HUBZone Program: Fraud and Abuse Identified in Four Metropolitan Areas
Published: 2009-03-25T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Small Business Administration's (SBA) Historically Underutilized Business Zone (HUBZone) program provides federal contracting assistance to small firms located in economically distressed areas, with the intent of stimulating economic development. In July 2008, GAO identified substantial vulnerabilities in SBA's application and monitoring process that demonstrated the HUBZone program is vulnerable to fraud and abuse. GAO also investigated 10 case studies of HUBZone firms in the Washington, D.C., area that misrepresented their eligibility. GAO was asked to determine (1) whether additional cases of fraud and abuse exist outside of the Washington, D.C., area; (2) what actions, if any, SBA has taken to establish an effective fraud prevention program for the HUBZone program; and (3) what actions, if any, SBA took against the 10 case study firms in GAO's July 2008 testimony. To meet these objectives, GAO identified selected HUBZone firms based on certain criteria, such as magnitude of HUBZone contracts and firm location. GAO also interviewed SBA officials and reviewed SBA data.
section_title: What GAO Found
paragraphs: GAO found that fraud and abuse in the HUBZone program extends beyond the Washington, D.C., area. GAO identified 19 firms in Texas, Alabama, and California participating in the HUBZone program that clearly do not meet program requirements (i.e., principal office location or percentage of employees in HUBZone and subcontracting limitations). For example, one Alabama firm listed its principal office as "Suite 19," but when GAO investigators performed a site visit they found the office was in fact trailer 19 in a residential trailer park. The individual living in the trailer had no relationship to the HUBZone firm. In fiscal years 2006 and 2007, federal agencies obligated nearly $30 million to these 19 firms for performance as the prime contractor on HUBZone contracts and a total of $187 million on all federal contracts. Although SBA has initiated steps in strengthening its internal controls as a result of GAO's 2008 testimonies and report, substantial work remains for incorporating a fraud prevention system that includes effective fraud controls consisting of (1) front-end controls at the application stage, (2) fraud detection and monitoring of firms already in the program, and (3) the aggressive pursuit and prosecution of individuals committing fraud. In addition, SBA did not adequately field test its interim process for processing applications. If it had done so, SBA would have known that it did not have the resources to effectively carry out its review of applications in a timely manner. As a result, SBA had a backlog of about 800 HUBZone applications as of January 2009. At that time, SBA's interim application process was taking about 6 months--well over its 1-month goal set forth in SBA regulations. SBA has taken some enforcement steps on the 10 firms previously identified by GAO that knowingly did not meet HUBZone program requirements. However, SBA's failure to promptly remove firms from the HUBZone program and examine some of the most egregious cases from GAO's July 2008 testimony has resulted in an additional $7.2 million in HUBZone obligations and about $25 million in HUBZone contracts to these firms. For example, a construction firm from the July 2008 testimony admitted that it did not meet HUBZone requirements and was featured in several national publications by name. It has continually represented itself as HUBZone certified and has received $2 million in HUBZone obligations and a $23 million HUBZone set-aside contract since the July 2008 testimony.

section_title: Letter
paragraphs: Created in 1997, the Historically Underutilized Business Zone (HUBZone)  program provides federal contracting assistance to small businesses in  economically distressed communities, or HUBZone areas, with the intent  of stimulating economic development in those areas. In fiscal year 2007,  federal agencies awarded contracts valued at about $8 billion to HUBZone  firms. The Small Business Administration (SBA) administers the HUBZone  program, one of several contracting assistance programs that the agency  oversees. Firms that participate in the program must be located in a  HUBZone and employ residents of HUBZones to facilitate the goal of  bringing capital and employment opportunities to distressed areas.
On July 17, 2008, we testified before this Committee that SBA’s lack of  controls over the HUBZone program exposed the government to fraud and  abuse and that SBA’s mechanisms to certify and monitor HUBZone firms  provide limited assurance that only eligible firms participate in the  program. In our testimony, we identified 10 firms from the Washington,  D.C., metro area that were participating in the HUBZone program even  though they clearly did not meet eligibility requirements. Of the 10 firms, 6  did not meet both principal office and employee residency requirements  while 4 met the principal office requirements but significantly failed the  employee residency requirement. We reported in our July 2008 testimony,  that federal agencies had obligated a total of nearly $26 million in  HUBZone contract obligations to these 10 firms since 2006. In addition,  federal agencies obligated more than $105 million to these 10 firms for  performance as the prime contractor on all federal contracts since 2006.
