Regulators blew chances to bring labor scofflaws in line

Earl Devaney served as the Obama administration's top official for preventing fraud and misuse of federal stimulus funds. Around the nation - in plain sight of regulators - thousands of companies avoided state and federal taxes, cheated vulnerable workers and undercut law-abiding competitors by calling workers "independent contractors."
Earl Devaney served as the Obama administration's top official for preventing fraud and misuse of federal stimulus funds. Around the nation - in plain sight of regulators - thousands of companies avoided state and federal taxes, cheated vulnerable workers and undercut law-abiding competitors by calling workers "independent contractors." Miami Herald

Earl Devaney carries himself with the force of an oncoming bus, intimidating without uttering a word. A onetime college linebacker and Secret Service agent, he exposed the underbelly of money and politics in Washington.

As an inspector general, Devaney helped take down Jack Abramoff and had a reputation in Washington for carrying a big stick. So it made sense that President Barack Obama put him in charge of hunting those who might make off with tax dollars from the $840 billion stimulus bill in 2009.

When he took charge, Devaney wasted no time going after phony contractors. In less than two years, his investigators opened more than 1,400 cases of abuse, fraud and waste.

But in all that oversight, he overlooked something.

Cheaters across the United States used a scheme that was staggering in its simplicity: wrongly treating employees as independent contractors to avoid paying taxes. Five years later, Devaney acknowledges that his group, working at the top levels of the Obama administration, wasn’t paying attention to misclassification .

“Everybody knows it’s a problem. It’s sort of a dirty little secret,” Devaney said in an interview. “But the resources really aren’t there to enforce it, and I suspect the bad guys know that.”

Devaney was the public face of stimulus oversight, but he was one of an army of Washington leaders who allowed the pervasive labor problem to persist unchecked for years. Several federal agencies had a role in letting it happen. Each blames another, shrugging off responsibility until, at the end, no one thought it was his job.

McClatchy’s yearlong investigation found that state and federal agencies tasked with distributing taxpayer money did little to ensure the companies cashing in followed the law. Workers were denied protections, taxpayers footed the bill and lawful competitors foundered.

The scheme was most prevalent in Southern states where unions are weak, federal payroll records show. But reporters found projects in 21 states and the District of Columbia in which businesses didn’t withhold the taxes they’re obliged to deduct from employees’ pay. At a time when state and federal governments struggle to find additional revenue, the McClatchy investigation reveals that the nation’s leaders are missing opportunities to recover billions of dollars each year by not enforcing rules already on the books.

“It’s the Wild West. It’s anarchy,” said Ross Eisenbrey, a former labor official who’s the vice president of the left-leaning Economic Policy Institute in Washington.

‘That stovepipe mentality’

Many companies teetered on the brink of insolvency during the recession. Some found refuge in taxpayer-funded stimulus projects from the American Recovery and Reinvestment Act of 2009.

Many construction firms that won the bids had been misclassifying for years; they brought their bad habits with them onto government jobs. Regulators wasted the chance to bring them in line, a McClatchy investigation found.


– Devaney had $84 million to run his office out of more than $350 million also divided among the Government Accountability Office, inspectors general and other agencies to dig out corruption and waste. But misclassification appeared to be on no one’s radar. Not Devaney’s. Not Congress’. Not that of the thousands of public servants across the nation the feds tasked to help watch the money.

– Companies face little risk when they treat employees as independent contractors, and they know it. Payroll records McClatchy examined offer a startling look into an industry populated by scofflaws. The companies were so unconcerned about being caught that they filed payroll records laden with fabrications. Bosses listed invalid addresses, fake Social Security numbers and the names of laborers who later told reporters they’d never worked on the projects.

– Agencies worked alone. Questions went unasked. Records, all on paper, were dumped into boxes and cabinets, never shared with the investigators who could have taken action.

– The federal government has a history of continuing to do business with companies that cheat on their taxes. And that didn’t change with the stimulus act.

Many agencies have parts to play to ensure tax dollars aren’t misspent on government projects. The U.S. Department of Housing and Urban Development handed out billions without heeding major labor laws or revenue codes. The U.S. Department of Labor rarely stepped in, nor did revenue officials. The agencies didn’t talk to one another.

