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DOE Inspector General Says M&O Contractors Should Not Audit Themselves

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Prior to 1994, the Department of Energy Office of Inspector General (DOE OIG), with assistance from independent public accounting firms, was responsible for auditing the annual Statements of Costs Incurred and Claimed for DOE’s management and operating (M&O) contracts. The OIG conducted these audits pursuant to the United States Government Accountability Office’s Generally Accepted Government Auditing Standards (GAGAS), also known as the “Yellow Book.”

In 1994, that all changed. Starting in that year, the M&O contractors were told that they were responsible for auditing themselves and their subcontractors under what was called the “Cooperative Audit Strategy.” Instead of complying with GAGAS, the M&O audit teams would henceforward comply with the Standards of the Internal Audit Institute (IIA). The change was driven by a GAO report that documented the inadequacies associated with the DOE OIG’s audit approach (“Energy’s IG has had difficulty in auditing, in a timely manner, whether costs claimed by integrated contractors are allowable and have been recorded in accordance with Energy’s accounting policies.”) At that point, the DOE OIG’s role was limited to conducting a limited assessment of the contractors’ internal audit work. The Contracting Officers would then take corrective action on any findings that the DOE OIG unearthed.

As the DOE OIG recently reported, not everybody has been a supporter of the Cooperative Audit Strategy. “For the 26 years that the Cooperative Audit Strategy has been in place, interested stakeholders, including GAO6 and the Department of Defense (DOD), have expressed concerns about the appropriateness of contractors auditing their own costs.”

Apparently, though it doesn’t explicitly say so, the DOE OIG has also been concerned about M&O contractors auditing themselves. That concern led to the issuance of a “special report” that was, essentially, a polemic that both attacked the use of M&O internal audit teams and supported the notion that the DOE OIG should, itself, be performing those audits.

The DOE OIG offered as the primary rationale for moving away from the Cooperative Audit Strategy the assertion that M&O internal audit teams are not independent from the contractors for whom they work. That lack of independence, according to the DOE OIG, undermines public trust. (“… the IIA audit standards do not include these objectives because ‘internal’ auditors are embedded within a company and are chartered to serve that company’s best interest. Internal company auditors in the private sector do not have the same elevated duty to public interest as Federal auditors and external auditors performing audits under GAGAS.”) The DOE OIG concluded that “no amount of changes to the Cooperative Audit Strategy would cure the fundamental defect that the internal auditors cannot meet the independence standards required by GAGAS.”

Except they are not subject to GAGAS so that argument does not seem very strong to us.

As a corollary to the lack of independence, the DOE OIG asserted that the M&O internal auditors aren’t finding the levels of fraudulent activity that they should be finding, leaving it to the OIG to find and investigate such wrongdoing. (“These problems would likely have been identified, reported, and corrected in a timely way through a GAGAS-compliant, independent audit.”)

Um, maybe? We think that assertion is undermined by the historical fact that the DOE OIG was not performing the required audits in a timely manner, which is why the Cooperative Audit Strategy was created in the first place.

As an additional corollary, the DOE OIG asserted that the M&O internal auditors have not been performing appropriate audits of subcontractor costs. According to the DOE OIG, there were subcontracts whose costs were not audited, subcontracts that missed being included in the audit universe because the Purchasing function misclassified them, and there were audits performed (but poorly). The problem with the assertions is that they are largely based on unissued reports that are still in draft, to which the contractors have not yet formally responded.

Another issue is with the subcontracts that were not audited because the Purchasing function misclassified them. First, there is no linkage between the issue raised and the alleged lack of independence. Maybe the root cause is that the M&O contractors’ purchasing systems are inadequate. Second, it is not clear that, had the DOE OIG been performing the audits, the misclassification would have been discovered. It is just as likely that the DOE OIG would have skipped those audits as well.

With respect to poor audits, another draft report indicates that “the M&O contractor did not sustain subcontract costs that were questioned by its own contract audit office in 54 of 61 (88.5 percent) subcontract closeout files, with no documentation or justification as to the M&O contractor’s rationale.” Based on that finding (as well as some other findings), the DOE OIG concluded that “either internal audit’s work was superficial and that the recommendations could not be acted upon, or worse, that the M&O contractor’s management may have disregarded the internal audit report findings and billed the Government for the questionable subcontract costs despite the internal audit report findings.”

Our concern with the foregoing is that it is not internal audit’s responsibility to disposition the audit findings and, if appropriate, seek recovery of unallowable costs from subcontractors. That’s the role of subcontractor management. While the DOE OIG findings may be legitimate and call into question whether the M&O contractor is appropriately managing subcontracts, it honestly seems to have nothing to do with how internal audit performs.

After the litany of M&O contractor internal audit deficiencies, the DOE OIG concluded with the recommendation that things return to the way they used to be. Ignoring its own historical malfeasance with respect to performing audits of M&O contractor and subcontract costs, the DOE OIG recommended that independent audits, performed by either the DOE OIG, DCAA, independent CPA firms, or some combination of those approaches, be implemented. The DOE OIG noted that “additional appropriations will be necessary” in order to effectuate the new (old) independent audit strategy.

