Cases of Defense Fraud Boom Amid Cutbacks : Military: Weapon purchases have plummeted, yet criminal fines and civil recoveries are soaring.

As darkness fell, a veteran Navy pilot launched his F-18 jet off the U.S. carrier Theodore Roosevelt during the 1991 Gulf War, but his combat mission would be suspiciously cut short less than an hour later.

After a jet engine gearbox failed, the $40-million plane lurched out of control and crashed into the Persian Gulf, according to a confidential Navy investigation report. The pilot ejected and was later rescued.

The faulty gearbox was produced by Lucas Aerospace, a British firm that pleaded guilty last month to 37 counts of criminal fraud, admitting that it supplied defective gearboxes, bypassed required inspections and falsified test records at plants in City of Industry and Park City, Utah.

After paying a record $18.5-million criminal fine, Lucas officials insisted that the gearboxes performed up to Navy requirements and never caused a safety problem. But prosecutors said in interviews that Lucas’ frauds were particularly egregious and triggered not only the Persian Gulf incident but scores of other flight emergencies.

In a larger sense, though, the Lucas case is just another ripple in a tide of defense fraud that is defying all expectations.

As Pentagon budgets have plummeted and contractors have seen their business volume erode, experts had expected that a similar decline would develop in fraud cases and fines. Just the opposite has occurred.

Although Defense Department purchases of weapons have dropped about 70% since 1986, fraud cases are up sharply. Criminal fines and civil recoveries reached a record $1.2 billion in 1994, up elevenfold since 1986.

Although defense fraud has faded from the public eye and is no longer the high-profile political issue it was in the late 1980s, it remains a high-stakes battleground between the government and an angry industry in courtrooms coast to coast. Nowhere is the intensity greater than in Southern California, the nation’s capital for defense fraud.

Federal prosecutors believe that tough times in the defense industry, in which increasing numbers of companies are going bankrupt or merging with competitors, have boosted the incentives to cheat.

“As military budgets shrink, we see more and more companies trying to maintain profits by cutting corners and committing fraud,” said Bryan Daly, the assistant U.S. attorney in Los Angeles who prosecuted Lucas. “There were a lot of people who thought that defense downsizing would result in fewer instances of fraud, but that has not been the case.”

Clearly, prosecutors are also more sophisticated in uncovering wrongdoing that has always existed, making it difficult to know with certainty all the reasons that underlie the increase in fraud cases.

The trend, however, cannot be explained as simply old cases from the mid-1980s that only now are being settled. Many of the cases involve business activities that occurred in recent years, nearly a decade after defense spending began to shrivel.

Derek Vander Schaaf, the Pentagon’s deputy inspector general, said in an interview that the percentage of major contractors under investigation is up sharply, even though the actual number of investigations his department is conducting has dropped in the last several years.

Vander Schaaf said 68 of the nation’s top 100 defense contractors are currently under investigation, a record number. By contrast, just 25 of the top 100 contractors were under investigation in 1985. And although criminal convictions have tapered off slightly in the last year, they remain far above the levels of the early 1990s.

“The problem will be there as long as there is human nature,” said Vander Schaaf, who has been the Pentagon’s most senior fraud investigator for 13 years.

But indignant industry officials say they are victims of a bloated federal investigative bureaucracy trying to justify its existence by prosecuting minor contract infractions. And layoffs have created an army of disgruntled whistle-blowers to help them, they charge.

The vast majority of fraud probes are dead-ends, but contractors end up spending millions of dollars in legal fees defending themselves, said attorney Herbert Fenster.

“The companies settle these cases even when they are innocent because it is too much headache to litigate and they don’t want their names in the paper for a long time,” he said.

Don Fuqua, president of the Aerospace Industries Assn., a Washington trade group, asserts its members are often victims of “ambulance-chasing” private attorneys who operate under the False Claims Act that allows private citizens to receive a bounty for uncovering fraud.

One Los Angeles defense executive fumed over a private attorney who placed a newspaper ad seeking whistle-blower clients, saying: “Uncle Sam Wants (to pay) You! You can help make a difference and be financially set for life.”

Nowhere is the issue more contentious than in Southern California, where about 75% of all criminal fines have been collected over the last four years--a proportion far in excess of the amount of defense contracting done here.

Michael Emmick, who heads the Justice Department’s defense fraud task force in Southern California, said confidential tips about wrongdoing continue to flood his office and that the quality of those tips remains high.

The defense fraud task force in Southern California is the largest and most experienced such prosecution effort in the nation, boasting 100 agents and attorneys from the FBI, the Defense Criminal Investigative Service, the Air Force Office of Special Investigations, the Army Criminal Investigations Division and the Naval Investigative Service, according to Richard R. Smith, the Pentagon’s top agent in Southern California.

Smith’s investigative team has cracked open some of the most bizarre cases of defense fraud anywhere.

Take, for example, former General Dynamics programmer Michael John Lauffenburger, who pleaded guilty in 1991 to creating a “logic bomb” inside his employer’s computers in his last days on the job--figuring that the company would have to recall him to fix the mess. Instead, he was sentenced to three years’ probation and community service.

Fred Saldana Jr., president of Pomona-based G&D; Aircraft Parts, was incarcerated for 14 months for delivering defective decoy launchers for Navy ships. After government inspectors approved a shipment of satisfactory decoy launchers and left the plant, G&D; would substitute defective ones that should have been either repaired or discarded. The Navy was forced to replace all the decoy launchers at a cost of $8 million.

