I-NET, Inc. is a high technology corporation that provides federal agencies with computer systems and support services. For fiscal year 1992, it was the third largest recipient of 8(a) contract awards, which totaled over $65 million. During its nearly 10-year (Sept. 20, 1984, to June 16, 1994) program participation, I-NET obtained 145 8(a) contracts totaling at least $508 million. At least 126 of the 145 contracts were awarded noncompetitively. TAMSCO is a high technology corporation that provides computer systems and support services to federal agencies and large Department of Defense contractors. For fiscal year 1992, it was the ninth largest recipient of 8(a) contract awards, totaling over $30 million. During its program participation from May 14, 1984, until September 18, 1993, TAMSCO obtained 108 8(a) contracts totaling at least $356 million. At least 82 of the 108 contracts were awarded noncompetitively. In March and April 1995, as a part of our continuing work on the 8(a) program, we testified that the program has continued to experience problems in achieving its objectives. As the value and number of 8(a) contracts continue to grow, the distribution of those contracts remains concentrated among a very small percentage of participating 8(a) firms, while a large percentage get no awards at all. This is a long-standing problem. For example, in fiscal year 1990, 50 firms representing fewer than 2 percent of all program participants obtained about 40 percent, or $1.5 billion, of the total $4 billion awarded. Of additional concern is that, of the approximately 8,300 8(a) contracts awarded in fiscal 1990 and 1991 combined, 67 contracts were awarded competitively. In fiscal year 1994, the top 50 firms represented 1 percent of the program participants and obtained 25 percent, or $1.1 billion, of the $4.37 billion awarded, while 56 percent of the firms got no awards. In fiscal year 1994, $383 million in contracts were awarded competitively. The eligibility and participation files for the top 25 8(a) contract award recipients for fiscal year 1992, from which we selected I-NET and TAMSCO, showed that approximately $816 million, or about 22 percent of the total 8(a) contract dollars awarded that year, went to the top 25 firms. These firms had obtained, as of May 1995, a total of $4.9 billion in 8(a) contracts. Of these firms, three were Black-owned; eight were Hispanic-owned; six were Asian-owned; and five were Native American-owned. SBA had initially recommended that 15 of these 25 firms not be accepted into the program because the applicants did not meet eligibility standards for one or more of the following reasons: The ownership or control of the firms resided in individuals other than those who were applying (8 firms). The owners were not economically disadvantaged (2 firms). The firm was acting as a broker/dealer in violation of the Walsh-Healy Act (1 firm). The firms lacked the financial capability to perform on the contracts they wished to bid on (5 firms). SBA could not provide adequate contract support for the firms to succeed (3 firms). These recommendations were overruled, in some cases by high-level SBA officials, despite the fact that some of the firms had not been recommended for acceptance up to three times previously for the same reasons. As of May 1995, 18 of these 25 firms had exited from the program; yet at least 17 are still performing on contracts awarded while they were in the program. According to SBA, the total dollar value of contracts awarded to the firms initially not recommended for participation in the program is at least $2.9 billion. An SBA Office of Inspector General (OIG) audit report (Sept. 1994) also questioned the continued eligibility of large 8(a) firms in the program and identified some of the same causes. In its report, it cited findings wherein individuals in the program had overcome their economic disadvantage but remained in the program by understating their net worth; SBA officials had miscalculated the net worth; high personal income was also not considered in the evaluation of net worth; and individuals remained in the program because either the firm's equity, the owner's personal residence, and/or the spouse's net worth were not considered factors in determining the owners' net worth. Consequently, individuals could remove equity from the firms and use it to purchase expensive personal residences exempt from net worth evaluations. According to SBA 8(a) regulations, negative control is the lack of power by a program participant to control a firm's operations. For the 8(a) program, SBA regulations state that a program applicant must unconditionally own at least 51 percent of the firm and control its operations. Control is further defined as a condition that would not allow a noneligible person to benefit from the program or subjugate the control of the firm's operations. SBA had concerns about negative control issues at both I-NET and TAMSCO, but it ultimately admitted both firms to the 8(a) program. SBA officials recommended denying I-NET acceptance into the program in four separate instances, but other SBA officials overruled these recommendations. SBA officials had determined that I-NET's owner and