Yesterday a Congressional committee published a 157-page report alleging a government contractor used questionable behavior to win federal contracts that could be worth more than $500 million. The worst part: While the contractor’s methods smell bad, some of his actions appear to be in line with the letter of the law.

In case you missed it: the House Committee on Oversight and Government Reform report (pdf) focused on the recent activities of Braulio Castillo, whose company, Strong Castle, took advantage of programs that give preferential treatment to certain types of small businesses to win IT contracts from the Internal Revenue Service.

Among Strong Castle’s alleged transgressions is the abuse of a federal program that sets aside some contracts for disabled veterans. According to the report, the company qualified for the program due to a foot injury that Castillo suffered when he was a student at the U.S. Military Academy Preparatory School, even though Castillo was later well enough to play college football at the University of San Diego and didn’t complete further military service.

Strong Castle was more devious still in seeking contracts through the government’s Historically Underutilized Business Zones (HUBZone) program, intended to create jobs in economically distressed areas. To qualify, the report says, Castillo opened an office in Washington, D.C.’s Chinatown and declared it Strong Castle’s principal location, even though he continued to work out of an office in a wealthy Virginia suburb. Rather than hire poor neighborhood residents, Strong Castle hired students at nearby Catholic University—who helped the company meet HUBZone requirements, even though the school’s annual tuition exceeds $36,000, according to the report.

Of course, if you really want to cheat to win government contracts, there’s nothing better than having a friend on the inside: The report says that Castillo’s decade-long friendship with IRS Deputy Director Greg Roseman was crucial to Strong Castle’s success winning contracts. Roseman invoked the Fifth Amendment in declining to answer questions during the hearing.

Castillo, who said in a statement that he “never received preferential treatment,” wouldn’t be the first government contractor to abuse set-aside programs. In 2010, amid reports that veterans were serving as straw men for businesses controlled by others, Congress passed a law requiring the Veterans Administration to take greater pains to ensure that companies applying for certification were truly veteran-owned. That same year, the Government Accountability Office published the results of an undercover investigation of HUBZone, reporting that the program was vulnerable to fraud and abuse.

Strong Castle was stripped of its HUBZone designation earlier this year, but the report indicates that the low bar for qualification in the disabled-veterans set-aside program means that Castillo seems to have qualified. To that end, Castillo told Congressional investigators that he first considered buying a company that qualified for the program, before deciding to apply for the designation himself.

Possibly the most disturbing finding in the report has less to do with Castillo and more to do with the way the IRS’s contracting department uses small businesses to funnel jobs to larger companies. By federal law, agencies are supposed to award 23 percent of prime contracts to small businesses, as well as certain set-asides for businesses owned by women and veterans. Most agencies fall short of those goals, but the IRS met targets in the past two years. Here’s how, according to the report:

“It is not unusual for the IRS to award a large sum contract to a small disadvantaged business such as Strong Castle, only to have the bulk of the funds go to a large computer manufacturer such as IBM (IBM) or Hewlett-Packard (HPQ). This practice completely undermines the goals of these programs. It is, in fact, a ‘pass through’ because in the end, a large corporation receives the funds, and in many cases, performs the work.”

A small technology contractor that won more than $500 million in Internal Revenue Service awards in less than a year had a “cozy” relationship with an agency official, according to a congressional staff report.

Greg Roseman, an IRS deputy director, may have “influenced the selection process” to benefit his friend, Braulio Castillo, president of Washington-based Strong Castle Inc., according to the House committee document. The two exchanged frequent phone calls and text messages, the report shows.

The Committee on Oversight and Government Reform, led by Representative Darrell Issa, a California Republican, is investigating how the small business, formed in late 2011, managed to attract so much contract business. The panel plans to hold a hearing tomorrow.

“What has led to the huge discrepancy between the potential for $500 million in contracts with the IRS alone and the mere $465,780 awarded by all other federal government agencies?” the report’s authors asked. “The difference is that the IRS -- where Strong Castle received well over 99 percent of its 2012 revenues -- employs Castillo’s long-time friend, Greg Roseman, who oversaw each and every contract awarded to Strong Castle by the IRS in 2012.”

A Strong Castle official wasn’t immediately available for comment, according to a representative who answered the phone at the company’s office. The company describes itself as a provider of “IT infrastructure and solutions for many federal customers.”

Foot Injury

The company was eligible for contracts that had been set aside for disabled veterans and for small businesses in economically disadvantaged communities. Castillo had suffered a foot injury in 1984 at the U.S. Military Academy Preparatory School, which he attended for a year, according to the report.

Castillo had no other connection to the military and his injury did not prevent him from playing softball as an adult, congressional investigators said.

“The case of Strong Castle and its cozy relationship with the IRS is but one example of a deeply flawed procurement process in the federal government,” according to the report.

The IRS has been surrounded by controversy since May 10, when the agency disclosed that it had subjected Tea Party groups applying for tax-exempt status to tougher scrutiny. Six congressional committees have opened inquiries and the Justice Department is pursuing a criminal probe. President Barack Obama installed a new temporary commissioner, Danny Werfel, last month.

The IRS didn’t respond immediately to a request for comment on the Strong Castle report.

Witness List

The witness list for tomorrow’s House hearing includes Roseman and Beth Tucker, IRS deputy commissioner for operations support, who oversees the agency’s back-office operations, is scheduled to testify tomorrow.

Roseman has been reassigned and isn’t overseeing procurement, according to a staff memo sent to Democratic members of the oversight committee. His attorney has told the committee that he will invoke his constitutional right not to testify at the hearing.

“Today, the IRS cannot look taxpayers in the eye and truthfully say they are protecting their contributions to government,” Issa in a statement. “By inappropriately using a personal relationship and abusing a provision designed to help disadvantaged businesses, the IRS and Strong Castle have made a mockery of fair and open competition for government contracts.”

Companies four North American Industry Classification System sectors and one subsector can now be bigger and still be classified as “small” businesses under new rules from the U.S. Small Business Administration.

The businesses have to be in the Agriculture, Forestry, Fishing and Hunting; Finance and Insurance; Management of Companies and Enterprises; Arts, Entertainment, and Recreation; and Support Services for Mining classifications.

The revised standards reflect changes in marketplace conditions and public comments that SBA received to the proposed rules, the federal agency says.

The new size standards will let more businesses obtain or retain small business status. It will also give federal agencies a larger pool of small businesses from which to choose for their procurement programs.

It will make more small businesses eligible for SBA’s loan programs.

Under the changes, thousands of additional firms will qualify as “small” and become eligible for SBA’s loan and federal procurement programs.

The SBA’s action is drawing criticism from a small business lobby.

“We don’t need more federal money going to larger corporations,” says Lloyd Chapman, president of the American Small Business League of Petaluma.

“If anything, the size standards should be reduced, he says, noting that the vast majority of companies in the U.S. have 20 or fewer employees.

He says the larger sizes are not meant to help small businesses but rather the federal government which is supposed to make a certain percentage of purchases from small businesses.

“It makes it easier for them to meet the small business goal if they increase the size standard. This is just a loophole they’re creating for themselves,” Mr. Chapman says. “It’s just another example of how the SBA is one of the most anti-small business organizations in the country.”