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Air Force One, Maybe

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The VC-25A aircraft, commonly known as “Air Force One,” needs to be replaced. This has been known for several years. The existing Boeing 747 aircraft—highly customized to meet Presidential needs—have been operating for more than 20 years (one report says nearly 30 years). The replacement aircraft, dubbed the VC-25B, has been in the works since contract award (to Boeing) in 2015.

It has not been a smooth ride.

President Trump tweeted his opposition to the Air Force One replacement program before he was sworn into office, complaining about excessive cost (“more than $4 billion”). In an effort to placate the Commander-in-Chief, the US Air Force bought a couple of used aircraft originally intended for a Russian airline, but that didn’t really work out in terms of cost control. At the moment, the replacement program is expected to cost $5.3 billion, even though Boeing’s contract is firm, fixed-price and valued at $3.9 billion (reportedly). One report says the tech manual used for maintenance and repairs costs $84 million all by itself. We didn’t confirm, but at least one report asserted that Boeing has taken a $486 million charge against earnings to cover its program overrun. Ouch.

But Boeing’s program is in even more trouble than simple budget pressures. It is also late.

If you were looking for “on-time, on-budget,” this is not your program.

As the Financial Times reported

The programme represents a sliver of Boeing’s top-line, which totalled $58bn in 2020. Yet it concerns some analysts because it is another black eye in a string of problems ranging from minor to catastrophic: debris left in the USAF’s KC-46 refuelling tankers, the Starliner crew capsule that failed to reach the International Space Station, the halted 787 deliveries and the two crashes of the 737 Max that killed a combined 346 people.

The Air Force One problems contribute ‘to an overall impression of Boeing having serious programme management and execution deficiencies, both in their commercial and military businesses’, said Teal analyst Richard Aboulafia.

‘It’s one on top of another, on top of another,’ added Bank of America analyst Ron Epstein. ‘That’s the issue, not Air Force One per se. It’s yet another fumble . . . It really makes you question what’s going on in their engineering organisation.’

Why is the program now estimated to be a full year behind original schedule?

According to reports, Boeing has offered two excuses for the program delay. The first is COVID-19. Apparently, the pandemic impacted Boeing’s ability to work on the aircraft. We expect that’s going to be a common excuse used by many contractors for schedule delays. Indeed, epidemics are one of the expressly listed causes for “excusable delays” found in the FAR. Reports state that Boeing has filed a Request for Equitable Adjustment (REA) with respect to its COVID-19 impacts. We’ll have to see what happens with that REA request.

The other rationale offered by Boeing is more interesting. Boeing is blaming a supplier, GDC Technics, for at least a part of the delay. According to various reports, GDC Technics was the supplier that was responsible for the aircraft’s interior. Obviously, the interior is a fairly critical aspect of a Presidential aircraft.

News reports indicate that Boeing terminated its subcontract and filed suit against GDC Technics in April, 2021. In its suit, Boeing alleged that the company had fallen more than a year behind schedule on designing the VC-25B interiors. GDC then countersued Boeing, claiming that Boeing had mismanaged the program.

Somewhere in the middle of the lawyer-led “He Said, She Said” battle, GDC Technics filed for bankruptcy, citing Boeing’s withholding of $20 million in payments the company said it was owed for completed work.

Regardless of the merits of the parties’ litigation allegations, this is but the latest example of the importance of diligent supply chain management. Responsible prime contractors don’t let their suppliers fall a year behind; they deploy leading risk indicators and take effective action when the risk indicators start flashing yellow. We’re going to assert (without knowing) that Boeing didn’t do that in this case.

This blog has emphasized the importance of effective supply chain management over and over. We’ve written so many articles on the subject we felt the readership had tired of our rants. Apparently, the folks at Boeing aren’t readers of the blog.

