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Iraq Contractor Accused of Offshore Shell Game

by David PhinneySpecial to CorpWatch
October 14th, 2004

Cartoonist: Khalil Bendib

Former managers working with Custer Battles, a high-profile private security company in Iraq, are accusing the firm of using affiliated "shell" companies in the Cayman Islands and other "tax haven" countries to fraudulently overcharge on government contracts by tens of millions of dollars. The accusations are spelled out in a lawsuit filed under the False Claims Act and made public October 8.

Custer Battles, headquartered in McLean, Virginia, first grabbed headlines after winning a $16.5 million contract in June 2003 to provide security for the Baghdad International Airport by hiring Nepalese Gurkhas. It was the first major assignment for the fledgling firm after being launched in October 2001.

Founded by two Army veterans, Scott Custer and Michael Battles -- a former Republican candidate for Congress in Rhode Island -- the firm had little experience in private security and employed only a handful of people at the time. The two entrepreneurs, both in their mid-30s, made their first payroll with credit cards and personal loans. Since then, Custer Battles has landed security contracts totaling an estimated $100 million that include protecting Iraq’s new currency and training the Iraqi army.

But during those early months in Iraq, the company resorted to using crooked accounting and "sham" companies in far-flung countries including the Cayman Islands, Cyprus and Lebanon, to dramatically pump up charges on contracts by as much as 162 percent on equipment, construction supplies and services, claim plaintiffs’ Robert Isakson and W.D."Pete" Baldwin, both of who worked for Custer Battles.

"When I see crooks come into a war zone where people are fighting and dying, I just turn them in," Isakson says. "In my opinion they were cheating the government and taxpayers and just being rewarded with more contracts."

Since the 1991 Gulf War, Isakson says his disaster relief and construction company, DRC of Mobile, Ala., has worked in support of the military and others as a subcontractor in Kuwait, Somalia and Kosovo. The former FBI investigator says he has blown the whistle on other frauds in the past, but Custer Battles trumps everything he has seen.

Custer Battles denies the allegations as "baseless" and portrays Isakson and Baldwin as in "direct competition" with the company. Custer Battles spokeswoman Jennifer Martin referred inquires about the lawsuit to an October 8 press release. "We believe that the individuals filed this claim solely as a last ditch effort to achieve a competitive edge over CB," the release says.

Nevertheless, the Pentagon temporarily banned the company from future government contracts on September 30 until legal proceedings are resolved. In an Air Force memo calling for the government-wide suspension, Custer Battles and its officers are accused of creating "sham" and "interlocked" foreign companies to fraudulently increase profits and inflate costs charged to the Coalition Provisional Authority (CPA), the temporary governing body in Iraq largely led and funded by the U.S. government.

"Adequate evidence" establishes that the conduct of Custer Battles and top individuals associated with the firm "is of so serious or compelling a nature that it affects their present responsibility to be government contractors or subcontractors," the memo concludes.

During one contract meeting with CPA officials, the Air Force claims that Battles absentmindedly dropped a spreadsheet on a table reflecting an attempted billing of $9,801,550 for expenses that cost the company $3,738,592. Under the contract, actual costs and invoiced costs should have been the same, the memo says, but had been marked up 162 percent.

The Air Force also makes additional accusations against the company, which include a $2.7 million bill fabricated from "forged leases, inflated invoices and duplication," as well as a $157,000 charge for a $95,000 helicopter pad in Mosul, Iraq.

Offshore tax havens popular with government contractors

Custer Battles is just one of many government contractors known to use offshore companies in countries commonly known as "tax havens," according to recent reports by the Government Accountability Office, the investigative arm of Congress.

One study, made public in February, finds that 59 of the 100 largest federal contractors in 2001 reported having subsidiaries in approximately 39 countries identified as tax havens. Such countries, including the Cayman Islands and Cyprus, levy negligible taxes on corporate income and provide privacy laws that shield businesses from international scrutiny.

