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Welcome to Apogee Consulting, Inc.

Recent Regulatory Changes

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We’ve been noting recent changes to the FAR and DFARS, but have held off writing about them—primarily because nothing we saw seemed earth-shattering. This article will summarize those changes. Perhaps if no one change merits an article, the aggregated changes will.

FAC 2005-99 was published June 5, 2018. The Federal Acquisition Circulars are number from the date of the last loose-leaf publication. Seems to be a bit of an antiquated approach, doesn’t it? We mean, it’s been more than a decade since the last loose-leaf FAR was published; does anybody really expect to see another one any time soon? Only the Federal government would continue to publish—and update—a loose-leaf binder of regulations in this digital age. Might want to rethink your numbering approach, FAR Secretariat. You know, join the 21st Century?

FAR Case 2017-009, containing a proposed rule to “expand special emergency procurement authorities for acquisitions of supplies or services that facilitate defense against or recovery from cyber attack, provide international disaster assistance under the Foreign Assistance Act of 1961, or support response to an emergency or major disaster under the Robert T. Stafford Disaster Relief and Emergency Assistance Act” was published June 26, 2018. The comment period is still open, for those interested.

Four final DFARS rules were issued on June 29, 2018.

DFARS Case 2015-D024 impacts definitization of Undefinitized Contract Actions (UCAs). It addresses how COs should use the Weighted Guidelines to determine how much profit the contractor should be entitled to. It’s a bit of a confusing rule. On one hand it directs COs to “document their consideration of the reduced risk” for actual costs incurred during the period between UCA award and definitization. On the other hand, it directs COs to “consider the reasons for any delays in definitization in making their determination of the appropriate assigned value for contract type risk” and permits the CO to add an additional one percent profit to the contract type risk factor in the Weighted Guidelines. If you are definitizing a UCA, or have just received one and will need to definitize it, then read the new rule.

DFARS Case 2018-D030 eliminated “the DFARS clause 252.216-7010, Requirements, the Alternate clause, the associated clause prescription at DFARS 216.506, and a cross-reference to the clause at DFARS 247.271-3(p),” because they are “duplicative of an existing Federal Acquisition Regulation (FAR) clause.” Glad they figured that out, finally.

DFARS Case 2018-D032 eliminated “the DFARS clause 252.215-7000, Pricing Adjustments, the clause prescription at DFARS 215.408, and the associated cross-references at DFARS 208.404, 212.301, 214.201, 216.506, 225.870, and introductory text for various 252.215 clauses to adjust clause prescription references,” because they are also “duplicative of an existing Federal Acquisition Regulation (FAR) clause rendering the DFARS clause unnecessary.”

DFARS Case 2015-D028 finalizes (with changes) an interim rule on determining price reasonableness for indirect offset costs in an FMS transaction. (Short answer: accept the contractor’s price.) If you are involved in FMS sales and/or offset agreements, this is a rule you’ll want to review. Otherwise, pass.

On the same day, six proposed DFARS rules were published for public comment. We are not going to link to them. Google is your friend. However, we will list them. They are—

  • DFARS Case 2016-D032, Electronic Submission and Processing of Payment Requests and Receiving Reports

  • DFARS Case 2017-D010, Inapplicability of Certain Laws and Regulations to Commercial Items

  • DFARS Case 2018-D009, Only One Offer

  • DFARS Case 2018-D025, Modification of DFARS Clause Surge Option

  • DFARS Case 2017-D014, Use of Commercial or Non-Government Standards.

  • DFARS Case 2017-D005, Submission of Summary Subcontract Reports.

Some of those proposed rules are fairly interesting and have implications that may be worthy of a comment or two (e.g., “only one offer”).

In addition to the official regulatory changes noted above, there were also a couple of less formal pieces of guidance issued.

The DoD issued Class Deviation 2018-O0016 on June 26, 2018, entitled “Defense Commercial Solutions Opening Pilot Program.”

The DoD also issued Class Deviation 2018-O0017 on June 29, 2018, entitled “Determining Contract Type for FMS Contracts.”

Finally, the Director of Defense Pricing/Defense Procurement and Acquisition Policy issued a guidance memo entitled “Negotiations of Sole Source Major Systems for U.S. and U.S./FMS Combined Procurements” on June 28, 2018.

Looking over the list of regulatory changes, we see a bit of an emphasis on Foreign Military Sales. If you are a contractor that plays in that sandbox, you may want to take note.

But for the rest of us, meh. Small steps….

As always, we are deeply indebted to Bob Antonio and his WIFCON website, who tracks and publishes regulatory changes as they happen. Without him, much of this blog—and certainly this article—would simply not happen. If you are not visiting WIFCON (“Where in Federal Contracting”) on a regular basis, you are missing out on a tremendous resource.


