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Navy contractors get prison in supply-chain scheme that points to larger fraud

Two San Diego defense contractors were sentenced to 15 months each in prison Thursday in a case that exposes much deeper problems with the Navy’s supply procurement system and suggests a larger “gray market” involving both sailors and contractors operating without oversight.

Jeffrey Harrington and Michael Mayer, owners of three supply companies, admitted to working outside the system set out for military contractors — a practice they partially justified with the claim that a lot of people do it.

The three companies are based in Barrio Logan: Veteran Logistics sells medical supplies, Industrial Xchange offers building and industrial materials, and Boston Laser Technology specializes in office supplies.

The Department of Defense could buy from a catalog of approved goods, supplied by contractors, through a web interface called EMALL, allowing the military to compare prices and encouraging competition. But the three companies bypassed that system by dealing directly with sailors and supply officers instead, negotiating prices for one material and then billing EMALL for a wholly different product that was off-catalog.

For example, in 2011 Boston Laser Technology won contracts for more than 10,000 Post-It writing pads for $248,411 for the Maritime Expeditionary Security Group 2 at Norfolk Naval Shipyard in Virginia. At least, that’s what the contracts were supposed to cover.

Rather than send Post-Its, the company sent 50 AC/DC transceivers at a price of $4,967 each for a grand total of $248,358.

A $1.3 million order for bags and organizers for the Navy Explosive Ordnance Disposal Group 2 in Norfolk ended with delivery of $924,000 worth of skydiving gear, according to the plea agreement. Other items the Navy ended up receiving: pot holders, batteries, refrigerators, toner cartridges, rice cookers, even a Playstation 3 and two pink Nintendo systems, according to court records.

The scope of the fraud is still unknown. Investigators audited 60 transactions in a four year period and found every one fraudulent — a mere slice of the $45 million in business the companies did with the Navy from 2008 to 2015.

The audit showed a loss to the Navy of $1.4 million, prosecutors said. But defense attorneys fought back against accusations of price-gouging, claiming the pricing was competitively set. In many cases, they explained, where a dollar difference emerged, the Navy was given a “credit” to spend — sometimes it was spent, sometimes not, according to prosecutors.

U.S. District Judge Michael Anello said the defense team submitted paperwork that was “somewhat persuasive” in showing that “the profit margin may not have been out of line with industry standards” and may not show a “systematically ripping off of the Navy.”

Despite that possibility, Assistant U.S. Attorney Rebecca Kanter argued that this case is about the much larger issue of undermining the oversight and competitive market system, circumventing safeguards, and creating opportunity for back-room deals and corruption. In fact, government investigators have been able to trace back items — TVs, iPhones and more — in kickbacks to sailors who looked the other way and went along with the scheme, Kanter said.

“They got to play God, in control of what their profit was,” Kanter said of Harrington and Mayer.

As to the Navy participants, Kanter said in sentencing papers and in court that several military and civilian personnel have been subjects of this investigation, and many have already faced court martial and administrative discipline. One ship prosecutors suspect participated in fraudulent transactions is the Lake Erie, a guided-missle cruiser based in San Diego, according to court documents.

No further information about those cases has been released.

Harrington’s attorney, Gregory Vega, said his client — a Navy veteran — did not cut corners out of greed or malice, but instead had the best intentions to make the Navy fleet-ready.

“The government always received product,” Vega argued. “This was not stealing from the government.”

Mayer’s attorney, Joseph McMullen, said the men worked outside the system because it was cumbersome and faulty — not delivering to its customers the way they wanted to receive items. The business owners instead formed good relationships with the sailors and supply officers and gained a reputation of getting the job done, still for a reasonable price.

“It’s capitalism at its best,” McMullen argued.

EMALL has since been replaced with a new upgraded system for obtaining supplies.

In addition to the prison sentences, both men were ordered to pay $10,000 in fines each and forfeit about $708,000. Both men also pleaded guilty to filing false tax returns. Harrington, 55, must pay about $141,000 in restitution to the IRS, and Mayer, 63, nearly $300,000. The three corporations must also share in the forfeiture and pay a separate $1 million fine.

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