COLUMN ONE : Under the Gun: Arms and Fraud : The nation's military suppliers have amassed quite a criminal record in a few years. It is a bizarre scandal in which personal gain is seldom a motive.

By RALPH VARTABEDIAN

May 9, 1990 12 AM PT

TIMES STAFF WRITER

Defense contractors are riding a boom these days, but the action is in the courtroom and not their weapons plants.

Since the mid-1980s, the largest 100 defense contractors have been convicted or pleaded guilty in 30 felony cases, including instances of phony testing of nuclear weapons, trafficking in secret documents and creative accounting schemes that bilked taxpayers.

General Electric has three felonies on its record; Rockwell International, TRW, Sundstrand and GTE each have two. More than two dozen contractor employees have pleaded guilty.

Include smaller suppliers and the numbers are staggering: more than 500 criminal convictions of individuals or defense companies in the past two years, and about $500 million in fines and damages recovered. In one recent six-month period, 11 presidents or owners of small firms were sent to jail or placed on probation.

“It is an absolutely horrendous record for the industry,” said William Fahey, an assistant U.S. attorney who heads a defense fraud task force in Los Angeles. “I don’t know of another industry that has established such a high criminality rate.”

Industry officials aren’t sure what hit them. After all, this was an industry in which no major corporation had been convicted of a felony since World War II--the same industry whose work in commercial aerospace is admired worldwide. Now, its lengthening criminal record is making it easier for Congress to chop the defense budget. The industry’s public image and the morale of its employees are at their worst in years.

The criminal record “has cast a cloud over the whole industry and the whole Defense Department,” Deputy Defense Secretary Donald Atwood said in a recent interview. “All too often, as the laws and practices have evolved, there has been a tendency to say that was . . . (acceptable) in the past. We can no longer have that.”

What accounts for this seeming epidemic of criminality? The reasons are many. After years of doing little, the government got tough in enforcing the laws on defense procurement. For all the Ronald Reagan Administration’s flag-waving commitment to a strong defense establishment, there was mounting public cynicism about “waste, fraud and abuse,” and politicians and prosecutors moved to capitalize on it. New regulations created pressures that drove ethically lax managers to break the rules.

The defense industry’s criminal record is likely to get even worse. Derek Vander Schaaf, deputy inspector general at the Defense Department, said in a recent interview that 60 of the top 100 defense contractors are under investigation in about 450 specific cases.

Among those closest to the defense industry, there is dispute about the meaning of the surge in criminal convictions.

Some observers say that abuses became so rampant the government had to take action. “When it gets near 25% (of major defense contractors being convicted) the stench is so bad you can’t stand it,” said Thomas O. Paine, a former administrator of the National Aeronautics and Space Administration and a former Northrop president. “You couldn’t ignore it any more. You had to clean it up.”

Industry representatives, however, blame hordes of eager-beaver investigators and a bewildering array of complex regulations. Herbert Fenster, a leading defense industry attorney, said that most fraud allegations are “nickel-and-dime cases” in comparison to the large sums of money involved in defense procurement.

“When you employ 10,000 or 20,000 people on a program, there is no way you are going to be lily white and pure,” Fenster said. “If the government spends enough money to investigate, it is going to find problems.”

Indeed, federal enforcement efforts are in vogue. The Defense Department’s inspector general oversees a force of 4,719 investigators, 10,434 auditors, 3,162 inspectors and 4,639 other compliance officials--a work force of 22,954 that numbered 17,874 in 1983.

The Justice Department ranks defense procurement fraud as its highest priority for white-collar prosecution--above insider stock trading and bank fraud.

The prosecutorial onslaught has cost the contractors plenty. In February, Northrop paid a $17-million fine--an industry record. General Dynamics spent $29 million successfully defending itself and four executives against charges of fraud at its Pomona division.

Don Fuqua, president of the Aerospace Industries Assn., acknowledged that legal expenses have been heavy, but he said he is more concerned about public perceptions.