It is not clear to us that the DOE OIG complied with applicable GAGAS when preparing this “special report.” It seems that there may have been some self-interest involved here, a self-interest that taints some of the findings. While it may well be true that the current M&O contractor internal audit approach should be improved, it is not at all clear that the correct path forward involves a return to the way things used to be, before DOE OIG was removed from its role because of a documented failure to perform.


No Porn for You

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The Consolidated Appropriations Act, 2021 (Pub. L. 116-260), was signed into law December 27, 2020. The final language was 2,124 pages long, covering 32 Divisions (or sections), each with multiple Titles. Division C (“Department of Defense Appropriations Act, 2021”) contained nine Titles. Title VIII “General Provisions” contained 138 Sections covering many aspects of DoD activity, and appropriating funding for those activities. (We should note that the other eight Titles within Division C contained their own multitude of Sections, but that’s not what we are talking about today.)

Section 8116 of Title VIII of Division C contained this limitation associated with certain appropriated funding:

SEC. 8116. (a) None of the funds made available in this Act may be used to maintain or establish a computer network unless such network is designed to block access to pornography websites. (b) Nothing in subsection (a) shall limit the use of funds necessary for any Federal, State, tribal, or local law enforcement agency or any other entity carrying out criminal investigations, prosecution, or adjudication activities, or for any activity necessary for the national defense, including intelligence activities.

You can find that prohibition on page 151 of 2,124, if you are inclined to check our veracity. (You should totally check. We could easily be fake news.)

As a consequence of that statutory requirement, on April 5, 2021, the Principal Director, Defense Pricing and Contracting, issued a Class Deviation (2021-O0003) that established a solicitation provision that requires “offerors to represent, by submission of their offer, that they are not providing as part of their offer a proposal to maintain or establish a computer network unless such network is designed to block access to pornography websites.” The provision is 252.239-7098, Prohibition on Contracting to Maintain or Establish a Computer Network Unless Such Network is Designed to Block Access to Certain Websites—Representation. It is to be included “in all solicitations, including solicitations for the acquisition of commercial items under FAR part 12.”

Because accessing porn is the most significant cyber-security threat facing the Department of Defense right now.


Without taking a moral stand either for or against pornography, and without entering into the legitimate debate about whether pornography degrades/exploits people or perhaps gives certain people a vehicle to generate wealth who would otherwise be stuck in a cycle of poverty—and without expressing an opinion as to whether such a limitation amounts to de facto censorship in possible violation of the First Amendment of the Constitution—let us see if we can find common ground by asking whether this is really the most important issue that Congress, and therefore the contracting officers of the DoD and the contractors of the DoD, should really be concerned with?

We assert it is not.

There are many cyber-security threats facing the Department of Defense at the moment.

"It's no secret that the U.S. is at cyber war every day," Ellen Lord, told the audience at the Professional Services Council's 2020 Defense Services Conference, in August, 2020. "Cybersecurity risks threaten the industrial base, national security, as well as partners and allies."

While Ms. Lord was talking, hackers had already broken into Texas-based SolarWind's systems and added malicious code into the company's software system. The system, called "Orion," is widely used by companies to manage their IT resources. Starting in March, 2020, “SolarWinds unwittingly sent out software updates to its customers that included the hacked code. The code created a backdoor to customer's information technology systems, which hackers then used to install even more malware that helped them spy on companies and organizations.” (Quoted from this article, written by Isabella Jibillian and Katie Canales.) According to that same article, “US agencies — including parts of the Pentagon, the Department of Homeland Security, the State Department, the Department of Energy, the National Nuclear Security Administration, and the Treasury — were attacked.”

The attack lasted for months and, even today, there is uncertainty about how many systems were hacked or what the damage was.

This is just one example of the real cyber-threats facing the Department of Defense. Accessing porn may be bad but it doesn’t take out entire “secure” networks.

But unfortunately, porn is the issue that Congress decided to focus on, and so now contractors must certify that they are not providing as part of their offer a proposal to maintain or establish a computer network unless such network is designed to block access to pornography websites.

It is a long-lamented concern that many of the most innovative infotech firms are reluctant (at best) to do business with the DoD. One of their concerns has been the amount of bureaucracy that comes with defense contracts. Commercial item contracts were one means of reducing that bureaucracy, but we see now that such contracts are subject to the same picayune compliance requirements as are the Major Defense Acquisition Programs, at least in this one respect.

Is blocking access to pornography such a big deal? Probably not. But the Congressional focus on blocking access to pornography is emblematic of a lack of focus on areas that are significantly more important to the national security posture of the United States.


Raytheon Wins at ASBCA (Again) Part 3

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In Part 1 of this analysis of the recent Raytheon victory at the ASBCA, we outlined the issues—which involved multiple appeals covering multiple issues across multiple years at both the Raytheon Corporate Home Office and its Missile Systems business unit. We also discussed the first major issue: the allowability of Raytheon’s premium class airfare. In Part 2 we discussed the treatment of two similar issues: Raytheon’s “Corporate Development” and “Government Relations” costs.

