Document gathering and data transfer in investigations

Contributed by Homburger AG

July 02 2012

Introduction
Background
Forbidden services for foreign states
Economic espionage
Violation of an industrial or business secret
Data Protection Act
Processing of data on employees
Comment

Introduction

The recent past has witnessed an increasing need for Swiss companies to conduct internal investigations and to disclose or hand over some or all of the results of those investigations to regulatory or other law enforcement authorities abroad, notably the United States. This update examines the main statutory obstacles with which Swiss companies are faced when responding to a foreign authority's request for information or document production. Those statutory obstacles need to be overcome irrespective of whether a Swiss company is fully (or even voluntarily) cooperating with a foreign authority.

Background

Increasingly, Swiss companies have been the target of investigations by US regulatory authorities (Federal Trade Commission, Futures Trading Commission, Securities and Exchange Commission, Department of Justice). A Swiss company's involvement in these regulatory (or administrative) proceedings can broadly be described as falling within one of two categories. Sometimes the Swiss company will itself be responsible for starting those proceedings (eg, as a leniency applicant or whistleblower). In such cases the Swiss company has an interest in proactively cooperating with the competent US authorities. In other cases a Swiss company will find itself defending against allegations raised by US regulatory authorities in proceedings that started either because another company (or employee) blew the whistle or as a result of a complaint.

Swiss rules relating to banking secrecy are excluded from the ambit of this update.

For the purpose of this update, the notion of 'documents' or 'information' is broad, including hard-copy documents, electronic documents, email traffic, chats and tweets.

Forbidden services for foreign states

Article 271(1) of the Penal Code provides that:

"[w]hoever performs, without authorization, acts on Swiss territory for a foreign state which are reserved to a public authority or a public official, whoever performs such acts for a foreign party or any other foreign organization, whoever aids and abets such acts, shall be fined or punished with a term of imprisonment of up to three years, in serious cases with a term of imprisonment of not less than one year."

Article 271 protects Switzerland's territorial sovereignty and aims at preventing foreign states or parties from circumventing international conventions on judicial assistance.

The gathering or taking of evidence in Switzerland for use in foreign proceedings (including any preparatory act performed on Swiss territory) qualifies as an act within the scope of Article 271. This is particularly the case with regard to the interrogation of witnesses (depositions) or the collecting of written witness statements on Swiss territory. The same applies if a party is to produce or obtain documents for use in foreign proceedings which are not in its possession or under its control and must be gathered from a third party in Switzerland.

The assessment under Article 271 of a party submitting its documents is not entirely clear. In an obiter dictum, the Federal Supreme Court held that a party submitting its (own) documents in foreign proceedings does not constitute an official act but a private act, and thus is not subject to the restrictions set out in Article 271.(1) However, according to the federal attorney general, any submission must additionally be voluntary (ie, absent of any formal request or order). Whether this requirement will be upheld by the Federal Supreme Court cannot be predicted with any certainty. Until this matter is clarified, there is a real chance of criminal prosecution for any Swiss company submitting its own documents in foreign proceedings on a non-voluntary basis (ie, in response to a foreign order such as a subpoena).

Article 271 applies only to the performance of official acts without proper authorisation. 'Authorisation' in the sense of this provision means:

• a general waiver by way of judicial assistance proceedings according to a specific Swiss federal statute;
• a bilateral or multilateral international convention; or
• in exceptional cases, an authorisation granted on an individual basis – an individual authorisation (if sought) must be applied for by the competent governmental department.

Economic espionage

Article 273 of the Penal Code reads as follows:

"Whoever spies out an industrial or business secret in order to make it available to a foreign state agency or a foreign organization or private undertaking or its agents, whoever makes an industrial or business secret available to a foreign state agency or a foreign organization or private undertaking or its agents, shall be fined or punished with a term of imprisonment of up to three years, in serious cases with a term of imprisonment of not less than one year. The prison sentence may be combined with a fine."

Article 273 is designed to protect national public and economic interests at large. The provision penalises any conduct which provides a foreign addressee with the opportunity to gain insight into Swiss business secrets.

A 'secret' within the meaning of Article 273 is any fact which is not publicly known or accessible and which shall be kept secret pursuant to the intention of the master of the secret, provided that this interest in keeping it secret is worth protection. An objective interest in secrecy that is worthy of protection is presumed. The definition of a 'secret' in Article 273 is comparable to that under Article 162 of the code (see below). Moreover, the secret must have a connection to Switzerland, either because it affects Swiss national interests or because the private party whose secrets are protected resides in Switzerland.

In 1977 the federal attorney set out defined guidelines as to what constitutes economic espionage under Article 273. The crucial statements are:

"1. As far as the disclosure is restricted to information with regard to which solely the disclosing person has a secrecy protection interest, the decision on the disclosure of such information can be left to this person.

2. However, according to Article 273 [of the Penal Code], it is forbidden and punishable to inform a foreign entity about economic facts

a) with regard to which there is a (direct) secrecy protection interest of Switzerland as a whole, or

b) with regard to which a third party that has not given its prior formal consent to the disclosure has a secrecy interest worthy of protection."