Subsequent to the hearing, you requested that we perform a follow-on  investigation. Specifically, you asked us to determine (1) whether cases of  fraud and abuse in the program exist outside of the Washington, D.C.  metropolitan area; (2) what actions, if any, SBA has taken to establish an  effective fraud prevention system for the HUBZone program; and (3) what  actions, if any, SBA has taken on the 10 firms that we found  misrepresented their HUBZone status in July 2008.
To determine whether cases of fraud and abuse exist for firms located  outside of the Washington, D.C. metropolitan area, we first obtained and  analyzed a list of HUBZone firms from the SBA’s Dynamic Small Business  Search database as of September 2008. We then obtained federal  procurement data from the Federal Procurement Data System-Next  Generation (FPDS-NG) for fiscal years 2006 and 2007. We assessed the  reliability of the data and determined that they were sufficiently reliable  for the purposes of our investigation. We analyzed the data to identify (1)  geographical locations that have both small fragments of HUBZone areas  within a metropolitan area, and (2) high concentrations of HUBZone firms  that reported obligations on HUBZone prime contracts totaling more than  $250,000 during fiscal years 2006 and 2007. Using the above criteria, we  selected four geographical areas for analysis: Dallas, Texas; Huntsville,  Alabama; San Antonio, Texas; and San Diego, California. Within those four  geographical areas, there were 36 firms that met our criteria for further  investigation. The firms selected as case studies and the federal  obligations associated with those firms did not include subcontracts that  they may have received. Such information was not readily available. We  conducted site visits for all 36 selected firms and used investigative  methods — such as interviewing firm managers, analyzing firm payroll  documents, and reviewing information from investigative databases — to  gather information about the firms and to determine whether the firms  met HUBZone requirements for principal office and 35 percent residency.  We also reviewed information about each firm from the Online  Representations and Certifications Application (ORCA) Web site. In the  course of our investigations, we found instances of HUBZone firms that  did not expend at least 50 percent of the personnel costs of a contract on  their own personnel. Although our review was not designed to evaluate  this requirement, we did report those instances that we discovered in this  report.
To determine what actions, if any, SBA has taken to reduce fraud and  abuse in the program as well as the actions SBA has taken on the 10 firms  that we found misrepresented their HUBZone status, we interviewed SBA  officials from the Office of Inspector General, HUBZone Program Office,  and the SBA General Counsel. We obtained and reviewed supporting  documentation where appropriate. We also reviewed SBA’s Dynamic  Small Business Web site to determine the current HUBZone status of the  10 firms we identified in our July 2008 testimony.
Our work was not designed to identify all fraud and abuse in the HUBZone  program or estimate its full extent for the entire population of HUBZone  firms. In addition, our work was not designed to determine whether the  selected firms we investigated committed fraud when originally applying  for HUBZone status or receiving a HUBZone contract award, but rather if  selected HUBZone firms are currently meeting HUBZone requirements.  We conducted our investigation from September 2008 through March 2009  in accordance with quality standards for investigations as set forth by the  President’s Council on Integrity and Efficiency.
subsections: section_title: Background
paragraphs: The HUBZone program was established by the HUBZone Act of 1997 to  stimulate economic development through increased employment and  capital investment by providing federal contracting preferences to small  businesses in economically distressed communities. These areas, which  are designated based on certain economic and census data, are known as  HUBZones. As of January 2009, there were approximately 9,300 firms  listed in the Central Contractor Registration database as participating in  the HUBZone program. To ensure HUBZone areas receive the economic  benefit from the program, SBA is responsible for determining whether  firms meet HUBZone program requirements. To participate in the  HUBZone program, small business firms generally must meet certain  criteria established by the SBA, most notably: (1) the firm must be at least  51 percent owned and controlled by one or more U.S. citizens; (2) at least  35 percent of its employees must live in a HUBZone; (3) the principal  office (i.e., the location where the greatest number of qualifying employees  perform their work) must be located in a HUBZone; and (4) the firm must  qualify as a small business under the size standard that corresponds with  its primary industry classification. In addition, once a firm receives a  HUBZone contract, the firm is required to abide by certain subcontracting  limitations, which for most firms is to expend at least 50 percent of the  personnel costs of a contract on their own employees or employees of  other qualified HUBZone small business concerns.