“It’s that stovepipe mentality,” said Alfred Robinson, a former acting administrator of the Department of Labor’s Wage and Hour Division.

“You’ve got all these agencies, and this is their fiefdom. They don’t care what the other regulations are,” said Robinson.

The burden of that inaction falls on workers.

Barbara Lynch worked for a Charlotte, N.C., cleaning company hired to dust and mop low-income housing in Charlotte during the recession.

She earned $8 an hour, even when she worked more than 40 hours in a week, Lynch said. Her boss, Erica Everett Hubbard, said in an interview that her workers were independent contractors, coming and going as they pleased without any direction from her.

Lynch never considered herself a business owner and doesn’t earn enough to cover overhead such as insurance and materials. Lynch said she never understood why her boss told her that she was “self-employed.”

“She told me that’s how the rules worked,” Lynch said.

The RAT Board

With the stimulus, Devaney had to meet steep demands. Money needed to be out the door right away. The public needed to see where it went. Funds had to be used to build what communities need – no swimming pools or golf courses.

At Obama’s behest, Devaney assembled a team of 29 inspectors general from federal agencies to create a special stimulus watchdog Recovery Accountability and Transparency Board, known as the “RAT Board,” and an oversight operation.

On a trip to Washington this summer, Devaney met McClatchy reporters to talk about misclassification on stimulus projects. Sitting at a booth near the back of a trendy cafe, Devaney thumbed through payroll reports listing hourly laborers as independent contractors. He shook his head.

Misclassification deserved more attention than it got under his watch, Devaney acknowledged. But he’s worked in government long enough to know that there are never enough watchdogs in enough places to do all that needs doing.

“There were so many other possible frauds, especially with recovery money, that it would have been, I don’t know, ninth or 10th on the list,” said Devaney, who now lives in Florida.

The recovery board’s effort was, in some ways, a recipe for disaster. Money moved so quickly into so many pockets. There were so many ways bad companies and unethical officials could abuse stimulus dollars. To stop misclassification, Devaney said, he would have needed “an army of investigators” he didn’t have.

McClatchy found, however, that no one appeared to even talk about the problem.

In half a dozen appearances before Congress, Devaney never mentioned the issue. And elected officials didn’t ask, transcripts show.

Of 1,553 waste, fraud and abuse probes into stimulus contracts that Devaney’s Recovery Accountability and Transparency Board is still investigating, none focuses on misclassification, according to the board.

“This never came up,” Devaney said.

Congress dictated the members of Devaney’s board. Inspectors general from major federal departments such as Justice, Energy and Transportation got seats. Missing: someone from the Department of Labor.

The Labor Department was involved, however. Labor officials issued reports for the board and put together a 14-minute training video provided to public servants monitoring payrolls on stimulus jobs. The video doesn’t mention misclassification.

The effect is clear. Local housing officials and municipal employees didn’t pay attention to whether workers were employees or contractors, interviews with more than 20 of them confirm. Some didn’t even know why it mattered.

“I don’t know that that means that they are being treated good or bad,” said Annemarie Maiorano, the director of the Wake County Housing and Community Revitalization program in Raleigh, N.C. “It is just what it is.”

Brian Dennison, the vice president of development and asset management for the housing authority in Fort Worth, Texas, said it wasn’t his office’s job to check whether a worker was properly classified.

“We don’t make that distinction,” Dennison said. “That is not our responsibility. It is the responsibility of the contractor. And then ultimately the authority over the 1099 and the W-2 is the IRS. That’s where that trail goes.”

McClatchy’s investigation found, instead, the trail ended in local officials’ closets and filing cabinets. The forms gathered dust while companies cheated their workers and padded their revenues with contracts funded by taxpayers.

Who’s checking the records?

The clues are in black and white on a simple sheet of paper.

A few little boxes on the payroll report should list Uncle Sam’s cut of the worker’s pay. Those following the rules list the taxes they must withhold from employees. Cheaters leave them blank or offer explanations: “employee pays own taxes” or “1099,” the tax form given to independent contractors.

