Shell companies have come under attack for obscuring illicit money
flowing into real estate. But it turns out they’re also a problem for the
Pentagon.
Some Defense
Department suppliers have used such front companies to fraudulently win
manufacturing bids, according to a U.S. Government Accountability Office study of
Defense Department contractors.
In some
cases, the shell companies helped contractors obscure that they were making
U.S. military equipment abroad, the GAO said, posing a risk to national
security and quality control. More often, they were used to win contracts meant
for companies owned by disabled veterans or minorities, it said.
The government watchdog reviewed 32 cases that made
their way to criminal prosecutions or lawsuits between 2012 and 2018. Taken
together, they illustrate how the Pentagon’s $350 billion in annual contracting can
be gamed using companies that exist largely on paper.
The problem
could be far bigger, since the GAO’s study wasn’t intended to gauge its scope.
The watchdog said the Pentagon had made only spotty efforts to pierce the secrecy
of shell companies.
“I don’t think anybody really knows the extent of the problem,”
said Robert Burton, a former top government procurement attorney now at Crowell
& Moring. “I do know that some of these folks have become quite proficient
at disguising ownership.”
Secrecy
Haven
Although
shell companies have many legitimate uses, they’ve also become an invaluable
tool allowing terrorists, money launderers, human traffickers and tax cheats to
evade detection.
Even as
countries in Europe and elsewhere are requiring greater disclosure, the U.S.
remains a tax and secrecy haven, allowing so-called beneficial owners who
profit from these corporations to hide their identities by registering in
states like Delaware, Nevada, Wyoming and South Dakota.
One case reviewed
in the GAO’s November report, involving a contractor in Paterson, New Jersey,
shows how the tactic can pose a safety risk for the armed forces. That
contractor, run by a businessman named Ferdi Gul, won 346 U.S. military
contracts over several years to supply parts for torpedoes, bomb ejector racks
and mine clearance systems. His company was registered with the Pentagon as a
domestic manufacturer.
But the
parts were actually made thousands of miles away in Gul’s native Turkey, U.S.
authorities say. Using a front company to disguise the arrangement,
Gul illegally exported military technical drawings there and defrauded the U.S.
of $7 million, they said.
The Pentagon
“routinely encountered significant problems with the quality of the parts,” and
tests revealed “numerous design flaws” in torpedo parts provided by Gul’s
company, court records show.
Two of Gul’s
employees pleaded guilty to their roles in the fraud. Gul, who was first
charged in 2015 and indicted in 2018, hasn’t responded to the case in federal
court in New Jersey. At the time of his indictment, he was believed to be living
in Turkey.
Legal
Framework
Lawmakers in
Washington are trying to bring more transparency to corporate ownership. The
House passed a bill in October that would force states to collect information
about who’s behind shell companies of all types and share it with law
enforcement. A similar bill is pending in the Senate Banking Committee.
In the absence of such transparency, the Defense Department
continues to face financial and national security risks in its supply chain,
the GAO said. Protecting that pipeline is a daunting challenge, and it begins
at the most basic level -- figuring out who actually owns its contractors and
benefits from their work.
The Pentagon
accounted for two-thirds of all U.S. government contracts last year,
awarding $350 billion in business to 38,000 companies. Foreign suppliers are
eligible for some Pentagon contracts but not for those involving certain
sensitive technologies.
The Defense
Department faces “several types of financial and nonfinancial fraud and
national security risks posed by contractors with opaque ownership,” according
to the GAO. Such opaque companies owned by adversary states could pose
intelligence threats, if they steal intellectual property or insert malware
into critical systems, the Office of the Director of National Intelligence said
in a 2017 report.
“Not only
might you have sanctioned parties doing contracting work, but enemies of the
U.S. getting access to our funds, our equipment, our sites and our personnel,”
says Greg Lisa, a Hogan Lovells lawyer who worked at the Treasury Department’s
Financial Crimes Enforcement Network. “That’s frightening.”