“The public loses confidence in the Department of Defense to manage, and they lose confidence that the industry isn’t out to steal public money,” Fuqua said. “I am not aware, though, of a case where somebody, a senior executive, has lined their pockets. For that, I am very grateful.”

Even top Justice Department officials agree that the pattern in defense fraud is different from those of other scandals in the thrift industry and on Wall Street.

“In defense, the big benefit flows to the corporation,” said Theodore Greenberg, deputy chief of the Justice Department’s fraud section. “A lot of these guys are motivated by pennies. It is very bizarre. In many cases, it is difficult to prosecute because you can’t prove tangible benefit.”

Executives have another explanation: Pentagon regulations are so complex that unintentional violations of administrative rules can later be interpreted as premeditated crimes.

Congressional critics argue that the regulatory system was erected to address earlier misdeeds. And the fact that top executives have escaped conviction reflects a failure in enforcement, they argue.

“I haven’t seen any of these contractors getting knocked off their jackasses,” said Rep. John D. Dingell (D-Mich.), one of the most ardent critics of the industry. “Nobody lost contracts because of misbehavior. Nobody paid.”

The record shows that many of the crimes were far more serious than a minor bending or misunderstanding of the rules.

Northrop pleaded guilty this year to 34 felony counts in one case, admitting that it had falsified test results on a guidance system for a nuclear armed cruise missile.

In other cases, contractors were convicted of trading secret documents to help themselves win contracts. Dozens of officials have been found guilty of taking kickbacks in exchange for sweetheart purchasing deals. At the subcontractor level, small firms have supplied defective and untested hardware, much of it affecting the safety of soldiers.

There is evidence that defense workers have grown disillusioned--and they have been encouraged to complain.

Many cases were initiated by whistle-blowers motivated by 1986 amendments to the federal False Claims Act, allowing individuals to sue on behalf of the government and share in any money collected. The amendments strengthened the hand of whistle-blowers and their allegations often led to criminal probes. In one of the largest False Claims Act cases, a group of whistle-blowers settled a fraud suit against General Electric in Ohio in 1989 and received $770,000.

Other workers reported wrongdoing simply because they lost faith in the industry. Each year, roughly 10,000 telephone calls and letters are received by the Pentagon’s inspector general on a “hot line” set up to hear allegations. Many complaints are without merit, but in a recent six-month period 1,758 hot line tips were referred for additional scrutiny.

Some experts believe that both the criminal enforcement effort and the changes in the law reflect a wide public cynicism of the industry. Yet, few in industry or government have attempted to come to grips with the prosecutions.

“When you ask, ‘How did this come to pass that all these companies are being convicted?’, you tend to get micro-answers,” said Fenster, the attorney. “Now that the industry is falling apart, it lacks the vision to realize it.”

The large, permanent defense industry so familiar today was born only at the beginning of the Cold War. Before that, weapons manufacturing was cranked up and wound down as needed for specific wars.

The industry grew in stature as a bulwark against communism until the Vietnam War shattered the American consensus on military policy. The industry has had a rough road since, lurching from one scandal to the next.

In the 1970s, several defense firms had bribed officials of foreign governments. In the 1980s, the industry inspired congressional outrage when it was found to have charged $400 each for ordinary hammers and supplied multibillion-dollar systems that were riddled with defects.

When the massive military buildup began in the late 1970s, many defense executives figured it would be the most lucrative period ever. President Reagan, however, sounded a warning in December, 1981, when he said that federal investigators would be as “mean as junkyard dogs when it comes to protection of taxpayers.”

Sperry Corp. became the first major defense contractor since World War II to be convicted of a felony when it pleaded guilty in 1983 to overcharging the Pentagon for its labor costs.