Many of the federal contractors named by GAO also hold multi-million dollar contracts in Iraq, including Fluor, Foster Wheeler (which is incorporated in Bermuda), Computer Associates International, Bearing Point, Harris, and others. (A separate GAO report released in August found that such companies enjoy a substantial competitive edge in winning contract awards over government contractors without such offshore operations.)

Houston-based Halliburton, the largest contractor in Iraq, holds billions of dollars in reconstruction and logistics contracts. It operated 17 subsidiaries in tax haven nations as of 2001, according to GAO.

CorpWatch has found that Halliburton makes use of one Cayman Island subsidiary, Service Employees International, Inc., to employ an estimated 70 percent of its workers from the United States and elsewhere for a major Pentagon contract for military support services.

Company spokeswoman Cathy Gist offered no comment on this employment practice but said in an e-mail earlier this summer that all Service Employees International, Inc. employees are covered by U.S. workplace rules.

A number of other companies contacted by for this report declined to comment on GAO’s findings of offshore subsidiaries or if such operations are used in their Iraq contracts.

Titan, a contractor that provided interpreters accused of being involved with torture incidents at Abu Ghraib prison, may have had as many as three offshore subsidiaries but they probably became dormant or recently dissolved because they were acquired through acquisitions of other companies, according to company spokesman Wil Williams.

"We can confirm that no bids – particularly U.S. government bids – or revenues were received or made out of these entities as far back as we can see," Williams says.

Bearing Point, which holds contracts worth up to $240 million for famine relief and directing Iraq’s transition to a sustainable market-driven economic system, is also identified by GAO as having operated 22 subsidiaries in tax haven countries during 2001.

Bearing Point spokesman John Schneidawind acknowledged existence of the subsidiaries but cautioned that his company never "availed itself" to accomplish tax savings as "some other entities are thought to."

Schneidawind also declined comment on a BearingPoint contract with Custer Battles for security that was reportedly terminated six months prematurely because of the fledgling firm's inexperience and misunderstanding of the agreement.

According to a September 20 USAID Inspector General report, security costs grew 49 percent under Bearing Point's Iraq Economic Reform Program.

"Bearing Point, in its cost proposal, proposed to spend approximately $894,000 for security costs during the base year of the contract, but later estimated its actual security costs at closer to $37 million," the report states.

Custer Battles also worked in tandem with Bearing Point on the Iraqi Currency Exchange (ICE), a 2003 effort that introduced new currency in Iraq, but performed security support, transportation and the building of new camps in Iraq to house and feed workers involved in the program under a contract directly with the CPA.

 Cayman Island subsidiaries

The allegations against Custer Battle’s use of offshore firms open a window into the possible ways such companies may be leveraged to raise profit margins, mask overcharges and conceal company costs. Those possible manipulations go far beyond the scope of recent GAO investigations focusing on potential tax avoidance through the use of "tax haven" subsidiaries.

"By conspiring to bill fictive costs generated by their shell entities," the lawsuit against Custer Battles contends, defendants fraudulently increased profits by including "artificial markups paid to shell entities owned or controlled by the defendants, but which themselves provided no additional service or item."

While the ICE contract allowed for a 25 percent profit over actual costs, Custer Battles made use of Cayman Islands operations, Secure Global Distribution and Middle East Leasing, to collect and inflate charges for even larger profits, according to the lawsuit. It claims that equipment, trucks and prefabricated buildings were leased through these companies at costs that were sometimes doubled in the process.
When asked to justify the high costs by the ICE Supervising Board, Custer Battles allegedly said that the leasing companies would not make leasing records available.

"Defendants Custer and Battles withheld from the ICE Board the fact that they, along with other defendants, owned or controlled these so-called leasing companies," the lawsuit says.

The lawsuit also claims that Abu Darwish, an alleged business associate of Custer Battles, was recently discovered on a plane leased by the firm with $12 million dollars worth of dinars, the Iraqi currency. The cash was confiscated by customs in Lebanon, where Darwish resides, the lawsuit claims.