Here’s a link to the ASBCA decision, in case you want to review the 100+ page decision. (Hint: you really should.)

In Part 3, we are going to discuss the treatment of patent costs incurred at Raytheon Missile Systems (RMS).

Let’s get to it.

Patent Costs

FAR 31.205-30 (“Patent Costs”) controls the allowability. In a nutshell, the cost principle says that patent costs required by a government contract are allowable and “general counseling services relating to patent matters, such as advice on patent laws, regulations, clauses, and employee agreements,” are allowable. Pretty much all other patent-related costs are not allowable. (But read the cost principle for the details, please.)

Raytheon had a policy to tell employees how to treat any inventions that might be produced on company time. (As we are learning from writing this series of articles, Raytheon seems to have had a policy for just about everything under the sun. Given how Raytheon has a near-unbroken string of victories for appealing costs questioned by DCAA, we suggest other contractors might want to consider doing the same.) Raytheon’s policy assumed that any new inventions would be discovered during performance of a government contract, but allowed that such might not be the case. The policy contained a form that the inventor was to complete and submit it to a committee for review. Importantly, the policy did not solely address patents; it addressed any intellectual property that might be created.

The Board described Raytheon’s policy as follows:

Form 10-5876 requires the inventor to describe the invention technically and to explain how it is new. It also requires identification of the labor charge code applicable to the time the inventor spent conceiving of or reducing the invention to practice. If the invention was discovered separately from government contract work, the inventor must identify the charge code for the company-funded program or overhead. If the work was performed under a government contract, the invention disclosure reports the contract number and the applicable FAR and Defense Federal Acquisition Regulation Supplement (DFARS) patent rights clauses.

(Internal citations omitted.)

The committee evaluated the invention disclosure to determine whether Raytheon should file for a patent or treat the intellectual property as a trade secret, innovation award, or a different type of intellectual property. If the committee decided not to seek a patent, the invention was not disclosed to the public and remained confidential. If the committee decided to seek a patent, the invention disclosure was submitted to another function for handling. According to Raytheon, at the point where the committee decided to seek a patent, the associated costs become subject to the 31.205-30 cost principle. All costs incurred prior to that point where not subject to the cost principle, because nobody knew whether or not they were related to a patent. Costs incurred before a decision to submit for patent processing were just regular (allowable) overhead costs, according to Raytheon.

The Board noted that, in 2007, 149 invention disclosure forms were submitted for committee review at RMS. Of that amount, 110 (74%) were approved for patent processing. Of the 110 patents that were processed in that year, 26 (24%) were related to a government contract (i.e., allowable), and the remainder were not (i.e., unallowable).

If you’ve read the previous two articles on this appeal, you will not be surprised to learn that DCAA (and DCMA) disagreed with Raytheon’s position on cost allowability. DCAA’s position, according to a quote in the Board’s decision, was that “’all effort incurred by RMS employees to prepare, review, and approve/disapprove invention disclosures for patent applications to be patent costs’.” (Emphasis in original.) According to the Board’s Findings of Fact (#122 and #123)—

DCAA based its questioned amount of $96,701 in ‘engineering labor costs claimed in the engineering overhead pool for RMS patent activities not required by contract.’ DCAA speculated that the actual costs incurred could be ‘substantially more.’ (emphasis added) DCAA concluded that RMS had violated CAS 405 by failing to identify adequately and exclude the expressly unallowable patent costs.

DCAA replied [to Raytheon’s objections] that, unlike RMS’ practice, FAR 31.205-30 did not exclude costs of invention disclosures not submitted for patent approval, or protected as intellectual property in some other way, from its unallowable cost restrictions.

The Board also noted that, perhaps because of the long delay associated with DCAA’s audit (the audit started in 2008 and concluded in 2014), the agency’s position had changed over time. Initially, the auditors had said there was “insufficient audit evidence” to support questioning the costs, but that initial position didn’t stop the agency from overruling the auditor’s judgment in the final report. (GAGAS violation, anybody?) In the end, the audit report questioned $96,701 of claimed indirect engineering labor costs and the DACO hit RMS with a CAS 405 noncompliance because Raytheon should have known that those costs were expressly unallowable. (Notwithstanding the fact that a different group of DCAA auditors at a different Raytheon business unit had found similar costs, in similar circumstances, not to be unallowable at all.)

Raytheon had attempted to create a “bright line” for cost allowability, similar to its treatment of Government Relations and Corporate Development costs. (See the Part 2 article for details.) In Raytheon’s view, it was not until it was clear that a patent would be pursued that the costs became subject to the 31.205-30 cost principle. In contrast, the DCAA/DCMA view was that all costs associated with a patent, including preparation of invention disclosures (and the Raytheon disclosure form) were expressly unallowable unless required by a government contract.

The Board disagreed with both positions.