president, Mrs. Kavelle Bajaj, lacked the technical and managerial experience to run a high technology computer firm. They also determined that, rather than Mrs. Bajaj, Mr. Bajaj, a recognized expert in the field, would actually control and run the firm's operations. A former I-NET Vice President for Marketing and Operations told us that Mrs. Bajaj lacked the technical and managerial skills needed to run a computer company and that he was hired by Mr. Bajaj in January 1985 to help start and run the firm and to "teach" Mrs. Bajaj how to run a business. For this, Mrs. Bajaj gave the former vice president 24.5 percent of the company. Shortly after leaving the company in 1988, this individual was replaced by Mr. Bajaj, who was appointed Executive Vice President. Mr. Bajaj formally became I-NET's president after I-NET exited from the 8(a) program in 1994. On the resume he submitted to SBA-OIG during its 1992 audit, Mr. Bajaj stated that he was "responsible for day-to-day operations" of I-NET. Mrs. Bajaj was adamant with us that she unconditionally owned and controlled the firm. However, Mrs. Bajaj provided no explanation when we asked her how she maintained control over I-NET while, at the same time, her husband represented that he had the day-to-day responsibilities for I-NET operations. Further, a senior SBA official told us that the memorandum prepared by an SBA regional staff member recommending acceptance into the program used "circular reasoning" in overruling the District Office's objections to this firm. Other SBA officials who relied on the first official's analysis agreed that it was "double talk" that inadequately addressed the reason to overrule the recommended refusal. One stated that I-NET's admission to the 8(a) program was "questionable." Nevertheless, these officials stood by their decision to recommend accepting I-NET. From the outset, SBA questioned the control that TAMSCO's nondisadvantaged (Caucasian) owner exercised over the disadvantaged (Hispanic) owner due to the structure of the board of directors, the owners' prior relationship, and their compensation. However, SBA allowed TAMSCO to participate fully in the 8(a) program. SBA identified the ownership and negative control issue at TAMSCO during the application process and twice recommended that the firm's application be denied. SBA determined that the firm was owned by two persons, with the Hispanic owner having 51 percent and the Caucasian owner, 49 percent. SBA compared their resumes and other documentation in the 8(a) application and found that the Caucasian owner had previously held supervisory positions over the Hispanic owner and that the two-man board of directors, on which both served, allowed the Caucasian owner to have negative control over the Hispanic owner. SBA officials concluded that the firm should be rejected because the Caucasian owner would improperly benefit from the program. We also found that the personal financial statements and other documentation showed that the Caucasian owner had a higher salary than the Hispanic owner and that the firm was located at the Caucasian owner's residence. A former official of the firm told us that the two owners were "co-dependent" and functioned as equals. TAMSCO's president (the Hispanic owner) told us that (1) despite his previous relationship with the Caucasian owner, ownership was structured so that TAMSCO would be eligible for Small and Disadvantaged Business contracts and (2) it was agreed that he would maintain total control over the firm's operations. The SBA official who overturned the two recommendations for denial had no answers or explanations as to why he had accepted TAMSCO into the 8(a) program over the prior objections of SBA officials concerning negative control. He also denied meeting or discussing the matter with TAMSCO's owners. However, the TAMSCO owners told us that they had had substantive discussions and meetings with him on the issue of negative control. I-NET provided false and misleading information to SBA regarding its equity ownership in the firm, the owner's educational credentials, and the owner's citizenship status. Despite these misrepresentations, SBA did not terminate I-NET from the program or suspend its contracts. I-NET submitted false statements to SBA about its equity ownership. Documents, interviews, and a federal court case revealed that I-NET had entered into partnership agreements with two individuals in January 1985 for a total of 49-percent ownership interest (each with a 24.5-percent share) without disclosing these transactions to SBA, as required by SBA regulations. One of the 24.5-percent equity owners also owned another computer services company. At the time, SBA regulations prohibited a business concern in a related field from owning any equity in an 8(a) firm. Although I-NET repurchased this ownership interest within a year of its issuance, Mrs. Bajaj never informed SBA about this transaction. Mrs. Bajaj submitted a false statement about I-NET's ownership status to SBA in January 1986, when I-NET notified SBA that 49 percent of the company's stock was unissued. However, 24.5 percent was still outstanding with the one remaining partner. Believing that SBA would approve only a 