Developed by the Bush administration, the mandatory use of E-Verify, a computer system for employers to check their workers against the Social Security database, is another example of the Obama administration’s emphasis on enforcing the immigration laws to keep illegal immigrants from living and working in the United States. However, the administration has yet to press for a comprehensive immigration reform plan that would legalize some of the immigrants already living and working here.

Many experts and government officials expect the E-Verify system to eventually become mandatory for private employers as well, though critics say it relies on flawed databases that may wrongly disqualify employees who are legally authorized to work in the United States. A 2007 study by a research organization hired by the Department of Homeland Security found that E-Verify’s error rate for foreign-born U.S. citizens was almost 10 percent. It also found that employers often terminated or refused to hire workers whose information was initially unconfirmed by the E-Verify system, rather than allow the employee or applicant to try to fix the problem.

About 169,000 federal contractors and subcontractors are expected to be covered by the mandate that begins today.

Treasury Secretary Timothy Geithner (WDCpix)

As the Wall Street bailout nears its first anniversary, the controversy over giving public money to private banks has become public knowledge. But an equally risky aspect of the financial rescue has flown largely under the radar: the government’s reliance on private contractors – many with potentially significant conflicts of interest – to help revive the stalled economy.

The Treasury Department knows that the law firms and investment managers hired to aid its salvage effort could be influenced by their ties to bailed-out banks; in fact, the department released a rule in January aiming to mitigate the problem.

That rule, however, has raised questions from watchdogs by asking contractors to identify and police their own conflicts of interest. And a careful review of bailout hiring agreements reveals an inconsistent set of rules applied to the types of private deals that contractors can make while serving as agents of the U.S. government.

Illustration by: Matt Mahurin

“It’s just a wonderfully closed circle,” Simon Johnson, former chief economist at the International Monetary Fund and leading critic of the bailout, said in a recent interview.

“They’ll sell you on this line that there’s a scarcity of talent,” so contractors must be plucked from Wall Street and remain part of its culture, Johnson continued. “It’s the same argument they’re using to explain why they’re appointing a Goldman Sachs lobbyist as [Treasury Secretary Tim] Geithner’s chief of staff. That’s part of how the club thinks.”

Can these contractors guide the bailout with the public interest in mind while simultaneously courting bailout-related business for themselves? It’s tough to say, but imposing greater transparency requirements is crucial, according to more than a dozen financial and legal experts interviewed for this story.

Right now, even as more of these lawyers and financiers are helping with the financial rescue, less is being disclosed about their handling of taxpayer-owned assets. Investment managers are setting values for securities that their companies may also hold privately, while law firms are approving government aid for companies they still represent in certain cases – but the public remains almost completely in the dark.

The Investment Managers

Consider the case of AllianceBernstein. Like many investment management firms, Alliance did not have a good 2008. Assets dropped by more than 40 percent, net income fell by one-third and the company was forced into its first layoffs in 35 years.

Yet things were looking up by late April, thanks to the Treasury. Alliance was one of three firms the department chose to monitor the assets and debt of banks receiving bailout. Its contract involves Alliance in highly sensitive issues, from executive pay limits to the execution of government stock warrants.

“We expect this to be an attractive proposition from a profitability point of view,” CEO Peter Kraus told analysts as he announced the news.

But Alliance executives also told analysts that the firm plans to apply for the Treasury’s Public-Private Investment Program, which could allow the firm to leverage its look at banks’ balance sheets into profits down the road.

If Alliance joins the PPIP, the company could partner with private investors to purchase the same types of mortgage-backed securities that it’s also handling for the government – thus earning a double windfall when the market value of those mortgage-backed securities increases.

Neil Barofsky, the special inspector general for the Troubled Assets Relief Program warned of this potential conflict in his most recent report to Congress: “transactions in these frozen markets will have a significant impact on how any particular asset is priced in the market. As a result, the increase in the price of such an asset will greatly benefit anyone who owns or manages the same asset, including the [public-private program] manager who is making the investment decisions…”

Under the Treasury’s conflict-of-interest rule, Alliance and its fellow contractors (FSI Group and Piedmont Investment Advisors) are only required to step aside from managing assets owned by a bailed-out bank if that bank’s assets provided more than 5 percent of the firm’s most recent annual revenue.