The SBA is legally responsible for ensuring that program participants meet  program requirements. If a HUBZone firm does not meet program  requirements or fails to notify the SBA of material changes that affect the  firm’s HUBZone eligibility, the SBA may use a variety of enforcement tools  against the firm. Depending on the severity of the infraction, SBA can (1)  decertify and remove the firm from the list of qualified HUBZone firms, (2)  suspend and/or debar the firm from all federal contracts, and/or (3) refer  the firm to the Department of Justice for civil and/or criminal prosecution.
In July 2008, we testified that SBA’s lack of controls over the HUBZone  program exposed the government to fraud and abuse. Specifically, we  identified substantial vulnerabilities in SBA’s application and monitoring  process by demonstrating the ease of obtaining HUBZone certification.
For example, by using fictitious employee information and fabricated  documentation, we easily obtained HUBZone certification for four bogus  firms. In addition, we also identified 10 firms from the Washington, D.C.,  metro area that were participating in the HUBZone program even though  they clearly did not meet eligibility requirements.
In June 2008, we reported that the Small Business Administration needed  to take additional actions to certify and monitor HUBZone firms as well as  to assess the results of the HUBZone program. Specifically, we found that  the map SBA used to publicize qualified HUBZone areas was inaccurate. In  addition, we found that the mechanisms that SBA used to certify and  monitor HUBZone firms did not meet federal internal control standards  and provided limited assurance that only eligible firms participated in the  program. For example, SBA verified the information reported by firms on  their application or during recertification—its process for monitoring  firms—in limited instances and did not follow its own policy of  recertifying all firms every 3 years. In the report, we made five  recommendations designed to improve SBA’s administration and oversight  of the HUBZone program. We recommended that SBA correct and update  its HUBZone map, develop and implement guidance to ensure more  routine verification of application data, eliminate its backlog of  recertifications, formalize and adhere to a specific time frame for  decertifying ineligible firms, and further assess the effectiveness of the  program. In responding to a draft of this report, SBA agreed with these  recommendations and outlined steps that it plans to take to address them.
section_title: Selected Case Studies of Fraud and Abuse Outside the Washington, D.C., Metro Area
paragraphs: HUBZone program fraud and abuse continues to be problematic for the  federal government. We identified 19 firms in the states of Texas, Alabama,  and California participating in the HUBZone program even though they  clearly do not meet program requirements. Although we cannot conclude  whether this is a systemic problem based on these cases, as shown in  figure 1 below, the issue of misrepresentation clearly extends beyond the  Washington, D.C., metropolitan area. In fiscal years 2006 and 2007, federal  agencies had obligated a total of nearly $30 million to these firms for  performance as the prime contractor on federal HUBZone contracts.
HUBZone regulations also place restrictions on the amount of work that  can be subcontracted to non-HUBZone firms. Specifically, HUBZone  regulations generally require firms to expend at least 50 percent of the  personnel costs of a contract on its own employees. As part of our  investigative work, we found examples of service firms that subcontracted  a substantial majority of HUBZone contract work to other non-HUBZone  firms and thus did not meet this program requirement. When a firm  subcontracts the majority of its work to other non-HUBZone firms it is  undermining the HUBZone program’s stated purpose of stimulating  development in the economically distressed areas, as well as evading  eligibility requirements for principal office and 35 percent residency  requirement.
According to HUBZone regulations, persons or firms are subject to  criminal penalties for knowingly making false statements or  misrepresentations in connection with the HUBZone program including  failure to correct “continuing representations” that are no longer true.  During the application process, applicants are not only reminded of the  program eligibility requirements, but are required to agree to the statement  that anyone failing to correct “continuing representations” shall be subject  to fines, imprisonment, and penalties. Further, the Federal Acquisition  Regulation (FAR) requires all prospective contractors to update the  government’s Online Representations and Certifications Application  (ORCA), which includes a statement certifying whether the firm is  currently a HUBZone firm and that there have been “no material changes  in ownership and control, principal office, or HUBZone employee  percentage since it was certified by the SBA.” Of the 19 firms that did not  meet HUBZone eligibility requirements, we found that all of them  continued to represent themselves as eligible HUBZone interests to SBA.  Because the 19 case examples clearly are not eligible, we consider each  firm’s continued representation indicative of fraud and/or abuse related to  this program.