The task force has also prosecuted a large number of big-money cases, including Teledyne for failure to properly inspect millions of electronic relays. The firm paid $85 million last year to settle civil fraud charges and a separate $17.5-million criminal fine.

Although many federal agencies are cutting back amid public outcries for less government, Los Angeles U.S. Atty. Nora Manella said she has no intention of reducing the defense fraud task force and may even increase it because of its effectiveness.

Prosecuting defense firms takes in more money in fines and settlements than it costs to operate, other prosecutors say, making it a “profit center” for the federal government.

They assert that defense firms increasingly consider fraud fines as merely a cost of doing business with the government and that guilty pleas no longer carry much of a stigma in the industry.

Such charges enrage industry representatives.

“There is nothing more traumatic to a company’s management than to enter a guilty plea,” said Brad Brian, a Los Angeles attorney who represents several major contractors. “To say it is considered a cost of doing business is ridiculous.”

Similarly, the concept that prosecuting defense fraud is a “profit center” is flawed and unfair, because it exposes Los Angeles firms to far tougher legal standards than exist in other jurisdictions, defense industry officials say.

“Industry does believe prosecutions are tougher in the Central District of California than elsewhere,” said Joseph Coyne, a Los Angeles attorney who represents contractors. “In some of the smaller communities, you have a more reasoned approach. Here, you have a lot of young, aggressive people trying to establish careers for themselves.”

Coyne said infractions that would be handled either as civil suits or as administrative disputes in other states are prosecuted as criminal felonies in the Los Angeles region.

Still, when a defense contractor is charged, 98% of the time they plead guilty in Los Angeles, according to Emmick, the fraud task force chief. That’s a higher percentage than in other fraud cases.

Before the early 1980s, the Justice Department had not indicted a defense firm for fraud since World War II. But fraud in weapons procurement became a high-profile political issue in the 1980s, when headlines nationwide heralded disclosures about $640 toilet seats and influence-peddling in the Pentagon by defense consultants.

Amid then-President Ronald Reagan’s controversial 1980s arms buildup, former Atty. Gen. Edwin M. Meese III vowed that his investigators would be “meaner than a junkyard dog” in watching contractors. He wasn’t bluffing.

By last year, the Justice Department was bringing criminal indictments against defense firms or their employees more than once every business day, on average.

But after years of guilty pleas and convictions that have touched almost every major defense contractor and every level of the Pentagon bureaucracy, the issue has lost much of its thunder. Nowadays, the public hardly notices when even a record criminal fine is assessed against a defense firm--apparently reflecting a post-Cold War ennui with military issues and a jaded acceptance of defense fraud.

“The more these cases are brought, the less the astonishment value,” said U.S. Atty. Manella. “But we don’t set our priorities by what causes the public jaw to drop.”

Even without the political hubris of years past, the issue of defense fraud is bitterly fought. In addition to paying $1.2 billion in fines and civil payments last year, the industry spends untold millions for attorneys and for ethics programs designed to keep the contractors out of trouble in the first place.

After a guilty plea or conviction, the Pentagon typically suspends or debars a firm or individual from receiving new contracts. Air Force suspensions and debarments, for example, hit a peak of 144 in 1994, up from 61 the prior year.

The overall Defense Department actions subsided slightly in the last year. The federal government list of suspended and debarred firms or individuals runs 300 pages.

To be sure, defense contractors have invested huge sums to prove they are responsible, law-abiding corporations--creating ethics training for employees, powerful in-house auditing departments and hot lines for employees to blow the whistle.

The industry also is seeking legislative changes that would lift many of the complex regulations and specifications that they are often charged with violating in criminal indictments. Pentagon officials support those efforts, arguing that the industry must become more efficient and should adopt commercial practices.

But those changes, along with new efforts to reduce the amount of federal oversight imposed on defense firms, strike prosecutors as risky.

“There is a public misperception that you can reduce government oversight and increase the trust placed in these corporations,” Daly said. “Based on the fraud we have seen, it would be wrong.”

In the Lucas case, for example, the firm admitted in its plea agreement that it created phony inspection and test records and that it delivered defective equipment. When federal agents searched the firm’s plants, they found 81 gearboxes ready for delivery--all with defective parts.

Lucas had employed 45 inspectors at its City of Industry plant, examining jet engine gearboxes, called air-mounted airframe accessory drives, or AMADs. But in an effort to cut costs, Lucas transferred a portion of the work to its Utah plant and assigned just 12 less-experienced inspectors to do the same work at both its California and Utah plants, Daly said.

As part of its guilty plea, the company agreed to increase its inspection work force, Daly said, and it now has 100 inspectors.

A Lucas spokeswoman disputed Daly’s numbers of past and current inspectors, but declined to provide company figures.

In the Navy F-18 accident during the Persian Gulf War, company officials say there is no evidence that the F-18 crashed as a direct result of a gearbox failure. But federal prosecutors and investigators say the evidence is overwhelming that the F-18 would never have crashed had the gearbox not failed.

“The thing that prompted this accident was the AMAD failure,” Daly said.

Steven Honigman, Navy general counsel, declined to comment on the accident, saying its investigation is confidential. But the Navy contends that Lucas gearbox failures have forced Navy pilots to abort 159 missions, including forcing 93 emergency landings, court records show.

The legal battles over defense fraud also reflect another reality: As defense budgets have dropped, the remaining money is increasingly precious both to companies and the government.

As aerospace analyst Wolfgang Demisch of BT Securities observed: “The fighting is so vicious because the stakes are so small.”