According to the Board—

The government misreads FAR 31.205-30 to apply more broadly than it does, and it adds language to the regulation that is not there. The regulation certainly does not specifically define ‘preparation’ of ‘invention disclosures’ ‘as an initial but essential step in the [p]atent application process’ (whether or not a patent is ultimately submitted, rejected, or obtained). Moreover, it does not state that all invention disclosures are patent costs, regardless of whether patents are involved. Indeed, some of RMS’ invention disclosures are associated with forms of intellectual property other than patents, or with RMS’ recognition of invention efforts that did not lead to patent applications. It is not clear whether such costs are among the costs at issue.

On the other hand, Raytheon also misreads FAR 31.205-30. RMS does not consider the costs to discover new inventions, of preparing and submitting invention disclosures, of a manager’s review of invention disclosure forms, or of [the committee’s] review to be patent costs, on the ground that there is not yet any patent and RMS does not know whether there will be one. RMS defines patent costs to be those occurring after the [committee] decides to pursue a patent. …

Raytheon’s interpretation of FAR 31.205-30 is unreasonable. Under its interpretation, patent-related invention disclosure costs would never be unallowable, even if no government contract requirement were involved, and the FAR’s reference to allowable patent invention disclosure costs would be superfluous.

(Internal citations omitted.)

The Board interpreted the cost allowability provisions of 31.205-30 as follows:

The reasonable interpretation of FAR 31.205-30 is that, when patents are involved, the costs of the associated invention disclosure and review are patent costs. They are allowable if incurred due to government contract requirements. Otherwise, they are not allowable. There is no exception for costs incurred during the invention disclosure preparation and review process prior to the decision to pursue a patent. If patents are not involved, the invention disclosure and related costs are allowable.

Even though Raytheon’s interpretation was rejected, it still won. The Board found that the DACO had questioned costs that were likely to be allowable. The Board wrote:

It appears that the $96,701 disallowed amount at issue improperly includes costs for subject inventions and might include costs for non-patent invention disclosures and review that are allowable. The Board cannot determine from the record what the proper amount of unallowable costs should be. This is a failure of proof by the government leading us to sustain the appeal.

In a final footnote the Board added this nugget:

In any case, if the government could have established the proper amount of unallowable costs, its various treatments of FAR 31.205-30, including its overly broad interpretation in this appeal, would have undermined its contention that the invention disclosure and review costs at issue were ‘expressly unallowable’ under FAR 42.709-1(a)(1). The government’s demand for a level one penalty was unwarranted.

(Internal citations omitted.)

So how should Raytheon enhance its policies and controls to address the Board’s finding that it has misinterpreted the cost principle?

If we were advising RMS and Raytheon—which, to be clear, we are not nor do they need any outside expertise in this area—we would suggest that all costs related to invention disclosures be treated as being unallowable. Perhaps the costs of preparing and reviewing the invention disclosure forms could be segregated in a separate Statistical Order. As the committee decides which inventions will be processed for patents (which is about 74% of them), the costs associated with the remaining 26% could be subsequently transferred to and allowable indirect account. Then, for the patentable inventions, since about 24% of those were required by a government contract, then those costs could also be identified and transferred to an allowable account (whether direct or indirect as circumstances dictate). Whatever would be left over would have been properly classified as being unallowable.

Alternately, RMS and Raytheon could record all costs as being allowable but perform a year-end analysis as above, and self-disallow or “withdraw” costs related to patents that were not required by a government contract. Either way would seem to work.

But we are not done yet. The ASBCA decision also dealt with outside patent costs.

External Patent (Legal) Costs

According to the Board: “Raytheon withdraws the ‘vast majority’ of patent costs it pays to its external counsel to prepare and submit patent applications, but it charges the government the costs associated with the preparation of its patent application if it considers the patent to be a ‘subject invention’ conceived of as a requirement of a government contract under FAR 31.205-30. These costs are charged to the government as indirect costs and are not charged directly to the contract.”

The Board noted that the DCMA DACO was concerned about the looming statute of limitations deadline, and therefore he and DCAA did not review the documentation that RMS provided when DCAA questioned 100% of its outside legal costs associated with patent processing. (Another GAGAS violation, anybody?)

The Board described the parties’ arguments as follows—

… DCMA contends that FAR 31.205-30(a) requires that, in order to qualify as direct costs of government contracts, Raytheon must prove that they are ‘literal line item requirements’ of the contracts. Additionally, even if Raytheon were able to demonstrate that the outside patent legal costs were required by government contracts, the costs should have been charged directly to the government contract involved, in accordance with FAR 31.201-2(a)(2), FAR 31. 201-4, and CAS 402. They were not and are therefore unallowable.

Raytheon alleges that the costs at issue are expressly allowable because each of the disallowed invoices was associated with a subject invention developed under a government contract. Raytheon asserts that RMS met its obligation under FAR 31.201-2(d) to maintain documentation supporting the allowability of its patent legal costs but the government chose to ignore the submitted documentation due to its statute of limitation concerns. Raytheon further asserts that DCMA has not met its burden to show that the costs are unallowable under FAR 31.205-30, which does not limit its allowability provisions to direct costs. It adds that, under the government’s ‘line item’ contention, ‘other than contracts for the purpose of acquiring patent application filing services, it is difficult to fathom what costs would be allowable . . . .’ Regarding allocability, Raytheon urges, and we have found, that, in accordance with CAS 402, RMS has consistently classified all of its legal costs as indirect expenses. This includes the legal costs for subject inventions, which benefit not just the government contract under which they were discovered but benefit Raytheon as a whole because it owns the patent. Therefore, the outside legal patent costs in question are properly allocable as indirect costs.