Table 1 highlights 10 firms that we found to be egregiously out of  compliance with HUBZone program requirements. Appendix I pro vides  details on the other 9 cases that we examined. We will be referring all 19firms to SBA for further investigation and consideration for removal from the program.
The following is a more detailed description of fraud and abuse from 3 of  the cases that we investigated.
Case Study 1: Our investigation clearly showed that this firm was being  used as a front company because it was subcontracting the majority of its  work to other firms. This firm is located in Fort Worth, Texas, and violated  HUBZone program requirements because it did not expend at least 50  percent of personnel costs on its own employees or by using the personnel  of other HUBZone firms as required by federal regulations.  This firm,  which consists of 8 employees, has obtained millions of dollars in  HUBZone contracts to provide environmental consulting services. At the  time of our investigation, company documents showed that the company  was subcontracting between 71 and 89 percent of its total contract  obligations to other non-HUBZone firms—in some cases, large firms. The  principal admitted that her firm was not meeting contract performance  requirements required by HUBZone regulations. Further, the principal  stated that the firm made bids on HUBZone contracts knowing that the  company would have to subcontract work to other firms after the award.  The principal added that other large firms use HUBZone firms in this  manner, referring to these HUBZone firms as “contract vehicles.”
By subcontracting the majority of its HUBZone work to non-HUBZone  firms, this firm is clearly abusing its HUBZone designation and  undermining the HUBZone program’s stated purpose of stimulating small  business development in economically distressed areas. Likewise, because  the subcontracting is being conducted by non-HUBZone firms this firm is  also evading eligibility requirements for principal office and the 35 percent  residency requirement. This firm has been obligated over $2.3 million in  HUBZone set-asides during fiscal years 2006 and 2007.
Case Study 2: Our investigation demonstrated that this firm continued to  misrepresent itself as HUBZone-eligible while failing to meet HUBZone  requirements. This firm, which is a two-person—father and son—ground  maintenance services company located in Jacksonville, Alabama, did not  meet the principal office requirement, failed the 35 percent residency  requirement, and served as a front company—subcontracting most of its  HUBZone work to non-HUBZone firms. Our investigation found that the  purported principal office was in fact a residential trailer in a trailer park.
As shown in figure 2 below, the “suite number” of the principal office  provided to SBA was actually the trailer number.
The president of the company claimed that the trailer is the principal  office and that an employee lived at that trailer. However, our  investigation found that the president knowingly misrepresented and  concealed material facts to a GAO investigator. We found that both  employees live in non-HUBZone areas that are located about 90 miles from  the trailer. Additionally, we verified that the trailer is occupied by  someone not associated with the company. Further, our investigation  found that neither employee lived in, nor worked at, the residential trailer  since August 2007. Specifically, the U.S. Postal Service provided us a  copy of the change of address form dated August 2007 that instructed the  Postal Service to forward all mail from the trailer to another office in  Birmingham, Alabama, which is not located in a HUBZone area. In  addition, we obtained utility bill information that indicated that the last  utility bill was paid by the firm in August 2007. According to DSBS, SBA  most recently certified the firm at this address in April 2008.
During the course of our investigation, this firm provided investigators  with questionable documents in an attempt to make the residential trailer  appear to be their actual principal office. As figure 3 shows, after our  original interview with the president, we found that a new mailbox with  the company name had been installed next to other mailboxes in the  trailer park to give the perception that the firm resided at this trailer park.
Despite the evidence that this firm had not paid utility bills or received  mail at this location for over a year, the firm president also provided us  with a “rental agreement” stating that their company was renting the  trailer until June 2009. The authenticity of this “rental agreement” is highly  suspicious given the evidence we gathered and our confirmation that an  individual not related to the company was living in the trailer.
For fiscal years 2006 and 2007, this firm received more than $900,000 in  HUBZone set-aside obligations.
Case Study 4: We determined that during the period of our investigation  this firm represented itself as HUBZone certified while failing to meet both  the 35 percent residency and principal office HUBZone eligibility  requirements. This firm, which is located in Huntsville, Alabama, and  provides information technology services, self-certified in ORCA in July  2008 that it was a HUBZone firm and that there had been “no material  changes in ownership and control, principal office, or HUBZone employee  percentage since it was certified by the SBA.” The firm was certified by the  SBA as a HUBZone firm in June 2002.
