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The Importance of a Company Hotline

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Recently we came across this article, written by attorneys (and former Federal prosecutors) A. Lee Bentley III and Jason Mehta, entitled “How Contractor Fraud is Reported Shouldn’t Affect How It Gets Investigated.” The article addressed something we have pondered from time to time—i.e., how does the government choose whether to pursue available administrative remedies or civil/criminal remedies?

For example, in one article we discussed differences between allegations of defective pricing and allegations of False Claims associated with defectively priced contracts. We wrote: “Now we have a new rule: If the Federal government detects the defective pricing, then it’s a TINA matter. But if the relator detects the defective pricing, then it’s a FCA matter. Which is inconsistent and, on its face, somewhat inequitable. But that’s the way we’re seeing it these days.”

Subsequently, we questioned that new rule when we came across allegations that BAE Systems (successor to the Stewart & Stevenson FMTV contractor) was being charged with both defective pricing and violations of the FCA—with no qui tam relator in sight.

Nonetheless, the DefenseOne.com article (link in the first sentence) seems to resurrect and support our initial theory. Stated simply: the government’s investigation methodology and selection of legal remedy often depends on the manner in which it learns of the alleged violation(s). The authors wrote:

The traditional way to blow the whistle is to report internally up the chain and—if that does not work—the whistleblower could report suspected wrongdoing to federal contracting officers or to Defense Department hotline numbers. When the allegations are raised up the chain, a series of investigative procedures are initiated and DOD scrutinizes the allegations with appropriate vigor. DOD has contractual rights under the Federal Acquisition Regulations to investigate these allegations, inspect the premises, review documents, and root out fraud. These administrative remedies have been a resounding success when DOD learns of instances of fraud. …

[But] when the government learns about the suspected fraud through a qui tam suit, the DOJ will initiate the investigation. The investigation is given the imprimatur of a “federal case” and the stakes are automatically elevated as the default remedy for a False Claims Act case is not recoupment, but rather civil penalties (recoupment plus extra money as a penalty). In addition to the investigative steps described above, the mere fact that a whistleblower files a False Claims Act suit often results in official DOJ interviews, subpoenas and meetings.

If this hypothesis is true, if the manner in which the government learns of the allegations of wrongdoing affects both the investigatory approach and the potential legal remedies, then wouldn’t you really want employees reporting their concerns to the company hotline? And if it came to that, wouldn’t you really want employees reporting their concerns to the DOD Hotline? Those are the better options, right? Because, according to the article (and our experience) when an employee resorts to filing a qui tam lawsuit under the False Claims Act, then the company will be in for a long and very expensive legal journey.

And if all that is true, then doesn’t that mean you really need to focus on making your company hotline as accessible to employees as possible? We mean, you want employees to use the hotline, right? So you need to make the entire process as user-friendly as possible. Otherwise, you risk having employees use other, less attractive means to have their concerns addressed.

What does that look like? Well, we touched on the topic in an article we published about 18 months ago. We wrote—

Allegations received via internal hotline should be logged. Then they should be investigated. The findings of the investigation should be summarized and the matter should be dispositioned by an independent party in accordance with applicable laws, regulations, and company procedures. Then – and this must always happen – the company must ‘close the loop’ by reporting back the disposition to the employee who made the original hotline allegations. (Obviously if the original reporter was anonymous, that’s not going to happen.)

Employees who call the company hotline to report concerns are not whistle-blowers; they are concerned employees. But you can quickly convert them into whistle-blowers by ignoring their concerns or failing to report back to them the findings of your investigation. And—as we’ve reported—you cannot retaliate against any employee who avails themselves of any fraud reporting mechanism.

In fact—as that last article noted—you are required by DFARS contract clause 252.203-7002 to inform your employees, in writing, of their whistleblower rights. Of course, we are quite confident that defense contractors with that clause in their contracts have already done so. Right?