(Internal citations omitted; emphasis added.)

The Board agreed with Raytheon, finding that the costs in dispute were allowable because they were required by a government contract. The Board also disposed of the government’s allocability argument (as it should have) writing—

We conclude that Raytheon and RMS’ regular disclosed practice of charging outside legal costs as indirect costs meets CAS 402’s consistency requirements and was proper under the circumstances of this appeal. All of the outside legal patent costs at issue are allowable and allocable as indirect costs.

That wraps up the patent cost allowability (and allocability) portions of the decision. In the next (and final) article, we’ll talk about the remaining issues, including costs associated with recruiting and costs associated with variable compensation.

Last Updated on Tuesday, 13 April 2021 17:40

Raytheon Wins at ASBCA (Again) Part 4

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This is the last article in a four-part series about the recent Raytheon victory at the ASBCA. Here’s a link to the ASBCA decision.

In Part 1, we outlined the issues and discussed the allowability of Raytheon’s premium class airfare. The Board decided that the government did not prove its contention that Raytheon’s travel policy was noncompliant with the travel cost principle at 31.205-46.

In Part 2 we discussed the treatment of two similar issues: Raytheon’s “Corporate Development” and “Government Relations” costs. The Board decided that the government did not prove that the disputed Government Relations costs were unallowable lobbying costs under the lobbying cost principle at 31.205-22, nor did the government provide that the disputed Corporate Development costs were unallowable organizational costs under the cost principle at 31.205-27.

In Part 3, we discussed the treatment of patent costs incurred at Raytheon Missile Systems (RMS). The costs in question were both internal labor and external legal costs. The Board decided that the government had failed to prove that the disputed internal costs were unallowable under the cost principle at 31.205-30. Further, the Board held that Raytheon’s claimed external legal costs were allowable and allocable to its government contracts as claimed.

In this final article, we are going to discuss certain recruiting-related costs claimed by Raytheon, questioned by DCAA, and disallowed by DCMA, as well as some variable compensation costs that kind of snuck in to the complex decision.

Let’s get to it.

Recruitment Costs

A. Recruiting Travel Costs

FAR 31.205-24 (“Recruitment Costs”) is one of those cost principles that lists stuff that is allowable but doesn’t really have much to say about stuff that is not allowable. The only item that is listed as being unallowable is “help-wanted advertising costs,” but only if “the advertising does not describe specific positions or classes of positions; or includes material that is not relevant for recruitment purposes …” Otherwise, pretty much anything that is connected with recruiting and reasonable should be found to be allowable.

If you’ve read along so far, you will be unsurprised to learn that DCAA and DCMA found a way to disallow certain of Raytheon Missile Systems (RMS) recruiting costs. Specifically, DCAA questioned (and the DCMA DACO subsequently disallowed) “$50,434 in airfare costs claimed for interviewees traveling to RMS’ Tucson, Arizona headquarters as [being] unallowable under FAR 31.201-2 for lack of supporting documentation, and $1,002 as excessive and unreasonable on the ground that the costs pertained to duplicate tickets. The DACO stated that the information RMS supplied did not show that interviews were actually completed or establish that the costs were for interviewees and not for their guests.”

Readers should note that this is a common theme running throughout all these consolidated appeals: the government seems to have taken the position that Raytheon must prove its costs to be allowable, or else they are unallowable. As has been shown by the other articles, that is not the case. While Raytheon (and other government contractors) have the obligation to maintain adequate documentation to support the claimed costs, it is the government that bears the burden of proof to show that claimed costs are unallowable. If the government cannot meet its burden, the claimed costs are allowable.

Raytheon maintained adequate documentation to support its costs, and provided that documentation to both DCAA and the DCMA DACO. The Board listed the voluminous amount of documentation provided to the government to substantiate claimed costs. The Board described DCAA’s assessment of the evidentiary material as follows—

DCAA nevertheless concluded, with a few exceptions, that there was insufficient support to establish that the individuals whose costs were in question actually participated in an interview and that ‘interview panels’ were completed, making the costs unreasonable in DCAA’s view. For example, DCAA questioned, and the COFD disallowed, airfare costs for four interviewees. They flew to Tucson around June 19, 2007 for a hiring event held by RMS at the Westin La Paloma hotel. The supporting documentation submitted to DCAA showed that they had submitted their resumes and stayed at the hotel. The government wanted an initialed ‘Travel Interview Reimbursement Form,’ submitted by some of the interviewees. Otherwise, the government did not accept that the individual was brought in by RMS for an interview.

(Internal citations omitted.)

