More than $2 billion in federal contracts supposedly awarded to small businesses actually went to much larger outfits, according to a new government report released Dec. 28. Issued by the Small Business Administration's Office of Advocacy, the report shows that at least 44 large companies that won the contracts were miscoded as small concerns in fiscal year 2002, the most recent year for which data was available, skewing federal procurement statistics.

The deals lost to big outfits would have lowered the small-business share of total procurement to 19.7%, from 20.5%. Congress now mandates that 23% of all federal contracts go to small businesses because they generally lack the resources and political muscle to go head-to-head with larger concerns. However, the actual proportion of contract funds going to smaller players consistently falls short of the goal that lawmakers have set. The report's findings represent a further blow to small businesses, especially manufacturers, which have long struggled to compete for federal dollars.

HONOR SYSTEM.

The Office of Advocacy's chief counsel called for needed reform, noting that the findings are evidence of a loophole, not illegal activity on the part of the government or the larger corporations involved. "This report clearly shows there are problems with the federal procurement system," said the chief counsel, Thomas M. Sullivan, in a statement. "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 problem the report revealed stems from the classification system. Small businesses are classified depending on their number of employees and annual revenue or market share. Currently, a self-reporting policy is in place where businesses simply state their size when they bid for a government contract. In an honor system of sorts, companies are not required to reclassify themselves if or when they experience rapid growth beyond small-business size standards -- 500 employees for a manufacturer -- or if the outfit is purchased by a larger concern. Competing contractors can contest a supplier's status as a small business, but because of the confusing coding system, supporting information has traditionally been hard to find.

While the issue has long been of concern to small-business owners, Sullivan noted that this analysis, compiled by Fairfax (Va.)-based Eagle Eye Publishers for the SBA, provides the first official documentation of the activity. "We finally have hard data," he said.

" NOT SURPRISING."

The SBA document, which tracks federal procurement issues, examined 1,000 of the largest contractors (in dollar volume) coded as small businesses in the fiscal year of 2002 when receiving small-business contracts. The 44 that were found in fact to be large companies or classified as "other" such as nonprofits or government agencies include San Diego-based Titan Corp. (TTN ) and the Waltham (Mass.) aerospace giant Raytheon (RTN ).

According to the report, $539.9 million of Titan's total $1.1 billion in government contracts were earmarked for small business, and $126.5 million of Raytheon's $7.4 billion in deals was misclassified. Organizations categorized as "other" in the report include the state of Texas and the national YWCA, which received a combined total of $59 million in small-business contracts.

"Errors are regrettable but not surprising," says Alan Chvotkin, senior vice-president of the Professional Services Council, an Arlington (Va.)-based trade association representing roughly 170 government service providers, large and small, including Titan and Raytheon. "We're highly dependent on individuals to make the coding input."

FIGURING OUT SIZE STANDARDS.

Critics accuse large contractors of exploiting the classification loophole and contend that the SBA has simply turned a blind eye to the ongoing problem.

"These companies acknowledge to shareholders that they aren't small companies, and yet, they make no effort to notify the government of [their non-]small-business status," says Lloyd Chapman, founder and president of the American Small Business League.

The group has been a longtime whistleblower on the issue of small-business government contracts and has organized over 2,000 citizens and owners of small outfits in an e-mail letter-writing campaign, prompting House and Senate small-business committee hearings on the issue. "They intentionally misrepresented their status," says Chapman.

The Defense Dept. was responsible for handing out nearly 80% of the $2 billion in misclassified funds, followed by the General Services Administration and the Health and Human Services Dept. In total, 31 federal agencies awarded small-business contracts to big corporations, including the Small Business Administration itself, which had over $1 million in misallocated funds, according to the Office of Advocacy report.