Thus, a company is free to disclose its own secrets (unless the disclosure harms the direct interests of the Swiss national economy, such as national economic supply in times of war or crisis). By contrast, it is not allowed to disclose the secrets of any Swiss third party. However, to the extent that secrets of a Swiss third party are concerned, such party may consent to disclosure (provided that the disclosure does not harm any direct interests of the Swiss national economy).

While the 1977 guidelines called for prior formal consent, there is a tendency in legal writing today to adopt a more flexible approach and to accept tacit waivers. Thus, if in the circumstances the master of the secret has evidently accepted the risk of disclosure, such a tacit waiver will, most probably, also be accepted as permitting disclosure.

Article 273 does not protect the interests of foreign third parties, even if the disclosing person is domiciled in Switzerland. This applies, in particular, to relations between foreign affiliates of Swiss companies and their business partners, as well as to agreements between parties domiciled in Switzerland and their business partners abroad – provided, however, that such agreements do not contain secrets of other persons or companies domiciled in Switzerland.

Disclosure of secrets does not violate the law if a competent Swiss authority orders disclosure (eg, in the course of judicial assistance proceedings). Conversely, an order by a foreign authority does not justify disclosure. In particular, according to the view of the Swiss government, a person or entity disclosing secrets in compliance with a foreign subpoena (or any other order or threat) is in breach of Article 273. The Swiss government even believes that such foreign pressure – however strong it might be – does not create a state of distress justifying the breach of Article 273. Otherwise, foreign authorities might be tempted simply to increase the pressure until a suitable state of distress is reached.

Violation of an industrial or business secret

A person disclosing a protected secret may also be punished according to Article 162 of the Penal Code, which stipulates that:

"[w]hoever discloses an industrial or business secret which he is bound to keep by law or by contract, whoever takes profit of such disclosure for himself or for any other person, shall, on request, be fined or punished with a term of imprisonment of up to three years."

Article 162 is designed to protect not only private Swiss interests, but also (and unlike Article 273) foreign interests. It prohibits the disclosure of information which has been entrusted by one party to another with the obligation to keep it secret. Therefore, the offender shall be punished only at the request of the master of the secret.

A 'secret' in the sense of Article 162 is any fact, information or document which:

• is not obvious and generally accessible;
• shall not be disclosed because it is not intended to be brought before the public; and
• is worth being kept secret.

The definition of a 'secret' in Article 162 is comparable to that under Article 273.

Industrial secrets relate to the details of production proceedings. They comprise plans, receipts, procedures and similar. Business secrets relate to supply sources, organisation, prices and clients. To be worthy of protection under Article 162, both industrial and business secrets must somehow be able to affect business results. It does not matter whether the secret originates in Switzerland or elsewhere; nor does it matter whether the master or the receiver of the secret is domiciled in Switzerland.

Contrary to Article 273, the business and industrial secrets protected under Article 162 may be violated only by a person who is subject to a statutory or contractual confidentiality obligation (or by any person taking profit of such violation). Contractual secrecy obligations in the sense of Article 162 certainly exist where there is an explicit clause in an agreement.

Data Protection Act

In Switzerland, the processing of personal data by the private sector is governed by the Data Protection Act and its implementing ordinance. The act is aimed at protecting individuals and legal entities against the misuse of their personal data (ie, all information relating to an identified or identifiable person).(2)

The act provides certain basic principles of data processing. Thus, personal data may be processed only for the purpose:

• for which it was collected;
• which is evident from the circumstances; or
• which is provided for by law.(3)

Furthermore, according to the principle of proportionality, data processing must not be excessive and must be undertaken in good faith.(4)

In addition, the act provides that personal data must not be disclosed abroad if the privacy of the persons concerned is seriously jeopardised as a consequence.(5) Jeopardy is presumed by virtue of law if the country of destination lacks comparable data protection.

If comparable data protection is lacking, data may be disclosed abroad only if one of the requirements set out in Article 6(2) of the act is fulfilled:

• sufficient safeguards ensuring adequate protection, in particular by way of agreement (lit a);
• consent of the data subject in an individual case (lit b);
• direct connection of the processing of a contractual party's data with the conclusion or performance of a contract (lit c);
• disclosure being essential either in order to safeguard an overriding public interest or for the establishment, exercise or enforcement of legal claims before the courts (lit d);
• disclosure being required in order to protect the life or physical integrity of the data subject (lit e);
• the data subject having made the data generally accessible and not having expressly prohibited its processing (lit f); and
• disclosure within the same company or group of companies, if binding corporate rules on data protection are in place that safeguard adequate protection (lit g).

The federal data protection and information commissioner must be informed about the safeguards pursuant to lit a and the data protection rules pursuant to lit g.(6) The list of constellations in Article 6(2) is exhaustive. In particular, an overriding private interest is insufficient justification for the disclosure of data abroad.

The commissioner keeps a non-binding list of countries which are considered to have data protection equivalent to Swiss law.(7) The transfer of personal data to a country that does not have comparable data protection is deemed a breach of privacy rights,(8) unless one of the specific requirements of Article 6(2) is fulfilled.