The contracts signed by Alliance, FSI and Piedmont, posted on the Treasury’s website, acknowledge six potential conflicts of interest and suggest how each can be worked around. Yet Treasury did not reveal which banks’ assets were given to which contractor, or even whether the investment managers are doing anything with the securities they’re being paid to watch.

An Alliance spokesman declined to comment when asked how the firm is working out any conflict-of-interest risks it may face.

“The whole idiocy of this,” Chris Whalen, co-founder of the banking risk-management firm Institutional Risk Analytics, said during a recent conversation, “is that the administration would even have these firms pretending to manage this stuff, giving them subsidized deals.”

Alliance is now poised to value assets once held by Merrill Lynch – the same company that paid Alliance CEO Kraus a $25-million bonus for three months of work. Kraus’ bonus, distributed just before Merrill was sold to Bank of America, was part of a $3.6 billion pot that is now under investigation by the New York attorney general and the Securities and Exchange Commission.

A Treasury spokesman did not respond to several requests for comment on conflicts of interest, but did point to its January regulation as evidence of the government’s action on the issue and awareness of possible problems.

The Law Firms

The risk of conflicts of interest is not limited to asset managers sitting on toxic mortgage-backed assets. Simpson Thacher & Bartlett, the prominent New York law firm chosen in October to be the chief legal adviser to the TARP, has a long history of shepherding mergers and acquisitions in the banking industry, particularly during the housing bubble’s halcyon days.

Before the bailout began, Simpson Thacher had advised Washington Mutual on avoiding insolvency and the board of AIG on winning help from the Federal Reserve. Come the crash, however, the law firm was put in charge of setting terms for the government’s investment in major banks – on the opposite side of the table from the banks it once helped make mighty.

Simpson Thacher’s original contract, signed in October, did not mention the need to work around or waive conflicts. When the law firm agreed to expand its bailout work in February, however, that pact stated that Treasury “HAS NOT WAIVED any potential conflicts of interest” – giving the government room to make case-by-case decisions if problems arose.

Yet the law firm’s contract, however, appears to allow an inherent conflict of interest: The Treasury cleared Simpson Thacher to continue representing private clients participating in “other programs in support of the [bailout]” – non-TARP initiatives such as the PPIP or the Term Asset-Backed Securities Loan Facility.

In fact, Simpson Thacher senior partner Lee Meyerson, whose pivotal role in the TARP made him American Lawyer’s No. 4 “Dealmaker of the Year,” continued to advise private-equity clients on how to snap up failing banks while he worked on the bailout. When Florida’s BankUnited collapsed last month, costing the government $4.9 billion, three private equity firms represented by Meyerson swooped in to take over the property.

Simpson Thacher did not respond to repeated requests for comment about the language in its Treasury contract and on its internal mechanisms to prevent conflicts of interest.

“These firms are making up the rules [of the bailout] and advising private clients about the rules,” Yale Law School professor Jonathan Macey, a banking specialist and author, said in a recent interview.

“The problem is, No. 1, this means we lose the appearance of fairness,” he continued. “And, No. 2, there’s a very strong inclination for the people making up the rules to be sympathetic to their own clients as opposed to other people’s clients when they’re writing the rules.”

Davis Polk & Wardwell, another law firm turned Treasury contractor, was so closely involved in drafting Geithner’s proposal for “resolution authority” to wind down non-bank institutions that when members of Congress received the Obama administration’s draft proposal on the topic, it still bore Davis Polk’s computer signature. Ironically, Davis Polk turned down a chance to apply for Simpson Thacher’s first bailout contract – citing the risk of conflicts of interest.

At the Federal Reserve

The Treasury is not the only bailout administrator that has come to lean on contractors.

BlackRock, which manages a $1.3 trillion asset portfolio that ranks largest in the world, was hired for three no-bid deals in October by now-Treasury Secretary Geithner, then president of the Federal Reserve Bank of New York.

Geithner assigned BlackRock to supervise toxic assets once held by Bear Stearns, as well as those held by AIG – deals worth at least $71.3 million over three years. Yet BlackRock, like Alliance, plans to participate in the Treasury’s PPIP, again offering the firm the possibility of benefits based on its knowledge of AIG and Bear’s exposure.

Lawmakers in both parties have raised concerns about BlackRock’s conflicts, as The New York Times reported earlier this month. But Charles Hallac, a founding partner of BlackRock and the head of its risk-advisory arm, BlackRock Solutions, said such concerns are unfounded.

