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The Set-Aside Syndrome

Minority-contracting programs can be undone by a city's inability to distinguish between a real and a fake minority firm.

David Malone had good news to report. As the chief of procurement for Chicago, Malone was able to tell the city's aldermen in the fall of 2003 that almost half of Chicago's contracts had gone to minority- and women-owned firms that year--a 40 percent increase from the year before. Moreover, the procurement office was working hard to winnow out "front" companies--firms set up to masquerade as minority businesses in order to win minority set-aside contracts.

Malone's assessment was welcome: Allegations of minority-contract fraud had plagued the purchasing office for years.

Two months later, however, the news was negative again. A federal judge threatened to shutter Chicago's set-aside program and gave the city six months to tighten up its regulations for minority contractors. The judge deemed the program's rules to be too lax in making sure that the city's set-aside money actually was going to small, disadvantaged, minority firms. Malone, who left office a week later when his four-year contract expired, was replaced. His successor lasted only one year before stepping down, amid a growing number of minority-contract scandals.

Municipalities across the county are perpetually struggling to increase the number of city contracts going to minority firms--as a means of encouraging small business development and to reflect a city's diversity. Collectively, however, the programs have been bogged down with problems. As the number of contracts going to minority firms goes up, it gets harder to ensure that money is going to qualified applicants. Increasing the percentage of minority contract work also means redoubling efforts to combat fraud.


Most cities that seek to augment the share of contracts going to minority business enterprises--MBEs--do so simply by setting a goal to target those firms. They may set up a minority business development program to help MBEs draft contract proposals or install a city official to act as a liaison with those firms.

Despite these efforts, cities on the whole have been unsuccessful at meeting their own goals. In St. Paul, Minnesota, for example, a pair of studies in the mid-1990s showed that there was discrimination in the city's contracting. Officials in 1997 passed an ordinance that set new MBE contract goals. But the share of contracts going to MBEs actually went down instead of up, plummeting from 8 percent in 2002 to 1.1 percent in 2004. Last fall, the city insisted that contract firms increase their use of minority subcontractors. A few months later, however, a group of minority firms filed a class-action lawsuit against the city for failing to uphold its own ordinance.

"It's a constant struggle," says Owen Tonkins, executive director of the National Association of Minority Contractors. Nationwide, he says, cities aren't doing enough to develop and target minority firms. The only city Tonkins identifies as a success right now is Baltimore, which has, as a result of a 2000 city council ordinance and mayoral directive to conduct more business with minority firms, nearly doubled its contract awards to minority- and women-owned businesses. MBEs now receive about 30 percent of city contracts.

Making MBEs more successful and profitable makes good business sense for Baltimore, says Samuel Lloyd, director of the Mayor's Office of Minority Business Development. The city earns dividends in areas such as property taxes and business taxes. And fostering an environment friendly to MBEs will encourage more minority firms to locate in Baltimore, which in turn will provide even more competition for city contracts. "The more competition we have, the better deals we can strike," Lloyd says.

That's all well and good. Not many cities would disagree with that rationale for building up MBE contracting. But Baltimore's boom in minority contracting puts it in the position Chicago was in three years ago: Success could pave the way for more opportunities for contract fraud.

Lloyd says the city has a tight certification process for MBEs. "If we are diligent in the process, it will reveal any problems," he says. "If somebody is engaged in a fraudulent practice, we'll discover it." Lloyd could be right. Baltimore may be able to handle a dramatic increase in MBE contracts in a way Chicago could not. There, the spike in minority contracting overloaded the city's procurement office. Officials are only now making real inroads against fake minority firms.


In the year following David Malone's departure as procurement chief, a string of phony minority firms began to surface in Chicago. A window installation company was charged with setting up a false minority front to win a $6 million contract with the city's public school system. The city paid $3 million to a minority firm supplying residential garbage bins, but the checks were actually cashed by a white-owned company.

Chicago overhauled its minority set-aside program in 2004 to comply with the federal ruling. While the new rules limited MBE participation to economically disadvantaged firms, they did not address the growing problem of front companies. By January 2005, U.S. Representative Jesse Jackson Jr., was calling for a clean-up of Chicago's "corrupt and apparently often phony affirmative-action program." Members of the city council's Black Caucus also called for hearings to review the program. Before those hearings could be held, however, Eric Griggs, the procurement chief who had replaced Malone a year earlier, announced he was stepping down.

In the wake of Griggs' departure and the roiling imbroglio over the contracting scandals, Chicago Mayor Richard M. Daley brought in Mary Dempsey to overhaul the already-revamped program. The city's longtime library commissioner, Dempsey had turned down past entreaties from Daley to take on especially tough jobs--as CEO of the city's public schools, for instance. But when he asked Dempsey to conduct a top-to- bottom review of the city's minority-contracting processes, she accepted, promising a "total scrubbing" of the scandal-ridden program.

"What happened in the past was a lack of clear enforcement and a lack of clear understanding about who these contractors were," Dempsey says. She brought in several new staff members, including Lori Lightfoot, a former assistant U.S. attorney and the head of the Chicago Police Department's Office of Professional Standards, who was charged with focusing specifically on the MBE contracts.

Since taking over in February, Dempsey and her team have made significant changes to the city's affirmative-action contracting process. Firms seeking minority certification must disclose tax returns, lease agreements and distributorship agreements before bidding on a contract. "A lot of this is information we've asked for in the past, but perhaps not in a consistent way," says Dempsey. "Now we ask for it all upfront." The city also has stepped up its efforts to make site visits before certifying a company as minority-owned. Companies must disclose whether they share facilities with other firms. Businesses seeking minority status must turn over payroll records and information about outside consultants used in the past three years. The procurement office has already taken action against several companies it says should not qualify as true minority-owned firms.

The single biggest factor that had allowed sham minority companies to proliferate, Dempsey says, was the agency's lack of staff to oversee the program. The procurement office was unable to vet all the supposedly minority-owned firms being awarded contracts. Staff has been added to focus on clearing up the MBE file base "so that we're confident these companies are who they say they are," Dempsey says. "We're not trying to play a game of 'Gotcha!' with people. We're trying to eliminate the fear and the suspicion around this program."

Chicago's experience can serve as something of a cautionary tale to cities looking to beef up minority contracting. With an increase in MBE contracts comes greater responsibility to ensure that money intended to help spur minority entrepreneurship is going to the right firms. That responsibility can mean increasing procurement staff size and changing the way cities monitor and certify minority firms.

Baltimore's Samuel Lloyd admits it can be tempting for cities to relax their regulations on MBEs in an effort to attract more bids from minority-owned companies. But the only way to maintain a respected minority-procurement reputation is by setting up strict regulations and keeping them in place. "There will always be people in the marketplace who will try to take advantage of the system," Lloyd says. "We have to ensure they don't."

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