They could have read this 2010 article, in which we pontificated that—

Your preoccupation with internal matters, your management metrics that focus only on internal issues (such as headcount), your application of Lean and Six Sigma solely to your own production line, your attempts to control cost growth by forcing suppliers into firm fixed-price development contracts or into making huge program ‘investments’—these actions betray a management naïveté, an erroneous impression that the management approach that worked to put a man on the Moon is the same approach that will lead to successful program execution in the 21st century.

Newsflash: it will not.

Program quality and execution risk cannot be transferred to suppliers. The prime contractor is responsible to the customer for the program. Period. If your attorney counsels otherwise, you should hire another attorney. If your subcontract manager or buyer or procurement specialist tells you that cost or schedule or quality or performance risk has been controlled by pushing it downwards in the supply chain, you should put a better support team in place.

Because you cannot build a wall between team members on a program; you cannot say, “This is your responsibility and this is my responsibility.” You cannot transfer risk; the most you can do is to share it. The more that design information and risk information is shared, and communicated, and managed as a team, the better the outcome. When you treat your suppliers as individual entities that succeed, or fail, on their own, then you will always suboptimize your outcome. That is axiomatic. It is a nearly inviolate law of 21st century program management.

Or they could have read this 2014 article, in which we opined that—

One of the truisms we have learned about creating an effective program management culture is that effective subcontractor management may be the most important single factor driving program outcomes. The success or failure of your program very likely hinges on how well you are managing performance that you have pushed outside your factory to external suppliers. We have observed this axiom over and over, whether discussing the Boeing 787 program or the Airbus A380 program or major defense acquisition programs. We have also observed that program execution risks found in the supply chain are, as a rule, under-managed.

Or they could have read this 2015 article, which focused on counterfeit electronic parts, in which we asserted that—

Many of the largest prime contractors have made a specialty of subcontracting out large portions of the SOW, to the point where they like to call themselves ‘system integrators’ and point to subcontract management as one of their (few) core competencies. Their program win strategy is to lock-up and deliver large teams of individual corporations (along with those corporations’ local Congresspersons and Senators). And it tends to work for them often enough that they keep on doing it. Either they have figured out how to manage the risks associated with supply chain management or, perhaps, they haven’t noticed that those risks keep increasing … and so they keep on with what has been working for them.

But make no mistake, those risks do keep increasing.

Point is, we’ve got a fairly strong pedigree in the area of effective subcontractor management (including supply chain risk management). We’ve got more than thought leadership on the topic—we’ve got hands-on experience in helping large program management teams at very large contractors get a handle on how to manage their supply chain risk. That thing that people now call SCRM (Supply Chain Risk Management)? We were practicing it more than a decade ago.

Based on what we guess about Boeing’s Air Force One replacement program, the program team didn’t read our articles and didn’t implement effective supply chain management techniques.

Thus, when a British Bank of America analyst states “It really makes you question what’s going on in their engineering organisation,” we believe we know the answer.

Dear Boeing, our contact information is on the website. You might want to give us a call.

Last Updated on Tuesday, 15 June 2021 18:26
 

Executive Compensation Failure

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Claiming only allowable compensation is tricky. It requires a decent amount of analysis. One of the trickier aspects of the compensation analysis is understanding that the compensation ceiling changes over time. One may also need to understand that the compensation ceiling applies to different groups of employees, or even different groups of customer contracts, depending on the year in which the costs were recorded (and/or the year in which the contract was awarded).

And this doesn’t really even apply to challenges to compensation reasonableness. That’s a whole ‘nother thing. No, we’re simply talking about compliance with FAR 31.205-6(p). It’s tricky, and contractors are required to get it right.

It’s so tricky, that DCAA has so far failed to issue comprehensive guidance to its auditors via the Selected Areas of Cost Guidebook. Chapter 10 of the Guidebook (Compensation for Personal Services) is “under construction,” and has been that way for years.