The defense procurement boom became a bust in the mid-1980s, as the Pentagon ran short of money for its ambitious plans and turned the financial screws on its suppliers. Profit margins on weapons programs were cut, financing for inventory was reduced, tax breaks were eliminated, competition was stepped up and money-losing, fixed-price contracts were imposed on the developers of new weapons.

These forces created tremendous financial pressures on the industry and opportunities for less ethically minded individuals.

Facing new regulations mandating competition for contracts, some firms sought advantage by procuring secret technical and budgetary information about future programs.

Hughes Aircraft, for example, pleaded guilty to two felony counts in March, admitting that its executives had been part of a “tightly knit group” swapping bootlegged Pentagon documents. The price of entry into the club was a valuable internal document.

The Pentagon’s insistence on certain fixed-price contracts also seemed to drive some executives to criminal behavior. Major defense firms have lost hundreds of millions of dollars on such contracts for the development of risky new technologies, and Pentagon leaders have ended the practice.

But the financial pressures created by the contracts apparently led some managers to attempt to recoup losses by shifting labor costs to cost-plus type contracts, under which the government would pay the full amount of any overrun.

The explosion of fraud cases raises the question of whether the ethics of those in the industry have declined.

Paine, the former Northrop president, said the industry always had some gaping holes on the ethics front. “In the aerospace industry, you have always had strong personalities with a drive for success, people who would regard ethical niceties as being for wimps. . . . These guys did not create a climate for ethics. It was the culture, and when people started to take a good hard look at it, it didn’t stand up.”

Moreover, Paine said, ethics deteriorated as national defense became more of a business than a spiritual calling.

“We operate this thing (defense apparatus) without a lot of challenge and aspiration and inspiration,” Paine said. “You don’t have the same kind of feeling.”

But defense industry spokesman Fuqua said that “ethics are higher in aerospace than in other industries.” Employees of most big contractors are sent to ethics training courses and must pledge in writing to obey the law and company rules. Firms have also set up corporate fraud hot lines.

Even the most outspoken ethics advocates have been embarrassed. Rockwell International was forced to plead guilty to criminal fraud again last year, after a 1985 guilty plea. It was alleged that Rockwell shifted charges from a fixed-price contract that had exceeded the ceiling to a cost-plus contract to allow the company to recoup additional funds.

To some, it seems ironic that prosecutions would blossom during a Republican presidency, but antagonism toward the defense industry transcends partisan politics.

“It is larger and it is deeper than liberals trying to get rid of the military,” Fenster said. “We don’t like our military complex any more today than we did in 1776. People in the industry forget the hatred toward DuPont after World War II because of the munitions the company made. The citizenry do not accept the concept of a standing army.”

If so, then the strong commitment to a massive peacetime arms buildup during the early 1980s may have been the real fluke of history. By the mid-1980s, politicians and prosecutors, sensing a public appetite for a clampdown on the defense industry, responded with a historic assault.

Half a dozen congressional committees called hearings to explore every facet of defense waste, including shoddy weapons production, bribery, overpricing of spare parts, bad bolts, abusive billing practices and false charges for labor.

Congress passed the Major Fraud Act of 1988, a new conspiracy and fraud law that doubled penalties to 10 years for each count of fraud.

Industry officials worry that publicity over defense fraud will leave the huge majority of employees in the field, who are honest, feeling unfairly tainted.

“I don’t think you can avoid that burden,” said George Wiley, director of human resources programs at Rockwell. “To allay that, we have communications, send letters to their home, put articles in the company newspaper.”

And there is concern that promising young people will avoid careers in aerospace.

“The thing we try to bring to the kids is that you don’t have to go to jail if you do the job right,” said Paul Weisend, professor of defense contract management at Cal Poly Pomona. “You don’t have to steal information.”

For their part, law enforcement officials say they aren’t in a mood to back off. Vander Schaaf, the deputy inspector general, echoed many officials in saying that he hopes the enforcement efforts won’t undermine support for the military. Still, he added: “These companies don’t plead (guilty) because they didn’t do anything wrong.”