Based on our review of payroll records and written correspondence that  we received from the firm, we determined that the firm failed the 35  percent HUBZone residency requirement. These documents indicated that  only 18 of 116 (16 percent) of the firm’s employees who were employed in  December 2007, lived in HUBZone-designated areas. To have met the 35  percent residency requirement, the firm would have needed at least 41  employees residing in HUBZone-designated areas, thus, the firm did not  meet this requirement by 23 employees.
In addition, we investigated the location that the firm purported to the  SBA as its “principal office.” Our investigation found that no employees  were located at this office. Additional investigative work revealed that the  firm’s primary office was not located in a HUBZone. During the interview,  the firm’s president acknowledged that he “had recently become aware”  that he was not in compliance with HUBZone requirements and was taking  “corrective actions.” However, the firm continued to represent itself as a  HUBZone firm even after the firm’s president acknowledged his company  did not meet the program requirements.
Based on our analysis of FPDS-NG data, between fiscal years 2006 and  2007 federal agencies obligated over $5.0 million in HUBZone awards to  this firm, consisting mainly of 2 HUBZone set-aside contracts by the  Department of the Navy.
section_title: SBA Has Initiated Steps to Address Internal Control Deficiencies but Has Not Incorporated Effective Fraud Controls
paragraphs: Our June 2008 report and July 2008 testimony clearly showed that SBA did  not have effective internal controls related to the HUBZone program. In  response to our findings and recommendations, SBA initiated a process of  reengineering the HUBZone program. SBA officials stated that this process  is intended to make improvements to the program that are necessary for  making the program more effective while also minimizing fraud and abuse.  To that end, SBA has hired business consultants as well as reached out to  GAO in an attempt to identify control weaknesses in the HUBZone  program and to strengthen its fraud prevention controls.
Although SBA has initiated steps to address internal control deficiencies  we identified in our June 2008 report, SBA has not yet incorporated  effective controls for preventing, detecting, and investigating fraud and  abuse within the HUBZone program. Internal controls comprise the plans,  methods, and procedures used to meet missions, goals, and objectives and  also serve as the first line of defense in safeguarding assets and preventing  and detecting errors and fraud. Fraud prevention, on the other hand,  requires a system of rules, which, in their aggregate, minimize the  likelihood of fraud occurring while maximizing the possibility of detecting  any fraudulent activity that may transpire. Fraud prevention systems set  forth what actions constitute fraudulent conduct and specifically spell out  who in the organization handles fraud matters under varying  circumstances. The potential of being caught most often persuades likely  perpetrators not to commit the fraud. Because of this principle, the  existence of a thorough fraud prevention system is essential to fraud  prevention and detection.
As of the end of our field work, SBA does not have in place the key  elements of an effective fraud prevention system. As shown in figure 4  below, a well-designed fraud prevention system (which can also be used to  prevent waste and abuse) should consist of three crucial elements: (1)  upfront preventive controls, (2) detection and monitoring, and (3)  investigations and prosecutions. For the HUBZone program this would  mean (1) front-end controls at the application stage, (2) fraud detection  and monitoring of firms already in the program, and (3) the aggressive  pursuit and prosecution of individuals committing fraud. In addition, as  shown in figure 4, the organization should also use “lessons learned” from  its detection and monitoring controls and investigation and prosecutions  to design more effective preventive controls.
We explain the three major fraud prevention elements in this model and  how SBA is attempting to address them, in further detail below.
subsections: section_title: Preventive Controls
paragraphs: We have previously reported that fraud prevention is the most efficient  and effective means to minimize fraud, waste, and abuse. Thus, controls  that prevent fraudulent firms and individuals from entering the program in  the first place are the most important element in an effective fraud  prevention program. The most crucial element of effective fraud  prevention controls is a focus on substantially diminishing the opportunity  for fraudulent access into the system through front-end controls.  Preventive controls should be designed to include, at a minimum, a  requirement for data validation, system edit controls, and fraud awareness  training. Prior to implementing any new preventive controls, agencies  must adequately field test the new controls to ensure they are operating as  intended.