The United States does not feature on the commissioner's list of countries with data protection equivalent to Swiss law. However, the commissioner agreed with the US Department of Commerce on a US-Swiss Safe Harbour Framework in December 2008.(9) This framework allows US companies and other organisations to self certify to the Department of Commerce their adherence to specific data protection principles. Data transfer to self-certified companies and organisations is possible without the need for an individual data protection agreement or one of the other requirements under Article 6(2) being fulfilled.

Whoever processes personal data without complying with the act may be sued for violation of privacy rights.(10) The petitioner may claim, among other things, the declaration of the unlawfulness of the data transfer and damages. In addition, the act stipulates penal sanctions (fines up to Sfr 10,000) for failure to comply with the obligation to inform the commissioner as required under Article 6(3) of the act.(11) The act does not provide for penal sanctions in case of a violation of its basic principles for processing personal data, except in the case of unauthorised disclosure of secret and sensitive personal data or personality profiles obtained by a person during his or her employment.(12)

Processing of data on employees

The act also applies to the personal data of employees. In addition, the employer may process the personal data of its employees only in accordance with Article 328(b) of the Code of Obligations, which reads:

"The employer may process data of the employee only to the extent that such data relates to the employee's suitability for the employment relationship or is necessary to perform the employment contract. Furthermore, the provisions of the Federal Data Protection Act of June 12, 1992, shall apply."

Generally speaking, Article 328(b) restricts the processing of data in an employee relationship to job-related data. Notably, this provision is mandatory in favour of the employee – namely, the employee cannot validly consent to the processing of his or her personal data beyond the scope defined by Article 328(b).

A violation of Article 328(b) is deemed a breach of the employment contract and exposes the employer to damages.

Comment

There are several statutory provisions to be observed by a Swiss company before documents or data can be transferred abroad in the context of a foreign investigation or proceedings abroad. The observance of those provisions can be a particular nuisance in circumstances where the Swiss company is seeking to cooperate (voluntarily) with a foreign authority's investigation. In that case, care must be taken to seek constructive dialogue with the foreign authority to explain the pertinent legal provisions and the restrictions they place on a Swiss company's ability to cooperate. In particular, it needs to be emphasised to the foreign authority that Swiss law does not prevent cooperation, but that it may delay timely cooperation (eg, because a formal authorisation needs to be obtained before data can be sent abroad). Foreign authorities (particularly in the United States) appear to be receptive to well-meaning explanations and they usually try to accommodate the domestic law restrictions to which a Swiss company may be subject.

For further information on this topic please contact Flavio Romerio or Katrin Ivell at Homburger AG by telephone (+41 43 222 1000), fax (+41 43 222 1500) or email (flavio.romerio@homburger.ch orkatrin.ivell@homburger.ch). The Homburger website can be accessed at www.homburger.ch.

Endnotes

(1) BGE 114 IV 128, 131 [1988].

(2) See Article 3(a) of the act.

(3) See Article 4(3) of the act.

(4) See Article 4(2) of the act.

(5) See Article 6(1) of the act.

(6) See Article 6(3) of the act.

(7) Available on the commisioner's website at www.edoeb.admin.ch.

(8) See Article 13(1) of the act.

(9) Also available on the commisioner's website at www.edoeb.admin.ch.

(10) See Articles 12 and following of the act.

(11) See Article 34(2)(a) of the act.

(12) Article 35 of the act.

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Inside The “Africa Sting” Trial: Anatomy Of A Failed Prosecution

A guest post today from Eric Bruce, Matthew Menchel and David McGill.  The authors were all trial counsel during the first “Africa Sting” trial in the United States District Court for the District of Columbia.  Bruce and Menchel are partners at Kobre & Kim LLP and lead their Washington, DC and Miami offices respectively and McGill is an associate in the firm’s New York office.

*****

Inside The “Africa Sting” Trial:  Anatomy Of A Failed Prosecution

Many media outlets and commentators have dedicated a great deal of attention to the DOJ’s decision to abandon its prosecution of 22 executives from the military products industry for alleged FCPA and money laundering violations arising from a first-of-its-kind sting operation that included an FBI agent posing as a representative of the minister of defense for the West African nation of Gabon.  And rightfully so—after all, it is not every day that the DOJ chooses to walk away from a major investment of investigative and prosecutorial resources, as well as 22 indictments, let alone in a high-profile context such as the “Africa Sting” case.  But for those on the front lines of the trial, the DOJ’s extraordinary decision to retreat from this case was the culmination of a long-running tactical chess match between the government and defense counsel that began long before the first witness was sworn in.