15-percent transfer of ownership, Mrs. Bajaj attempted to reduce the remaining partner's interest to 15 percent and privately negotiate away the remaining difference. In 1988, Mrs. Bajaj submitted a second document to SBA, stating that 49 percent of the stock was "unissued," despite the outstanding 24.5-percent equity ownership by the remaining partner. She told us that she considered the stock unissued until a dispute with this partner over his ownership was resolved. In August 1994, 2 weeks after agreeing to withdraw from the program, I-NET notified SBA that it intended to sell 20 to 25 percent of the firm's stock through a private placement offered through a large investment company. When SBA officials learned of the impending sale, SBA attorneys recommended against approving it because its terms would have relinquished control of the firm to the outside private investors. The terms of the transactions, according to the SBA attorneys who reviewed the documents, enabled the investors to have negative control over the firm's operations. SBA has not issued a decision, but I-NET completed the sale without a waiver from SBA, thus potentially jeopardizing its current 8(a) program contracts. The SBA Associate Administrator for Minority and Enterprise Development told us that the matter was being handled immediately; but, as of August 14, 1995, no final decision had been rendered. Mrs. Bajaj provided false information about her educational credentials, which SBA relied upon, in part, for admittance to the 8(a) program. She certified on the resume accompanying her 8(a) application to SBA in January 1983 that she had obtained an AA degree in Computer Science and Technology from Montgomery College in Rockville, Maryland. Transcripts from Montgomery College show that she never earned the stated degree. SBA denied I-NET's application for the 8(a) program in October 1983 because of lack of technical and managerial experience. Mrs. Bajaj again submitted a resume with the same false information in a reconsideration appeal application later that month. According to a former I-NET senior executive, Mrs. Bajaj attached a resume that contained the same false information to contract proposals submitted to agencies. In 1992, when the SBA-OIG audited I-NET, I-NET provided the OIG another resume claiming she held the same nonexistent AA degree. Mrs. Bajaj admitted to us not having the degree and stated that she "naively" thought that the credits she had earned to obtain her Bachelor of Science degree in Home Economics from the University of Delhi, India, counted toward an AA degree in computer science and technology. SBA documents show that SBA relied in part on Mrs. Bajaj's false information about the AA degree at the time when it was certifying I-NET for program participation. In an October 1993 document, the SBA Regional Counsel stated that the "original recommendation for I-NET's approval was based, at least in part, on false information submitted by the applicant regarding Mrs. Bajaj's degree." Although SBA officials acknowledged this fact in October 1993, I-NET remained in the program for another 9 months and obtained additional contract awards totaling at least $13.5 million. When asked about this document, the Regional Counsel stated that the falsification was not itself sufficient to terminate the firm, despite SBA regulations that providing false information to SBA is grounds for termination from the program. Mrs. Bajaj also misrepresented her citizenship on her first application on January 11, 1983. She said that she was a U.S. citizen, but she did not obtain her citizenship until May 13, 1983. (U.S. citizenship is a requirement for acceptance into the 8(a) program.) She told us that she thought she would be a citizen by the time the application was processed. She also said that although SBA had told her that she need not be a citizen at the time of application, she was concerned that her pending citizenship status would have held up her 8(a) application. I-NET was accepted into the program on September 20, 1984. SBA did not recognize that I-NET had provided misleading financial statements concerning its total revenues. Furthermore, I-NET misstated its financial condition as being at risk in efforts to continue 8(a) program contracts. I-NET submitted financial statements to SBA that misrepresented its size by excluding certain revenues from the total sales, which allowed it to meet size standards for contracts in 1991 and 1992. I-NET explained the exclusion of this revenue in footnotes to its audited 1988 through 1990 financial statements, claiming that it was entitled to exclude these revenues because I-NET had earned no income on the revenues. SBA did not recognize or react to the information in the 1988 through 1990 financial statement footnotes until 1992. These exclusions permitted I-NET to obtain at least 11 contracts for which it was not eligible. However, I-NET included these revenues in its yearly total sales figures in submissions to an outside investment firm when it was seeking private outside investment. Our review of I-NET's 1989 and 1990 corporate tax returns, submitted to SBA, shows that I-NET's gross receipts as reported to the Internal Revenue