SBA officials stated that as part of their interim process they are now  requesting, from all firms that apply to the HUBZone program,  documentation that demonstrates their eligibility. SBA stated that, in the  past, it only requested additional information when it encountered obvious  “red flags.” Although requiring additional documentation has some value  as a deterrent, the most effective preventive controls involve the  verification of information, such as verifying a principal office location  through an unannounced site visit. If SBA verified purported principal  offices by conducting unannounced site visits, such as we did for our  investigation, SBA would likely find similar instances of firms attempting  to defraud the HUBZone program. In addressing one of our prior  recommendations, the SBA issued a Desktop Manual for processing  HUBZone applications.  The manual provides guidance that alerts SBA  staff of circumstances that warrant the need for supporting  documentation. Although the Desktop Manual provides discretion to the  analyst about the need to conduct a site visit, the Desktop Manual does not  provide criteria when such site visits are warranted. In addition, SBA does  not screen firms or individuals to ensure that they are not affiliated with  prior firms that failed program eligibility reviews. As a result, an owner  can change the name of a company that was removed from the HUBZone  program to a new business name and be accepted back into the HUBZone  program. Further, SBA did not adequately field test its interim process for  processing applications. If it had done so, SBA would have known that it  did not have the resources to effectively carry out its review of  applications in a timely manner. As a result, SBA had a backlog of about  800 HUBZone applications as of January 2009. At that time, SBA officials  stated that it would take about 6 months to process each HUBZone  application—well over the 1 month goal set forth in SBA regulations.
section_title: Detection and Monitoring
paragraphs: Although preventive controls are the most effective way to prevent fraud,  continual monitoring is an important component in detecting and  deterring fraud. Monitoring and detection within a fraud prevention  program involve actions such as data-mining for fraudulent and suspicious  applicants and evaluating firms to provide reasonable assurance that they  continue to meet program requirements. As demonstrated in our July 2008  testimony, SBA’s fraud control vulnerabilities in its application process  make detection and monitoring particularly important for the HUBZone  program. As a result of SBA’s control vulnerabilities, there are likely  hundreds and possibly thousands of firms in the HUBZone program that  fail to meet program requirements. Although monitoring and detection is  an important component of a fraud prevention system, we reported in  June 2008 that the mechanisms SBA used to monitor HUBZone firms  provided limited assurance that only eligible firms participate in the  program. Specifically, we reported that a firm could be in the HUBZone  program for years without being examined. In addition, although a  HUBZone firm is supposed to be recertified every 3 years, we reported  that more than 40 percent of the firms in the program for over 3 years had  not been recertified. To address these weaknesses, SBA officials stated  that during this fiscal year, they will be conducting program examinations  on all HUBZone firms that received contracts in fiscal year 2007 to  determine whether they still meet HUBZone requirements. In addition,  SBA officials stated that as of September 2008, SBA had eliminated their  backlog of recertifications.
Although SBA has initiated several positive steps, SBA will need to make  further progress to achieve an effective fraud monitoring program. For  example, SBA has not found an effective and efficient way to verify the  validity of a stated principal office during its recertification and  application processes. In addition, SBA officials stated that although they  modified their approach for conducting program examinations of  HUBZone firms this fiscal year, they have not established a streamlined  and risk-based methodology for selecting firms for program examinations  going forward. Further, in order to determine whether firms meet  eligibility requirements, SBA needs to incorporate an “element of surprise”  into its program examinations such as using random, unannounced site  visits to verify a stated principal office. Finally, SBA does not evaluate all  HUBZone program requirements during program examinations;  specifically, SBA does not review whether HUBZone firms are expending  at least 50 percent of the personnel costs of a contract on their own  personnel. As a result, as shown by several of our case studies, certain  firms are allowed to act as “front” companies, whereby they subcontract  the large majority of their work to non-HUBZone firms. This undermines  the program’s stated purpose of increasing employment opportunities,  investment, and economic development in HUBZone areas.