From our perspective as defense counsel for Pankesh Patel, a U.K. citizen who went to trial in the opening trial of the “Africa Sting” case, there were two especially critical developments that shaped the outcome of the first trial and contributed mightily to the DOJ’s failed prosecution efforts: (1) the Court’s pre-trial ruling on the admissibility of alleged evidence of prior bad acts; and (2) our unusual decision to call the government’s lead case agent as the sole defense witness in our case-in-chief.
The 404(b) Rulings
As the saying goes, every battle is won or lost before it is ever fought.  And this case was no exception.  After reviewing the documents and recordings evidence produced by the government before trial, it became immediately clear to us that the legal fight over the admissibility of alleged “prior bad acts” evidence would have an enormous impact on the trial.
The government argued that its vast collection of alleged prior bad acts evidence should be admitted under Federal Rule of Evidence 404(b) as evidence of the defendants’ knowledge and intent.  Alternatively, the government argued that if any of the defendants asserted an entrapment defense (given that the charges arose from a sting operation), the same prior bad acts evidence should be admissible to show that the defendants were predisposed to commit FCPA violations.
The government, however, exercised almost no restraint in the type and quantity of evidence they sought to admit under Rule 404(b).  In their Rule 404(b) Notice, the government sought to admit evidence of an additional seven allegedly corrupt deals against the four defendants in the first trial.  Seeking to admit such a wide range of prior bad acts evidence pertaining to deals outside the U.S. was, in our view, a strategic misstep by the government.  This scattershot approach by the government bolstered our argument that the evidence should be excluded under Rule 403 because admitting the evidence would risk transforming an already-complex, multi-defendant trial into a divergent series of mini-trials involving witnesses and events from all over the globe.
Moreover, because our client, Mr. Patel, was a U.K. citizen operating a small U.K. company who had not done any prior deals in the United States, we also advanced some unique arguments that further highlighted the prejudice and confusion that would have arisen if the alleged prior bad acts evidence was admitted.  For example, we argued that evidence concerning allegedly corrupt conduct by a U.K. citizen in Nicaragua, if true, might violate U.K. law or Nicaraguan law, but it could not possibly demonstrate our client’s intent or predisposition to violate U.S. law, let alone the FCPA in particular, where that alleged conduct had no connection to the United States and our client was not even a U.S. citizen.
Ultimately, the Court agreed with our arguments and denied the government’s motion to admit the alleged prior bad acts evidence, largely under a Rule 403 analysis.  Having succeeded in substantially narrowing the scope of trial, our next challenge was to make the flaws in the government’s sting operation the focus of trial.
The “Commission Sandwich”
As former federal prosecutors, we were familiar with the DOJ’s guidelines pertaining to undercover operations and, more specifically, the requirement that the illegality of the deal be made reasonably clear to the targets of an investigation.  In this case, we believed there were significant problems with the manner in which the government ran the sting operation—most notably, its reliance on the cooperating witness, Richard Bistrong, to make strategic decisions about the operation and how to explain the illegality of the Gabon deal in various meetings with the defendants.  Further, instead of allowing Bistrong’s importance in the operation to gradually recede as an FBI undercover assumed greater responsibility, as is traditionally the case with sting operations, the government made the critical mistake of allowing Bistrong to “call the shots” and make key investigative decisions throughout the entire investigation.
For example, at Bistrong’s suggestion, the government chose to describe the allegedly corrupt payment to the Gabonese Minister of Defense as a “commission” when speaking with the defendants, instead of using any number of words that would have more clearly connoted its supposed illegality – e.g., bribe, kickback, payoff, “butter up,” “grease,” etc.  Worse yet, having chosen an innocuous word for the payment, the government—again, at Bistrong’s urging—intentionally buried the commission reference between perfectly legitimate discussion about other aspects of the transaction, thereby further increasing the chances that a target would miss it.  Bistrong even came up with a catch phrase for this technique—he called it the “commission sandwich.”  In a text message that Bistrong sent to the lead FBI case agent explaining his approach, Bistrong proudly explained “I just think its important to sandwhich [sic] the commission statement.”
Naturally, the “commission sandwich” and the way in which the FBI let a highly-incentivized informant orchestrate the sting operation were important themes we wanted to weave into our defense.  But resolving the tactical question of how to bring the “commission sandwich” and other serious flaws in the sting operation to light at trial ultimately required a bold stroke.
Calling the Lead Case Agent
In the weeks leading up to trial, we became convinced that, as a matter of trial strategy, the government would not call its star cooperating witness, Richard Bistrong, to the witness stand.  It was not simply that Bistrong had a lot of “baggage,” though the sheer amount of it – including corruption, false statements, habitual drug use, and frequenting prostitutes – was staggering.  Rather, it was Bistrong’s conduct during the sting operation itself, including lying to defendants about the legality or illegality of the deal and discouraging them from seeking legal advice, that led us to conclude that the government would leave Bistrong on the sidelines.  After all, the government already had tape recordings of all of the calls and meetings involving the defendants’ discussions with Bistrong and the undercover agents.  So why risk putting him on the stand?
When the government filed a series of motions on the eve of trial seeking to preclude the defense from, among other things, impeaching non-testifying witnesses; making missing witness arguments; attacking the legitimacy of the government’s undercover techniques; and making use of recordings not otherwise introduced by the government, our hunch was proven correct.  Not only that, but it had also become clear to us that the government intended to go even farther and would not call its own lead case agent, FBI Special Agent Christopher Forvour, as a witness.  By avoiding Bistrong and Agent Forvour, the government’ s strategy, it seemed to us, was to present a sanitized version of the sting operation through witnesses who were several steps removed from the operational decisions, thereby leaving us with little room to bring out evidence of the investigation’s shortcomings.
To countermand this strategy, we asked the government witnesses who were called as witnesses a series of questions about strategic decisions relating to the sting operation.  If the answer was “I don’t know,” the next question was always “Well, who would know?”  The answer was always the same:  Agent Forvour.  We took this approach for two reasons.  First, we thought this strategy would at least raise questions in the minds of the jurors as to why the government never called its lead case agent, who was present at counsel’s table for the entire trial.  Second, it set the stage for us to possibly call Agent Forvour as a witness in our defense case to get answers to questions that everyone in the courtroom was now curious about.
Ultimately, after a lot of internal debate amongst the trial team, we made the very unusual decision to call the lead case agent in our case-in-chief.  It was not a decision without risks.  Calling a professional witness over whom you have no control and who does not want to help you, without knowing what he will say, can easily backfire.  Nevertheless, because the government had largely succeeded to that point in limiting the trial evidence to tape recordings admitted through witnesses who had no role in directing the investigation, we felt the jury lacked a clear understanding of the serious problems underlying the government’s investigation.
In the end, the strategy worked.  Through Agent Forvour, we were able to demonstrate the major flaws in the government’s investigation and demonstrate just how much Bistrong, as opposed to the FBI, was in charge of key operational decisions and scripting what words would be used to describe the unlawful payments to the defendants during the sting.  In the process, we believe that we came across as truth-seekers (a critical element to any advocate’s credibility), shedding light on all the things that the government had strived to keep from the jury.  The momentum of the entire case swung in our direction during that examination.  It was truly a game-changing decision.
While the net result of the first trial was a deadlocked jury and a mistrial, our ability to capitalize on the government’s avoidance of its two key witnesses worked well enough that the government changed its trial strategy 180 degrees and decided to call both Bistrong and Agent Forvour in the second trial.  But because we succeeded in locking the government into positions that were developed during the first trial, it fared no better the second time around.  The second trial also ended in a series of mistrials and acquittals and, thereafter, the government decided to end this failed prosecution, dismissing all remaining charges against all 22 defendants.
The Future of FCPA Enforcement
While it remains to be seen exactly how the DOJ’s failed prosecution of the “Africa Sting” case will impact future enforcement efforts, this sort of high-profile setback will undoubtedly impact the way in which the DOJ and the FBI conducts their investigations and evaluates their cases for prosecution.  At the same time, we expect that companies and individuals who find themselves as targets of FCPA enforcement efforts will become increasingly aggressive in resisting the Department’s interpretation of the statute, which had gone largely unchallenged in the years preceding the “Africa Sting” trial.