Some of the recruitment costs claimed by RMS included airfare for both candidates and their spouses or “guests.” RMS withdrew those costs, but the rationale it provided—that the job involved a relocation and it would be easier to recruit candidates if their spouses/other were familiar with the area—seems reasonable to us. Given that there is nothing in the cost principle that states such costs are unallowable, that was a magnanimous gesture on Raytheon’s part.

Back to the matter at hand, the government’s position was, as noted above, that Raytheon had failed to retain sufficient documentation to support its assertion that the people who came for interviews were, you know, actually interviewed.

For its part, Raytheon argued that the questioned costs were in fact expressly allowable under the cost principle and that the cost principle did not specify any particular type of documentation in support of claimed costs. Raytheon asserted that it provided ample documentation, and that there was simply no basis in the FAR for the government to require specific types of documentation, such as forms signed by the interviewee, to prove that an interview occurred. Raytheon argued that the government’s entire position was based on speculation that the interviews never took place.

Rather than use excessive verbiage to mock the government’s position, the Board simply stated that the government had not met its burden to prove that the disputed recruiting costs were unallowable. Which seems a bit of a shame to us, but we are not lawyers and probably lack the required comity that admission to the bar would confer.

B. Recruiting Souvenirs

FAR 31.201-1 implements statutory requirements making the costs of “advertising designed to promote the contractor or its products” unallowable, specifically including “costs of promotional items and memorabilia, including models, gifts, and souvenirs.”

Raytheon provided potential employees with “recruitment reminders,” that including such trinkets as “mouse pads, pens, pencils, coffee mugs, and possibly T-shirts, that bear Raytheon’s logo, with at least some, if not all, showing its website, which, if accessed, would enable checking for available jobs.” Pursuant to a prior agreement, Raytheon withdrew 85% of the costs of such items but claimed 15% under the theory that they were really recruiting inducements and therefore allowable under the recruitment cost principle (discussed above).

The government argued that the items were not costs associated with recruitment, but instead just souvenirs intended to call favorable attention to the company—and hence unallowable. The government’s position was that the 15% of the total amount that Raytheon claimed in its 2008 costs was unallowable; moreover, the costs were expressly unallowable because Raytheon’s agreement to withdraw 85% of the total amount indicated it knew the costs were unallowable.

The Board agreed with the government that the disputed costs were indeed unallowable souvenirs and not allowable recruiting costs. However, the Board declined to find that the costs were expressly unallowable, writing—

First, the government’s argument that, due to its prior practice of withdrawing 85% of its RRI costs, Raytheon has tacitly acknowledged that its RRI costs are unallowable, is plainly wrong, as this litigation exemplifies. As we have found, in the past, DCMA and Raytheon resolved their RRI cost dispute with the stated cost allocation, but Raytheon continued to believe that its RRI costs were allowable. However, we conclude that the most reasonable reading of the regulations pertinent to this dispute is that the costs of the items in question are unallowable.

(Internal citation omitted.)

This was the single area in which Raytheon lost its appeal, albeit the amount in question was $17,780. Since the Board declined to find the costs in question were expressly unallowable, Raytheon owes the government a check for that amount—or, at least, that amount factored for the government’s flexibly priced contract participation in the indirect cost pool where the costs were originally claimed.

Not that huge of a loss, in our view.

Variable Compensation Costs

Somehow government assertions that certain variable compensation costs (e.g., bonus, incentive compensation, and restricted stock costs) for employees engaged in expressly unallowable activities were themselves expressly unallowable got mixed into the various disputes between Raytheon and the government.

The activities that the DCMA DACO claimed as being expressly unallowable were those previously discussed in Part 2 of this series—i.e., Raytheon’s “corporate development” costs. (See Part 2 for details.)

Citing to a prior ASBCA decision, the government argued that “bonus, incentive compensation, and restricted stock awards paid to Raytheon employees performing unallowable activities under FAR 31.205-47 were expressly unallowable and that the same categories of payments to employees performing unallowable activities under FAR 31.205-22 and FAR 31.205-27 were unallowable.”

Raytheon disagreed (duh), asserting that “the government has failed to meet its burden to prove that Raytheon owes it $1,368,175 in allegedly unallowable bonus, incentive compensation, and restricted stock awards [and] the evidence of record is paltry and insufficient to prove the government’s claim.”

The Board was able to differentiate the current circumstances from the ones that formed the basis of its prior decision. It wrote—

Unlike in that decision, we have not found any claimed costs to be unallowable under FAR 31.205-22, FAR 31.205-27, or FAR 31.205-47. Thus, the employees in question were not performing unallowable activities and any bonus, incentive compensation or restricted stock payments associated with their allowable activities are not expressly unallowable or unallowable.

Thus, Raytheon won on this point, as well.

As we noted in the first article, our information is that the government will appeal the Board’s decision. Accordingly, some of the interpretations in this decision may change. But in the meantime, this is a significant decision with which every government contractor should become familiar.