 

Section 809 Panel Issues Volume 2

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At the end of June, 2018, the Section 809 Panel issued another report, numbered Volume 2 of 3. You remember the Section 809 Panel, right? We’ve written about it several times before, including this article discussing the Volume 1 Report from January, 2018. The Section 809 Panel is “charged with making recommendations that will shape DoD's acquisition system into one that is bold, simple, and effective.” To this end, the Panel is peopled with individuals who have long and distinguished pedigrees in government contracting—from both within government and without.

Or, as somebody (not us) has pointedly noted, the same people who didn’t solve these challenges at the time they arose are now here, long afterwards, to suggest some fixes.

Anyway, we had some really good things to say about the Volume 1 Report’s recommendations. We objected to nothing and embraced everything. As we’ve noted, some (but not all) of those recommendations made their way into the 2019 National Defense Authorization Act (NDAA). It’s obvious that somebody read the Volume 1 report and liked some (but not all) of what they read.

With respect to the Volume 2 report, we have fewer good things to say. That’s not because we don’t like what we read, but instead because those things weren’t written in the same way. Volume 1 was marked by really concrete, actionable, recommendations that were supported by lots of detail. In contrast, Volume 2 seems to be marked by a higher-level discussion and more summary recommendations. That’s not to say there is a lack of meaty, important, recommendations in Volume 2; but they are harder to find (and presumably take action upon) than they were in Volume 1.

We are not going to recap the entire Volume 2 report. As always, we encourage you to read it for yourselves. Here’s a link for you to follow. Rather than discuss the entire report, we are instead going to focus on Section 4, Cost Accounting Standards. Not only is it the Section that interests us the most; we also think it’s an outstanding exemplar of what’s good (and not so good) about the format and content of Volume 2.

Volume 2, Section 4, Cost Accounting Standards (CAS) starts out by establishing a foundational assertion, which becomes the theme of the entire Section. That assertion is “Reinvigorating the Cost Accounting Standards Board and updating Cost Accounting Standards would ease compliance burden, yet retain appropriate oversight for cost accounting.” (Italics in original.) Following the foundational assertion, two recommendations are provided. Note that these recommendations are numbers 29 and 30 (counting serially from the recommendations in Volume 1 and the prior three Sections of Volume 2). The first CAS recommendation is: Revise 41 U.S.C. §§ 1501-1506 to designate the Cost Accounting Standards Board as an independent federal organization within the executive branch. The second CAS recommendation is: Reshape CAS program requirements to function better in a changed acquisition environment.

See what we mean about the nature of the Volume 2 recommendations?

With respect to the first recommendation (technically, Recommendation #29), the report states that the problem is that the Office of Federal Procurement Policy (OFPP) hasn’t been doing its job with respect to operating the CAS Board. (That is a lament often made on this website.) The report states—

The CASB’s current configuration within OFPP is ineffective at providing oversight for application of CAS to federal government contracts. CASB has only rarely met in recent years, and member positions often go unfilled for long periods. Meanwhile, changes to government contracting require ongoing updates to the standards and resolution of questions about CAS applicability. Because CASB has not been responsive to these changes, contractors are overly burdened by the need for added layers of compliance to many rules that have not kept pace with new business models. CASB needs to be reinvigorated as an independent organization and removed from OFPP. …

The most pressing problem with the current CASB formulation is the administration of the board at OFPP, partly due to a lack of leadership and subject matter expertise. The OFPP administrator position changes frequently and is often vacant, leaving the role in the hands of an acting administrator, most often a career civil servant versed in procurement policy, but without the requisite authority or experience in accounting and contract management to push forward needed CAS reforms. … As a practical matter, when there is no Senate-confirmed administrator, nothing of substance happens at the CASB. Even when there is someone in the job, most OFPP administrators are not accountants, have not previously shown an interest in the issues within the board’s jurisdiction, and are not experientially well-qualified to lead the board. Based on CASB’s consistent lack of activity, OFPP administrators clearly have not prioritized CAS.

Again, how can anybody who follows the CAS Board’s (lack of) activity and the resulting litigation before the ASBCA and CoFC argue with the foregoing? It’s all absolutely true. Making the OFPP Administrator the CAS Board Chair has been a disaster and has caused an untold amount of wasted resources as Contracting Officers and contractors both try to apply outdated CAS rules to an evolving acquisition environment. But so what? Where is the actionable recommendation?

Oh, there it is, buried within the word-wall of page upon page of discussion. While traversing the discussion, one finds a more actionable recommendation, as if coming upon a pirate's treasure:

… the Section 809 Panel recommends that any statutory enactment enabling the physical move of CASB out of OFPP also designate the OMB director as the principal officer over CASB with the authority to delegate CASB members to act as officers of the United States. OFPP should remain responsible for the mechanics of publishing the regulations in the Code of Federal Regulations, where they have been located since 1993, but it will have no responsibility for determining the substance of the CAS requirements

Contining on ... finally--after nearly seven printed pages of discussions--one finds specific recommendations. Only they are not called recommendations. They are called “conclusions” because … reasons. Apparently, this is all an academic exercise. Unlike the Volume 1 Report, which had sub-recommendations under many of the recommendations, Volume 2 has taken a different tack—and, in our opinion, that decision is to the detriment of the Report’s potential impact.