Finding the bid riggers 12 red flags of contract and procurement fraud

CHARLES PIPER, CFE, CRT

July/August 2012

 The rise in contract management and the outsourcing of goods and services has created an increase in procurement fraud. Here are some red flags that can help you save millions.

The top execs at QRX Inc. were quite concerned about their contracting officials (CO). The COs had been selecting several new bidders for jobs and seemingly ignoring longtime contractors. QRX wasn't opposed to new blood, but the established contractors were beginning to grumble. QRX called me in to investigate.

I discovered the COs in one bidding round had given low ratings to all the reputable contractors. However, then they gave high ratings to a new company and awarded the contract to that company at double the price they could have paid. I later learned the bid evaluators were friends with the contractor. The winning bidder actually had offered a bid evaluator a job with the company during the bid evaluation process.

Though I've changed some of the details, this actual case shows just one of many red flags ("Awards to non-lowest bidder," see below) in procurement and contract fraud. This is one of the more complex types of frauds to investigate because there are so many ways in which the contracting process can be manipulated to exclude fair and open competition and/or to unjustly profit.

When I first starting investigating contract fraud, I was a bit overwhelmed. Not only did I have to learn the rules of contracting, then I had to figure out how the rules were or could be manipulated or circumvented. Making it more difficult were the lies of some dishonest contracting officials (CO) when I asked for explanations about procedures. However, as I kept (skeptically) asking questions and learning, I got better at catching the "bad guys" in the contract arena.

In this article, I'll describe 12 red flags that could indicate fraud and provide examples to help fraud examiners work with their bosses or others to be skeptical when examining, auditing or investigating contracts and procurements. I'll also give some examples of how I've identified wrongdoing in those areas. (This list is far from exhaustive. See the 2012 Fraud Examiners Manual, 1.1901.)

12 RED FLAGS 

1. Repeated awards to the same entity.  
2. Competitive bidder complaints and protests.  
3. Complaints about quality and quantity.  
4. Multiple contracts awarded below the competitive threshold.  
5. Abnormal bid patterns.  
6. Agent fees.  
7. Questionable bidder.  
8. Awards to non-lowest bidder.  
9. Contract scope changes.  
10. Numerous post-award contract change orders.  
11. Urgent need or sole source.  
12. Questionable minority/disabled ownership.   

1. REPEATED AWARDS TO THE SAME ENTITY

Determine why the same entity is repeatedly awarded contracts for the same services or products and if the stated reasons are justified. Review the contracting official's (CO) pre-award contract documentation to identify if he advertised the need or obtained other quotes or bids at the proper time.