Nonetheless, it is DCAA’s position that a contractor who claims compensation costs in excess of the 31.205-6(p) ceiling(s) has claimed an expressly unallowable cost. (See the Contract Audit Manual at 6-414.8.) Recently, this position was put to the test at the Armed Services Board of Contract Appeals (ASBCA).

Ology Bioservices, Inc. (Ology) appealed a Contracting Officer Final Decision applying a penalty for Ology’s inclusion of claimed executive compensation costs in excess of the FAR ceiling in its Fiscal Year 2013 proposal to establish final billing rates, which was submitted on time six months after the close of Ology’s fiscal year. However, DCAA had some issues with Ology’s submission and Ology was required to fix those issues and resubmit its proposal, which it did about six months later. DCAA audited the proposal and questioned costs. After the audit report was issued, and after a “lengthy negotiation” with the DCMA contracting officer—a period that lasted nearly six years (December 2014 through May 2020)—the COFD was issued, in which the contracting officer determined that Ology had claimed executive compensation costs that exceeded the FY 2013 ceiling by $1,749,890. As Judge O’Connell of the Board wrote, “The CO found that $979,938 of this amount was allocated to covered contracts and assessed Ology a penalty in this amount. In addition, she demanded interest that brought the total government claim to $1,109,160.”

In the Board’s analysis of the situation, the matter was not nearly as straight-forward as DCAA and DCMA claimed it was. Of particular import was the fact that OFPP had not published the FY 2013 compensation cap until March 15, 2016. “The government has not provided any explanation as to why there was such a delay in establishing the FY 2013 cap.”

Long-time readers of this blog know that we have complained about OFPP’s lack of diligence before. Several times. The fact of the matter is that OFPP didn’t like the ceilings that were calculated at the time, and expressed the dislike by failing to carry out the statutory duty imposed on the agency, the duty that required timely publication of the ceiling. The situation continued after the executive compensation ceiling became the contractor compensation ceiling and the new benchmarks were adopted during the Obama Administration. The situation is now so bad that even DCAA has told their auditors not to count on the OFPP and, instead, to calculate their own ceilings for audit purposes.

Back to Ology’s appeal.

Because the correct FY 2013 “cap” was not issued in time, the government’s position was that the FY 2012 cap applied to the costs that Ology had claimed. The rationale for that position was that, when OFPP had published the FY 2012 cap amount, the language used was ““amount applies to limit the costs of compensation for contractor employees that are reimbursed by the Government to the contractor for costs incurred on all contracts, after January 1, 2012 and in subsequent contractor FYs, unless and until revised by OFPP.” (Emphasis added.) Thus, even though the statute required an annual ceiling to be calculated and published, the government argued that the last published ceiling applied prospectively, on a flat-line basis.

The Board analyzed the statute that established the executive compensation ceiling (10 U.S.C. § 2324) based on the language in place at the time it would have applied to Ology. The Board concluded that the statute required publication of an annual cap value, and that it was unreasonable to hold Ology accountable for claiming costs in excess of an outdated ceiling. To be clear, the Board agreed that Ology had claimed unallowable costs; however, the Board found that the excess costs were not expressly unallowable and that Ology should not have to pay penalties and interest on the excess amounts.

Judge O’Connell wrote—

Neither the statute nor any FAR provision specified a date by which OFPP must establish the cap. While it is reasonable to infer that Congress granted OFPP some leeway as to when it would set the cap, we do not believe that Congress intended OFPP to have unlimited time to update the cap or for the government to apply an outdated cap for years on end. … Further, the government imposed on the contractor an obligation under the Allowable Cost and Payment clause to submit its final indirect rate cost proposal within six months of the end of its fiscal year, FAR 52.216-7(d)(2). The government required the contractor to certify at that time that the proposal did not include any expressly unallowable costs, FAR 52.242-4(c). To submit the proposal and make this certification, the contractor would have to know the cap for that year. …