The “conclusions” are:

  • CASB should be physically located in GSA, which will provide office space and facilities, including clerical support. GSA will have no responsibility for CASB’s substantive work.

  • CASB should have a budget sufficient to support a full-time, permanent staff of at least three people.

  • CASB should be part of the Executive Branch, but completely independent of any department of any other agency.

  • The existing requirements for CASB to meet at least quarterly and to publish minutes of its meetings should be retained.

  • Section 820 of the FY 2017 NDAA creating a Defense CASB should be repealed.

  • CASB should have five members….

  • Authority to appoint the members of the CAS Board should be vested in the Director of OMB.

  • There should be rules for member appointment, including the chair, that include limits on removal; appointment terms consistent with the length of experience necessary to govern, administer and reform CAS; and that provide for independence in the decisional and regulation process free from supervision by OMB.

  • The statute creating CASB should also direct that the board’s standards and regulations will continue to be published by OFPP, and/or other relevant regulatory bodies, in Part 99 of 48 CFR.

  • Disestablish the Cost Accounting Standards Board and remove its statute from chapter 15 of Title 41 (‘Division B, Office of Federal Procurement Policy’). Create a new independent board codified in Title 31 (‘Financial Management’).

Okay. By our count that’s 10 sub-recommendations. But you have to get through a lot of words to get to them, and when you get to them you might miss them, because they aren’t even called “recommendations”. Note: we are not saying we disagree with those recommendations; most of them are quite reasonable and would go a long way to reduce CAS-induced acquisition confusion. However, given the potential streamlining implications of their enactment, we have to wonder why they seem to be buried. The word “hidden” comes to mind. Just like a pirate's treasure.

So much for Recommendation #29.

With respect to Recommendation #30 the problem is stated as “… CAS program requirements lack sufficient nimbleness to accommodate the evolving acquisition environment. Except for changes in monetary thresholds, CAS program requirements have remained relatively static since the 1970s. This condition exists despite substantial changes in what DoD purchases, how DoD conducts purchases, and what contract vehicles DoD uses.” Again, how can anybody who has to deal with CAS argue with that statement?

Despite what seems to us to be a certain amount of “obviousness” of the problem statement, the report goes on for more than 20 pages of history, discussion, tables and footnotes—which no doubt provides a solid foundation for the recommendations to come, if only readers have the patience to slog through it all. Seriously, some if it seems like the kind of padding one would find in an undergraduate term paper. Did readers really need Table 4-9, which provides an illustration of the Uniform Contract Format? Are people unaware of it? Seems to us that, if such a reiteration was deemed necessary, then a simple FAR reference would have sufficed.

After skimming through 20 pages or so of historical recap interspersed with various issues caused by the Ancien Régime of CAS, one finally gets to the recommendations. Only (as before) they are not called “recommendations” because they are called “conclusions”. Okay. There are eleven recommendations. They are as follows:

  • Decouple the CAS-covered contract monetary threshold from the TINA monetary threshold and set the monetary threshold at $25 million. The monetary threshold should be stated at the outset of 48 CFR Chapter 99 and, thereby, eliminate the need for the monetary exemption at 9903.201-1(b)(2), which is used for inflation adjustments.

  • Eliminate the trigger contract exemption at 41 U.S.C. §1502(b)(1)(C)(iv) and 48 CFR 9903.201-1(b)(7), as it would no longer be necessary if the CAS-covered contract monetary threshold were raised to $25 million.

  • Raise the full CAS-coverage monetary threshold to $100 million.

  • Raise the disclosure statement monetary threshold to $100 million. The condition for not requiring a disclosure statement from a segment that has CAS-covered contracts totaling less than $10 million and representing less than 30 percent of segment sales should be eliminated, as it would be no longer necessary.

  • Revise commercial item exemption at 48 CFR 9903.201-1(b)(6) as proposed by CASB in 2012.

  • Expand the CAS exemption at 48 CFR 9903.201-1(b)(15) to include any fixed-price type contract whose price is based on price analysis without the submission of certified cost or pricing data.

  • Add specific guidance for hybrid contracts to CAS program requirements at 48 CFR 9903.201-1 that would exclude exempted portions of contracts from CAS-coverage, including the application of monetary thresholds. Add a definition of hybrid contract to the CAS definitions at 48 CFR 9903.301.

