The “Largest and Most Brazen” Government Contract Fraud?
In October, 2011, reports emerged from Alaska, such as this one, indicating that Alaskan Native Corporation (ANC) Eyak Technology LLC (EyakTech) was a participant in a “massive kickback scheme” involving “corrupt” officials in the U.S. Army Corps of Engineers (USACE). Reports quoted the U.S. Attorney as stating it was “one of the most brazen corruption schemes in the history of federal contracting."
Prosecutors alleged that the USACE personnel accepted $20 million in bribes and kickbacks from EyakTech employees, and used the money “for BMW's, Rolex and Cartier watches, flat-screen televisions, first-class airplane tickets and international properties.” Reportedly—
… EyakTek subcontract[ed] work on its $1 billion federal contract to a Virginia firm that is identified in the indictment only as ‘Company A.’ Prosecutors allege the chief technology officer for ‘Company A’ would then submit fraudulently inflated invoices for the work.
One of the corrupt Army Corps of Engineers officials would approve the invoices, prosecutors say. The federal payment would go to EyakTek, which subtracted its profit margin and paid the rest to ‘Company A,’ according to the indictment.
The inflated invoices allegedly totaled about $20 million between 2007 and this year, according to the indictment. The chief technology officer of ‘Company A’ would allegedly funnel shares of the extra cash to Eyatek executive Babb and the Corps of Engineers officials who were part of the scheme.
Harold F. Babb (EyakTech Director of Contracts) was arrested, as was Michael Alexander and Kerry Khan—both employees of USACE. In addition, Khan’s son, Lee, was also arrested.
More recently, Mr. Alexander has reportedly agreed to plead guilty to his part in the scheme. The Washington Post (link in previous sentence) reported that Alexander “plans to plead guilty to charges of bribery and conspiracy to launder money.” According to the WaPo—
Prosecutors said that Alexander, a program director, and Kerry F. Khan, an Army Corps program manager, received kickbacks in exchange for directing government contracts to a subcontractor specializing in software encryption devices and other information assurance technology. … The scheme, which authorities said spanned roughly four years, involved phony and inflated invoices for government contracts and millions of dollars in kickbacks that were funneled through a network of shell companies in the United States and around the world. …
The two Khans and Babb have pleaded not guilty. Two officials with an EyakTek subcontractor — Nova Datacom — have already pleaded guilty.
Recently we wrote about fraud at commercial headphone-maker Koss. We report on Koss from time to time in support of our assertion that fraud in the government contracting sector is no more prevalent than it is in the commercial sector. We report on corrupt government employees in the (perhaps futile) reminder that it often takes two to tango—and that too much focus on contractors without an equivalent focus on controls within the Federal government creates a gaping opportunity for corruption.
Not all ANC companies are corrupt; not all USACE personnel are crooked. And not all contractors are out to gouge the government. But there are enough miscreants and fraudsters to make investments in internal controls and oversight worthwhile. This story, which has been under our radar screen for the past three or four months, reminds us that the wrongful actions of a few taint the rest of contractors and government employees—almost all of whom are focused on doing the right thing and spending taxpayer funds wisely.
ASBCA Throws Out Untimely Government Claim for Increased Costs from Changes to Cost Accounting Practice
First things first. Thanks to the website PubKLaw.Com for bringing this important ASBCA decision to our attention before the Board published it on its own website.What makes this particular ASBCA decision important is the following:
The Board of Contract Appeals dismissed the Government’s case against Boeing because it was filed more than six years after the claim accrued.
We’ve reported on this issue before—namely, right here. In fact, the Board cited to that particular decision as support for its decision in the Boeing matter.
Let’s recap.
- In October 2000, Boeing submitted a revised CASB Disclosure Statement that included revised cost accounting practices, to become effective January 1, 2001.
- Upon request, Boeing provided a cost impact analysis.