Service were also substantially greater than those reported to SBA. In 1992, SBA found that the excluded revenue should have been counted for 8(a) size purposes. Therefore, in early 1993, SBA considered terminating certain contracts on the grounds that I-NET was not eligible because it had exceeded its size standards. In response, I-NET submitted an Impact Analysis Statement to SBA in April 1993. The statement said, in part, ". . . (t)he banking industry continues to label I-NET and Kavelle in a negative way . . . and maintaining adequate capital and credit are a constant challenge which leaves the company at risk." However, in reviewing the matter and determining if I-NET met early graduation criteria, SBA found that I-NET had a $25-million line of credit with its bank, had obtained loans and financings exceeding $2 million, and had sales approaching $100 million per year. Based on its review, SBA did not find that I-NET was at risk. When asked about this apparent contradiction, Mrs. Bajaj told us that it was her view that $25 million was not sufficient credit. During this same time period, however, I-NET did not portray itself as a company at risk when it sought outside investors. A written private placement memorandum about I-NET states that as of June 1993, I-NET had a backlog of over $580 million in contracts and projected revenues through 1997 of about $1.3 billion. Subsequent to our interview of Mrs. Bajaj, I-NET provided us a written response to the risk issue. It stated that, at the time the memorandum was written, I-NET ". . . had severe cash flow problems and was having difficulty securing credit." Furthermore, in December 1993, SBA determined that I-NET again had claimed erroneously that it lacked access to credit when it was appealing SBA's October 1993 proposed early graduation action. In its review, SBA also determined that I-NET appeared to be misleading SBA by using inappropriate time periods to calculate earnings. Although SBA officials responsible for monitoring I-NET's progress had become aware that I-NET had grown too large for continued program participation, SBA allowed the company to remain enrolled for almost 2 additional years. During this time, I-NET continued to obtain large contract awards. In fact, 6 days prior to I-NET's initially being recommended for early graduation in September 1992, it was awarded a $134-million contract. The SBA official who approved the contract award was also responsible for initially recommending I-NET's early graduation. When we interviewed him, he explained that, under SBA regulations, until a firm is officially out of the program, it can still obtain contract awards for which it is eligible. Although he wanted I-NET out of the program, he felt he could not deny contract awards until I-NET had either graduated or been terminated. However, SBA regulations and a 1982 federal court decision, in conjunction with a Comptroller General decision on the same issue, concluded differently. Both the court and the Comptroller General determined that an 8(a) firm that has exceeded size limitations must have its 8(a) contracts suspended. The regulations also state that contracts can be suspended pending a termination action by SBA. When asked about this contradiction, responsible SBA officials responded by stating that SBA lacked the proof required to terminate I-NET, despite regulations regarding actionable offenses for termination, which include providing false information to SBA--something that SBA concedes occurred. In January 1993, the SBA-OIG provided a draft audit report to the SBA office responsible for I-NET, recommending that no further contracts be awarded to I-NET because it had exceeded its size standards and had provided incorrect information to SBA for its annual size-standard determinations. However, until I-NET left the program in June 1994, SBA awarded I-NET additional contracts totaling at least $62 million. In 1993, the U.S. Coast Guard directed a noncompetitive IDIQ contract with a maximum value of $14 million to TAMSCO. During the preaward phase of the contract, Coast Guard contracting officials, who told us that it was always their intention to award the contract to TAMSCO, met with TAMSCO representatives and discussed the contract, competition thresholds, and Standard Industrial Classification (SIC) codes. The Coast Guard changed the original SIC code so that TAMSCO would be eligible for the award; used the IDIQ contracting option; and lowered the labor hours to avoid competition. Further, one Coast Guard official's notes referred to this IDIQ contract to TAMSCO as a "graduation present" from the 8(a) program. Coast Guard officials changed the SIC code assignment and minimum contract value. Following these changes, TAMSCO was awarded a large noncompetitive IDIQ contract 1 day before its term was to expire in the 8(a) program in September 1993. Had the Coast Guard contracting officer's originally assigned SIC code been used, TAMSCO would not have been eligible for the contract because the company had exceeded the size standard for the originally assigned SIC code. Based on notes that the Contracting Officer's Technical Representative (COTR) wrote during meetings between Coast Guard