No BlackRock analyst managing the AIG and Bear holdings will take part in the PPIP, or “any kind of program where they’re using government funds to make money for clients, Hallac explained in a telephone interview.

BlackRock was selected because of its expertise in separating its investment business from its risk-advisory business, Hallac added. “We didn’t want to show this to anybody who was going to try to make money in the markets with this information. So we created a separate team within BlackRock Solutions to just manage the Fed portfolio.”

However, he said some employees in line to work on the PPIP have helped with a separate Fed program that involves buying up mortgage-backed securities.

The financial world often uses the anachronistic phrase “Chinese wall” – a phrase that came into wide use after the 1929 stock market crash – to describe an investment firm’s internal efforts to isolate compromising information.

To a certain extent, then, the debate over conflicts of interest at BlackRock and other firms depends on whether you believe Chinese walls can survive in the age of BlackBerries and blogs.

“Let’s be honest, it’s bullshit. They don’t exist,” Barry Ritholtz, the CEO of the independent research firm Fusion IQ and the creator of the Big Picture financial blog, said in an interview. “They’re a theoretical, abstract legal construct that looks and sounds good when you’re developing legal constructs.”

One hedge fund manager, who requested anonymity in order to speak candidly, said he is more concerned bailout contractors’ access to Geithner and Federal Reserve Chairman Ben Bernanke.

“The public-private cooperation that’s going on – not just in the PPIP – ought to be very unsettling to people,” the hedge-fund manager said. “These guys are on the phone with Geithner, Bernanke, with everybody who matters and is setting policy in Washington. And at the same time, they’re trading their own books.”

While bias among these government contractors is undeniably problematic, some experts asserted that it is also unavoidable. As this argument goes, if the government ruled out firms that did significant business with a bailed-out bank, there would be no one left to hire.

“Because Treasury doesn’t have the in-house expertise, it’s inevitable that they would have to contract out,” said Campbell Harvey, a professor of international business at Duke University. “It’s also inevitable that there will be conflicts of interest. If you’re qualified, then almost by definition, there’s a conflict of interest.”

William Seidman, former chairman of the Resolution Trust Corporation (RTC), which led the recovery effort after the 1990s savings-and-loan crisis, offered a sharp contrast to Treasury’s current opaque bailout contracts.

Seidman said he racked up large auditing bills to ensure that his contractors were complying with conflict-of-interest rules. “Occasionally we had transactions that we didn’t make public for some sort of public-policy reason, but … most we had to report to Congress,” he said in an interview shortly before his death on May 13.

“It was expensive,” Seidman added, “but the program had so much potential for fraud or conflict that we thought it was essential.”

Elana Schor is the Washington correspondent for Streetsblog, a news Website focusing on sustainable transportation and infrastructure. She has formerly covered Congress for The Hill and The Guardian.

While most of the debate over the proposed stimulus bill has focused on whether the federal government ought to embark on a plan expected to cost taxpayers some $885 billion, equally important is how that money gets spent. Much of the construction and other work will have to be done by private companies contracting with federal, state and local governments. But how the government contracts with private companies, and how those contracts are monitored, can make all the difference to the program’s success.

Illustration by: Matt Mahurin

Although government watchdog groups have been largely supportive of the bill’s provisions for oversight of government contractors, some say that a key problem may have been overlooked: several important means of holding government contractors accountable are missing from the voluminous 647-page stimulus bill. Most importantly, the stimulus bill fails to adequately protect employees of government contractors, who are in the best position to blow the whistle on fraud and abuse of taxpayer money. The Senate version of the bill also doesn’t protect federal employee whistleblowers — an odd oversight given that state and local employees are protected. And neither version explains how the government is going to ramp up its own hiring quickly enough to oversee and coordinate all these new government contracts.

Supporters of the 2009 American Recovery and Reinvestment Bill, including President Obama, claim it will create some four million jobs. But how can the government ensure that the money is spent wisely?

