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The Wages of Fraud: A Follow-Up

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More than a year ago, we first wrote about the issues at Bradken. As we discussed at the time, the corporate structure of Bradken was interesting, but the bottom-line was that its US subsidiary, based in Tacoma, Washington, had for some time been “the U.S. Navy’s leading supplier of high-yield steel for naval submarines.” As a subcontractor, Bradken provided castings to Navy prime contractors for use in fabricating submarine hulls.

For thirty years, Bradken produced castings that had failed lab tests and did not meet the Navy’s standards. The fraud started well before the company’s acquisition by foreign ownership and continued for a decade after the acquisition. Bradken settled its civil False Claim suit for $10.8 million, and the company entered into a deferred prosecution agreement with respect to the criminal charges it was facing.

As part of its Deferred Prosecution Agreement, Bradken agreed to make a public statement. We wrote about that public statement in a follow-up article. We believe that public statement is well worth reading, and we recommend you follow the link to it.

While the company was settling its legal liabilities, its former Director of Metallurgy, Ms. Elaine Thomas, was facing her own legal issues. She was charged with Major Fraud against the United States. On November 8, 2021, Ms. Thomas pleaded guilty to “defrauding the United States by falsifying test results that measure the strength and toughness of steel used in U.S. Navy submarines.” She will be sentenced in February, 2022. She faces “up to 10 years in prison and a $1 million fine,” according to the DoJ press release.

When we first wrote about this situation, we were careful to make sure it was clear that the Ms. Thomas had only been accused of fraud, because everybody is entitled to be considered to be innocent until proven guilty in a court of law. However, now that Ms. Thomas has pleaded guilty, we can dispense with the niceties and call her what she is: a fraudster.

This article at TheDrive.com, written by Thomas Newdick, adds some details to the story. Newdick’s article quotes Thomas’ attorney as saying, “she regrets that she failed to follow her moral compass — admitting to false statements is hardly how she envisioned living out her retirement years.” Well, then. That makes it all better, doesn’t it?

Newdick’s article adds—

Exactly what drove Thomas to falsify the results of the strength tests is still unclear, but according to the Justice Department, she thought it was ‘stupid’ that the Navy demanded the tests be carried out at -100° Fahrenheit. As a result, the department contends, Thomas changed the results to false positives in some cases.

Interestingly, the Newdick article adds commentary about other problems facing the Navy’s submarine program, and he notes that the problems lay unnoticed for several years before discovery—which ought to concern everybody. However, the article ends on an optimistic note, in which Newdick writes, “… after this fiasco, the Navy will surely be keeping an especially close eye on the production quality of structural components needed to ensure these powerful submarines perform according to their exacting specifications.”

We shall have to see whether or not the Navy has learned any lessons from this—and other—contractor fraud cases.

Last Updated on Wednesday, 17 November 2021 18:26

New Definition of Commercial Item

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The FAR was recently revised, via a final rule, to implement Section 836 of the FY 2019 NDAA. Essentially, the final rule splits the current definition of “commercial item” (found at FAR 2.101) into two definitions: “commercial product” and “commercial service.”

Before we get to deep into the weeds, let’s note that the FY 2019 NDAA directed that the new definitions become effective 01 January 2020. The fact that it took the FAR Council an additional nineteen months beyond the statutory requirement is evidence that the FAR rule-making process is broken. But you already knew that, so let’s move on.

As the promulgating comments noted

… the amendment to separate ‘commercial item’ into ‘commercial product’ and ‘commercial service’ does not expand or shrink the universe of products or services the Government may procure using FAR part 12, nor does it change the terms and conditions with which contractors must comply. … This rule does not create new solicitation provisions or contract clauses. This rule merely replaces the term ‘commercial item(s)’ with ‘commercial product(s),’ ‘commercial service(s),’ ‘commercial product(s) or commercial service(s),’ or ‘commercial product(s) and commercial service(s)’ in the FAR including in part 52, as appropriate. This rule does not impose any new requirements on contracts at or below the SAT or for commercial products, including COTS items, or for commercial services.

Essentially, then, the revision is about semantics only. A commercial product is still defined by one of six definitions—the same definitions that were always in FAR 2.101. A commercial service is still defined by one of two definitions—the same definitions that were always in FAR 2.101. Nothing has really changed, except for “bifurcating” the definition into two separate definitions.

If nothing changed, then why did it take so long to promulgate the final rule? That’s a question that only the FAR Council can answer.