Last Updated on Friday, 16 April 2021 08:23

Raytheon Wins at ASBCA (Again) Part 2

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In Part 1 of this analysis of the recent Raytheon victory at the ASBCA, we outlined the issues—which involved multiple appeals covering multiple issues across multiple years at both the Raytheon Corporate Home Office and its Missile Systems business unit. We also discussed the first major issue: the allowability of Raytheon’s premium class airfare. Here’s a link to the ASBCA decision, in case you want to review the 100+ page decision. (Hint: you really should.)

In Part 2, we are going to discuss two related issues: the allowability of Raytheon’s “Corporate Development” and “Government Relations” costs.

Government Relations Costs

Most large government contractors maintain some sort of “government relations” function. The term encompasses a number of activities, but prominent among them is lobbying—i.e., the effort to influence senior military officers and Congress folks to fund programs that are important to the contractor. FAR 31.205-22 makes lobbying and other political activity costs unallowable, but provides exceptions for certain specified activities. Among the exceptions is the effort to provide Congress with technical and factual information related to performance of one or more of the contractor’s contracts.

As one of the very largest defense contractors, Raytheon maintained a robust “Washington Office,” staffed with roughly 20 employees—though not all of those employees were traditional “lobbyists.” Because this is a sensitive area, Raytheon maintained policies and procedures to help its employees determine what activities were allowable and what activities were unallowable. In addition, Washington Office employees received training to help them properly record their time.

Raytheon collected the unallowable costs and “withdrew” them from its indirect cost rate calculations. That is to say, Raytheon didn’t claim the costs that had been identified as being unallowable. Raytheon’s methodology was described by the Board as follows:

For the lobbying cost withdrawal calculation, Raytheon established a ratio of unallowable hours worked by the Government Relations employees to their total hours worked. The ratio’s numerator was the total number of unallowable hours reported by the lobbyists. The denominator was the total number of work hours available during a given year to the employees who reported unallowable hours, based upon a 40-hour work week less vacation and holidays. Dividing the numerator by the denominator yielded a percentage—the lobbying disallowance factor. Raytheon applied this factor to what it deemed to be Government Relations’ recoverable expenses (including the salary and fringe benefits paid to its lobbyists and their administrative staff) to determine the costs associated with unallowable lobbying activities under FAR 31.205-22.

As can be seen from the above description, Raytheon did not engage in what is popularly called “total-time accounting.” Total-time accounting is the recording of all hours worked, including uncompensated overtime. Once all labor hours are recorded, the contractor has some options about how to account for the uncompensated overtime, but Raytheon didn’t bother with any of that—because it told its employees not to account for any hours in excess of 40 per week. There is no regulatory requirement that mandates total-time accounting, but many smaller contractors have felt the pressure from DCAA auditors to implement it. This decision makes it clear that Raytheon’s practice of “accounting for labor costs as a function of time paid, rather than time worked” is an acceptable method of labor accounting.

Moreover, Raytheon’s time sheets for salaried, exempt, indirect personnel didn’t record hours worked; they recorded only exception hours such as paid time off and hours associated with unallowable activities (e.g., lobbying). It was assumed that, unless an exception was being recorded, all labor costs for those indirect employees would simply be equal to the amount of their salary, and that amount would be recorded in the employees’ home cost centers. No doubt this saved Raytheon some labor processing time and, once again, neither the government nor the ASBCA indicated there was anything wrong with this approach to labor accounting.

What DCAA did have a problem with was the amount of unallowable lobbying that Raytheon had identified and withdrawn from claimed indirect cost. Unsurprisingly, DCAA thought Raytheon’s withdrawal (which was about 50% of all government relations costs) was too low. In the words of the ASBCA, “Essentially, DCAA viewed some of Government Relations’ activities as related to lobbying and expressly unallowable and Raytheon viewed them as allowable.” In Raytheon’s view, activities such as “planning and administrative matters; human resources issues; conferences; external and internal matters that had nothing to do with trying to influence legislation; interpreting existing law for Raytheon headquarters or business divisions; budget analysis after a statute had been enacted; and examining international issues” were completely allowable and claimable. DCAA (and subsequently DCMA) disagreed.

DCAA was not consistent in the amount(s) it believed represented unallowable activities. New specialist auditors were brought in, and those auditors developed a “strategy” to question 100 percent of all Raytheon’s government relations costs. The ASBCA wrote—

The auditors questioned all of cost center 90206’s costs due to an alleged lack of adequate records. They deemed the employees in question to be lobbyists and stated that Raytheon ‘cannot justify the lobbyists[,] time was allowable’. They speculated that employees other than those interviewed might have assisted lobbyists with the creation of white papers or with technical information; many of those employees had trouble remembering their activities during FY 2007; and, because they did not normally take part in lobbying activities, they might not have known how to record their time. We have not been directed to any evidence to support this speculation.

(Internal footnotes and citations omitted.)

In fact, “While DCAA’s initial audit report recommended changing Raytheon’s total disallowance factor from 53.3% to 65.9%, during her testimony [the DCAA auditor] disavowed that report.” Subsequently, “[the auditor] based her ultimate conclusion that all of cost center 90206’s costs should be disallowed on the fact that she did not find documentation ‘either way’ on whether the costs were allowable or not, or claimed or not.” So basically, the auditor who had spent hours upon hours reviewing Raytheon’s claimed costs and the source documents let herself be overruled by the new auditors—to the point where she knew nothing, nothing at all.

