INSIDE THE BIGGEST PENTAGON SCAM An extraordinary federal investigation called Operation Ill Wind reveals how secrets are sold, bids are rigged, and officials are bribed. Can Clinton stop the fraud?
By Irwin Ross REPORTER ASSOCIATE Wilton Woods IRWIN ROSS, a longtime contributor to FORTUNE, is author of Shady Business, a study of corporate corruption undertaken for the Twentieth Century Fund.

(FORTUNE Magazine) – Voters loved it when Ross Perot thundered against a government corrupted and betrayed by lobbyists and consultants sporting ''alligator shoes and $1,000 suits.'' Now Bill Clinton vows to crack down on influence peddling by former bureaucrats and to impose the strictest ethics requirements ever on officials who serve in his Administration. Well, Mr. President-elect, good luck. You'll need it.

Now meet the reason. His name is Melvyn R. Paisley, and for more than five years during Ronald Reagan's presidency, he served as an Assistant Secretary of the Navy with major responsibility for procurement. No one more brazenly exploited Washington's infamous ''revolving door'' than Paisley. According to the government, in the first 15 months after he left the Pentagon in March 1987, Paisley collected more than $500,000 in consulting fees from companies he had earlier befriended. Even worse, while in office, he corrupted the bidding process on hundreds of millions of dollars of weapons systems in order to divert contracts to those who secretly bought his services. The scams that swirled around Paisley were brought to light -- and eventually to justice -- as part of Operation Ill Wind, the biggest and most successful federal investigation ever of defense procurement fraud. Since it was launched in September 1986, Ill Wind has led to the conviction of nine government officials, 42 Washington consultants and corporate executives, and seven companies. The best known are United Technologies, the seventh-largest defense contractor; Unisys, the 15th largest; Loral Corp., No. 16; and Teledyne, No. 37. (For how the feds cracked the case, see box.) Unisys agreed to pay the biggest total penalty -- $163 million in fines, damages, and forfeitures, plus the cost of its investigation. Just recently, John O'Brien, former chairman of Grumman and the highest executive nailed so far, pleaded guilty to two counts of fraud in a case related to Ill Wind. Though two trials are still pending, the investigation is finally winding down, and the full story of what was uncovered can now be told. WHY TELL IT? Ill Wind provides an unparalleled worm's-eye view of exactly how secrets are sold, officials are bribed, bids are rigged, payoffs are hidden, and other favors are delivered. Such shenanigans naturally tend to cluster where the money is. During the 1980s, the Pentagon was Washington's biggest honey pot. It will remain so even as it shrinks, but in the 1990s, more honey may flow from a new civilian R&D agency, the Energy Department, or whoever handles the infrastructure buildup Bill Clinton plans. While eliminating such illegal activities is undoubtedly impossible, Ill Wind offers insights into how they may at least be discouraged. Though this sorry saga features a huge cast of characters, its antihero is clearly Melvyn Paisley. No other government official toppled by Ill Wind ranked so high, raked in so much, drew such a stiff sentence (four years in prison), or seemed a more unlikely candidate for corruption. Indeed, until its last chapter, Mel Paisley's life had largely been a classic American success story. He was born on October 9, 1924, in Portland, Oregon, and spent his preschool years in a logging camp on Oregon's Umpqua River. His father worked as a high climber -- the daring fellow who shinnied up the trunk to shear off the top 25 feet. His mother toiled in the cookhouse. When America entered World War II, young Mel enlisted in the Army Air Corps but had to wait a year, until he turned 18, before he could put on a uniform. Trained as a pilot, he flew scores of missions over Europe at the controls of a P-47 fighter, downed several enemy planes, and came home with a chestful of medals, including the Distinguished Service Cross. Mustered out as a captain at age 21, Paisley then earned a bachelor's degree in engineering. After a few months of graduate school at MIT, he was hired by Boeing as a junior engineer. There Paisley flourished for 28 years, rising to international sales manager for a division of Boeing Aerospace. In his last years at the company he found a great friend and admirer in John Lehman, a consultant to Boeing, who became Secretary of the Navy under Ronald Reagan. Less than a year after taking office, Lehman got Paisley named his Assistant Secretary for Research, Engineering, and Systems.