Using the Freedom of Information Act and state public records laws, McClatchy gathered tens of thousands of pages of payroll records from construction projects in 28 states.

The federal government requires that companies performing work on federal projects comply with Davis-Bacon and Related Acts, regulations that obligate private companies to pay wages deemed fair by the Department of Labor. McClatchy focused on HUD projects because they offered the widest window into the construction industry; nearly every one of its trades is involved in the building of apartment complexes.

McClatchy’s investigation found that federal regulators rarely see the records that the local officials collect. Only a few local officials can remember anyone from the federal government asking to see them; when officials from HUD did inspect the records, they raised no issues with companies that treated hourly workers as independent contractors.

Some local officials say they’re ill-equipped to monitor labor laws and revenue codes on payroll forms.

“Our housing authority staff doesn’t have that kind of expertise, to review and make certain of the classification of workers,” said Van Johnson, the executive director of the Palm Beach County Housing Authority in Florida.

Studying a stack of payroll records her agency gathered for a low-income housing development, Maiorano, the North Carolina housing official, didn’t register the meaning of reports listing “pays own taxes” or “1099” where tax deductions should be. When a reporter explained, Maiorano couldn’t understand why federal regulators hadn’t directed them to flag this issue.

“That’s a very easy fix for HUD,” she said.

‘No one raised an eyebrow’

On a warm day in May, about two dozen local government officials sat facing a projector screen in a government meeting room outside Raleigh.

Two federal HUD regulators had traveled there from Atlanta to explain how to inspect payroll records. Through the morning, the two women emphasized the importance of the oversight, saying the laborers listed on the payroll reports “deserve to earn a decent living like everyone else.”

One of the regulators, Jennifer Dupont, passed out copies of records and asked listeners to study a company’s payroll forms.

She asked them to spot a problem involving a carpenter’s pay. He’d been paid $12 an hour rather than $13.83, the prevailing wage. Dupont moved on, ignoring another problem: In the blanks where withholding taxes belong, the owner had written of the workers: “PAYS OWN TAXES.”

When told about the training, Eisenbrey, the former labor official, said it was lacking.

“They’ve obviously been ignoring it. No one raised an eyebrow,” Eisenbrey said. “That’s bad training.”

In interviews with McClatchy, officials from housing authorities and municipalities across the country couldn’t recall getting any guidance from HUD about workers treated as independent contractors instead of employees.

Two sentences in a manual distributed to contractors working on HUD projects are the only hint that the agency knows what misclassification is. The message warns contractors that the agency reserves the right to refer to the Internal Revenue Service payroll records showing workers without tax withholding.

The threat is empty.

HUD officials in the Atlanta office, which oversees eight states in the Southeast, have referred no payroll reports to the IRS for review, a spokesman said. In fact, the forms rarely reach Atlanta; the locals are instructed to keep them. HUD doesn’t ask them to make IRS referrals on its behalf.

Federal officials at HUD do receive payroll forms for construction of apartments insured by the Federal Housing Administration. Records for two FHA projects that HUD officials in Atlanta reviewed show widespread misclassification, but no referral was made.

Dupont and Dondra Merrell, the other federal housing official leading the training in North Carolina, declined through a spokesman to be interviewed.

Jerry Brown, a HUD spokesman in Washington, said in a statement that HUD doesn’t have the authority to monitor or enforce federal tax laws and that guidance provided to local officials is consistent with Department of Labor policy. He said HUD is tasked with ensuring that contractors pay proper prevailing wages, but it doesn’t enforce proper classification of workers as employees or contractors. He said there is no requirement that certified payroll records be transmitted to the IRS.

“HUD involves other agencies on an as-needed basis,” he said.

Chances of tax audit low

All matters of taxes are guarded closely by the IRS.

A host of privacy laws prevent the agency from blasting news releases trumpeting its efforts. Every now and again, a tax lien appears in a binder in a county courthouse. Tax auditors will say no more, and they don’t alert other agencies to companies that run afoul of tax obligations. A simple tax code on the lien offers a clue as to whether the company may have misclassified workers.