For the record, we’ll note that these audits took place more than a decade ago, and so the lack of ability to discuss procedures and to provide sufficient evidence for conclusions—or even the lack of ability to reach a consistent conclusion—should in no way have any implications for DCAA’s 2020 and 2021 audit quality. Readers are reminded that DCAA recently passed its external peer review of its audit quality system where it was noted that only 50% of all selected sample audits had deficiencies, many of which were repeat findings from previous external peer review audits. The other 50% were just fine.

Perhaps it was the flawed DCAA audit methodology that led the ASBCA to find that “DCMA has not met its burden to prove that the Government Relations costs at issue are unallowable lobbying costs and thus has also not met its burden to prove that Raytheon violated CAS 405 regarding those costs.” As the Board wrote, “[the DCAA auditor’s] conclusion, as self-described, is unsupportable and underscores the fact that DCMA has not met its burden of proof.”

Corporate Development Costs

What even is Corporate Development, anyway? The Board answered that question by quoted from another Raytheon appeal.

Raytheon’s Corporate Development department was responsible for working with its business units in strategic development and growth opportunities, including strategic analysis of a business’ capabilities to market its products and services to the government and function in government work. Where there were gaps in business’ capabilities, Corporate Development would work with them to determine the right ways to fill the gaps, either through, inter alia, internal investment, research and development, licensing of intellectual property (IP), partnerships or acquisitions. This process was known as ‘gap analysis.’ Working with Raytheon’s businesses on M&A and divestitures was not Corporate Development’s primary role but was part of its work to find strategic growth initiatives.

How did it work?

Corporate Development made proposals for acquisitions or divestitures to the Acquisition Council which, in 2007 and 2008, consisted of senior Raytheon leaders, including the Chief Executive Officer, Chief Financial Officer, General Counsel and Vice President of Corporate Development. Raytheon declared its intentions regarding potential acquisitions and divestitures through the Acquisition Council. Corporate Development did not know which route Raytheon was going to follow until after the Acquisition Council made its decision. Occasionally, even after an Acquisition Council decision, Raytheon would change course based upon information developed during the acquisition or divestiture process

(Internal citations omitted.)

As was the case with Government Relations, Raytheon maintained robust policies and procedures to help its Corporate Development folks distinguish allowable gap analysis activities from unallowable Merger & Acquisition (M&A) activities. According to those policies and procedures: “Unallowable acquisition costs commence with the submission of an indicative offer. Unallowable divestiture costs commence when the decision to “go to market” with the offering materials is made.” This policy statement, and others, articulated Raytheon’s “bright-line” rule between allowable and unallowable activities. The Board wrote, “Raytheon asserts that its ‘bright line’ rules accurately reflect the relationship among FAR 31.205-12, -27 and -38(b)(4), in accordance with Raytheon I, and it posits that all ‘planning’ is not unallowable, pointing to allowable economic or market planning.”

Timekeeping was consistent with the bright-line rule. Based on the timekeeping, Raytheon withdrew approximately 50% of its Corporate Development costs as being unallowable, while claiming the other 50% as allowable expenses. In what may be becoming a familiar refrain in this series of articles, DCAA disagreed and asserted that 100% of all Corporate Development costs were unallowable. The CACO agreed with DCAA and told Raytheon that not only were the costs unallowable, they were expressly unallowable—meaning that Raytheon owed the government penalties and interest. For grins, the CACO threw in a CAS 405 noncompliance, as well.

Would you be surprised to learn that the Board thought Raytheon’s bright-line policy was reasonable and that the government had failed to meet its burden of proof? Right. In much the same way as they decided the Government Relations issues, the Board wrote:

DCMA has not carried its burden to prove by a preponderance of the evidence that the amount of unallowable hours withdrawn by Raytheon’s personnel, which is supported by documentation and credible witness testimony (see, e.g., findings 41-45, 57-58, 60), from its CY 2007 and 2008 incurred cost proposals was inaccurate, nor that any of the included Corporate Development costs were unallowable, let alone expressly unallowable and subject to penalties. Thus, DCMA has also not met its burden to prove that Raytheon violated CAS 405 regarding those costs.

(Internal footnotes omitted.)

And for grins, the Board wrote “Raytheon’s ‘bright-line’ policy represents a reasonable reading of the FAR provisions governing organization, economic planning, market planning and selling costs and, applying the General Dynamics standard, it was not unreasonable for Raytheon to treat the costs at issue as allowable.” Thus, if you are looking at developing a similar policy to help your employees navigate between allowable planning activities and unallowable M&A activities, you really ought to review this decision and get into the details of what Raytheon’s policy said.

Okay, that’s Part 2. We still have other aspects of this important ASBCA decision to discuss. Stay tuned for more.

Last Updated on Monday, 05 April 2021 19:15

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Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.