Young, aggressive, controversial, Lehman, then 38, blew into Washington determined to fulfill Reagan's pledge to restore America's military might by expanding the Navy's fleet to 600 ships. As Lehman's point man in that effort, Paisley quickly developed a reputation as a decisive administrator who rapped out orders in a strong, raspy voice and frequently dressed down underlings in the presence of others. His boss's trust in him enhanced Paisley's already significant power. Eighteen months before Ill Wind became public, Lehman declared that Paisley had been his first choice for the job and had turned out to be ''the best Assistant Secretary for Research and Development the Navy has ever had.'' (Lehman, who was never implicated in any wrongdoing and is now a managing director at Paine Webber, refused to talk to FORTUNE about either Paisley or Ill Wind. Paisley, now serving time at a minimum security federal prison near Las Vegas, also refused to be interviewed.) During all these years, the only hint of scandal to color Paisley's reputation was his turbulent domestic life. The most bizarre incident was the death in 1968 of his second wife, Mary Lou. Paisley told Seattle police that he awoke in the middle of the night to find her body on a bathroom floor, her head facedown in a towel soaked with carbon tetrachloride, with which she had apparently cleaned brushes that she used for her oil paintings. Paisley also reported that she had imbibed some alcohol before retiring and taken two sleeping pills. Her death was ruled an accident, a finding left unchanged when local authorities, prompted by the Ill Wind revelations, opened a new investigation 20 years later. Soon after Mary Lou's death, Paisley wed his secretary at Boeing. That union ended in divorce shortly before he married Vicki McKim, a Boeing computer analyst many years his junior, in 1980. When did Paisley cross the line from bullying bureaucrat to crook? And why? The many lengthy documents filed in court when Paisley and other defendants pleaded guilty (and which provided much of our chronology) offer no way to pinpoint the debut of his illegal activity. But money was clearly the motive. Paisley took a pay cut when he left Boeing, a loss he apparently felt was only partly assuaged by a $183,000 severance payment that his former employer granted him when he resigned. Defense consultant William M. Galvin was Paisley's partner in his felonious schemes. They met at Paisley's swearing-in festivities in December 1981. Galvin invited the Navy's Mr. Procurement to his home for a Christmas tree trimming party later that day. A large, barrel-chested man whose heartiness and gregariousness would typecast him as a salesman in any setting, Galvin had little technical competence in defense matters but a vast talent at parlaying friendships into business and bestowing favors large and small. He entertained lavishly at his 17-acre estate in Front Royal, Virginia. Unlike other consultants, Galvin had never worked at the Pentagon, but he had impressive clients, among them Unisys, Loral, Martin Marietta, and United Technologies. The first documented deal between Galvin and Paisley occurred in December 1985. On Christmas Eve, the two flew to St. Thomas in the Virgin Islands on vacation. There they hatched a complicated scheme to get the Navy to select Martin Marietta as prime contractor on a research program whose identity still remains classified. They also agreed to form a company, called Sapphire Systems, that would become a subcontractor on the program, though Paisley's financial interest in it would naturally remain concealed. Sapphire didn't take long to shine. On April 5, 1986, Paisley and Galvin met in New York City with an individual identified by the government only as ''a high corporate official of Martin Marietta (now retired)'' to discuss strategy for obtaining the prime contract. Paisley suggested that the company retain Galvin as a consultant, which it did. Seven months later Paisley formally named Martin Marietta the prime contractor, irately overriding a Navy official who questioned the arrangement. By the end of the month, initial funding for the project had been approved, with $900,000 to go to Marietta and $300,000 to Sapphire. Things were looking so bright that at one point Galvin proposed that Marietta buy Sapphire at some future date for $5 million. In the end, however, the whole scheme disintegrated. Once Paisley resigned from the Pentagon in 1987, the Navy dropped Marietta and signed up another prime contractor. Still, Paisley's Martin Marietta connection served him well. Several months after he swept through the revolving door, the company, at Galvin's