Thus, focusing on making your company hotline an attractive and user-friendly option for employees with concerns starts with education. You need to tell them about it. For certain defense contractors, you need to tell them about it in writing. But for the rest, perhaps an email blast will be sufficient. Let them know that you want them to use the hotline when appropriate. Obviously, reporting up the chain of command is preferable; but often that approach is problematic for one reason or another. So the company hotline is the best next option.

  • Let employees know that it’s okay to use the hotline; that they will not be retaliated against. Rather, they will be protected.

  • Let employees know that their concerns will be taken seriously and that the concerns will be investigated impartially, perhaps by an outside party.

  • Let employees know that they will be hearing back from somebody with the results of those investigations.

  • Make sure that the company hotline number is prominently posted. Make it easy to dial. Make sure reports are logged.

Because the alternatives are much less pleasant.

 

Sanders to Speak at NCMA Orange County Chapter

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Once again I will make the journey from San Diego to Irvine in order to present to the Orange County Chapter of the NCMA. This time they let me choose my own adventure. I picked Contract Close-Outs.

First: Link to presentation details. Follow the link and you will see that I’m presenting October 17th, starting at 6:45 PM. (I’ll need that time to navigate the traffic on The 5.)

Second: Why Contract Close-Outs? I mean, could I have picked a more boring topic? Nobody cares about closing-out contracts.

Exactly.

The fact is, closing-out contracts can be very important to the financial health of any contractor. The fact is, the government cares very much about closing-out contracts and eliminating “Unliquidated Obligations” that can mess up financial statements, and keep agencies from getting “clean” audit opinions. The fact is, your backlog of physically completed but not formally closed contracts is like an anchor, holding you and your company back.

So I chose a topic that is seemingly of little importance, but which actually has a potentially significant impact on both government and contractor.

If you’re in the area, why not show up and participate in the discussion?

 

Proposed DFARS Rule on Contract Financing – Latest Update

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Another update here on the proposed rule we told readers about in this article. It’s DFARS Case 2017-D019.

In our article (link in 1st sentence), we didn’t have many nice things to say about the proposed rule. Subsequently, we updated readers with another article, in which we had even fewer nice things to say about it. In that second article, we wrote—

Readers, rarely do we advocate for a particular position vis-à-vis a proposed rule. However, this is one of those times. The proposed rule is so obviously biased against contractors and it’s potentially unworkable as written even if it weren’t. When one adds in the fact that business system adequacy is already subject to what many call punitive payment withholds, this rule is simply a very bad idea.

So what’s changed since then?

Well, what’s changed is that the Department of Defense got the message and withdrew the proposed rule.

On October 4, 2018, a notice was published in the Federal Register announcing that “DoD is withdrawing the proposed rule on performance-based payments and progress payments that published on August 24, 2018, and is cancelling the public meeting previously scheduled to be held on October 10, 2018.”

Simple. Clear. To the point.

But it didn’t tell the whole story.

The rather banal official notice didn’t mention the Washington Post story, written by Aaron Gregg, that stated—

A Defense Department plan to save taxpayer dollars by paying defense contractors less money upfront on major weapons deals has drawn the ire of influential Republican lawmakers, who say the scheme will hurt the technological prowess of the U.S. military. In a Sept. 24 letter addressed to Deputy Secretary of Defense Patrick M. Shanahan, House Armed Services Committee Chairman Mac Thornberry (R-Tex.) and Senate Armed Services Committee Chairman James M. Inhofe (R-Okla.) asked the Defense Department to walk back a proposed policy that would cut the amount of financing support that defense contractors get in the early phases of a contract. They called the plan “fundamentally flawed” and asked for it to be rescinded, saying that it would cause the department to fall behind on its national security strategy, which prioritizes competing with Russia and China for technological dominance.

The WaPo story also noted that “Defense contractors and their lobbyists reacted sharply to the proposal, with the three major defense industry associations unanimously opposing the rule in a Sept. 14 meeting.”