- The cost impact analysis was audited by DCAA, who issued its audit report on June 14, 2002 to the cognizant DCMA administrative contracting officer (ACO). That audit report asserted that Boeing’s changed cost accounting practices would result in $7.4 million in increased costs (consisting of decreased costs on Boeing’s fixed-price contracts).
- On September 15, 2003, the cognizant ACO prepared a “prenegotiation memorandum that “a determination that Boeing's accounting revision was not in the government's interests, barring the government from paying resulting increased costs, and described a negotiation strategy for obtaining reimbursement of costs the government had incurred.”
- On September 17, 2003, the cognizant ACO wrote Boeing stating the findings and offering to settle the matter by using Boeing’s cost impact to establish the unallowable increased costs. To Boeing’s numbers, the ACO added amounts for assumed profit and an interest rate on the costs.
- On December 23, 2003, Boeing responded to the ACO’s letter, disagreeing with pretty much everything.
- “The accounting change was raised at a series of additional meetings between the parties between 2004 and April 2005. During those meetings, Boeing also contended that the accounting revision's effect upon fixed-price contracts should not have been included in the assessment of its costs, and that interest was not recoverable by the government.”
- “Subsequently, between 2005 and 2010, some ‘intermittent discussions and evaluations continued between [the contracting officer] and Boeing representatives in an attempt to settle the matter’.”
- On October 25, 2010, the ACO issued a Final Decision, demanding $6.42 million from Boeing.
- Boeing submitted an appeal of the ACO’s Final Decision to the ASBCA.
In the words of the ASBCA decision: “Quite simply, [Boeing] contends that because the decision was issued more than six years after the government's claim for those costs accrued, it is a nullity.”The Government argued against Boeing’s motion, but on rather interesting grounds. The ASBCA summarized the Government’s arguments as follows—
The government's 25 October 2010 final decision quite succinctly describes the events upon which it premises its claim, and demonstrates that the government knew of those events more than six years earlier. …
Although it does not deny the accrual date of its claim, the government advances two arguments in response to Boeing's motion. First, the government suggests that its 25 October 2010 decision is not the relevant final decision in this appeal. According to the government, the contracting officer's 17 September 2003 letter to Boeing is the contracting officer's final decision asserting the government's claim for the costs of the accounting revision. … Alternatively, the government contends that its 25 October 2010 final decision is valid because the six-year limitation for bringing the claim was equitably tolled by Boeing's conduct …. Neither argument is persuasive.
We’ll elide recital of the Government’s first argument, focusing instead on the second argument. As the ASBCA wrote
As support for its contention, the government emphasizes that three months after the contracting officer issued the 17 September 2003 letter, Boeing ‘unexpectedly took issue with each and every facet of the...1etter’… . The government contends that Boeing could have raised that issue sooner, and then waited another year and a half, until 14 April 2005, before presenting the evidence it claimed supported that position. Similarly, the government complains that Boeing initially agreed in 2002 that the accounting revision costs affected fixed price contracts, but then reversed that position during discussions in 2004. …
The government summarizes its position by accusing Boeing of leading the contracting officer ‘to believe that the contract adjustment issue was on the verge of settling’ but then it ‘belatedly interjected entirely new, overriding issues into the discussions; and finally it compounded the situation by providing supporting information in a thoroughly, untimely manner.’ According to the government, these actions breached Boeing's duty not to ‘hinder or delay the [government] in performance of the contract’ by ‘play[ing] [the contracting officer] along’ which then ‘induced [her] into allowing the limitations period to pass.’ Therefore, the six-year limitation should be considered tolled.