The experience of government contracting in Iraq and post-Hurricane Katrina stand as stark warnings. The Bush administration, in what came to be seen as among its most glaring failures, authorized trillions of dollars in government spending with little oversight or accountability. A study by the House Committee on Oversight and Government Reform, for example, found waste, fraud and abuse in $1.1 trillion worth of government contracts governing reconstruction work in Iraq. The Pentagon’s inspector general similarly estimated that some $15 billion spent in Iraq was never adequately accounted for. And just one company – KBR, the former Halliburton subsidiary created by former Vice President Dick Cheney when he was Halliburton’s CEO – billed the government more than $2.7 billion worth of questionable and unsupported goods and services. House investigations found KBR billing taxpayers $45 for a case of soda, for example, and $100 to wash a bag of laundry; meanwhile, the company was abandoning new trucks paid for by the government that had broken down instead of properly maintaining them. Much of the key information about misspending by federal contractors came from their own employees.

Overall, Congress and the Obama administration have made extraordinary efforts in the stimulus legislation, despite strong pressure from government contractors and their lobbyists, to require transparency and accountability so as not to repeat the mistakes of the recent past. But due either to oversight or pressure from contractors’ lobbyists, several critical protections are missing.

Experts say that one key way to prevent fraud and abuse by private contractors is to protect those who report it to higher-ups at the company. But that protection has been left out of the stimulus bill. This means someone like Rory Mayberry, a former KBR manager in Iraq, who testified to Congress about KBR charging the government for meals it never served, overpaying sub-contractors, and serving spoiled food to U.S. troops, might not have job protection if he first reported the problem to one of his supervisors. The same is true for Ben Carter, a former Halliburton water purification specialist who discovered that his employer was providing US soldiers with dangerously contaminated water.

That’s because the definition of protected whistleblowing activity under the bill includes going to an Office of Inspector General or going to Congress, but not going to your own employer.

“The biggest defect in the current language in the house and senate versions, is about blowing the whistle internally,” said Stephen Kohn, president of the National Whistleblower Center and a lawyer who represents whistleblowers.

He and Adam Miles, legislative representative for the Government Accountability Project, appear to be among the few advocates who’ve picked up on this critical omission. “It will post significant problems in the provision’s effectiveness, because a whistleblower’s instinct is to report wrongdoing internally, to supervisors or others in chain of command,” said Miles. “So they could be fired just for doing their job.”

Those employees would be protected if they reported the problem to Congress or an Inspector General. “But for people not that savvy, or who don’t have such a big issue – they’re seeing, say, double-charging for meals, or a thousand-dollar toilet seat – if they report it within the company, they’re not protected. And they’re out there.”

“It’s a rare employee who takes the leap of going to a federal inspector general,” agreed Kohn. “Most employees report indications of fraud and abuse within the company.”

Certain provisions of the federal False Claims Act — which allows people outside government to sue contractors for defrauding the government and recover a portion of the damages — would seem to protect government contractor whistleblowers; but experts say the law emphasizes recovering money owed to the government, not protecting whistleblowers. And ever since the Supreme Court decided the case of Garcetti v. Ceballos in 2006, ruling that the First Amendment doesn’t protect government workers blowing the whistle as part of their job duties, advocates for whistleblowers have worried that the Garcetti ruling will end up strangling courts’ interpretation of the False Claims Act as well. As Jack Balkin, professor at Yale Law School and founder of the blog Balkinization, wrote at the time: “the effect of the Court’s decision [in Garcetti] is to create very strong incentives against whistleblowing of any kind.”

Although the Garcetti case was about a public employee, “the effect of Garcetti has been spreading like wildfire,” said Miles. “That if an employee is acting pursuant to job duties, they’re not protected as a whistleblower. That needs to be addressed in the law.”

“It’s a gray area,” agreed Kohn. “But it’s one that absolutely has to be fixed, because that’s where most employees start.”

There are other problems with the whistleblower protections in the stimulus bill. For example, while the House version protects state, local and federal whistleblowers, the Senate version strangely leaves out protection for federal employees — a protection that a broad range of public interest groups have been advocating for years. (The omission may be because the House version includes whistleblower protection for intelligence workers, which critics argue is dangerous because it would allow disclosure of classified material to federal overseers.) The result is that while the employee of a government contractor can safely blow the whistle to the government, were the Senate bill to pass as it stands now, the government employee supervising that contract could not. What’s more, the public employee protections extend only insofar as the fraud pertains to the spending of stimulus bill dollars. If the fraud is in a contract authorized under the Troubled Assets Relief Program, or TARP, for example, the whistleblower protections don’t apply.