Efforts to locate Darwish for comment have been unsuccessful, but Custer Battles attorney Annemarie Carney said the allegation "is entirely inaccurate."

Baghdad airport

Isakson says he began to protest to Custer Battles about fraudulent practices after his company modified an airport terminal into an operational post for Custer Battles at a cost of several million dollars.

During that time, Isakson says he witnessed Custer Battles bill for work that was never performed and equipment that was never delivered. The company also leased eight stolen forklifts belonging to Iraqi Airways to the CPA after repainting them, he says.

Contract requirements for 138 security guards at Baghdad International Airport were never met, but the company continued to charge for that amount of service, according to the compliant. Originally a $13.6 million contract, the price soon rose to $16.5 million after the award was made.

Isakson claims that top associates with Custer Battles attempted to recruit him in fraudulent schemes but he rebuffed their efforts."I refused to cooperate with them," he says.

Within a month, Isakson says, tensions ran so high that Custer Battles employees drew their weapons on Isakson, his 14-year-old son and another worker. He says they were then stripped of their security IDs and guns and escorted to the airport gate.

Having little money to stay at a hotel and no ID for access to the CPA Green Zone, the three fled through war-torn Iraq until they reached Amman, Jordan, and then traveled back to the United States.

"I had no money, no ID, no weapons and we were left outside the gate in a war zone," Isakson says."What was I supposed to do?"

Isakson and Baldwin both say they wanted to report Custer Battles to authorities in Iraq, but did not know who to report their allegations to until returning to the United States.

To this day, Isakson maintains that Custer Battles owes his Alabama company several million dollars for unpaid work and several hundred thousand more in personal loans he made to help Custer Battles through its first month in Iraq.

The FBI and U.S. Justice Department have been investigating the allegations against Custer Battles since February, said attorney Alan Grayson, who is representing Isakson and Baldwin. On October 4, the Justice Department formally rejected Grayson's request to join the lawsuit filed under the False Claims Act to recover tens of millions of dollars in taxpayer money.

The Justice Department offered no explanation for declining to join the case, but false claim complaints generally stand a far better chance in court when they receive government backing. Custer Battles now believes that because the Justice Department declined to participate, the firm will soon be absolved of the charges made in the lawsuit.

Grayson interprets the Justice Department decision as a backroom political deal, noting that Michael Battles, a cofounder of Custer Battles ran as a Republican candidate for Congress in Rhode Island against Democrat Representative Patrick Kennedy in 2002. Although he lost the race, Battles received backing during the campaign from Haley Barbour, a former chairman of the Republican National Committee. Battles has also worked as a commentator for the Fox News network.

"Justice said it has no interest in this case because the contracts were through the Coalition Provisional Authority even though it was funded with taxpayer money," Grayson says.

Justice spokesman Charles Miller says he is aware of the Grayson’s views, but that the department does not comment on such cases.

The plaintiffs, he points out, are "free to pursue their case."

Meanwhile, Custer Battles continues to build its business. Although the security contract for Baghdad airport has ended -- reportedly because of constant feuding with CPA officials and an addition to the contract's scope for covering cover ports -- the company projects $200 million in business by next year.

Much of that new business is hoped to be outside of Iraq, which presently comprises 90 percent of its work, according to the Associated Press. Custer Battles opened a new office in Qatar in July is reported to have $35 million in commitments to invest in projects such as a shrimp farm in southern Iraq and home-loan financing operations in Eastern Europe. The company also is setting up a 227-acre corporate training center near Fort Bragg in North Carolina, the report said.

In March, Custer Battles also established what it calls an "office of corporate integrity," according to a press release posted on its Web site.

"Integrity is a core principle of Custer Battles' corporate values," Custer said in the release. "The OCI will help to ensure that everything Custer Battles does, as a company, complies with the highest ethical standards that are expected of ourselves and our employees."

To download a copy of the lawsuit click on the pdf icon below.

Contact the author, David Phinney, at phinneydavid@yahoo.com.