officials and TAMSCO, it appears that the Coast Guard officials and TAMSCO had concerns about the competition thresholds. In essence, we believe that they wished to avoid the $3-million threshold required for competitive 8(a) service contracts. The Coast Guard lowered the labor hours, thus being able to award an IDIQ noncompetitive contract. Our analysis of labor costs determined that Coast Guard officials lowered the total number of labor hours in the contract by 46 percent from what was specified in the contract solicitation. Thus, the minimum contract value dropped below the $3-million competition threshold, from $4.6 million to $2.1 million. We interviewed a Coast Guard officer involved in the contract award who also developed the original minimum contract value. When we asked him about a Coast Guard finding that if fully loaded labor rates had been used in the contract, the minimum value of the contract would have exceeded competitive thresholds, he had no answer. However, he stated that the Coast Guard officials had done everything possible to get TAMSCO the contract, including changing the SIC codes and using the IDIQ contracting option. The COTR also told us that the SIC code was intentionally changed to meet TAMSCO's eligibility and that the Coast Guard viewed competition of contract awards as a hindrance to furthering the mission. A draft of an internal Coast Guard memorandum, written to justify the contract award to TAMSCO, sheds light on Coast Guard attitudes about the use of competition and 8(a) sole source contracts. The COTR sent the memorandum--in electronic mail (e-mail) format--to another Coast Guard official for comment. The commenting Coast Guard official responded to the COTR's memorandum--also by e-mail--by interspersing his remarks in all capital letters. (See fig. 1.) According to two former TAMSCO officials involved in the award, the COTR had provided them with a later draft of the internal memorandum to review before he submitted it to higher-level Coast Guard officials. One of the TAMSCO officials told us that providing TAMSCO the memorandum to review was inappropriate; the other felt uncomfortable with receiving the document because the Coast Guard was always careful not to release internal documents. According to these two former TAMSCO officials and TAMSCO's president, while they did not think it improper for TAMSCO to provide information on the 8(a) program and other contracting procedures to the Coast Guard, they agreed that the Coast Guard should have been using its own contracting officials to obtain the information. Notes that the COTR took during Coast Guard/TAMSCO discussions also referred to suggestions that the contract be awarded to TAMSCO as a "graduation present" before the end of TAMSCO's 8(a) program participation. For example, one note stated, in part, "IDIQ: Grad Pt. -eligible until grad from program Sept 18, '93." In other words, TAMSCO could get a sole source IDIQ contract as a graduation present until its graduation date of September 18, 1993. (See fig. 2.) In addition to the Coast Guard contract, TAMSCO obtained at least 22 other 8(a) awards within 2 weeks of its "graduation" from the program totaling at least $63 million. Thirteen of the awards were IDIQ contracts from a number of government agencies, including the Coast Guard award. We began our investigation by reviewing the application, eligibility, and participation files for the top 25 8(a) contract award recipients for fiscal year 1992, as compiled in our 1993 report. These records were located in 10 SBA District Offices nationwide. The files for two firms were unavailable for review. A third file did not contain eligibility documents. We looked for indicators of potential regulatory violations and criminal misconduct. We initially selected four of the firms for further investigation. However, the records we compiled for one firm were destroyed in the Oklahoma City bombing tragedy on April 19, 1995, and our investigation of another firm was not complete at the time of this publication. We then narrowed our investigation to two firms--I-NET, Inc. of Bethesda, Maryland, and Technical and Management Services Corporation (TAMSCO) of Calverton, Maryland. We interviewed officials and reviewed documents from the SBA, Office of Inspector General; various SBA district and regional offices; SBA's Central Office; U.S. Department of Transportation, Office of Inspector General; U.S. Coast Guard; Resolution Trust Corporation, Office of Inspector General; Defense Contract Audit Agency; Department of Justice; and the Federal Bureau of Investigation. We also interviewed current and former employees of the firms, subcontractors, representatives of financial institutions, and others. As requested, we plan no further distribution of this report until 30 days from the date of this letter. At that time, we will send copies of this report to the Administrator of SBA and to others upon request. If you have any questions concerning this report, please call me at (202) 512-6722 or Robert H. Hast, Assistant Director for Investigations, New York Regional Office, at (212) 264-0982. Major contributors to this report are listed in appendix III. Section 8(a) of the Small Business