“That’s a gigantic problem,” said Kohn. “Say a bridge is being built and the tar on the bridge is being paid for by the stimulus. But the bolts are being paid for by a state block grant. So someone working on the bridge blows the whistle to the government about the bolts being weak or broken. Unless that worker can show those bolts are being paid for by the stimulus, they can be fired,” explained Kohn. “That’s crazy — it should cover all taxpayer dollars.”

Another looming problem for accountability in the stimulus package is that the government doesn’t have sufficient qualified staff to monitor all the new contracts it will be entering into. So even though the bill includes lots of new oversight and transparency requirements, as noted by watchdog organizations such as Taxpayers for Common Sense and the Project on Government Oversight, it’s not clear how the government is going to have enough qualified staff in place to put them to good use.

Government contract lawyers blame the lack of qualified government contract oversight officials for many of the cost overruns, fraud, waste and mismanagement in Iraq and after Hurricane Katrina. The House Committee on Government Oversight, for example, found that 70 percent of post-Katrina contracts were awarded without competition, were poorly planned and subject to little oversight, and that contractors relied excessively on subcontractors to do the work. Similar problems plagued the Department of Homeland Security’s contracts, the committee found.

In the wake of such scandals, the stimulus bill requires competition, and demands that the government post its reasons for issuing any no-bid contracts. But it doesn’t explain how the government will hire qualified workers quickly enough to oversee and monitor the bid process and its aftermath. “This is going to be a massive amount of spending very quickly,” said Jeremy Madson, spokesman for the Professional Services Council, a lobbying group for government contractors. “And as we learned with Iraq and with Hurricane Katrina, If you don’t have the people to manage it, if you don’t engineer the process well, you’re going to have big problems.”

But can the government hire the people it needs to oversee these contracts quickly enough?

Tom Abbott, a lawyer who represents major government contractors such as KBR and Bechtel, is skeptical. “It takes too long to hire people into government and get them trained,” he said. “There’s no time. You can’t build the government workforce back up in 90 days. It would take six months.” Indeed, a recent GAO report found that the Treasury Department is having trouble hiring enough qualified workers fast enough to oversee the Troubled Assets Relief Program, or TARP. “So the talk is already that the way to solve it is to hire contractors to do the oversight,” said Abbott.

Outsourcing oversight could just create more of the same problems, however.

Government agencies have “very few knowledgeable people who can look at a contract with a green eye shade,” said Marthena Cowart, spokesperson for the Project on Government Oversight. But they need to hire them, she said, adding that the experience of having contractors such as KBR and Halliburton oversee themselves in Iraq was “not a great idea.”

“Government is supposedly representing you and me and not corporate interests,” she said. “They would be truly independent.”

As for the time pressure, she added: “People say it would take too long to hire government workers. But as my grandmother used to say, ‘You start at the beginning and go to the finish.’ ”

During a news conference at the Obama-Biden transition office in Washington, Obama named Nancy Killefer, a former Treasury official in the Clinton administration, to fill the new post of chief performance officer.

From Obama’s prepared remarks:

For nearly thirty years – as a leader at McKinsey & Company, and as Assistant Secretary for Management, Chief Financial Officer, and Chief Operating Officer at Treasury under President Clinton — Nancy has built a career out of making major American corporations and public institutions more efficient, effective and transparent.

Nancy is an expert in streamlining processes and wringing out inefficiencies so that taxpayers and consumers get more for their money. And during her time at Treasury, she helped bring the Department into the twenty-first century, modernizing the IRS and preparing systems for Y2K.

But Nancy also understands that at the end of the day, government services are delivered by people. That’s why she’s always worked tirelessly to empower employees to take matters into their own hands: to rethink outmoded ways of doing things, to embrace new systems and technologies, and to take initiative in developing better practices.

When Nancy was offered her first position at Treasury, she responded, “If you’re willing to embrace significant change, then you’re looking at the right person. But if you just want to keep the trains running on time, don’t ask me to do this job.”

When I heard that, I knew I’d chosen exactly the right person for the challenges we face.

The Associated Press points out the first-glance irony inherent in today’s announcement.

Yet, even as [Obama] announced the post that’s also aimed at spending taxpayer money more efficiently, Obama was spending his first week in Washington promoting his mammoth economic stimulus plan that could total as much as $775 billion over two years — much of the new spending aimed at creating jobs and stoking the troubled economy.

But, I guess if the plan is to blow money like its going out of style to get the economy moving again, bringing on a specialist to maximize government efficiency probably isn’t the worst idea in the world.