Be on the lookout for backdated documents. During one contract examination, I found that a CO wrote, "A determination was made that Contractor X was the best value." A red flag was the use of the past tense word "was." I found printed pages of another vendor's prices from that vendor's website, but the small font printed at the bottom of the pages indicated they were printed two weeks after the contract was awarded.

The CO initially told me that she'd obtained the prices before the contract was awarded. However, when I confronted her with the evidence, she admitted that she'd never obtained the second price quote, and she'd prepared and printed competitor pricing information after the fact. The CO subsequently told me that she'd pre-selected the winning vendor.

2. COMPETITIVE BIDDER COMPLAINTS AND PROTESTS

A sure way to overlook corrupt procurements is to not listen to or consider losing bidders' complaints and protests. Contracting offices typically will determine if complaints have merit. However, a more objective way is to have knowledgeable, experienced, independent, objective and impartial Certified Fraud Examiners/investigators review the complaints. Also, many governmental groups enlist other objective governmental agencies to review official protests.

Periodically select a random sample of losing bidder complaints and scrutinize the outcomes to see if the complaints are being resolved appropriately. However, note that many entities never officially complain or protest because they believe they would never be awarded any future contracts if they did, or they believe complaining would be fruitless and a waste of time.

I interviewed one vendor who said he kept submitting bid proposals to an entity, but the entity would never award him any contracts. The vendor thought that if he blew the whistle just because he suspected corruption nobody would listen to him. The vendor was delighted to be interviewed and share his input. The investigation later determined the CO was prematurely and secretly opening sealed bids and providing competitors' bid prices to his buddy who was paying the CO bribes.

3. COMPLAINTS ABOUT QUALITY AND QUANTITY

Repeated complaints about a contractor or vendor's quality of services or products are red flags for many types of fraud, such as defective products, product substitution, short quantity shipments, "ghost" shipments (submitting invoices for payment but never shipping the items), double billings, etc. These deficiencies may or may not be accidental.

I asked one entity's quality control representative (QCR) what she did when she learned a vendor had submitted an invoice and received payment but never shipped the products. The QCR said, "I tell them they have 30 days to ship the products." In essence, the deficient vendor's punishment for submitting false claims was to do what they were supposed to do in the first place but only when they got caught. Keep in mind that it's easy for a vendor to underbid when they have no intentions of providing what's requested.

4.MULTIPLE CONTRACTS AWARDED BELOW COMPETITIVE THRESHOLD    
During an investigation, I learned that many employees had complained that they hadn't received a vendor's (already paid for) shipments or the vendor had delivered reduced orders. The customers complained after the vendor had submitted invoices and received payment. I found evidence in the corresponding contract files' pre-award documentation that the CO had repeatedly favored the vendor in two ways.

First, the CO often eliminated competition by keeping prices under the $2,500 threshold, which would have required competition. (Sometimes, he seemed to split several orders to keep them under $2,500.)

Second, when the total contract price was more than $2,500 but under $25,000, the CO obtained telephone price quotations from three vendors, as was required in this price range. I found the suspect vendor's prices were always listed third in every contract file and were always slightly less then the competitors' prices. I thought it was strange that the CO never telephoned the suspect vendor first. I found evidence that the CO received bribery payments — cash and cashier's checks — from the suspect vendor. When I interviewed the CO he admitted he provided the competitors' price quotes to the suspect vendor to ensure the favored vendor could always underbid the competition.

The CO said he believed he was ensuring that his company saved money by getting the lowest price. He said he didn't know anything about all the complaints against the vendor because another department handled those.

5. ABNORMAL BID PATTERNS

Most companies that receive multiple bids for high-dollar procurements will log the bid prices received on a bid abstract or similar document. If most bid prices are high, and one is low, that's an obvious anomaly. For example: If five vendors bid $60 to $75 per foot of cable, and one vendor bid $15 per foot, that's a red flag indicating the lower-priced cable may not meet the requirements or specifications asked for. That's exactly what happened in a case I investigated; my client later determined that the vendor provided defective cable. Similarly, something might be amiss if three vendors bid $60 to $75 per foot of cable, and three bid $10 to $15 per foot. Interviewing all the vendors separately could result in some interesting details.

If you observe three similar high bids and one low bid you should also suspect that the three high bidders never expected an honest low bidder to submit a price proposal for the same contract. It could be that the low bid is honest, and the three highest bids are intentionally inflated. Ascertain what other contracts the three high-priced vendors bid on, and review those contract files.

6. AGENT FEES

Often contractors or vendors are required to provide and/or certify their costs and pricing data (which most would rather not do) prior to being awarded contracts. Scrutinize anything listed as "agent fees." You'll want to discover the name of the agent and what he or she would do to earn those fees.

An "independent" agent in an investigation I conducted was known as a "10 percenter." As the name implies, he would receive 10 percent of the contract price but only if his contractor was awarded the contract. (Yep — that was a red flag to me too!) The 10-percenter agent was known to frequent the COs' office areas, and he often took them to lunch. And there's no telling how many gift cards or sporting event tickets he gave the COs.