As noted above, the Board was unconvinced by the Government’s arguments. It concluded—
We do not perceive any misconduct by Boeing that could have induced or tricked the government into missing the deadline for submitting its claim for the accounting revision costs. We do not perceive any misconduct by Boeing that could have induced or tricked the government into missing the deadline for submitting its claim for the accounting revision costs. … Although Boeing may have unexpectedly disputed her conclusions, which it continued to do with various arguments and materials it presented to her in meetings that occurred over the next year and half, nothing about that constituted misconduct, or should have induced her not to protect the government's rights. If anything, Boeing's continued resistance to the government's conclusions, and to settling the matter, should have heightened the government's awareness of the need to issue a final decision to preserve its claim before the deadline expired. It should not have caused the government to believe that a final decision would be unnecessary. …
Given the facts, it seems clear that it was lack of diligence, and not any misconduct by Boeing, that was the reason the government sat on its rights here until it was too late.
The Board devoted considerable attention to other cases and matters that may have had implications on its decision, a recital that we will spare our readership. (You are welcome.)The Board concluded with the following statement:
Because the government's 25 October 2010 final decision claiming the accounting revision costs was untimely, it is not valid. Given that it is invalid, it is a nullity and we lack jurisdiction to entertain an appeal from it. Accordingly, we dismiss the appeal for lack of jurisdiction.
As was the case with the defective pricing matter we previously brought to your attention, the Government’s failure to file a claim within six years of believing it had been injured caused it to lose its case. We expect the Government to appeal this decision but, until then, this is a great victory for Boeing.
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Update on Fraud at Headphone-maker Koss
We’ve been following the stories of fraud and embezzlement at commercial headphone-maker Koss for quite some time. We first wrote about it here, in support of our thesis that instances of fraud within the government contracting community are no more prevalent than they are in the commercial sector (or in the government-employee sector for that matter). More than two years ago, we wrote—
 On December 24, 2009 reports emerged that Koss Corporation fired its long-time VP of Finance and Corporate Secretary, for allegedly embezzling millions from the company. The individual in question (Ms. Sujata ‘Sue’ Sachdeva), was ‘suspended’ on December 21st, ‘for financial improprieties,’ and was fired on December 24th for embezzling as much as $31 million over the past 18 years. Two members of the Koss accounting staff who reported to Ms. Sachdeva were also put on unpaid administrative leave. According to the Wall Street Journal, ‘The government alleges she embezzled company funds to pay off her personal American Express credit-card charges for the purchases of furs, jewelry, apparel and home decor.’
Importantly, Ms. Sachdeva, as VP of Finance, was responsible for many ‘management representations’ provided to its external auditors, Grant Thornton. Because those representations can no longer be relied upon, Koss’ financial statements must be reaudited, and will likely need to be restated. Koss is a publicly traded company, so the SEC and PCAOB will also be involved in the resolution. But Grant Thornton won’t be involved in that resolution, because that audit entity was dismissed after the fraud was uncovered.
Quite a lot has happened in the past two years. In July, 2010, we wrote that—
On July 17, 2010, Ms. Sachdeva pleaded guilty to six counts of wire fraud for embezzling roughly $34 million from her employer over a period of approximately 11 years. … S-Squared admitted that, ‘During the 12-year span she authorized the issuance of more than 500 cashier's checks costing Koss about $17.5 million. That figure includes $10 million to American Express, plus payments to high-end retailers, including Neiman Marcus and Saks Fifth Avenue. Payments also went to charitable groups.’ In addition, ‘From February 2008 to December 2009, she authorized 206 wire transfers totaling $16 million from Koss accounts to American Express to cover items she bought with the credit card.’ The plea agreement stated that Koss employees worked ‘in concert with Sachdeva or at her direction’ to make fraudulent entries to the company's books to conceal the embezzlement. ‘These entries would falsely overstate assets, understate liabilities, understate sales, overstate cost of sales, and overstate expenses,’ and the false entries ‘concealed the actual receipts and profitability of Koss,’ allowing the scheme to continue.
We further noted a couple of points raised by Francine McKenna on her blog regarding this family-owned and family-operated publicly traded company. We wrote—
Management oversight of the financial reporting process is severely limited by Mr. Koss Jr.’s lack of interest, aptitude, and appreciation for accounting and finance. Koss Jr., the CEO and son of the founder, held the titles of COO and CFO, also. Ms. Sachdeva, the Vice President of Finance and Corporate Secretary who is accused of the fraud, has been in the same job since 1992 and during one ten year period worked remotely from Houston!