urging, hired him as a consultant. By the time Ill Wind became public in June 1988, Martin Marietta had paid him some $200,000. (The company, which cooperated with the Ill Wind investigation, has not been charged with any wrongdoing.) Paisley was more successful in the illegal chores that he undertook in 1986 on behalf of Sperry Corp., which merged with Burroughs that November to form Unisys. Sperry was bidding to supply the Navy an airport surveillance radar system. When Sperry's ''best and final offer'' (known in the trade as a BAFO) proved too high, Paisley blocked the contract award to a competing company. He then went to extraordinary lengths to persuade his Pentagon colleagues to alter the terms of the competition in ways that would favor Sperry. He later passed to Galvin information on a rival's bid. With this illegal edge, Sperry ! easily came in as low bidder in the second round of BAFOs and won the contract for $45 million. AROUND THIS TIME Paisley learned that Sperry was also doing poorly in a competition to make the radar transmitter for the Aegis weapons system installed on some destroyers and small cruisers. Ever mindful of the company's interest, he arranged a meeting at his home on a Saturday in May, with Galvin, a Sperry engineer, and Charles F. Gardner, a Sperry vice president. After a long discussion of various strategies, Paisley came up with the solution: Sperry's best bet was to team up with Westinghouse and bid for the contract together. Back in the Pentagon, Paisley once again rearranged the playing field to favor his friends. RCA and its subcontractors, which originated the Aegis program, were already the primary source. That left open the role of additional suppliers. Rather than continuing to take rival bids for different components of the system, Paisley declared that two teams of two companies each would compete to be the second source for the entire system. To eliminate potential rivals, Paisley drastically shortened the period in which bids could be received. In June 1987, Sperry and Westinghouse (an innocent in the whole affair) were awarded the contract. Favors like these prompted Gardner to become one of Paisley's principal paymasters. An old Washington hand, Gardner was general manager of Sperry's surveillance and fire control systems division, headquartered in Great Neck, Long Island. That position gave him a convenient way to covertly finance -- apparently without the knowledge of his corporate superiors -- a steady stream of bribes, favors, and illegal political contributions. He did so by arranging for ''technical services'' contracts with outside parties, ostensibly for things like special reports. Though he had authority to spend up to $1 million per contract, Gardner avoided auditors' scrutiny by limiting them to $100,000 each. To provide conduits for the payments, Gardner arranged for James G. Neal, one of the many consultants he used, to set up shell corporations. Neal obliged with a dazzling display of letterheads -- James Neal Associates Inc., Anchorage International of Northern Virginia Inc., Orion Tech Inc., Tech Plans Inc., Polaris Tech Inc., Jay Dee Tech Inc., and Dubhe Associates. All these entities received consulting contracts from Sperry. Neal also set up another corporation, Daltech Inc., which served as a channel to transmit funds received by Neal back to Gardner. In the end the bill for all these ill-gotten gains was normally picked up by the government, since Sperry added consultants' fees to either its direct or its overhead costs on military contracts. In August 1986, Gardner used Neal's network of companies to buy a condominium in Sun Valley, Idaho, from Paisley for $149,000, well above its market value. Indeed, 15 months later, Gardner and Neal resold the condo for only $100,000. Government investigators claimed that the difference between the two prices was a bribe, a charge to which Gardner later pleaded guilty. After Paisley left the Pentagon, Unisys fulfilled a promise that Gardner had previously made and employed him as a consultant, paying him $98,000 from May 1, 1987, to May 14, 1988. Though most of the favors Paisley delivered earned him relatively small change while he was in office, one scheme might have produced a major payoff -- if only it had worked. It involved an effort to get a lucrative Navy contract for an Israeli company called Mazlat, which was teamed with an American company, AAI. In 1985, Mazlat/AAI won a Navy contract for a system of short-range, unmanned planes used to gather combat intelligence and known as RPVs (remotely piloted vehicles). Subsequently, the Navy announced a competition for a medium-range RPV system. Mazlat/AAI