If nothing changed, then why did Congress, the Section 809 Panel, and the FAR Council decide to make the change? Well, according to the public law and the promulgating comments:

… ‘acquisition workforce has faced issues with inconsistent interpretations of policy, confusion over how to identify eligible commercial products and services’. [Sic.] Bifurcating the definition of ‘commercial item” into ‘commercial product’ and ‘commercial service’ is a way to provide clarity for the acquisition workforce, which may result in greater engagement with the commercial marketplace.

Thus: no amount of training could help the Federal acquisition workforce with understanding the difference(s) between products and services. It literally took an Act of Congress to create two definitions where only one had existed before. The Act of Congress was necessary because contracting officers didn’t understand the FAR. What this says about the acquisition workforce, and the training thereof, we’ll leave to the imaginations of our readership.

While this in an important change—because the definition of commercial item (or commercial product and commercial service) is critical—it is not any kind of substantive change. Kind of like when TINA became whatever it’s called now (Truthful Cost or Pricing Data). Nobody calls it what it’s called now: everybody calls it TINA. Why? Because we’re trying to communicate with each other.

Similarly, no matter what you’ll be calling it going forward, it will always be “commercial item” to the people who’ve been dealing with it for years. For example, we don’t see DCMA’s “Commercial Item Group” (CIG) changing its name to “Commercial Products and Commercial Services Group” (CPACSG) … but who knows? Maybe they’ll surprise us and make the change.

Last Updated on Wednesday, 10 November 2021 18:23

Statute of Limitations, Again

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In 2020, Triple Canopy appealed several Contracting Officer’s Final Decisions (COFDs) to the ASBCA. The dispute involved an interpretation of the contract clause 52.229-6 (“TAXES-FOREIGN FIXED-PRICE CONTRACTS”, June 2003) as it applied to Triple Canopy’s work in Afghanistan. The ASBCA denied Triple Canopy’s appeals, finding them time-barred by the Contract Disputes Act’s Statute of Limitations.1

We’ve written a lot about the CDA Statute of Limitations here on this blog. In our layperson’s view, the appellate forums (fora?) have applied the rules of claim accrual inconsistently. We’ve been told that our viewpoint is wrong by people who’ve been to law school, passed the bar, and get paid tremendously huge hourly rates to help contractors in court. However, we remain convinced that the rules are not clear, not implemented via bright-line standards, and thus remain a source of confusion for the contracting parties.

Our position is: if the rules of CDA claim accrual are so clear and evenly interpreted, then show us the textbook that lays the rules out for all to see. (Note: if you know of such a textbook, please send us an email. We want to buy it.)

Our point of view regarding this issue seemingly was bolstered by a recent decision by the Court of Appeals, Federal Circuit, a decision that reversed the ASBCA’s Triple Canopy decision, calling it an error “as a matter of law.” Which to us, means that the ASBCA Judges didn’t interpret the CDA Statute of Limitations correctly.

So what did the ASBA Judges get wrong?

According to the Appellate Court, the matter turned on when Triple Canopy’s claim had accrued. The government argued, and the ASBCA found, that the claim accrued when Triple Canopy “was legally obligated to pay the [Afghan government tax] assessment.” That was when the company knew, or should have known, that it had suffered an injury. According to the ASBCA, “The fact that the final amount could change does not matter, nor does the fact that actual payment had not yet occurred.”

However, Triple Canopy had argued, and the Appellate Court agreed, that the claim accrued when the company had exhausted its appeal rights (to the Afghan government). In support of its argument, Triple Canopy had pointed to paragraph (i) of the 52.229-6 clause, which states that the contractor must ““take all reasonable action to obtain exemption from or refund of any taxes or duties.” In other words, the ASBCA found that clause to give the contractor discretion in pursuing a tax reduction (since the contract was FFP), but the Appellate Court found that there was no discretion involved.

The Appellate Court wrote—

We agree with Triple Canopy that, because it was seeking reimbursement of the GIRA assessment pursuant to the Foreign Tax Clause, it had to comply with paragraph (i)’s requirement that it ‘take all reasonable action’ to obtain ‘exemption’ from the assessment. This meant appealing the assessment. In the circumstances of this case, we thus view the appeal to GIRA as a ‘mandatory preclaim procedure’ that had to be completed in order for Triple Canopy’s claims to accrue and the CDA limitations period to begin to run.

To sum this up, we have to say that if the learned Administrative Judges of the ASBCA are getting the CDA Statue of Limitations wrong, then what hope do any of us laypeople have?