section_title: Investigation and Prosecution
paragraphs: The final element of an effective fraud prevention system is the aggressive  investigation and prosecution of individuals who commit fraud against the  federal government. However, SBA currently does not have an effective  process for investigating fraud and abuse within the HUBZone program.  Although SBA’s Desktop Manual for Processing HUBZone Applications  states that an analyst may refer a HUBZone application to the Office of  Inspector General or the Office of General Counsel, SBA has not  established specific criteria or a process for referring firms that knowingly  do not meet program requirements. To date, other than the firms identified  by our prior investigation, the SBA program office has never referred any  firms for debarment and/or suspension proceedings based on their  findings from their program eligibility reviews. By failing to hold firms  accountable, SBA has sent a message to the contracting community that  there is no punishment or consequences for committing fraud or abusing  the intent of the HUBZone program. However, as noted below, the SBA  has started the debarment process on 7 of the 10 firms we found to have  fraudulently or inaccurately misrepresented its HUBZone status in our  earlier work.
section_title: SBA Has Initiated Some Enforcement Actions Against 10 HUBZone Firms Previously Investigated by GAO
paragraphs: SBA has taken some enforcement steps on the 10 firms that we found did  not meet HUBZone program requirements as of July 2008. According to  SBA, as of January 2009, two of the firms have been removed from the  program and two others are in the process of being removed. However,  SBA’s failure to examine some of the most egregious cases we previously  identified has resulted in an additional $7.2 million in HUBZone  obligations and about $25 million in HUBZone set-aside or price  preference contracts to these firms. For example, a construction firm  identified in our July 2008 testimony admitted that it did not meet  HUBZone requirements and was featured in several national publications  by name. It has continually represented itself as HUBZone certified and  has received $2 million in HUBZone obligations and a $23 million  HUBZone set-aside contract since our testimony. See figure 5 for a  reproduction of the continual representation this firm makes on the top  banner of its Web site.
In the written statement for the July 2008 hearing, the Acting  Administrator of SBA stated that the SBA would take “immediate steps to  require site visits for those HUBZone firms that have received HUBZone  contracts and will be instituting suspension and debarment proceedings  against firms that have intentionally misrepresented their HUBZone  status.” SBA has referred 7 of these firms to its General Counsel for  suspension and debarment. However, as of February 2009, according to  SBA’s Dynamic Small Business Web site, 7 of the 10 firms that we  investigated were still HUBZone certified. Table 2 highlights the 10 firms  that we noted at the July 2008 hearing that clearly did not meet the  HUBZone program requirements, new HUBZone obligations and contracts  these firms received, as well as the actions the SBA has taken against  these firms as of January 2009.
As noted in the table above, as of January 2009 SBA has conducted  program evaluations on 7 of the 10 firms to determine whether the firms  meet the eligibility requirements for the HUBZone program. Based on  these evaluations, SBA has removed 2 firms from the HUBZone program  and is in the process of providing due process to 2 additional firms to  determine whether they should be removed. SBA officials stated that no  action will be taken on 3 firms because SBA’s program evaluations  concluded that these firms met all the eligibility requirements of the  HUBZone program. We attempted to verify SBA’s work, but were not  provided with the requested documentation to support their conclusion  that the firms moved into compliance after our July 2008 testimony. SBA  officials said they have not yet performed program evaluations for 3 of the  most egregious firms because they are experiencing technical problems  with SBA’s caseload system. As such, these 3 firms remain eligible to  receive HUBZone set-aside contracts. SBA is also pursuing suspension and  debarment actions for 7 of these firms, and the Department of Justice  considering civil actions on 5 of the 10 cases.
section_title: Conclusions
paragraphs: Our work on the HUBZone program to date has shown that numerous  ineligible firms have taken advantage of the opportunity to commit fraud  against the federal government. The SBA has initiated steps to correct  internal control deficiencies, but it still falls short in developing measures  to prevent, detect, and prosecute fraud within the HUBZone program. Our  work demonstrates that SBA’s fraud controls lack important elements  needed to screen and monitor firms which has led to HUBZone awards to  firms that did not meet program requirements. For example, SBA’s failure  to verify principal office locations through unannounced site visits has led  to firms operating their businesses from locations that are far from  economically disadvantaged. In addition, a lack of oversight for  monitoring all of the program requirements has allowed HUBZone firms to  subcontract large portions of HUBZone work to non-HUBZone firms  thereby failing to meet the program requirement that at least 50 percent of  the personnel costs of a contract be expended on its own employees.  Lastly, SBA’s lack of enforcement within the HUBZone program has not  had the effect of deterring fraudulent actors from entering or remaining in  the program. Going forward, SBA must develop and incorporate effective  fraud controls into its overall internal control process that will minimize  fraud and abuse in the HUBZone program.
section_title: Recommendations for Executive Action
paragraphs: To establish an effective fraud prevention system for the HUBZone  program, the Administrator of the Small Business Administration should  expeditiously implement the recommendations from our June 2008 report  and take the following four actions:    Consider incorporating a risk-based mechanism for conducting  unannounced site visits as part of the screening and monitoring process.