Perhaps Ms. McKenna was prescient—or perhaps she’s just that smart—but Mr. Koss, Jr. has been in hot water with the SEC over his role (or lack of role) in the Koss fraud fiasco. Recently, Mr. Koss, Jr. and the company reached a settlement with the SEC.
In October, 2011, the SEC filed both a complaint and proposed settlement agreement with Michael J. Koss (former COO, and CFO, and currently CEO). The complaint alleged improprieties—
… based on Koss Corporation’s preparation of materially inaccurate financial statements, book and records, and lack of adequate internal controls from fiscal years 2005 through 2009. During this period, Sujata Sachdeva (“Sachdeva”), Koss’s former Principal Accounting Officer, Secretary, and Vice-President of Finance, and Julie Mulvaney (“Mulvaney”), Koss’s former Senior Accountant, engaged in a wide-ranging accounting fraud to cover up Sachdeva’s embezzlement of over $30 million from Koss.
Among other control failures, the SEC asserted the following—
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Sachdeva and Mulvaney were able to hide the substantial embezzlements in Koss’s financial records in part because Koss and Michael J. Koss did not adequately maintain internal controls to reasonably assure the accuracy and reliability of financial reporting.
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While Koss’s internal controls policy required Michael J. Koss to approve invoices of $5,000 or more for payment, its controls did not prevent Sachdeva and Mulvaney from processing large wire transfers and cashier’s checks outside of the accounts payable system to pay for Sachdeva’s personal purchases without seeking or obtaining Michael J. Koss’s approval.
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As a result, Sachdeva, with Mulvaney’s assistance, was able both to initiate and authorize wire transfers of Koss’s funds to her personal creditors totaling approximately $16.3 million, and to order cashier’s checks payable to credit card companies and her designated payees totaling approximately $15.5 million.
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Koss’s computerized accounting systems were almost 30 years old and access to the accounting systems could not be locked at the end of the month and there was no audit trail. Sachdeva and Mulvaney were thus able to make undetected post-closing changes to the books and bypass an internal control requiring Michael J. Koss to authorize those changes.
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Many account reconciliations were either not prepared or were not maintained as part of Koss’s accounting records. To the extent that reconciliations were conducted, they were improperly performed by the same persons who initiated or recorded the transactions (i.e. Sachdeva or Mulvaney), enabling those persons to make modifications to the reconciliations to cover up fraudulent entries.
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While Sachedeva provided Michael J. Koss with reporting certifications for his review, he did not conduct an adequate review of Koss’s accounting in connection with these certifications.
This is good stuff, because it tells us what went wrong at Koss. (Apparently, many things went wrong ….) Our readers should review their accounting policies, procedures, and controls in light of the SEC’s allegations, and see if they are similarly vulnerable to employee embezzlement.
This report stated: “The proposed settlement would enjoin the company and Mr. Koss from future violations and order Mr. Koss to reimburse Koss $242,419 in cash and 160,000 of options pursuant to Section 304 of the Sarbanes-Oxley Act (Mr. Koss had previously voluntarily reimbursed $208,895 in bonuses to Koss).” Both Koss the company and Koss the CEO consented to the SEC’s injunctive order without either admitting or denying the underlying allegations, as is commonly done is such matters. Unfortunately for all parties, the Judge in the case (Judge J. Randa) didn’t believe the proposed settlement was reasonable and thought it was overly vague. In December, 2011, Judge Randa directed the SEC to explain why its proposed settlement was “fair, reasonable, adequate, and in the public interest."
In January 2012, the SEC responded to the Judge. The FedSECLaw story (link above) reports the details of the SEC’s response. The story concludes with the following—
… Judge Randa is the latest Judge to question how the SEC does things, focusing on the language of the Judgment – language which is similar (if not identical) to the language which it has used for years. The SEC could satisfy Judge Randa by amending the language, but seems reluctant to do so (other than adding language from the consents, which is also similar, if not identical, to language used in other consents).