  • Require contracting officers, to the maximum extent practicable, to identify the portions of the contract that are not CAS-covered when a hybrid contract is contemplated.

  • Add specific guidance for indefinite delivery vehicles to CAS program requirements at 48 CFR 9903.201-1 that would determine CAS applicability at the time of order placement. Evaluate each order for CAS applicability on its own. Add a definition of indefinite delivery vehicle, using the existing definition at FAR 4.601.

  • Place the CAS clause by full text in contracts that at the time of award are CAS-covered pursuant to CFR Part 9903. Require contracting officers to make an affirmative written determination at the time of award that a given contract, in whole or part, will be CAS covered. Provide contractors means to confirm or question contracting officers’ determinations.

  • Revise the CAS clause to (a) remove the self-deleting provision for CAS coverage, (b) accommodate provisions for hybrid contracts and indefinite delivery vehicles, and (c) state that, if subsequent to award of the CAS-covered contract, it is established that the contract, or portions thereof, should not have been determined to be CAS covered, the CAS clause will be deemed inapplicable to the contract, or portions thereof.

As before, we think those are all good, important, recommendations that, if implemented, would go a long way toward solving a lot of CAS-caused problems and disputes. There are still any number of CAS-related issues that need to be addressed, including (but not limited to) the definition of “increased cost in the aggregate” and appropriate treatment of concurrent changes in cost accounting practice; but the foregoing recommendations represent a good start in the right direction.

We only hope that somebody finds them within the report, and acts on them.


Last Updated on Friday, 06 July 2018 16:30
 

Whose Money Is It Anyway?

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In 1999, the National Nuclear Security Administration (NNSA) awarded a complex and potentially very large contract to a company that subsequently became CB&I Areva MOX Services, LLC (“MOX Services”). The contract directed MOX Services to design and build a Mixed Oxide Fuel Fabrication Facility (“MFFF”) at the Department of Energy’s Savannah River site, located near Aiken, South Carolina. The MFFF project was created to satisfy the nuclear non-proliferation agreement between the Russian Federation and the USA. When operational, the MOX facility will convert Russian legacy weapons-grade plutonium into fuel suitable for commercial power reactors. The NNSA awarded the contract’s Option 1 to MOX Services on a cost reimbursement basis, with MOX Services eligible to earn various types of fee or profit, including incentive fee. The contract included the standard FAR “changes” contract clause for cost-reimbursement contracts, 52.243-2.

Importantly, in order to more accurately estimate the costs of construction, the parties apportioned the risks. The NNSA took on certain risks that were expressly excluded from the contract's scope of work. In particular, the NNSA accepted risks related to the amount and timing of project funding, and agreed to process appropriate contract changes if the risk materialized. In addition, the contract specifically and broadly excluded risks “related to” the Russian parallel project requirements from its scope. Since the NNSA accepted these risks, they were beyond the scope of the contract, and their potential impacts on the project were not included in the MFFF cost or schedule estimates. Unsurprisingly, Congressional funding uncertainty and delays in the Russian project significantly impacted cost and schedule.

Stuff happens. What are you going to do?

One of the aspects of the MFFF construction contract was awarded on a cost-plus incentive fee (CPIF) basis. The available incentive fee was either 6.75% of estimated costs or 7.0% of estimated costs, depending on whether NNSA ordered a “hot start.” According to MOX Services, NNSA ordered a “hot start” and thus MOX Services was entitled to the 7.0% incentive fee band. However, the NNSA Contracting Officer used the 6.75% incentive fee band, a decision which led to a dispute. Further adding fuel to the dispute fire, NNSA suspended the quarterly incentive fee payments after making 12 payments (equaling $29.1 million). From February 2011 forward, MOX Services was not being paid the incentive fees to which it believed it was entitled.

Just to make matters more interesting, most of the incentive fees were “provisional” in nature, meaning that they “vested” in accordance with a contract schedule. “For at least the first year after MOX Services invoices for quarterly incentive fees, the entire incentive fee is provisional. For as long as MOX Services’ performance has remained within the cost and schedule parameters during the previous four quarters, 50% of the provisional incentive fee payment becomes final, and cannot be reclassified or taken back by NNSA. The other half of each quarter’s incentive fee remains provisional.” If MOX Services didn’t make sufficient construction progress within cost and schedule parameters, then it could lose its provisional incentive fees. At the point at which NNSA suspended the quarterly incentive fee payments, MOX Services had “vested” in about $7.5 million of the total payments, leaving about $21.6 million in “provisional” incentive fee payments.

MOX Services filed a certified claim for about $53 million, related to incentive fees it had allegedly been denied. Not only did the Contracting Officer reject the claim, they demanded immediate repayment of all provisional incentive fees MOX Services had received. MOX Services appealed the decision to the Court of Federal Claims.