1 Because the ASBCA is now issuing decisions as .pdf files, we have difficulty linking to them. See ASBCA Nos. 61415, 61416, 61417, 61418, 61419, 61420, May 20, 2020.


Proposed Rule Would Require TWO Incurred Cost Submissions

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The 2017 National Defense Authorization Act (NDAA), also known as Public Law 114-328, required the Department of Defense to change the way it managed contractor IR&D and B&P expenses. Section 824 required:

  • Contractor IR&D expenses allocated to DoD contracts must be reported separately from other contractor indirect expenses

  • The current limitations found in the DFARS IR&D/B&P cost principle, that limits allowable costs to those found to be of interest to the DoD (via one of seven possible avenues) were eliminated in favor of “a CEO determination that IR&D expenses will advance the needs of DoD for future technology and advanced capability.”

  • Existing DFARS cost principle language governing B&P cost allowability, which seemed to imply that contractor B&P expenses must also be of interest to DoD, was revised to eliminate that requirement

  • In addition, contractor B&P expenses allocated to DoD contracts must be reported separately from other contractor indirect expenses.

  • The DCAA must revise its Annual Report to Congress format to provide—

    • a summary, set forth separately by dollar amount and percentage, of indirect costs for independent research and development incurred by contractors in the previous fiscal year

    • a summary, set forth separately by dollar amount and percentage, of indirect costs for bid and proposal costs incurred by contractors in the previous fiscal year

Link to the 2017 NDAA language here.


Regulations prescribed under subsection (a) may not include provisions that would infringe on the independence of a contractor to choose which technologies to pursue in its independent research and development program if the chief executive officer of the contractor determines that expenditures will advance the needs of the Department of Defense for future technology and advanced capability as transmitted pursuant to subsection (c)(3)(A).

Now, in 2021, the DAR Council has promulgated a proposed rule to implement the 2017 NDAA requirements. Let’s look at it. The proposed rule—

  • Adds language at DFARS 231.205-18(c) to require contractor CEOs to determine that IR&D expenditures will advance the needs of DoD for future technology and advanced capability.

  • Adds a requirement for major contractors to include a statement in their submission to the Defense Technical Information Center (DTIC) that the CEO of the contractor has made the determination required by 10 U.S.C. 2372. This statement serves as evidence for DoD, when determining whether IR&D costs are allowable. The proposed rule notes that major contractors are already required to upload IR&D activities in DTIC in order to provide DoD with information on the progress of these activities; so this rule adds a requirement for those major contractors to include a statement in the DTIC input that the CEO determination has been made.

  • Since the list of seven activities of potential interest to DoD was deleted, the requirement for the DCMA ACO to compare the IR&D activities uploaded in DTIC to the list of seven IR&D activities of potential interest to DoD no longer exists. Therefore, DFARS 242.771-3(a) is proposed to be modified to remove DCMA responsibilities for determining if an activity is of potential interest to DoD.

  • Adds language to clarify that IR&D and B&P costs will be reported independently from other incurred indirect costs in a new paragraph at DFARS 231.205-18(c)(iv).

  • Decouples IR&D and B&P by stating “IR&D and B&P” instead of “IR&D/B&P” throughout the text. However, for the purposes of calculating the threshold that requires major contractors to submit IR&D activities and statements regarding the CEO determinations in DTIC, the rule does not change the calculation, which combines IR&D and B&P, to ensure the definition of “major contractor” remains the same.

  • DFARS 242.771-3(c)(1) is proposed to be modified to change the content of the communication from DoD to contractors from the “planned or expected DoD future needs” to the “planned or expected needs of DoD for future technology and advanced capability.” In addition, the responsibilities of the Office of the Under Secretary of Defense for Research and Engineering are expanded to include providing on the DTIC website communities of interest on DoD's future needs. An email address for additional information is also provided.

Importantly, the proposed rule adds a contract clause at DFARS 252.242-70XX, Independent Research and Development and Bid and Proposal Incurred Costs, which requires all contractors with noncommercial awards exceeding the simplified acquisition threshold to provide an incurred cost submission of IR&D and B&P costs for the prior Government fiscal year to a website for DCAA to access.

We’ve thought about that final requirement. Why couldn’t the DAR Council just modify the Allowable Cost and Payment contract clause (52.216-7) to require an additional schedule in the contractor’s annual proposal to establish final billing rates? After all, there are already about two hundred zillion schedules; what’s one more? But then we realized that many defense contractors don’t have any cost-reimbursable or T&M contracts; they are 100% FFP contractors—especially the smaller subcontractors. If the DAR Council simply modified the 52.216-7 clause, then many defense contractors wouldn’t be reporting their IR&D and B&P expenditures. Thus, the new contract clause makes a kind of sense, given Congressional direction.