While it is true that OFPP eventually met the statutory directive to establish an FY 2013 cap, it did so long after it would provide guidance to contractors, at least those who complied with their contracts by submitting timely indirect cost rate proposals. Applying the FY 2012 cap to 2013 compensation would have the odd effect of placing contractors who complied with their deadlines in a worse position than a contractor who waited until after the March 15, 2016 issuance of the FY 2013 cap to submit its proposal. The Board believes that Congress expected more of OFPP than a technical compliance with the statutory directive that was too late to be helpful. …

This dispute involves FY 2013 compensation and the FY 2013 would be the cap that applies, not the FY 2012 cap. The FY 2013 cap did not exist when Ology certified its FY 2013 indirect cost rate proposal and the government has, in any event, abandoned the argument that the FY 2013 cap could be applied retroactively to Ology’s FY 2013 proposal. Accordingly, there is no issue that requires a hearing. The government cannot carry its burden of demonstrating that Ology included expressly unallowable costs in its FY 2013 proposal and that a penalty was warranted. Ology is entitled to summary judgment that its FY 2013 executive compensation costs were not expressly unallowable at the time it certified its final indirect cost rate proposal because the FY 2012 cap was no longer applicable.

Although Ology won its victory, please don’t see this decision as a free rein to include the full amounts of contractor compensation in your final billing rate proposals. A ceiling still exists—albeit it must be manually calculated using the existing statutory formula because OFPP cannot be arsed to do its job. Costs claimed in excess of that (manually calculated) ceiling are still unallowable.

What this decision does, however, is provide support for the argument that costs claimed in excess of that ceiling are not expressly unallowable.

To that extent, it’s an important decision.

Last Updated on Saturday, 12 June 2021 19:00
 

The Intersection of Defective Pricing, False Statements, and False Claims

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First, an apology of sorts. It’s been a long time since I’ve posted an article. The truth is, I’ve been struggling with an article I need to write/post, but it won’t come together, at least right now. It’s 4,000 words long, and I’ve discussed my points with a respected colleague and a very respected member of the Beltway Legal Bandit bar, and I still don’t think it’s ready for prime time. While I’ve been wrestling with it I’ve not been posting. Sorry about that – to the extent you noticed.

Moving on from that mea culpa, here is another article about how defective pricing can become something else, something more fraught with legal peril. When I say “another article” I mean just that – I’ve posted on this topic before. There are many articles on this blog discussing defective pricing. There are even a couple of articles discussing the interesting intersection between defective pricing and false claims. For example, you can check out this 2013 article if you’re so inclined.

In today’s article, we have another interesting evolution from allegations of defective pricing to allegations of violations of the False Claims Act, with potential allegations of violations of the False Statements Act along the way. (Note: If you want to know more about those two things then feel free to do a keyword search on this site; I’ve written about them as well.) That being said, as always I have to remind readers that I am not an attorney and you shouldn’t think that I am giving out legal advice. I’m just a layperson with, shall we say, some experience in the areas being discussed.

Let’s start with the Department of Justice press release headline: “Navistar Defense Agrees to Pay $50 Million to Resolve False Claims Act Allegations Involving Submission of Fraudulent Sales Histories.” So: $50 million is a rather large legal settlement value. Let’s see what caused Navistar—maker of MRAP vehicles—to have to negotiate and agree on such a large settlement.

According to the DoJ, the settlement was made to resolve allegations that the contractor “fraudulently induced the U.S. Marine Corps to enter into a contract modification at inflated prices for a suspension system for armored vehicles known as Mine-Resistant Ambush Protected vehicles.” Let’s unpack that a bit.