Judge Wheeler described the dispute as follows:

On September 29, 2016, MOX Services submitted a certified claim to NNSA for approximately $53 million in suspended incentive fee, representing the incentive fee amounts from fiscal years 2011 to 2015 that NNSA has not paid. In responding to the certified claim on December 7, 2016, the contracting officer issued two final decisions in a single letter. Not only did the contracting officer deny the certified claim for $53 million, but he demanded MOX Services to refund all of the provisional incentive fee payments previously made. As relevant here, the contracting officer directed MOX Services to return $21.6 million in provisional incentive fee in MOX Services’ possession. Through a combination of direct payments and reduced NNSA payments of MOX Services’ invoices, MOX Services has satisfied NNSA’s demand for repayment of the provisional incentive fee plus interest.

In addition, NNSA refused to reimburse MOX Services for more than $2 million expended in outside legal fees and consultants associated with submitting a Request for Equitable Adjustment (REA) to adjust the contract’s cost and schedule parameters for the impacts associated with funding and Russian performance.

So there were two issues before Judge Wheeler: (1) Did NNSA have the contractual authority to demand refund of the $21.6 million in provisional incentive fees before construction had been completed? and (2) did the CO have a valid basis for rejection of MOX Services’ invoice for REA preparation fees?

With respect to issue (1), Judge Wheeler wrote:

The NNSA’s attempt to claw back $21.6 million in provisional incentive fees is premised on the assertion that MOX Services has hopelessly exceeded the estimated project cost, has no chance of meeting the project schedule parameter, and thus will not be able to show entitlement to any incentive fees at project completion. In opposition, MOX Services maintains that the estimated project cost and schedule must be adjusted under the changes clause, FAR 52.243-2, because MOX Services is not responsible for the increased costs and schedule delays incurred to date. These contentions present factual issues that will be resolved in the other claims that MOX Services has submitted to the Court. It remains to be seen whether the estimated cost and schedule will require adjustment.

If that were the end of the opinion, we wouldn’t have bothered to write about it. Nope. Judge Wheeler had more to say, and what he had to say is important for those considering pushing a dispute with their government customers. He wrote—

Regardless of which party is responsible for the increased costs and schedule delays, none of the contract provisions permits the NNSA to claw back provisional incentive fees before the completion of the MFFF. What is most troubling here is that the contracting officer used the denial of MOX Services’ certified claim, and demand for refund of $21.6 million, as a way to gain leverage over MOX Services through baseless retaliation. The law requires contractors to certify that their claims are ‘made in good faith,’ that all ‘supporting data are accurate and complete to the best of the contractor’s knowledge and belief,’ and that the amount requested ‘accurately reflects the contract adjustment for which the contractor believes the Federal Government is liable.’ Surely, a reciprocal obligation to act in good faith applies to the government. See Moreland Corp. v. United States, 76 Fed. Cl. 268, 292 (2007) (‘Under the Contract Disputes Act, a contracting officer’s review of certified claims submitted in good faith is not intended to be a negotiating game where the agency may deny meritorious claims to gain leverage over the contractor.’) The same reasoning applies where the contracting officer conjures up a baseless claim to demand immediate refund of provisional incentive fees.

[Emphasis added. Internal footnotes/citations omitted.]

Judge Wheeler directed NNSA to return the $21.6 million in had inappropriately taken from MOX Services upon receipt of an invoice for that amount.

With respect to Item (2), Judge Wheeler noted that NNSA Counsel had agreed with MOX Services that the CO lacked a valid rationale for denying payment of the more than $2 million it had expended in preparing its REA. Thus, MOX Services was entitled to reimbursement for those costs.

Judge Wheeler’s opinion also deals with other government arguments, which are worth reading. But we were struck by the part(s) we wrote about above.

One more thought: the original contractor, back in 1999, was Duke Cogema, Stone & Webster, LLC. Stone & Webster was a prestigious engineering company with a long pedigree. The company played a significant role in World War II industrial mobilization and production—including performing as a key contractor for the Manhattan Project. Unfortunately, by the late 1990’s, the company wasn’t operating at the same historic levels. It was acquired by The Shaw Group in the early 2000’s. In 2012, The Shaw Group sold it in two major pieces—and the nuclear power piece ended-up at Chicago Bridge & Iron Company (CB&I), who subsequently sold it to Westinghouse Electric Company, which was owned by Toshiba. In 2017, Westinghouse filed for Chapter 11 bankruptcy protection, citing losses from nuclear reactor construction projects.

We will never know how the NNSA Contracting Officer’s decisions, discussed in this article, which cost its contractor nearly $25 million in lost cash flow and an untold amount of unallowable legal fees pursuing its appeals, impacted the corporate financial situations related in the foregoing paragraph. Who knows what might have happened, had the CO dealt fairly with the contractor?