The Defense
Department, through a spokesman, declined to comment.
Banning
Contractors
Burton, the
former procurement attorney, said he helped ban contractors for a variety of
regulatory violations during his years of government work. Some of them would
later resume work for the Pentagon using shell companies to disguise their
identities.
“They just
sort of slithered away and created a new entity,” he said.
For foreign
adversaries like China, Russia or Iran, shell companies could be a point of
entry into the Pentagon’s procurement system. Last year, the Air Force scrapped a $420 million contract
to make bunker-busting bombs after a competitor complained that it had been
given to a foreign-owned company with ties to a U.S-sanctioned Russian
oligarch.
Federal contractors are supposed to self-report ownership
information to the government, but the Defense Department often can’t verify
that information.
Defense
Department contracting officers lack the “time, resources or training they need
to conduct in-depth reviews or analysis of the ownership aspects of a
particular company,” the GAO said. The ownership data in the federal database
used by the Pentagon to assess vendors lists only “prime contractors,” not
subcontractors in the supply chain.
Sensitive
Contracts
For particularly
sensitive contracts, the Pentagon has taken steps to address risks from
suppliers with murky ownership. In those cases, it has increased collection of
ownership data prior to awarding contracts and excluded suppliers who pose
significant risks of infiltration by adversaries. It’s also sought to identify
officers, directors and owners of suppliers deemed to pose a supply-chain
threat.
While the
GAO praised some Pentagon efforts to monitor contractor ownership, it said
they’ve been piecemeal. It recommends that the Pentagon emulate the private
sector by using commercially available data mining and analysis tools to
uncover identifying information from a range of databases.
Banks, for
example, use credit bureaus and other data sources to gather personal
information on new customers and to report suspicious financial activities to
law enforcement.
“There’s a
rule in banking called ‘Know Your Customer,”’ said Jeffrey Lovitky, a
Washington lawyer and expert in government procurement law. “In military
procurement, there really should be a rule, ‘Know Your Contractor.’”
In another
case reviewed by the GAO, the government didn’t know the true supplier when it
granted a contract to a New Jersey company to make safety gear called wing pins
for F-15 fighter jets.
The winning
bidder was a company called Allied Components LLC,
created by a man named Robert Luba. It turned out that was a shell company.
Luba and a business associate, Hannah Robert, used another company based in
India to manufacture the components, while lying to the Defense Department
about their supplier, prosecutors said. Working with an unidentified partner in
India, Robert secretly exported technical drawings for aircraft parts, nuclear
submarine torpedo systems and attack helicopters.
Foreign
Contracts
To avoid
detection, Robert and her Indian partner posted sensitive military data on the
password-protected website of a New Jersey church where Robert was a volunteer.
In addition to illegally exporting the blueprints, they used them in seeking
contracts in the United Arab Emirates, Pakistan and Indonesia, prosecutors
said.
The contactors’ crimes had safety implications, too. The Defense Department discovered wing pins provided by Luba failed to meet hardness specifications. The military eventually had to replace the wing parts in 47 F-15 jets.
Luba “not only jeopardized the lives of men and women on the front lines of our national defense, he put all Americans at risk,” according to Paul Fishman, the U.S. attorney in New Jersey at the time. Luba pleaded guilty in 2013 to violating the Arms Export Control Act, and conspiring to do so. Robert pleaded guilty to a similar conspiracy two years later.
The contactors’ crimes had safety implications, too. The Defense Department discovered wing pins provided by Luba failed to meet hardness specifications. The military eventually had to replace the wing parts in 47 F-15 jets.
Luba “not only jeopardized the lives of men and women on the front lines of our national defense, he put all Americans at risk,” according to Paul Fishman, the U.S. attorney in New Jersey at the time. Luba pleaded guilty in 2013 to violating the Arms Export Control Act, and conspiring to do so. Robert pleaded guilty to a similar conspiracy two years later.