First, this issue had to do with a contract modification. That means that Navistar already had a contract and was negotiating some type of price adjustment with its customer, the USMC. Apparently, the contract mod had something to do with the MRAP suspension system, but that’s not the important part. What’s important is that all post-award contract price adjustments valued in excess of $2 million are always subject to TINA (Truth-in-Negotiations Act or what is today called the Truthful Cost or Pricing Data Act). TINA is applicable because there is no competition when a contract mod is being negotiated; such actions are always on a single source basis. Even if there was competition when the contract was originally awarded, there is no competition in a contract modification situation. Consequently, Navistar was required to certify that the cost or pricing data it provided to the USMC negotiators was accurate, complete, and current. A failure to provide accurate, complete, and current cost or pricing data when the contractor certified that it did so is called “defective pricing,” and there are contractual remedies associated with that situation. (See, for example, the FAR contract clause 52.215-10.)

But there may be more to this situation than simply a failure to provide accurate, complete, and current certified cost or pricing data. The DoJ added more details, as follows:

The United States alleged that Navistar knowingly created fraudulent commercial sales invoices and submitted those invoices to the government to justify the company’s prices. The sales reflected in the commercial sales invoices never occurred. The government relied on the fraudulent sales invoices in agreeing to Navistar’s inflated prices.

The foregoing seems to indicate that maybe TINA wasn’t involved and maybe this was not a case of relatively simple defective pricing.

Besides the presence of adequate price competition, another exception to the requirement to obtain certified cost or pricing data is when a commercial item is being acquired. When acquiring commercial items, the contracting officer is prohibited from obtaining certified cost or pricing data. (See FAR 15.403-1(b)(3).) The FAR is clear that “Any acquisition of an item that the contracting officer determines meets the commercial item definition in 2.101, or any modification, as defined in paragraph (3)(i) of that definition, that does not change the item from a commercial item to a noncommercial item, is exempt from the requirement for certified cost or pricing data.”

Accordingly, it seems that Navistar may have been claiming that the MRAP vehicle suspension system, or a component thereof, was a commercial item. In that case, it would not have been required to provide certified cost or pricing data; in fact, the contracting officer was prohibited from requesting it.

So what happened? Even though commercial item acquisitions are not subject to TINA and there is no requirement to provide certified cost or pricing data, that doesn’t mean that the contractor gets off scot free. Indeed, the contracting officer is directed to obtain sufficient information (other than certified cost or pricing data) to permit a determination that the price being paid is fair and reasonable. This requirement is discussed at FAR 15.403-3.

There is a lot of language in that FAR section discussing the kind of information that might support the determination that the price being paid for a commercial item is fair and reasonable. FAR 15.403-3(c) states (in part)—

(1) At a minimum, the contracting officer must use price analysis to determine whether the price is fair and reasonable whenever the contracting officer acquires a commercial item (see 15.404-1(b)). The fact that a price is included in a catalog does not, in and of itself, make it fair and reasonable. If the contracting officer cannot determine whether an offered price is fair and reasonable, even after obtaining additional data from sources other than the offeror, then the contracting officer shall require the offeror to submit data other than certified cost or pricing data to support further analysis (see 15.404-1). This data may include history of sales to non-governmental and governmental entities, cost data, or any other information the contracting officer requires to determine the price is fair and reasonable. Unless an exception under 15.403-1(b)(1) or (2) applies, the contracting officer shall require that the data submitted by the offeror include, at a minimum, appropriate data on the prices at which the same item or similar items have previously been sold, adequate for determining the reasonableness of the price.

(Emphasis added.)

So that’s what I think happened to Navistar. Without knowing anything more than provided by the language in the DoJ press release, I think Navistar claimed that its suspension system was a commercial item. When the contracting officer requested sales history information to support why the price being quoted by Navistar was fair and reasonable, somebody made a bad mistake and (allegedly) created fraudulent sales information, and then provided that information to the contracting officer.

If that was the case—and I think it was—then we are looking at far more than a tawdry defective pricing case. We are looking at a potential violation of the False Statements Act (18 U.S.C. § 1001). If the contract mod was awarded on the basis of one or more false statements, then (potentially) every contract invoice Navistar submitted thereafter was potentially a false claim. Violations of the False Claims Act can get expensive very very quickly.

Thus, a $50 million settlement probably seemed like a very good idea at the time.