Last Updated on Sunday, 01 July 2018 12:30
 

Termination Troubles

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Recently we published an article criticizing DCMA for over-reliance on DCAA auditors. In that article, we noted that a Contracting Officer cannot use the fact that they are awaiting a DCAA audit report as a pretext for failing to issue a Contracting Officer’s Final Decision (COFD) as required by the Contract Disputes Act. The DCAA audit report might address the amount of the costs at hand but cannot address whether or not the contractor is entitled to those costs. Determining entitlement is the CO’s job.

And now comes a story about a CO who failed to rely on DCAA. She failed to listen to DCAA, to incorporate the audit findings into her decision, and, as a result, the government may have overpaid a subcontractor's Termination Settlement Proposal (TSP). Maybe.

For those who don’t know, a TSP is what happens when your contract has been terminated for convenience (T4C). We’ve discussed terminations before – see, for example, this article. As we noted in that article, when a contractor receives a T4C notice, it needs to take certain actions. The first action is (perhaps obviously) stop work. We wrote—

Now, that doesn’t mean turn off the lights and walk out the door. To the contrary, you must cease ongoing contract performance in a reasonable, prudent, and measured manner. For example, you don’t tell your procurement staff to stop work—because they need to flow down the T4C Notice to your contract suppliers and subcontractors, and they need to administer the supplier termination efforts. You also don’t stop the production machines, leaving materials in the middle of fabrication.

Instead, you take measures to shut down production like a prudent business person, and you protect the government’s interest. That means finishing production at a reasonable stopping place, carrying the finished and unfinished goods to property storage, and logging them in. That means saving all work and logging/indexing what’s been done and what’s not been done. Doing all this may take a few days. As we used to say, ‘You can turn off a faucet, but there’s still a few drops left to go.’

Remember, you’re going to have to justify all this work to Government auditors. So it’s not a license to permit employees to keep charging numbers beyond that which is necessary and prudent. Consider it a rapid ramp-down, or perhaps a safe landing without power. Approach the situation in a business-like and prudent manner.

In this story, which comes courtesy of a formal DoD OIG report (link right here), it appears that neither the contractor nor the subcontractor read our article on terminations. As a result, the subcontractor had problems passing its DCAA audit.

But let’s start at the beginning—at least, the beginning as the DoD OIG told the story. On August 11, 2009, the USAF issued a “stop work” notice to the contractor with respect to purchases of titanium for the F-22 fuselage. That stop work order including, obviously, all subcontractors connected with that activity. On December 18, 2009 that activity was formally terminated for convenience. Now the DoD OIG didn’t address the issue, but it would have been interesting to know the chronology of the prime contractor's communications with its subcontractor(s). While we don’t know that, we do know that one subcontractor submitted a TSP to the Air Force, in the amount of $2,930,817, on August 27, 2010. That TSP was updated twice, once to remove more than one million dollars in “unallowable costs,” and again to provide “updated supporting documentation.” The final version of the subcontractor’s TSP was dated October 11, 2011—more than a year after initial submission.

Less than a month later (November 5, 2011), the USAF Terminating Contracting Officer (TCO) requested a DCAA audit of the subcontractor’s TSP. DCAA issued its report on April 29.2014. In other words, the audit report was issued two years and five months after the request was issued. Yes, you read that correctly: DCAA took 29 months to audit a TSP valued at $1,860,001.

In that audit report, DCAA questioned $825,910 of the claimed $1,860,001—or more than 44 percent of the TSP value. DCAA questioned several aspects of the TSP, including $353,577 in costs incurred after issuance of the “stop work” order. DCAA also questioned $472,333 in claimed costs, asserting that they were unallowable. (Remember, the subcontractor had already removed more than a million dollars’ worth of unallowable costs before DCAA received the audit request.)

With respect to the costs incurred after receipt of the “stop work” order, the DCAA audit report apparently questioned subcontractor costs incurred after receipt of the stop work order by the prime contractor, ignoring the date on which the subcontractor received a stop work order from the prime. The DoD OIG report stated “The DCAA audit report questioned $353,577 in subcontractor costs that were incurred up to 109 days after the Air Force termination contracting officer issued a stop-work order for all activities associated with the purchase of titanium for the F-22 aircraft.” Though we are not lawyers, we bet a skilled government contracts attorney could exploit that audit report position. It is very possible that, if the prime contractor were negligent in transmitting the stop work notice to the subcontractor, the costs would be allowable for the subcontractor but unallowable for the prime contractor. Interestingly, the DoD OIG report ignored this potential issue.

With respect to the alleged unallowable costs, DCAA questioned $86,691 in claimed costs “because the proposed costs were not based on current market prices at the time of the settlement proposal.” That’s weird, right? Because presumably the costs were already incurred, so what impact could current market prices have on historical costs? Anyway, we don’t know. Perhaps there was a contract clause that would have required revision of historical costs to current costs (e.g., a “mark to market” requirement). But absent such a clause, that seems to be a weird finding.