sought to supply one component -- the equipment that monitors the pilotless craft -- and planned to offer the same ground control mechanism that it used on its short-range system. In March 1986, Galvin hosted a breakfast at his home for Paisley, Mazlat's president, and an Israeli consultant. They struck a deal. Paisley would try to influence the Navy to adopt the Mazlat system for the new RPVs, in return for which Mazlat would pay a 2% royalty into a Swiss bank account of Lorena Associates, a company owned by Galvin. The four would share the royalties. Mazlat made a down payment of $50,000 into the Lorena account, and other payments brought the total to around $200,000. Orders for the ground control stations were expected to reach $100 million eventually, which would mean $500,000 for each man. Though pleased with this arrangement, Paisley was unsure how to manage his overseas stash and asked Galvin for advice. ''I don't understand how to do it best, to bring some of that money out of Switzerland,'' he told Galvin in a telephone call the government tapped. Galvin's reply: ''Well, I leave it there . . . if you bring it here, you've got to pay the taxes.'' A good reason to leave it in Switzerland, Paisley concluded. In May he did what he was paid for, issuing a directive that mandated the adoption of the Mazlat ground control system. But over the next two years the scheme fell apart because the Mazlat component performed poorly. (The two Israelis who made the deal have not been indicted, nor has Mazlat.) After Paisley resigned from the Pentagon, he immediately teamed up with his friend Bill Galvin and set to work parlaying insider information into hard cash. At the time one of Galvin's clients, the Pratt & Whitney division of United Technologies, was having trouble getting the Navy to renew its contract to produce the F404 engine, which powered the Navy's Hornet fighter, formally known as the F/A-18. General Electric also manufactured the engine, and Navy procurement officials were making noises that they might give the entire job to GE because Pratt & Whitney's prices were too high. Enter Paisley, who informed Galvin that he had ''stolen'' some valuable price data involving GE's bid on the F404 engine on his way out the Pentagon door. Soon after Paisley mentioned his helpful theft, Galvin telephoned Eugene J. Tallia, the head of Pratt & Whitney's Washington office, and asked him to hasten over with his ''pad and pencil'' for some numbers. Galvin sent his car for Tallia, who soon appeared in Galvin's suite in the Watergate office building, where Paisley unburdened himself of the data. (Tallia was never charged with any wrongdoing.) In the weeks that followed, P&W revised its figures to match GE's proposed prices and was rewarded with a contract for 30% of the production needed in 1988, the same percentage it had before. That happy agreement occurred on June 4, 1987. Late that month Paisley was hired by United Technologies as a consultant, and he was paid $218,000 over the following year. Presumably, he could have looked forward to collecting years of such hefty fees from United Technologies, Martin Marietta, Sperry, and his other corporate clients had Operation Ill Wind not cut his consulting career short. WHAT LESSONS does this investigation offer policymakers? The Pentagon has tightened procurement regulations as a result of it. The major change has been to curb the use of multiple ''best and final offers'' -- an obvious oxymoron and an easy way to fiddle bids. Since August 1988 a contracting officer must get approval from a higher authority before authorizing a second BAFO, and records must be kept of these approvals. More significant has been a tightening of ethical compliance programs among corporations. Unisys has been particularly aggressive in this regard, establishing new channels such as telephone hotlines to encourage whistleblowers. Clinton's proposal to curb the rapidity with which influence can be legally peddled may also help. Currently, the law restrains -- or is supposed to restrain -- a former officeholder from lobbying his own agency for one year. Clinton wants to raise that to five years. But none of these changes do more than make things slightly harder for determined lawbreakers like Paisley and his friends. Can anything else discourage them? While in office, Paisley himself made one drastic, if unlikely, suggestion. Asked by a congressional committee what should be done about corrupt military officials and defense contractors, he replied that ''you have to hang them from a tree where everyone can see them.'' Short of that, Ill Wind should, at least until memory fades, act as a powerful deterrent.