The official notice didn’t mention exactly how the rule was withdrawn. In a DefenseNews.com story, authors Aaron Mehta and Joe Gould wrote: “In a statement released at the unusual time of 7:19 PM, Deputy Secretary of Defense Patrick Shanahan said the decision to withdraw the proposed acquisition changes stemmed from a lack of ‘coordination’ inside the department.” Whereas we had assumed the initiator of the proposed rule was Mr. Shay Assad, their article stated that it had originated from the desk of Ellen Lord (USD, Acquisition & Sustainment). The article quoted her as saying in a September 5 interview, “I believe the lifeblood of most industry is cash flow, so what we will do is regulate the percentage of payments or the amount of profit that can be achieved through what type of performance they demonstrate by the numbers.”

The official notice didn’t mention that Mr. Shanahan said the rule was being withdrawn because it had been released “prematurely.” The DefenseNews.com article quoted him as saying in his official statement that the proposed rule was “prematurely released, absent full coordination” within the DoD. Interestingly, we didn’t think that was supposed to happen. We had thought that proposed rules were supposed to be well-coordinated with all stakeholders.

Guess we were wrong.

So all that is good news if you are a defense contractor; though of course perhaps not so good news if you are Ellen Lord, Shay Assad, or a member of the DAR Council who failed to get stakeholder agreement before prematurely releasing the rule for public comment.

But if you think this is over, you are wrong about that.

The Federal Register notice contained the following language—

This proposed rule is withdrawn in order for DoD to conduct additional outreach with industry regarding contract financing methods. Implementation in the Defense Federal Acquisition Regulation Supplement (DFARS) of section 831 of the National Defense Authorization Act for Fiscal Year 2017 will be addressed in a proposed rule to be published under DFARS Case 2019-D002. Any other changes to contract financing policy will be addressed under DFARS Case 2019-D001.

So: Note DFARS Case 2019-D001, now opened to address “contract financing policy.” Ms. Lord has provided notice to defense contractors that she believes they have been overpaid in the past few years (a time of low interest rates where borrowing was cheap) and, now that interest rates are increasing (and borrowing is becoming more expensive), it’s now time to lower contract financing amounts. Ms. Lord is an accomplished business person, so perhaps she’ll explain that logic to the business people who will now need to borrow more money, at higher interest rates, in order to finance their contract performance obligations.

Also note DFARS Case 2019-002, now opened to implement Section 831 of the 2017 NDAA. As a reminder, Section 831 reinforced the regulatory preference for performance-based payments and expressly stated “Performance-based payments shall not be conditioned upon costs incurred in contract performance but on the achievement of performance outcomes …” and “In order to receive performance-based payments, a contractor’s accounting system shall be in compliance with [GAAP], and there shall be no requirement for a contractor to develop Government-unique accounting systems or practices as a prerequisite for agreeing to receive performance-based payments.” We are excited to see the DAR Council swiftly implement those clear statutory requirements.

To wrap this up, the contractors have won the first skirmish. But the fight is not yet over and we expect more battles to come.

Last Updated on Sunday, 07 October 2018 18:49
 

Palantir’s Victory is Complete

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Use this site’s search feature (hint: it’s over there on the far right of the home page) and type in “Palantir.” You’ll see that we’ve written several articles either about (or perhaps only mentioning) that Silicon Valley Company. We’re going to assume you’ve seen those articles and so we won’t be linking to them in this one.

Anyway, the title says it all.

The Palantir story is the story of how the DoD views innovation. Truly, it doesn’t want it. What we mean to say is, if you are a defense contractor that can offer a small innovation that marginally improves performance or marginally decreases costs, then that’s great and those innovations will be accepted gratefully. But if you are not a defense contractor and you offer a disruptive innovation that dramatically changes the paradigm, then forget it. DoD doesn’t want you or your product.