Also, DCAA questioned $84,023 in claimed costs because they were not “allocable” to the terminated portion of the subcontract. They were costs that the subcontractor “did not incur as estimated at the time of the settlement proposal” and they were “overstated when calculating the proposed direct costs.” That tells us that we are dealing with indirect costs. Somehow the subcontractor was using estimated final indirect rates instead of actual rates (perhaps because it hadn’t yet calculated its actual rates). Further, since DCAA was questioning allegedly overstated direct costs, then obviously indirect costs allocated to that figure would also be questioned.

Finally, DCAA questioned $301,619 in raw material costs (titanium, we presume) that the subcontractor had acquired and processed “before the Air Force contracting officer exercised a contract option to authorize the material.” Again, a weird finding. It makes it sound like the subcontractor had a prime contract directly with the Air Force, instead of a subcontract with the prime contractor. Who cares what the USAF CO did or did not exercise? Instead, the question should be what direction did the prime contractor provide to the subcontractor? Unfortunately, the DoD OIG report didn’t address that question.

To sum it up, the DoD OIG treated the DCAA audit report as if it were Gospel, whereas we might have picked a few nits with its conclusions.

But the real issue here is the DCMA Contracting Officer, and how she treated the DCAA audit report. The DoD OIG report stated that—

In the price negotiation memorandum, the DCMA Contracting Officer indicated that she would uphold all of the DCAA-questioned costs totaling $825,910. However, in another section of the price negotiation memorandum, the DCMA Contracting Officer authorized reimbursement of the full proposed amount of $1,860,001 in subcontractor termination costs. The price negotiation memorandum did not address the inconsistency or explain why the DCMA Contracting Officer authorized full payment of the $1,860,001 subcontractor’s termination settlement proposal.

Oops!

The DCMA TCO signed the PNM; the TCO’s Supervisor signed the PNM. Nobody noticed the discrepancy. On April 28, 2016, the prime contract was modified and the subcontractor’s TSP was approved as submitted for 100% reimbursement. The DCMA TCO notified DCAA on May 3, 2016. And the DoG OIG Hotline received a complaint on August 22, 2016, alleging that the TCO “failed to comply with the [the FAR and the contract] when she did not uphold any of the [DCAA] questioned costs of $825,910 [and] authorized full payment of the $1,860,001 subcontractor’s termination settlement proposal.”

Needless to say, the DoD OIG substantiated those allegations.

But what’s interesting is what the TCO said during her interviews with the DoD OIG. According to the DoD OIG report, the TCO stated that she lacked experience and knowledge in how to deal with the issues involved with settling a TSP, including negotiating and documenting her evaluation of DCAA questioned costs. She stated that she “did not have any experience with contracting actions greater than $750,000 because prior to this termination, she only handled contracting actions below $750,000, which did not require negotiations involving DCAA audits…” The DoD OIG folks checked and confirmed that she had the requisite training; however, that training apparently didn’t stick. They would also have checked with the TCO’s supervisor, to try to figure out why he would have approved that PNM—but he retired a few months after the Hotline report had been submitted.

The TCO had her Warrant rescinded.

What about the contractor and the subcontractor, who had allegedly received $825,910 in cost reimbursements to which they were (allegedly) not entitled? According to the DoD OIG report—

[The TCO] issued a request for a voluntarily refund to the prime contractor. However, the contractor declined the request because the signed contract modification settling the termination costs was final and the contractor had already paid the subcontractor. DCMA determined that, because the DCMA Contracting Officer acted within the scope of her official duties, the Government is bound by the finality of her actions and, as a result, the funds cannot be recouped.

So that, it seems, was that.

One final thought:

The DoD OIG report didn’t really address the issue of the prime contractor’s role in this brouhaha. In fact, the report seemed to confuse the roles and responsibilities of the various parties involved in the termination process. For the record, FAR 49.107(b)(2) requires the prime contractor to review its subcontractors’ TSPs—even if they are also being reviewed by a governmental audit agency. The TSP Certification, executed by the prime contractor, states “The contractor has examined, or caused to be examined, to an extent it considered adequate in the circumstances, the termination settlement proposals of its immediate subcontractors...” There is a real question, at least in our minds, as to whether the prime contractor fulfilled its responsibilities in this situation.

Which leads us to this conclusion:

Readers, if you are a prime contractor or subcontractor in receipt of a “stop work” order or formal T4C Notice, we urge you to do a couple of things right away: (1) stop work, and (2) contact people who understand the termination process and know what to do. If you try to figure it out on your own, you may find yourselves the topic of your very own DoD OIG audit report.