When I questioned contractors about their agents' participation in contracts, a typical response would be, "He helped us put the bid together." (Yeah, I bet he did.) Sometimes an agent represents more than one bidder perhaps for the same contract. In one case it was determined that the 10-percenter was also the middleman to facilitate bribery payments. Entities need to have written policies describing when outsiders can frequent their work areas plus written rules and training for their employees on the dollar amount limit per year that COs and other employees may receive in gifts from vendors, contractors and others. If there are no in-house rules, there are no rules — period!

7. QUESTIONABLE BIDDER

Entities' policies differ on how they determine price reasonableness. Some perform market analysis, some research their entity's price histories for the same or similar items/services, some search the Internet, some do all three, etc. But many rely on the bidders' integrity to submit fair and competitive prices. Entities often reason that no serious vendor would intentionally submit a price that was too high because it would never be awarded the contract or too low because it wouldn't make a profit.

However, vendors sometimes take advantage of entities' trust. I worked a case in which several bidders secretly conspired to take turns being the low bidder — bid rigging at its worst. All the bids, including the low bid, were much higher than the market average. But because the prices were similar, the CO assumed the low price must be reasonable.

Some contractors also invite "complementary bids" because there are other advantages for vendors if awarded those contracts. For example, in federal procurements, adequate competition and price comparability is sufficient to determine price reasonableness and allows the low bidder to avoid certifying their cost and pricing data. (See Federal Acquisition Regulation 15.402 and 15.404.)

When contractors don't have to certify their cost and pricing data, they may switch suppliers and vendors during contract performance. However, if they have to certify the cost and pricing data, the contractor will have to get permission from the CO before making any changes. If those changes result in reduced expenses for the contractor, the government can reduce the contract award price. In short, based on such rules, a fraud examiner or investigator shouldn't assume it's an honest coincidence that there is competition and/or price comparability.

Sometimes contractors that compete for the same contract actually perform subcontract work for the winning bidder. This can be determined to be more than a coincidence when it's observed repeatedly over time, and contractors seem to be taking turns being the low bidder. By alternating contract awards and subcontracting to each other, all the conspiring contractors always have work (and income) — often at inflated prices.

Reviewing contracts and paper files alone will not prove a conspiracy. At some point, you'll have to conduct well-planned interviews. With skill (and perhaps leverage), you can sometimes obtain useful information during interviews.

For example, when I investigated a vendor for providing defective products, I learned he wasn't the lowest bidder. I asked the owner of the company how his company was awarded the contract because his bid price was higher. The owner said that the low bidder ended up landing a separate higher-dollar contract with another company, and so that low bidder backed out just before the contract was to be awarded.

The owner told me, "After the other contractor backed out, I had no choice; I had to go through with it." I thought that was a strange choice of words. I would have expected the owner to respond with something like, "I was ecstatic when the low bidder backed out because that allowed my company to get the contract!" The owner's response prompted me to examine the contract's bid abstract. By conducting additional research, I found that the original low bidder and several of the other bidders had since been convicted in federal court for bid rigging. Some of those other bidders also had been convicted of paying bribes to COs to obtain U.S government contracts. During the investigation, one suspect plant manger committed suicide.

Because of the "adequate competition and price comparability" clauses, the contractor I was investigating didn't have to certify cost and pricing data. After the contract was awarded, the owner switched (without needing the CO's approval) from using a previously quoted supplier to a less-expensive supplier who had provided cheaper substandard material. By making the switch, the owner stood to make an extra $1 million profit. By using laboratory handwriting comparisons and conducting interviews, I later proved that the company officials conspired to and did submit false samples of the less-expensive material for testing because the cheaper material couldn't meet required specifications. (That's why it cost $1 million less).

Sometimes vendors submitting bid proposals don't even have the facilities to do the work. They're essentially shell companies that are either submitting complementary bids for the above reasons, or, if they're awarded the contracts, they intend to subcontract the work to others — perhaps to one or more of the other bidders.

Government contracts usually include a clause limiting the amount of work that can be subcontracted (See FAR 52.219-14 Limitations on Subcontracting). However, in one case, I learned the "required" clause was intentionally omitted from the contract by a CO, thus allowing the contractor to sub-out 100 percent of the work.

Some unscrupulous contractors have been known to submit bids using fictitious companies or bids submitted by relatives. Be alert for bids submitted with the same mailing addresses or telephone numbers. In one case, I found three companies located at one residential address. Also be alert for bids that have the same misspellings, are sent with the same fax number or show similarities in handwritten signatures.

8. AWARDS TO NON-LOWEST BIDDER

As in the opening case of this article, sometimes bid evaluators — those who rate and score each bid — intentionally decide early which companies they'll award contracts — no matter what. Entities often award contracts on "best value" determinations, not lowest price. For example, a brand-new company with the lowest price might not be selected because a more seasoned contractor, which has previously completed jobs for the entity, seems to be a better value by offering less risk.

It's also a good idea to verify bid evaluators' statements that bidders were "unresponsive." Sometimes bid evaluators falsely report that bidders failed to respond to certain questions or requests, and then they eliminate those bidders from further consideration.