Act, as amended, established the Minority Small Business and Capital Ownership Development Program, or 8(a) program, to promote the development of small businesses owned by socially and economically disadvantaged individuals so that they could develop into viable competitors in the commercial marketplace. To be eligible for the program, a small business must be 51 percent unconditionally owned and controlled by one or more socially and economically disadvantaged individuals. The company must also meet the small business size standards established by SBA for the firm's industry as defined in the classification categories prescribed by the Standard Industrial Classification (SIC) Manual. SBA approves applicable SIC codes for participating firms. Participating 8(a) firms may have one or more SICs assigned to them by SBA. To be considered a small business and remain eligible for the program, participating firms must not have outgrown all their SBA-approved SIC codes. Size standards for each SIC code are generally defined by the firm's number of employees or its average annual gross sales. Under the program, SBA acts as a prime contractor, entering into contracts with other federal agencies and then subcontracting work to firms in the 8(a) program. Firms in the program are also eligible for financial, technical, and management assistance from SBA to aid their development. Participating firms can stay in the program for up to 9 years. The Small Business Act, as amended, and federal regulations define "socially disadvantaged" as those persons who have been subjected to racial, ethnic, or cultural bias because of their identities as members of groups, without regard to their individual qualities. Certain racial and ethnic groups such as Black Americans, Hispanic Americans, Subcontinental Asian Americans, and Native Americans are presumed to be socially disadvantaged. However, individuals in groups not cited in the act, who can demonstrate that they are socially disadvantaged, may also be eligible. SBA regulations define "economically disadvantaged" as socially disadvantaged individuals who are unable to compete in the free enterprise system because their opportunities to obtain credit and capital have been more limited than those of others in similar businesses. Further, program applicants must demonstrate a personal net worth that does not exceed certain limits so as to meet and maintain the criteria for an economic disadvantage. Each 8(a) firm under SBA's regulations is subject to a program term of 9 years. However, SBA may also, under its regulations, "graduate" an 8(a) firm prior to the expiration of its 9-year program term if that 8(a) firm substantially achieves the target objectives and goals set forth in its business plan. To date, according to SBA, no 8(a) firm has graduated. Colsa Inc. Barry L. Shillito, Senior Attorney Leslie Krasner, Attorney Adviser The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 6015 Gaithersburg, MD 20884-6015 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (301) 258-4066, or TDD (301) 413-0006. 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Summary:
Pursuant to a congressional request, GAO reviewed the Small Business Administration's (SBA) 8(a) program, focusing on whether: (1) ineligible 8(a) firms have received contracts through their improper participation in the program; (2) 8(a) firms have misrepresented themselves to enter and stay in the program; (3) firms exceeding the size standard have inappropriately received 8(a) awards; (4) SBA has allowed ineligible firms to remain in the program after they exceeded the size limitations; and (5) federal contracting authorities have improperly used indefinite delivery, indefinite quantity (IDIQ) contracts to avoid competition. GAO found that: (1) the two firms studied were initially recommended for nonacceptance into the 8(a) program because of eligibility questions about who actually controlled the firms; (2) SBA justification for accepting the firms was questionable, since the questions about the firms' ownership were never fully answered; (3) one firm's owner misrepresented her personal qualifications, her equity in the firm, and ownership changes, but SBA took no action when it found out about the misrepresentations; (4) the firm received millions of dollars worth of 8(a) contracts after it had grown too large to participate in the program; (5) although the firm hid its size by excluding items from its financial statements, understating its total revenue, and representing itself as a company at financial risk, it had considerable access to credit; (6) SBA allowed the firm to remain in the program and receive new 8(a) contracts even after it had determined that the firm had grown too large for continued program participation; (7) the Coast Guard awarded a sole-source IDIQ contract to the second firm by changing the contract's classification code to one for which the firm was eligible and altering the contract's original minimum value below the minimum threshold for mandatory 8(a) competitive procurements; and (8) the Coast Guard believed that competitive 8(a) procurements hindered its mission and viewed the contract as a graduation present to the firm.