Last Updated on Wednesday, 04 July 2018 07:47
 

Corruption at the Top

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It is perhaps arguable whether anti-corruption training actually reduces instances of employee wrongdoing. After all, one might reasonably expect that employees already know their corrupt behaviors are wrong; do we really think reminding them of the rules one more time is going to affect their decision-making?

It is perhaps more certain that anti-corruption controls, both preventive and detective, reduce instances of employee wrongdoing. If employees know that they are likely to be found out, it might well affect their decision-making. If employees think the company is watching and checking, they might decide not to engage in corrupt behaviors.

But when there is corruption at the top—especially when there is collusion amongst executives who are ostensibly in charge of the anti-corruption controls—well then. That’s a different kettle of fish altogether. How are you going to prevent corruption in those circumstances?

It’s likely you cannot do so. Collusion makes corrupt behaviors easier to hide and collusion at the top makes them easier to carry out. In such circumstances, perhaps the best one can hope for is detection of the corruption after the fact.

In related news, we have another Department of Justice press release to discuss. In it, the DoJ announced that “Kristie Lynn McDonald [who] was the Vice President of Finance and Administration of a software company in Sterling, Virginia,” was recently sentenced to 15 months in prison and 3 years of supervised release. She was ordered to pay $1.813 million in restitution.

What did Ms. McDonald do? According to the press release, she “conspired with the company’s Chief Executive Officer Robert Lewis to defraud the United States by failing to pay over to the IRS more than $1.8 million in payroll taxes withheld from employee paychecks.” The conspiracy to defraud took place over roughly a two-year period, between January 2011 through February 2013.

Interestingly, this DoJ press release actually gave some details of the corruption. It stated—

McDonald and Lewis circumvented the company’s normal payroll and accounting procedures by paying some employees with manual paychecks. The employees still received the correct pay after withholdings, but by bypassing the accounting system, McDonald and Lewis were able to hide the fact that the withholdings were not being paid over to the IRS. … [In addition] McDonald and Lewis failed to remit the full amount of employee retirement contributions to the company’s retirement plan. Through their actions, the company failed to transfer nearly $225,000 in voluntary employee retirement withholdings.

As part of their scheme, “they also caused the company to file false quarterly employment tax returns with the IRS that underreported the amount of tax due.”

The key point in the above is that the normal automated payroll system was bypassed by issuing manual payroll checks. That should have been a red flag to the payroll department; unfortunately, it’s likely that the payroll department reported to the VP of Finance and Administration—who probably made up some pretext as to the need for manual paychecks.

Routine payroll reconciliations and/or bank reconciliations might have caught the scheme. But guess who was responsible for seeing that those controls were performed? Yep. The VP of Finance and Administration.

Why did the CEO and VP of Finance and Administration collude together? According to the press release, “McDonald and Lewis used the misappropriated money to pay the operating expenses of the company, which included their own six figure salaries and salary raises for other employees.” They needed the cash “to conceal the company’s failing financial condition from its Board of Directors.”

Thus, it seems that the company had a cash-flow problem. It might even have had trouble making its payroll obligations. Rather than admit the problem and make some hard decisions about the company’s future, the CEO and VP of Finance and Administration conspired to steal money from employees (their 401(k) contributions) and from the U.S. Government (the employment taxes).

Not a good idea. But because the corrupt decision-making was at the top of the company, it was hard to prevent. Those individuals had override authority, and they probably used it to further their scheme. The corporate check on the executives—the Board of Directors—was kept in the dark.

It would be nice to understand how the scheme was finally detected. Did somebody perform a reconciliation and call the IRS? Did the IRS audit the tax returns and see the missing withholdings? We don’t know.

But this story provides a reminder that “tone at the top” is a critical aspect of ethics and business conduct systems. When the “tone at the top” is missing, the results tend to show up in the company’s financial results. When the corruption is at the top of the company, it’s just a matter of time until the company’s operations suffer an abrupt end.

 

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Newsflash

In March 2009, Nick Sanders’ article “Surviving Government Audits: Have the Rules of Engagement Changed?” was published in Government Contract Costs, Pricing & Accounting Reports (4 No. 2 GCCPAR P. 11). Apogee Consulting, Inc. is proud to announce that Mr. Sanders’ article was selected for reprint and publication in Thomson West’s The New Landscape of Government Contracting.  Mr. Sanders, Apogee Consulting’s Principal Consultant, joins such distinguished contributors as Professors Steven Schooner and Christopher Yukins, Luis Victorino and John Chierachella, Joseph West and Karen Manos, Joseph Barsalona and Philip Koos and Richard Meene, and several others.  The text covers a lot of ground, ranging from the American Recovery and Reinvestment Act (ARRA) to Business Ethics and Corporate Compliance, and includes several articles on the False Claim Act and the Foreign Corrupt Practices Act.  In addition, the text includes the full text of many statutory and regulatory matters affecting Government contract compliance.

 

The book may be found here.