As with many federal agencies, resources are tight at the IRS. Audits of taxpayers were at an all-time low last year, with less than 1 percent getting that extra scrutiny from revenue collectors. For businesses, the chances of being audited are even lower. Of more than 29 million employer tax returns, the IRS examined 60,800 last year.

For any potential audit, examiners weigh their time and investment against expected recovery. That’s particularly true in recent years with budget cuts, said Steve Miller, former IRS acting commissioner.

Miller said payroll taxes had a small footprint in the IRS’s universe. Small construction operations with poor records and a heavy reliance on hard-to-trace cash rarely make the cut.

“To think that the IRS would be aggressive in this area is unlikely,” Miller said. “They’re not going to ignore something they find. But is it going to be the focus area? I wouldn’t think so.”

The Government Accountability Office criticized the IRS and the Department of Labor in 2009 for doing little on the issue of misclassification. Both agencies vowed to explore ways to work together more closely and with state agencies to thwart the practice.

Lack of training, resources

Devaney doesn’t think the lack of oversight is deliberate. He blames a lack of resources and proper training.

He also points to a long-standing turf war between state and federal officials. Federal officials have learned over time not to big-foot locals, to avoid inflaming tensions.

“Because they might get mad at us,” Devaney said. “And they might accuse us of being Big Brother and tell us to mind our own business.”

On stimulus projects, Washington’s oversight interest was unlike ever before, according to Dempsey Benton, who led stimulus operations in North Carolina in 2009. A parade of federal regulators came to Raleigh in those years to oversee how stimulus dollars were spent. Still, regulators were mum on misclassification.

“I don’t recall that being on anyone’s punch list in discussions with us,” Benton said.

Florida’s stimulus czar, Don Winstead, who served as a special adviser to then-Gov. Charlie Crist, had a similar recollection.

“I don’t recall anyone raising issues about people being classified as employees,” he said.

Private projects targeted

Yet when it comes to private projects, the Department of Labor has stepped up its enforcement on misclassification as part of Vice President Joe Biden’s Middle Class Task Force.

Hilda Solis, then the federal labor secretary, in 2011 requested $25 million to boost enforcement targeting misclassification. Fourteen states have signed agreements to share more information with the Labor Department’s Wage and Hour Division. Obama’s 2015 budget proposal includes nearly $14 million to combat misclassification.

The additional resources were part of the Obama administration’s efforts to make permanent changes that would remain in place long after the stimulus, said Jared Bernstein, former chief economic adviser to the vice president. He said combating misclassification on the stimulus was important, but that the administration had a “ton on its plate.” And Congress, he said, has not particularly supported Obama’s efforts to implement changes that could curtail the problem.

Obama and members of Congress talk about the need to rein in the tax evaders, but the federal government has a history of awarding contracts to companies that don’t comply with the nation’s tax laws.

Some of the biggest wage and hour violators have government contracts worth billions of dollars. A 2011 GAO report found that at least $24 billion in stimulus funds went to 3,700 companies owing hundreds of millions of dollars in federal taxes. Obama signed an executive order this summer that requires federal contracting agencies to check for signs of labor violations; some are hopeful that will address part of this problem.

“The government should be a model employer and should not promote undercutting and chiseling by private-sector employers,” said Catherine Ruckelshaus, general counsel of the National Employment Law Project.

It’s all disconcerting to contractors such as Rick Suarez, the president of Ready Windows in Hialeah, Fla. To win a government job, contractors must either accept a tiny profit or cheat, which many do. But he doesn’t entirely blame the companies. The government, he said, has allowed the problem to fester.

“It’s a system where people have to undercut each other by any means possible to get work,” he said.

At the cafe this summer, Devaney’s brain churned as he thought of all the ways investigators could crack down on misclassification. Devaney is a fixer by instinct. He could see the dollar signs, and how much in revenue could be recovered.

“If you start adding it up as you go across the country,” he said, “it’s a lot of money.”

Yamil Berard of the Fort Worth, (Texas) Star-Telegram, Nicholas Nehamas of the Miami Herald and David Raynor of The News & Observer in Raleigh, N.C., contributed to this article .