This story at CFO.com asserts that difficulties in drafting approved settlement agreements may lead to more litigation, stating—
Sachdeva and two other employees in the accounting department were fired long ago. The company restated its financials, dismissed its accounting firm, and changed several procedures in the finance department, including doing away with petty cash. Koss Corp. also hired a new CFO and has pledged to keep the CEO and CFO roles separate.
SEC chairman Mary Schapiro has acknowledged the frustration judges and the public have expressed about the regulator’s settlements. More cases could end up in litigation, consuming the regulator’s time, if agreements are more difficult to reach. Last year the commission made 682 settlements, virtually the same number as 2010, according to a NERA Economic Consulting study released earlier this week.
From our point of view, the fundamental story here concerns the consequences of weak internal controls and oversight failures, and of trusted employees who took the advantage of the opportunities with which they were presented to steal a huge amount of money. We are not particularly concerned with whether or not corporate attorneys and their external counsel can negotiate quick and relatively inexpensive settlements with the SEC.
Koss is a commercial company, but don’t think that your company is exempt from the litany of failures recited by the SEC. What happened to Koss can happen to any company, when management focuses attention on irrelevant or extraneous aspects of the business, instead of focusing on taking care of business.
Fraud is All in the Family
The Department of Justice press release headline caught our attention, but it was the story that caught our sense of irony.
The headline? “Father and Son Convicted for Fraudulently Billing NSA Over $1.455 Million During a 10 Year Period.”
Yes, it’s true. In mid-December 2011, the DOJ announced that a Federal jury had convicted William Turley and his son, Donald Turley, “of conspiring to commit and committing wire fraud arising from a fraudulent billing scheme.”
The Senior Turley owned Bechdon Company, which manufactured “metal, plastic and sheet metal parts and other specialty items for customers including the National Security Agency (NSA).” The Junior Turley “served as the program manager on the NSA contract.” According to the press release, the Turleys “instructed employees to inflate the amount of hours they spent working on NSA jobs and in some cases, to misreport the time they spent working on the NSA jobs.
The Turleys were caught through responses to “voluntary interviews and polygraph examinations” related to obtaining NSA security clearances. During his interview, the Senior Turley was asked whether he had ever committed a crime. He “admitted to ‘moving time around’ on the NSA contract and admitted his conduct was ‘illegal’.” During his interview, the Junior Turley “admitted that in the week prior to his interview he had inflated the amount of time he recorded working on NSA jobs on his own daily time cards and had instructed Bechdon employees to inflate the hours they worked on NSA jobs on their daily time cards.”
Whoops!
But that’s not even the best part of the story. The best part concerns the third Turley—Christina Turley Knott, who worked as a bookkeeper for Bechdon, where as part of her duties she prepared and submitted invoices to the NSA. She was also embezzling from her father’s company.
The DOJ reported—
William and Donald Turley became aware that from 2002 through 2005, Christina Knott embezzled approximately $4.5 million from the company, but chose not to pursue claims against Knott for fear that she would reveal their scheme to defraud NSA.
The DOJ is seeking forfeiture of $1.4552 million that the Turleys misbilled NSA—as well as Turley-owned residences in Annapolis and Owings, Maryland, and in Palm Beach, Florida. The two male Turleys are facing 20 years in prison for their crimes.
The female Turley, who failed to report her embezzled funds as income on her Federal tax return, also pleaded guilty to fraudulently billing NSA. She is facing up to 20 years in prison for her role in the conspiracy and three years in prison for the tax offense.
So just to be clear: The daughter stole more than $4 million—and would have gotten away with it, too—if not for her meddling brother and father, whose answers to their security interviews revealed a plot to steal a relatively paltry $1.45 million from the U.S. Government.
We think you’ll agree with us that these crimes were all in the family.
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