Another thought. The majority of False Claims Act cases start out as lawsuits filed by whistleblowers, or qui tam relators, as they are called. This case was not an exception. As the DoJ noted in its press release, “The civil settlement includes the resolution of claims brought under the qui tam or whistleblower provisions of the False Claims Act by Duquoin Burgess, a former Government Contracts Manager for Navistar. … Burgess will receive $11,060,000 out of today’s settlement.” That turns out to be roughly a 22% bounty.

And now a final thought: I will be speaking on a panel on Tuesday, June 8th, at the American Conference Institute’s 12th Advanced Forum on DCAA & DCMA Cost, Pricing, Compliance & Audits. I will be joined by two others—Phil Seckman (Dentons) and Jamie Sybert (Grant Thornton). Our topic will be “Are You Prepared for Defective Pricing Audits?”

A timely topic, isn’t it?

 

Hanford. Again.

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Some places just keep coming up over and over again on this blog. Hanford, Washington, is one of those places. From a quick search, it looks like our first article set in this locale was published in 2013. It concerned time card fraud. Other articles followed. The former plutonium manufacturing site just seems to be a hotbed for corruption. It got to the point where, in 2017, we guessed the cause: “it must be something in the water.”

It’s not necessarily all about corruption in the classic sense of the term. The Dept. of Energy Inspector General has published reports critical of various Hanford contractors’ activities without explicitly calling those activities "corrupt." For example, in 2020, we reported that the DOE IG had expressed concerns with two contractors’ small business reporting accuracy. One of those contractors was CH2M HILL Plateau Remediation Company (CHPRC). CHPRC is a wholly owned subsidiary of CH2M (formerly CH2M Hill), which is now a wholly owned subsidiary of Jacobs Engineering Group (Jacobs). If you want to know the details, follow the link to our blog post.

Now, about a year later, CHPRC is back in the news. Or, at least, the subject of a Dept. of Justice press release. According to the press release, CHPRC agreed “to pay $3,038,270 million to resolve allegations that CHPRC violated the False Claims Act by submitting false and fraudulent small business subcontract reports.”

Are the issues the formed the basis of the fraud allegations the same as the ones that DOD IG reported on a year ago? They don’t seem to be.

Instead—

This settlement resolves allegations that CHPRC falsely reported to DOE regarding its HUBZone subcontracting efforts. Specifically, the settlement resolves allegations that CHPRC falsely represented that subcontract awards to two companies, Indian Eyes, LLC, and Phoenix-ABC A Joint Venture (“PABC”), were to HUBZone businesses, when in fact CHPRC knew that both entities did not have HUBZone status during the time period of the subcontracts.

Why would CHPRC want to “falsely represent” that certain subcontract awards were made to HUBZone businesses? According to the DoJ, “CHPRC’s contract provided for fee-based incentives regarding CHPRC’s success in subcontracting to HUBZone businesses, and for the imposition of monetary penalties if CHPRC missed its goals and failed to exercise good faith efforts to award HUBZone subcontracts.” In other words, CHPRC’s profit could vary based on the entities that received subcontracts.

As with many False Claims Act settlements, this one started with a qui tam suit. Apparently, the original 2014 suit was filed by “a Hanford-area small business” that is now known as Apogee Logistics. Let me assure you that Apogee Consulting, Inc. is not connected in any way with Apogee Logistics.

As we noted, CHPRC is owned by CH2M, which is in turned owned by Jacobs Engineering. Did Jacobs Engineering know about the 2014 suit when it acquired CH2M? Maybe. Maybe not.

But if it was aware of the pending litigation, it certainly could have established a settlement reserve. Had it done so, payment of the $3 million (and associated attorney fees) might not impact corporate earnings whatsoever. Investors will have to wait for the next quarterly earnings report to see if that’s the case.

Last Updated on Tuesday, 08 June 2021 15:25
 

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.

 

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Newsflash

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.