We suspect the reason for the above behavior is grounded in bureaucracy and career management. Major programs have Program Executive Offices. Major programs have Strategic Program Offices or Special Program Offices. Those various offices are staffed by military service members and civilian employees, each of whom has a career to manage. If you put their programs at risk, then you also put many careers at risk. Or so we suspect. You may have your own notions of how things work, including how lobbyists and politicians influence program decisions.

In fact, at least one Industry Association offers training entitled “How Washington Works® -- Navigating the DOD” which is a “fast-paced” two-day course covering “the three principal DOD decision-making support systems and how they are used by the Army, Navy, Air Force, Marine Corps, and USSOCOM to provide an integrated approach to strategic planning, capabilities needs assessment, systems acquisition, and program and budget development.” We have not taken the course, so our assertions are simply speculation. Those who have taken the course may well have better notions about the system than we do.

But back to Palantir’s story. In 2016, Palantir filed suit against the US Army, alleging that it was violating statutes and regulations in its acquisition plan for the “Distributed Common Ground System-Army Increment 2.” The first bid protest, at GAO, did not go Palantir’s way. But Palantir was successful at its second bid protest, when Court of Federal Claims Judge Horn told the Army to do better market research to determine whether or not its needs could be met by commercial items (e.g., Palantir’s products), as required by the Federal Acquisition Streamlining Act (FASA). Judge Horn also issued a rare permanent injunction preventing the Army from awarding the DCGS-Increment 2 contract until it had done so.

Meanwhile, Palantir and Raytheon were partnering. Perhaps Raytheon saw the writing on the wall and thought that half a loaf was better than nothing. Or perhaps Palantir realized that Raytheon already knew How Washington Works® and could smooth any Army concerns about using an outside-The-Beltway contractor. In any case, that approach seeming promising to both companies—so promising, that General Dynamics (another DCGS-2 bidder) filed its own bid protest at the GAO when it learned that the partnership was going to win the $876 million contract award. But that protest was denied.

So the Palantir/Raytheon team won the DCGS-2 contract. But that didn’t stop the government from appealing the COFC decision and injunction. Recently the Court of Appeals, Federal Circuit, ruled on the government’s appeal, affirming the COFC decision.

The respected law firm of Arnold Porter published a client advisory article, written by Nathaniel Castellano, Charles Blanchard, and Dominique Casimir. In that article, the Palantir decision is described as being possibly “one of the most significant procurement precedents of the decade.” What makes the decision so important, according to the attorney authors is that it –

… breathed new life into the government's obligations under the Federal Acquisition Streamlining Act (FASA) to prioritize, to the maximum extent practicable, the acquisition of commercial and nondevelopmental solutions. Weaning agencies off their historic preference for developmental solutions is critical now more than ever, as it is readily apparent that maintaining the United States' technological and battlefield superiority depends on its ability to harness technologies from the commercial sector and become a more commercial-friendly business partner. The decision will have the practical impact of requiring agencies to more carefully document their market research. Palantir will also provide useful leverage for companies seeking to eliminate (whether by negotiation or protest) solicitation provisions that are not accommodating to commercial vendors.

In other words, the decision creates gaping holes in the barriers that have historically prevented non-traditional defense contractors from successfully selling their goods and services to the DoD. It requires DoD acquisition folks to perform more robust market research, seeking to identify commercial sources with already-developed solutions. It requires that, if they are available, those commercial sources be given preference over funding development of new solutions by traditional sources. As such, it’s kind of a big deal.

The Arnold Porter article noted “Technology Network (TechNet), an association of chief executive officers and senior executives of leading technology companies from across the nation, submitted an amicus curiae brief in support of Palantir. TechNet argued that the Army's approach to DCGS is product of a DoD culture predisposed to favor full development of government-unique solutions instead of relying on the commercial and nondevelopmental solutions that FASA directs agencies to favor.”

