Defense contractor fraud

Defense contractor fraud remains one of the biggest areas for False Claims Act litigation. Below are common ways defense contractors cheat the government. Many times a defense contractor may be guilty of a combination of fraudulent schemes.

• Cross-charging
• Product substitution
• Improper cost allocation
• Failure to comply with contract specifications
• Violations of the Truth‑in‑Negotiations Act (TINA)
• News articles about Phillips & Cohen cases involving defense contractor fraud

Cross‑charging

This is one of the most common types of defense procurement fraud. A company may have one contract that is a "fixed‑price" contract, i.e., where the company receives a fixed price for a certain number of weapons no matter how much it costs to produce them. The company also may have another contract that is a "cost‑plus" contract, i.e., where the government pays the company for the cost of making the weapons, plus a percentage of its costs as a profit.

In this circumstance the company has a strong incentive to charge time it spends working on the fixed‑price contract (where it gets paid the same no matter how much time it takes) to the cost‑plus contract (where it gets paid for its costs plus profit). This may be accomplished by instructing employees to write down on their time cards that they worked on the cost‑plus contract when they actually worked on the fixed‑price contract.

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Product substitution

The government frequently specifies that its defense contractors build products using a certain grade or quality of parts. There often is a further requirement that the parts be purchased from American companies. Sometimes companies are tempted to provide substitute (and often inferior) parts that they can get more cheaply from an unauthorized source. If they do this without getting permission from the government contracting officer, it can form the basis for a False Claims case.

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Improper cost allocation

Improper cost allocation is a more subtle version of the cross‑charging scheme. If a company has both government contracts and private commercial contracts (like most large aircraft companies), they are supposed to spread (or "allocate") their costs fairly among the different jobs. With direct costs, such as time a worker spends building an engine or other part for the aircraft, this is a simple matter. If the part will go into a plane for the government, the cost of building it is charged to the government job.

When the costs are less directly tied to a particular project, such as supervisors' time, the correct allocation is a little trickier. The temptation is to shift more costs to the government, which may pay on a cost‑plus basis, and away from private customers, who simply pay the market price for the aircraft. Such cost‑shifting allows the companies to quote lower prices to their commercial customers (gaining a competitive advantage) without having to absorb the losses for such price cuts.

Companies that deliberately allocate a disproportionate share of "indirect" or "overhead" costs to the government are committing fraud.

A qui tam lawsuit brought by Phillips & Cohen on behalf of a whistleblower alleged that TRW Inc. padded bills submitted to the government under space and technology contracts, including billing the government for work done on non-government contracts. Northrop Grumman, which acquired TRW, paid $111.2 million to the federal government to settle the qui tam case.

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Failure to comply with contract specifications

Because reliability is critical with expensive and lethal weapons systems, the Defense Department requires its contractors to build those systems in accordance with very detailed product specifications. These specifications dictate not only the type of materials to be used for the contract, but other requirements such as the appropriate quality assurance steps that the company must follow to ensure the quality of the product. Although the burdens imposed by the specifications are costly, the government covers those costs as part of the contractor's payment.

If a company starts to overrun its budget on a contract, particularly a fixed‑price contract, or falls behind in its delivery schedule, it may be tempted to cut corners by omitting required testing, quality procedures or other steps in the production process.

Teledyne Relays paid the federal government $88 million to settle a qui tam lawsuit brought by Phillips & Cohen attorneys that alleged the company failed to properly test the reliability of electronic switches known as “relays” that it sold to the government. Those parts were used in the space shuttle, military satellites and in a wide array of sophisticated weapons systems including the Nike nuclear missile and the Patriot missile.

In a separate whistleblower case brought by Phillips & Cohen, Hughes Aircraft Company paid $4 million to settle charges that the company routinely lied about conducting important quality assurance tests of certain components used in missiles, fighter planes and other military systems.

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Violations of the Truth‑in‑Negotiations Act (TINA)

When the government needs to procure highly specialized weapons systems, it frequently chooses to use a company that already makes them, known as a "sole‑source supplier." This ensures a company with expertise will be the one making the weapons.

The problem for the government is to ensure that it pays a fair price since it cannot put out the contract for competitive bids. TINA requires the contractor to truthfully disclose all relevant information about its costs to the government in sole-source contract negotiations. That way, the government can make an informed decision about what price is fair to pay for the product.

Companies sometimes are tempted, however, to hold back relevant information, or to deliberately inflate their projected costs to get a higher price. Such conduct can form the basis for a False Claims Act case.

A whistleblower represented by Phillips & Cohen brought a qui tam lawsuit   charging that FMC Corp. had inflated its research and development costs as part of its Department of Defense work. The Army used the inflated figures to reach a price that it would pay FMC for the Bradley fighting vehicle. FMC paid $13 million to the federal government to settle the qui tam case.

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