scandal centered on Jack Abramoff. The charges against Safavian stem from actions taken before he became chief of the Office of Federal Procurement Policy. Still, as details of his story dribble out, they are not likely to bolster small business's confidence that this administration is committed to tackling their problems. For example, Safavian came to know Abramoff when they were both associates at the Washington, D.C., law firm Preston, Gates and Ellis--which happens to be the paid lobbying firm for at least two of the large corporations that received no-bid contracts for post-Katrina services, Shaw Group and Fluor Corp.

Nine days after Safavian's arrest, Rep. Chris Van Hollen (D-Md.) joined Democratic members of Congress in drafting a letter to the U.S. Comptroller, asking him to investigate any possible misconduct in the federal contracting process. In the letter, Van Hollen asserts: "It cannot go unnoticed that perhaps the key government official dealing with federal procurement and the management of $300 billion worth of federal contracts has been arrested in connection with his past role in the procurement process."

Meanwhile, the "Small Business Index" released in November by House Democrats indicates that small business confidence hit an eight-year low in the third quarter of 2005, compounded by high energy prices, dwindling access to capital, and the devastation wrought by Hurricanes Katrina and Rita.

Still, small business ownership remains an aspiration for plenty of Americans, and politicians from across the ideological spectrum continue to pay lip service to the sector's importance. But the federal government is failing to fulfill its pledge that small businesses will receive a fair share of government contract spending. Until some deeply embedded institutional practices are overturned, small businesses are not likely to reap the benefits the political system has promised them.

Christopher Moraff is a Philadelphia-based writer and reporter. He last covered SBA contracting misappropriations for Entrepreneur.