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Federal Apparel Fraud Crackdown Nets $11 Million

The U.S. federal government closed the book on a pair of fraud lawsuits involving two apparel businesses ordered to pay $11.2 million combined.

VE Source, a company that sources and manufactures performance apparel for military, law enforcement and first responders, owes the government $7.6 million as part of its settlement. According to the complaint, the New Jersey business falsely claimed to be eligible for government contracts intended for small businesses owned and operated by disabled veterans.

New York-based men’s apparel retailer and wholesaler Luchiano Visconti, meanwhile, will pay $3.64 million for falsely underreporting the value of apparel imported from overseas to avoid paying customs duties owed on the goods. The defendants knowingly submitted customs entry forms and related invoices to U.S. Customs and Border Protection (CBP).

The government has been hot on fraud cases, recently charging Michael Malekzadeh, founder of now-defunct online sneaker resale business Zadeh Kicks LLC, with wire fraud, conspiracy to commit bank fraud and money laundering. Allegations against Malekzadeh include selling limited-edition and collectible sneakers that he knowingly could not fulfill, ultimately swindling consumers out of $70 million.

VE Source claimed veteran-owned status

In the VE Source case, the government alleged that the company unlawfully obtained more than $16 million in contracts with the U.S. Department of Agriculture and the U.S. Defense Logistics Agency, which are set aside for “service-disabled, veteran-owned small businesses” (SDVOSBs).

At the center of the suit is VE Source’s ownership—Sherman Barton officially owns 51 percent of the company and Christopher Neary owns the remainder. But the suit alleged that Barton was more or less a figurehead since he fulfilled the requirement of being a service-disabled veteran, whereas Neary was not.

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As such, Barton’s ownership stake was a workaround to show ownership and control by a service-disabled veteran, essential preconditions to obtaining government contracts and the payments that come with them.

The complaint said that around the summer of 2009, Neary and two other men, Robert Pao and Ron Norton discussed options to create a business that could take advantage of government contracting opportunities designated for SDVOSBs. Pao already worked for the company Neary owned, a similarly named apparel sourcing firm called Vertical Source, Inc. (VSI). Norton suggested Barton become the owner of the new company.

When the four met, Barton did not want to play an active role in the business. But after being assured he would “just need to be a 51 percent owner on paper,” Barton agreed to the arrangement.

Barton did not take any steps to form the business, according to federal documents. Rather, Norton prepared the paperwork to incorporate the business and registered VE Source as a limited liability company in Delaware. All four parties were aware that the federal government had guidelines to qualify as an SDVOSB.

Norton exited the business two years later in 2011, and when Pao exited in 2015, Neary gained 49 percent of total shares.

The complaint supports the government’s allegations that VE Source falsely certified itself as meeting SDVOSB requirements—and thus wasn’t eligible to bid on the contracts it won.

For one, in 2012, the U.S. Department of Veterans Affairs Center for Verification and Evaluation (VA CVE) denied VE Source’s application for verification as an SDVOSB after the agency determined Barton “did not control the business.” It pointed to 2010 documents showing that Barton did not receive 51 percent of company profits, rather all four owners received equal pay. The VA CVE also noted that both Pao and Neary each had extensive experience managing clothing businesses, whereas Barton did not.

The following  year, the agency denied two more reconsideration requests from the sourcing firm. VE Source instead accessed online certification programs to certify that the company was an eligible SDVOSB.

Further supporting the government’s case, as Neary increased his ownership interest in VE Source from 16.33 percent to 49 percent, Barton didn’t receive any compensation. Neary earned far more in compensation than Barton from 2015 to 2019 and took “loans” from VE Source upwards of $1 million, the complaint said.

Additionally, Neary was responsible for signing virtually all significant, legally binding documents on behalf of VE Source, and placed limits on Barton’s corporate spending power.

The connection between VE Source and Neary’s own business entity, The Neary Companies, was highlighted in the suit. VE Source ended up co-locating with the Neary Companies and then operated out of Neary’s Shrewsbury, N.J. home as early as 2017.

VE Source paid Vertical Source to manage one of the two government contracts, shared office equipment, employees and vendors with the Neary Companies, with Neary even creating a holding company to manage VE Source.

The U.S. government entered a separate settlement agreement with Neary, Barton and Vertical Source, under which Neary will pay $120,000, Barton will pay $75,000 and Vertical Source will pay $180,000 to resolve claims made in a civil lawsuit filed under the False Claims Act.

Luchiano Visconti skimped on $1.8 million in customs duties

As for Luchiano Visconti, the apparel retailer and wholesaler along with manager Sasha Hourizadeh admitted in the settlement that they regularly provided customs brokers with information and documentation, including commercial invoices, that significantly understated the value and prices paid for imported apparel.

From December 2013 to August 2019, the men’s wear business dodged more than $1.8 million in customs duties that it was obligated to pay on its imports.

“Luchiano Visconti and Hourizadeh engaged in a fraudulent scheme to cheat the government of customs duties owed by falsely reporting the value of the apparel brought into this country,” Damian Williams, U.S. Attorney for the Southern District of New York, said in a statement. “This Office is committed to combatting customs fraud and will continue to hold companies, as well as their executives, accountable when they [misrepresent] the value of imported goods to evade paying legally required duties.”

In connection with the lawsuit and settlement, the U.S. government joined a whistleblower lawsuit that had previously been filed under seal pursuant to the False Claims Act.

The whistleblower—Mehmet Mustafa Karadag, the general manager at Karadag, one of Luchiano’s Turkish apparel suppliers—filed the “qui tam” lawsuit in December 2018 after discovering the alleged fraud through his firm’s commercial dealings with Luchiano.

Karadag will receive a whistleblower award of approximately $728,000 from the proceeds of the settlement. Qui tam whistleblowers under the False Claims Act are entitled to awards of 15 percent to 30 percent of any recovery.

“Evidence suggests that customs fraud is rampant,” Karadag’s attorney, Mark A. Strauss, said in a statement. “Whistleblowers like our client in this case play an important role in leveling the playing field for honest importers who responsibly declare and pay the duties they owe. We believe that similar import-duty evasion schemes are proliferating as importers attempt to avoid the significant tariffs on Chinese imports under Section 301 as well as the new tariffs being imposed on imports from Russia.”

The government’s complaint also alleged that in some cases, Hourizadeh altered commercial invoices issued by a foreign manufacturer so that the invoices reflected lower and false prices.

There were also other instances, the defendant acknowledged, where a foreign manufacturer transmitted two categories of invoices to Luchiano Visconti that, together, reflected the actual price paid for the apparel.

The first category of invoices identified specific quantities and prices for the imported apparel. These invoices, in sum, reflected a substantially lower price than what the brand actually paid for the imported goods. The second category of invoices were for services relating to the production of the men’s wear, such as pre-production services, patent services and designer services.

In reality, and as reflected in Luchiano Visconti’s own banking records, the suit said, these invoices generally reflected an additional amount paid by the brand for the same shipment of apparel.

The defendants, however, routinely failed to provide their customs broker with the second category of invoices, which constituted a substantial portion of Luchiano Visconti’s payments for the apparel.

“Trade enforcement is a priority for CBP, and this settlement serves as a great example of collaborative efforts to enforce trade laws,” said AnnMarie Highsmith, executive assistant commissioner, U.S. Customs and Border Protection’s (CBP) Office of Trade, in a statement. “The dedication of the men and women of the CBP Office of Trade, the Office of Chief Counsel, and the United States Attorney’s Office to protect a fair and competitive trade environment is vital to facilitating lawful trade.”