Paying workers as independent contractors instead of as employees may land a former executive in jail for criminal wire fraud. On June 12, 2019, the former operations manager and vice president of a Florida-based mail transportation contractor pled guilty to two counts of wire fraud related to such treatment. The Government’s case was based on pricing estimates for employee-related costs that the contractor later did not incur because it instead used independent contractors.

In the June 1, 2018 indictment of Alexei Rivero, the Government contended that Rivero purposely misclassified the drivers it hired as independent contractors. According to the indictment, this allowed the contractor to “misappropriate” $1.5 million in USPS contract payments “designated” for fringe benefits and $1.2 million designated for payroll taxes.

The Cost Worksheet

The Government alleged that Rivero provided fraudulent estimates to the U.S. Postal Service on a form called the “Cost Worksheet.”  The misnamed Cost Worksheet is actually a pricing estimate form. The form is provided to bidders as an aid in understanding the potential costs they might incur in performing the contract. Bidders enter figures for various cost categories and total them up to arrive at the fixed-price they intend to submit as their bid price. They submit the Cost Worksheet form to the Postal Service along with a separate form that contains only their total fixed-price bid amount.

The Cost Worksheet contains blank lines for 19 separate categories of potential costs in performing the resulting contract. Six of those categories are for employee-related expenses, such as payroll taxes (Social Security, Medicare, and unemployment taxes) and fringe benefits. When filling out the form, Rivero listed amounts for all of these items.

The alleged fraudulent estimates

The Government contended the employee-related cost estimates were fraudulent because, after it won award, the contractor treated its drivers as independent contractors, not employees. The drivers thus never received any fringe benefits, such as health and welfare coverage, and vacation and holiday time. And the contractor did not pay the federal or state authorities the employee’s portion of payroll taxes, including Social Security, Medicare, and unemployment tax. The Government contended that amounts designated for these expenses were thus misappropriated by the contractor.

It is not clear whether the Government considered the estimates fraudulent because the contractor never intended to treat drivers as employees, or because during performance it did not do so and yet retained all the benefits from its bid price.  In either case, however, the Government’s theory was predicated on the Cost Worksheet serving as a representation of the contractor’s expected actual cost and intended method of performance.

As noted in a prior article, however, the Cost Worksheet is not a statement of actual costs or anticipated estimated costs for each cost category. It can’t be about actual costs because it is prepared before the contract has been awarded and before performance costs are incurred. And it can’t even be an estimate of costs for each cost category because the form contains no cost category for profit, nor any guidance on where to put profit. Bidders thus have no choice but to put their estimated profit in one or more of the cost categories. If profit is included in a cost category, it can’t be an estimate of the “actual cost” for that category.

Another common misunderstanding about the Cost Worksheet is its use in the evaluation of price proposals. HCR solicitation Provision 4-2, entitled “Evaluation,” states that an offeror’s price will be evaluated based on the figure provided on a different form, PS Form 7405. This form seeks only a total fixed price and contains none of the cost categories set out in the Cost Worksheet.

Neither should the Cost Worksheet be considered a representation as to whether the contractor intends to use employees or independent contractors. The form contains no cost category for independent contractors or instructions as to where such costs should be placed. Indeed, the most suitable categories for independent contractor costs are the ones that Rivero chose as they relate to the cost of labor.

So the issue here should have been whether the contractor’s treatment of its drivers as independent contractors was a violation of the Service Contract Act, not whether its Cost Worksheet figures were fraudulent statements. If the contractor improperly treated its drivers as independent contractors rather than employees, then it violated the Service Contract Act, potentially risking debarment. But violation of the Service Contract Act does not mean the contractor has also committed criminal wire fraud.

A preventative measure

As long as the Postal Service continues to use the Cost Worksheet form (and its close cousin the Cost Statement), there remains the possibility that third parties will mistakenly think the figures on these forms are representations about actual cost or methods of performance. One preventative measure contractors can take would be to add a legend to these forms that reads: “Figures represent pricing estimates, not actual costs.”  This legend would make it clear that the figures shown are not actual or historical costs and should be not regarded as such.