Consider incorporating policies and procedures into SBA’s program  examinations for evaluating if a HUBZone firm is expending at least 50  percent of the personnel costs of a contract using its own employees.
Ensure appropriate policies and procedures are in place for the prompt  reporting and referral of fraud and abuse to SBA’s Office of Inspector  General as well as SBA’s Suspension and Debarment Official.
Take appropriate enforcement actions on the 19 HUBZone firms we found  to violate HUBZone program requirements to include, where applicable,  immediate removal or decertification from the program, and coordination  with SBA’s Office of Inspector General as well as SBA’s Suspension and  Debarment Official.
section_title: Agency Comments and Our Evaluation
paragraphs: We received written comments on a draft of this report from SBA’s Deputy  Associate Administrator of the Office of Business Development and  Government Contracting. In the response, SBA agreed with three of our  four recommendations. SBA stated that it is in the process of re- engineering the entire HUBZone certification and eligibility process, and  SBA believes that our recommendations are useful in making necessary  program changes to minimize program risk and ensure that only eligible  firms received HUBZone program benefits. SBA’s written comments are  provided in appendix II.
SBA disagreed with our recommendation to consider incorporating  policies and procedures into SBA’s program examinations for evaluating if  a HUBZone firm is complying with the performance-of-work requirements  by expending at least 50 percent of the personnel costs of a contract using  its own employees. SBA stated that although this requirement is included  in SBA HUBZone regulations, it is not a criterion for HUBZone program  eligibility but rather a mandatory contract term. SBA stated that  contracting officers are required by the Federal Acquisition Regulations to  insert such clauses regarding subcontracting limitations. If firms submit  bids that indicate that they will not meet this requirement or fail to meet  this requirement during performance of the contract, the contracting  officer has the authority to reject a firm’s bid or terminate the contract for  default. SBA stated that it will continue to work with contracting officers  to ensure that this requirement is monitored.
While we recognize that contracting officers have a responsibility for  monitoring the subcontracting limitation, SBA also has this responsibility.  In order to receive HUBZone certification, a firm must certify to SBA that  it will abide by this performance requirement, and SBA is required by  statute to establish procedures to verify such certifications. In addition,  verification that a firm is meeting the performance-of-work requirements  is one of the subjects that SBA may review during its program  examinations. Since SBA is not performing this review, it is possible that  many firms may be receiving the benefits of the HUBZone program while  evading the program requirements. Therefore, we continue to believe that  SBA should consider incorporating policies and procedures into SBA’s  program examinations for evaluating if a HUBZone firm is meeting the  performance-of-work requirements.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies of this report to the  Administrator of the Small Business Administration and other interested  parties. The report will also be available at no charge on GAO’s Web site at  www.gao.gov. If you or your staff have any questions about this report,  please contact me at (202) 512-6722 or kutzg@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who contributed to this report are  listed in appendix III.
section_title: Appendix I: Additional Case Studies of HUBZone Firms That Did Not Meet Program Eligibility Requirements
paragraphs: This appendix presents summary information on 9 of 19 firms that clearly  did not meet the program eligibility requirements of the HUBZone  program. Table 3 shows the remaining case studies that we investigated.  As with the 10 cases discussed in the body of this report, these 9 firms  continued to represent themselves as eligible HUBZone interests to SBA.  Because these 9 case examples clearly are not eligible, we consider each  firm’s continued representation indicative of fraud and/or abuse related to  this program.
section_title: Appendix II: Comments from the Small Business Administration
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Erika Axelson, Gary Bianchi,  Donald Brown, Bruce Causseaux, Eric Eskew, Dennis Fauber, Craig  Fischer, Robert Graves, Betsy Isom, Jason Kelly, Julia Kennon, Barbara  Lewis, Olivia Lopez, Jeff McDermott, Andrew McIntosh, John Mingus,  Andy O’Connell, Mary Osorno, Chris Rodgers, and Matt Valenta also  provided assistance on this report.