His letter to the
Honorable Harold Damelin, Inspector general of the SBA
Kerry's complete letter (pdf document)

His letter to the
Honorable Hector V. Barreto, Administrator of the SBA
Kerry's complete letter (pdf document)

Small-business advocates have suspected for awhile that some contracting dollars intended for small firms go to large companies. Now, they have the evidence to prove it.

Small Business Administration officials have released a 2004 report showing that $2 billion of the $50.8 billion earmarked for small businesses in fiscal 2002 did not get to them.

The study, conducted by Eagle Eye Publishers, found that of the top 1,000 small businesses receiving federal contracts in 2002, 44 were actually not small businesses. Thirty-nine were large businesses, while five were nonprofit organizations, government entities or other organizations.

The SBA study comes on the heels of an earlier report from the Center for Public Integrity that showed about 30 percent of the contracting money that supposedly went to small firms through Defense Department contracts during a six-year period ended up in the coffers of large companies. The SBA study has caught the attention of agency officials and members of Congress.

"We now have hard data and not just anecdotes from across federal agencies," said Thomas Sullivan, chief counsel at SBA's Office of Advocacy. "What's needed is more transparency in the contracting system and timely public access to user-friendly procurement data so that mistakes and other problems can quickly be corrected."

The report's authors refrain from suggesting that large companies are intentionally defrauding the government by taking small-business contracts. However, they discuss loopholes in the small-business rules – some of which have since been closed or tightened – that allowed companies to continue operating as small firms for some time after larger companies acquired them or they outgrew their small status.

"We were very careful not to point any fingers," said Chad Moutray, chief economist at the Office of Advocacy. "That's not the job of this office. As far as we're concerned, no one did anything wrong."

Rep. Nydia Velazquez (D-N.Y.), ranking Democrat on the Small Business Committee, said the SBA report shows that small businesses are not getting the full benefit of programs designed to aid them.

"The [Office of] Advocacy report only confirms what Democrats on the Small Business Committee have been saying," she said. "Federal agencies are taking credit for awarding small businesses with contracts when, in fact, they were going to large businesses. Opportunities [for small businesses] are dropping, and the federal government has no credible ability to monitor the level of federal contracting dollars going to small businesses."

The need for accurate small-business data goes beyond simply ensuring that the small firms get a fair deal, said procurement lawyer David Nadler, a partner at Dickstein Shapiro Morin & Oshinsky. "It also misleads Congress," he said. "Congress makes appropriations based on that information."

Small businesses suffer

Although the $2 billion figure that Eagle Eye analysts reported may not seem like much when compared to the total of $50 billion, it could mean a lot to small companies, said some small-business owners.

"In real dollars, that's a lot of jobs and a lot of opportunity that's being missed," said John Moliere, president of a small business called Standard Communications.

Simple miscoding is not the worst problem that small businesses face, he added. Too often, agency officials choosing prime contractors or primes looking for subcontractors see the government's small-business goals as a nuisance.

"They use our capability, they check off the box, and they go forward and ignore small business in general," Moliere said. Although situations such as that do not qualify as miscoded expenditures, they still limit chances for small businesses to succeed, he said.

Lloyd Chapman, president of the American Small Business League, said he believes many large companies are guilty of fraud, and the report SBA officials released ignores the issue. Chapman's group has filed a lawsuit demanding that SBA officials release more information.

The results shown in the report were not surprising, he said. "I've always known this," he said. "I've been telling people this for a decade. Now, there's irrefutable proof that we've been right. It's going to help convince Congress and the media."

SBA officials are wrong to assume that cases of sidetracked small-business contracting funds are honest mistakes, Chapman said. "It's ridiculous for the SBA to stick their head in the sand and try to pretend," he said. "I think that's irresponsible and not policing the situation. In fact, I would say they're encouraging it."

He said no new laws are needed, but officials must enforce existing laws, including the elements of the Small Business Act that set penalties for companies misrepresenting themselves as small businesses.

"The law is dependent on the integrity of the administration," he said. "Small business should not have to look at legal remedies, but we're having to do that."

Study limited in scope

Paul Murphy, president of Eagle Eye, said his analysts were not always able to determine how a particular transaction was coded incorrectly. In many cases, former small businesses acquired by larger firms carry the name of the larger firm.

In such cases, "we couldn't tell if it was a company they bought and renamed, or if it got miscoded from the start," he said. "The data doesn't reveal that level of insight."

How small is small?