The Federal Circuit agreed with Palantir and the Court of Federal Claims, finding (in a unanimous decision) that “the Army did not rationally use its market research results to determine whether there are available commercial items that: ‘(A) meet the agency's requirements; (B) could be modified to meet the agency's requirements; or (C) could meet the agency's requirements if those requirements were modified to a reasonable extent.’” The Court also found that the Army’s decision to focus on developing a new solution, rather than exploring whether a commercial solution might be available, was “arbitrary and capricious.”

For several years now, we have documented the entrenched DoD bureaucracy’s fight against true innovation, using the Palantir story as the poster child for that fight. We are very happy to now report that Palantir won on all fronts, and that its victory might pave the way for other innovative commercial firms to enter into the defense marketplace.

Last Updated on Sunday, 07 October 2018 18:52
 

Level One and Level Two Penalties

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Unallowable costs.

Expressly unallowable costs.

Directly associated unallowable costs.

The foregoing are “flavors” of unallowable costs about which government contractors need to know. In addition to those groups, contractors need to know that the government has the right to impose penalties for inclusion of unallowable costs in proposals to establish final billing rates.

What else do contractors need to know? How about—

  • The government can impose penalties equal to the amount of the unallowable cost, plus interest. These are commonly known as Level 1 penalties.

  • The government can impose penalties equal to twice the amount of the unallowable cost, plus interest. These are commonly known as Level 2 penalties.

  • The government can (and in certain circumstances, must) waive imposition of penalties and interest.

Complicated stuff, right? Well, we’ve written about the topic before.

Here’s a link to a 2015 article on expressly unallowable costs.

Here’s another link to a 2017 article on expressly unallowable costs and associated penalties.

And here’s a link to an article discussing an ASBCA decision regarding expressly unallowable costs and imposition of penalties, with respect to The Raytheon Company. In that decision, the ASBCA addressed five separate cost allowable issues and Raytheon won on four of them.

Here’s a summary of the results:

  • Raytheon’s appeal of penalties and interest associated with $336,900 in fractional airline expenses was sustained, meaning that the Board found those costs were not expressly unallowable.

  • Raytheon’s appeal of penalties and interest associated with $63,000 in other executive airplane costs was sustained, meaning that the Board found those costs were not expressly unallowable.

  • Raytheon’s appeal of penalties and interest associated with $200,000 paid to a software firm to design and build a Mergers & Acquisitions (M&A) database was sustained, meaning that the Board found those costs were not expressly unallowable.

  • Raytheon’s appeals of penalties and interest associated with roughly $395,000 in consultant costs were sustained. The costs were alleged to be expressly unallowable because of a lack of work product (see 31.205-33(f)). In this instance, the Board went out of its way to find that the consultants’ costs were not only not expressly unallowable, but also both reasonable and allowable.

  • Raytheon’s appeals of penalties and interest associated with roughly $225,000 in lobbyists’ salaries was denied, because the Board found that such expenses were expressly unallowable.

All in all, Raytheon won on roughly $900,000 of the $1,120,000 in dispute.

Recently, Raytheon and the government were back at the ASBCA, asking the Board for reconsideration of that decision. Raytheon wanted reconsideration of the one area in which it had lost (lobbyist salaries) and the government wanted reconsideration of one of the four areas in which it had lost (fractional airline expenses). Both motions for reconsideration were denied.

But the decision was notable more for the discussion than the result. With respect to Raytheon’s contentions, the Board found that, when read together, the FAR cost principles clearly made the salaries of employees engaged in lobbying activities to be expressly unallowable. With respect to the government’s contentions, we thought the Board’s discussion regarding unallowable costs and imposition of penalties to be instructive.

According to the decision—

The government contends that the Board made clear errors of law when it ruled in Raytheon II that Raytheon's aircraft fractional lease costs were not expressly unallowable under the parties' February 2005 Advance Agreement and thus were not subject to penalties and that, even if they were expressly unallowable, penalties were not warranted because the pertinent penalty statute and regulations do not apply to costs that are expressly unallowable under a contract.