In a case I worked, the bid evaluators reported that Vendor A refused to provide required financial records to determine if the vendor was "responsible." Vendor A was then considered, "unresponsive." Regarding Vendor B (a bid evaluator's friend), the bid evaluators wrote, "Vendor B stated he understood the requirement to provide financial records." But alarmingly, the bid evaluators failed to also write that Vendor B also had refused to provide the financial records. Vendor A was kicked to the curb, and Vendor B was subsequently awarded the contract.

9. CONTRACT SCOPE CHANGES

Bidders often submit price quotes based on detailed descriptions of services/products the customers wants. By advertising specific needs, COs can compare apples to apples. In an investigation I conducted, the CO added work to the contract after it was awarded that was totally unrelated to what was advertised. That contractor was delighted because it stood to make much more money. But the other bidders rightfully complained that they never got a chance to bid on the other new work.

Surreptitiously changing the scope of the contract requirements may be a violation of internal contract rules. Keep in mind that the CO and the contractor might have planned or conspired to make the changes even before the contract was awarded. Entities normally require changes to contracts to be documented in the form of contract modifications or amendments.

10. NUMEROUS POST-AWARD CONTRACT CHANGE ORDERS

After an entity awards some contracts to the low bidder or to the contractor that presented the best value, the entity might amend or modify the contract to add similar requirements and therefore dollars to be paid. In one case I worked, the vendor and CO knew all along that additional work/requirements would be added, but that information wasn't listed in the advertisement so the competition wouldn't know about it. More often, work or services also might be added to an existing contract simply to save time and the additional expense of re-advertising the new need.

11. URGENT NEEDS OR SOLE SOURCE 

Many entities allow contracts to be awarded without competition when there's an urgent need for items without delay. (The U.S. Department of Defense might do this during wars.) But sometimes the urgency doesn't exist or only exists because of poor planning. When there's no competition, the entity might have unjustly favored the selected vendor, and/or the entity might be paying more than necessary.

Occasionally entities consider some vendors to be the only suppliers ("sole sources") that can provide desired services or products and therefore award them contracts without competition. Check a contract file to determine how the entity determined the sole source designation, and then attempt to discover if the vendor actually is a sole source. Simply querying the Internet might find many others who could've provided the service or product.

12. QUESTIONABLE MINORITY/DISABLED OWNERSHIP

Federal, state and many municipalities award a certain percentage of their contracts to minority- and/or disabled-owned businesses. The rational is obvious. But statistics have shown that all too often, the reported owners aren't actually minorities or disabled. Many require that the minority- or disabled-owned business perform approximately 50 percent of the work/service, but investigations have found that sometimes a higher percentage is outsourced. Also, many set-aside contract requirements include that minority/disabled owners actually run the operations or be in decision-making positions. However, sometimes those owners are nowhere to be found in or around the business.

The U.S. Department of Defense, Office of Inspector General recently publicly published a report, "Inadequate Controls Over DoD Service-Disabled Veteran Owned Small Business (SDVOSB) Set-Aside Program Allow Ineligible Contractors to Receive Contracts" (Report No. DODIG-2012-059, Feb. 29, 2012). The OIG reported that several SDVOSB contracts were awarded to ineligible contractors and several more contractors misstated their SDVOSB status.

COMPROMISED CONTRACTING OFFICALS

Fraud examiners, investigators, auditors and compliance personnel who are responsible for examining, analyzing, reviewing or overseeing the compliance of contract and procurement award procedures should be mindful of these 12 red flags. Keep in mind that occasionally, dedicated COs are forced to compromise their integrity in contract-awarding decisions because of inappropriate guidance, directions or pressures from their superiors.

Skilled fraud examiners/investigators also will conduct thorough and well-planned interviews during their examinations. Even when only one anomaly is identified, don't automatically dismiss it as accidental or a coincidence because additional research, interviews and analysis may identify patterns, financial losses, collusion, corruption or conflicts of interest.

Charles Piper, CFE, CRT, is a private investigator, consultant and owner of Charles Piper's Professional Services in West Tennessee. Visit www.piper-pi.com.

SIDEBAR:

Detecting schemes during the presolicitation phase

The most prominent schemes involved during the presolicitation phase of contracting or procurement are need recognition schemes and bid tailoring.

Need recognition schemes — The typical fraud in the need recognition phase of the contract negotiation is collusion between the buyer and contractor, in which the buyer's employee receives a gratuity or kickback for recognizing a need for a particular product or service.

Bid tailoring schemes — Entities prepare bid specifications and statements of work detailing the types and amounts of goods and services to be provided to assist in the selection process. They're intended to provide both potential bidders and the selecting officials with a firm basis for making and accepting bids.

A well-written contract will contain specifications, standards and statements of work that clearly detail the rights and entitlements of the contactor. Carelessly written contracts make it easier for a contractor to claim at a later time that he's entitled to more money than the buyer intended to pay.

Bid-tailoring schemes occur when an employee with procurement responsibilities, often in collusion with a supplier or contractor, tailors bid specifications to give an unfair advantage to a certain contractor.

There are various methods used to commit bid-tailoring schemes. Sometimes, the buyer's personnel and the contractor deliberately collude to write vague specifications. At other times, there's an agreement to amend the contract to increase the price immediately after the award.

Source: 2012 Fraud Examiners Manual, 1.1902


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