That is the heart of the debate over SBA's planned overhaul of size standards.

Several organizations representing small and minority businesses hope to persuade SBA that size standards for federal procurement should be increased, because businesses competing for federal contracts tend to be larger than the average small firm.

Another group, the California-based American Small Business League, is urging business owners to oppose a "grandfather" clause that would permit businesses currently classified as small to automatically retain their eligibility under the new standards.

SBA issued an advance notice of proposed rulemaking Dec. 3 asking for comments on a number of specific issues relating to the standards. (SAA, 12/17/04) The comment period has been extended until April 3. To see the notice, go to www.regulations.gov and click on "Small Business Administration." The agency also plans public meetings to hear comments before it issues a proposed rule.

SBA is "asking the community, Tell us what to do" in rewriting the standards, said Fernando Galaviz, president of the Association of Small Businesses in Technology in Arlington, VA. "We commend them for it."

"The real issue here is the viability of a small business," he said in an interview. "When is a small business reasonably in a posture to become competitive in the mainstream marketplace?"

SBA has traditionally set size standards by surveying all businesses in a particular industry to determine which ones qualify as small. Galaviz and others argue that size standards should take into account the unique nature of the federal marketplace, which demands a certain amount of heft to compete.

Noting that large corporations are the dominant players in federal procurement, he asked, "How is a $21 million or $50 million firm to compete with a $2 billion firm?"

But the president of the American Small Business League, Lloyd Chapman, has long pushed for action to limit small-business programs to firms that he believes are truly small, such as those with fewer than 100 employees. The League urges SBA to require annual recertification of small businesses to make sure they have not outgrown size standards.

In a letter posted on its website, the League says, "The SBA needs to redirect attention to policies and procedures that direct the flow of federal contracts away from large businesses and back to small firms with less than 100 employees. These true small businesses are the firms that Congress intended to benefit from the Small Business Act when it was passed." Chapman said several hundred firms have used the letter as a model for their comments on the issue. (See www.asbl.com.)

SBA issued a proposed rule last March to revamp its size standards, but withdrew the proposal in July in the face of widespread opposition. (SAA, 7/9/04) The December notice said, "SBA remains committed to modifying its size standards in a manner to make them simpler and easier to use."

Some comments on the proposed rule advocated separate size standards for federal procurement, larger than the standards for SBA's other programs, such as loans. Before 1984 SBA had a separate set of standards for procurement. In its December notice, the agency invited comments on whether it should return to that policy, but SBA officials have said in the past that they did not intend to increase size standards.

Other comments suggested two-tiered size standards for procurement, with the lower dollar-value contracts reserved for very small businesses. Legislation would be needed to create tiered standards, but SBA invited comments on the issue.

SBA's 2004 proposal would have based new size standards on the number of employees rather than a company's revenue, with limits ranging from 50 employees to 1,500, depending on the industry. The rule would have set ceilings on receipts as well as employment in 31 industries, including construction and many services; to be eligible for federal small business programs, a company would have to stay below both the employment and receipts limits.

In its December notice, the agency asked whether it should reconsider that approach and base some or all standards on receipts.

Small Business Administration officials have extended the public comment period on possible new rules governing small-business size. The Advance Notice of Proposed Rulemaking, published Dec. 3, 2004, followed SBA officials' withdrawal of a controversial proposed rule last summer.

Agency officials are trying to find ways to simplify the process by which businesses are certified as small. But some critics contended that the proposed rules would have made it easier for large companies to take contracts intended for small players.

SBA officials currently are seeking public comment on issues including the best way to simplify the system, whether temporary or contract workers should count as employees for size determination, the grandfathering of small-business eligibility and the establishment of tiered standards which would further separate larger small businesses from the smallest.

Comments can be submitted until April 3. The deadline originally was Feb. 1.

SBA officials have said they are trying to close loopholes that allow companies to manipulate the system. They also want to simplify the often-confusing system for determining a company's size. The agency's critics say that some of their recent proposals would make it easier for large firms to take billions of dollars in contracts meant for small business.

The idea of grandfathering businesses that have their small-business status changed by new regulations is troubling, said Lloyd Chapman, president of the American Small Business League.

He said he believes the extension of the comment period is an attempt by SBA officials to gain more support for grandfathering.

"Even the way they presented the proposal was designed to manipulate the results of the public comment," he said. "They did not ask the public if they should grandfather large businesses, they asked what approaches should the SBA use to grandfather."