*****

Regarding aircraft fractional lease costs, the CACO assessed level one/single penalties against Raytheon under FAR 42.709-1(a)(1). As noted, that FAR provision states that a penalty applies if the indirect cost at issue is expressly unallowable under ‘a cost principle in the FAR, or an executive agency supplement to the FAR, that defines the allowability of specific selected costs.’ It does not include the terms ‘contract,’ ‘agreement,’ or the like. … if an agency head determines that a submitted indirect cost is expressly unallowable under a "cost principle" referred to in subsection (a) [of 10 U.S.C.§ 2324], then the agency head is to assess a penalty equal to the amount of the disallowed costs plus interest. Again, for level one penalties, the statute does not use the term ‘contract,’ ‘agreement,’ or the like. The FAR 52.242-3, Penalties for Unallowable Costs clause, incorporated into the contract, is to the same effect at subsections (b) through (d) [of the statute]. The aircraft fractional lease costs at issue were not stated to be unallowable under a FAR cost principle or executive agency supplement to the FAR.

(Internal citations omitted. Emphasis added.)

Because the fractional aircraft lease costs were not named as being unallowable under a FAR cost principle (or FAR supplement), the government was prevented from calling them “expressly” unallowable costs and imposing penalties for their inclusion in Raytheon’s proposal to establish final billing rates. Because the costs were not “expressly” unallowable, the government could not assess Level 1 penalties plus interest.

However, the government argued that Raytheon should be subject to Level 2 penalties plus interest, because an Advance Agreement executed in 2005 named the costs as being unallowable. Since the Advance Agreement was, in essence, a contract, then the FAR 31.001 definition of “expressly unallowable cost” would apply. (The definition states that an expressly unallowable cost is “a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable.”) (Emphasis added.)

Readers should note the distinction being made by the Board in this decision between statute (10 U.S.C. § 2324), regulation (FAR 42.709-3, contract clause (52.242-3), and the FAR cost principles (FAR Part 31 and the definitions at 31.001). The distinction is crucial. The decision stated—

The plain language of the statutory and regulatory provisions regarding level one penalties does not include contracts. The contract aspect of the definition applies when level two, or double, penalties are at issue. Double penalties apply if the agency head determines that a contractor's proposal for settlement of indirect costs ‘includes a cost determined to be unallowable in the case of such contractor before the submission of such proposal.’

Thus, if the government were correct that the Advance Agreement formed a contract in which fractional aircraft costs were named as being unallowable, and that contract was executed before Raytheon submitted the final billing rate proposal in which they were included, then Raytheon could be subject to Level 2—but not Level 1—penalties.

Unfortunately for the government, the Board found that the Advance Agreement did not name the costs as being unallowable. The decision stated, “As more fully explicated in Raytheon II, while Raytheon agreed not to charge a portion of its aircraft fractional lease costs to the government, it did not concede that they were unallowable under the FAR.” (Internal citation omitted.) Oops.

The Board went on to add that, in any event, the CACO never assessed Level 2 penalties “and the government did not pursue level two penalties during the hearing.” Because the CACO did not assess Level 2 penalties, the Board declined to apply them.

Importantly, Judge Scott, writing for the board, stated “The assessment of penalties is not a mere matter of quantum, but rather involves entitlement under the statutory and regulatory scheme. A claim for level two penalties is separate from a claim for level one penalties.” (Emphasis added.) Because “there is no proper government claim for double penalties before us, as required by the Contract Disputes Act, 41 U.S.C. § 7103(a)(3), and we lack jurisdiction to entertain such a claim.”

Thus, the CACO’s failure to properly read the statute, regulations, and contract clause (as interpreted by the Board) created a situation where penalties and interest were unable to be assessed against Raytheon, even if the Advance Agreement had acted to invoke the definition of “expressly unallowable costs” found in FAR 31.001.

For contractors dealing with imposition of penalties and interest, we think the Raytheon appeals are must-reading.

 

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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.