If implemented as a final rule, the proposed language will require almost all defense contractors to submit an incurred cost submission. Some will be submitting their final billing rate proposals (which are not incurred cost submissions, but whatever) as they have always done. Now they will have an additional (real) incurred cost submission to submit for their B&P and IR&D project expense detail. So they will have two annual submissions to make. Other defense contractors, who have not had to submit anything before, will now have to submit one—the B&P and IR&D incurred cost submission.

Fun times ahead!

And what will DCAA do with the new submissions they receive? According to the Public Law and the proposed rule, they will have to aggregate the data and report summary-level statistics to Congress each year. Will the auditors want to use those submissions as audit leads? Well, they’re not supposed to—but we’ll have to see. Historically, DCAA as an agency has a rather poor record of resisting temptation to use information received for one thing as an audit lead for something else. But we can be optimistic, right?

Another thing that occurs to us is that there will need to be a standard submission format. If DCAA lets contractors do their own thing, then they’ll have trouble aggregating the data they receive. The current language of the (draft) contract clause is fairly permissive. It states—

… the Contractor shall—

(1) Report to [website TBD] a consolidated spreadsheet of all independent research and development (IR&D) and bid and proposal (B&P) costs incurred by the Contractor during performance of any DoD contract in the previous fiscal year, beginning October 1 through September 30; and

(2) Submit this report no later than December 31 of each year.

(b) IR&D and B&P incurred costs shall be reported separately and shall be reported by costs attributable to—

(1) The Department of Defense (non-foreign military sales);

(2) Foreign military sales; and

(3) Other.

We’re going out on a limb here, and will bet the existing permissive language becomes more prescriptive when the rule is finalized. The proposed clause language is also ambiguous, conflating the government fiscal year with a contractor fiscal year. Finally, the proposed language requires submission by 31 December but the (for a calendar year contractor), final costs won’t be known for at least six months after that date. We’ll also bet some of those details are caught in the final rule. At least, we hope they will be. You can help make that happen by submitting comments, which are due by not later than 29 November. The address for submission of comments is found in the proposed rule.

In summary, there are going to be a lot of defense contractors who now have to submit the new IR&D and B&P incurred costs reports. Many of them will have never submitted an incurred cost report before. We predict confusion. And perhaps more work for government contract accounting consultants.


Time Charging Problems Haunt Northrop Grumman for Years

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In 2013, Northrop Grumman Mission Systems identified that certain employees stationed in OCONUS locations had perhaps mischarged some of their time between 2010 and 2013. For example, it was alleged that some employees charged labor hours to government contracts for time spent on recreational activities such as attending movies. Upon discovery of the issues, the company “took disciplinary action against those who we found acted improperly and violated company policy, and we took corrective action to strengthen our time-charging processes even further. We cooperated with the government as it investigated the issues over the following years.” (See this article.)

Upon discovering its time charging problems, Northrop hired outside attorneys (who likely hired forensic accounting consultants) to investigate. Normally, such investigations do more than simply quantify the amount of the problem; they also look at internal controls to see where they may have failed, and they attempt to identify those employees responsible for the alleged wrongdoing and the control breakdowns. Such investigations are never cheap. In this case, it appears that Northrop Grumman incurred roughly $15 million over a four-year period related to this matter.

Think that’s a lot of shareholder money? Well, Northrop’s “support” of the government investigation involved “collecting more than 25 million records from employees in the United States, and overseas, producing over 1.3 million pages of documents, and interviewing over 100 employees.” Such efforts do not come cheaply.

In 2018, Northrop and the government entered into a settlement agreement, in which the company agreed to pay $30 million, in addition to $1.65 million in burdened labor costs it had already refunded to its US Air Force customer. The DoJ press release headline understates the settlement amount because it omits the $4.2 million paid to the U.S. Attorney’s Office of the Southern District of California (as explained in the first article.) So: $31.65 million would be the settlement amount—an amount that does not include the cost of hiring outside attorneys and consultants to investigate the problem and reach a settlement.

Flash forward to 2020—seven years after the initial wrongdoing was reported to the government—and Northrop’s DCMA contracting officer issued a Final Decision in which he “determined that from FY 2012 to 2016 NGMS had included expressly unallowable legal costs of more than $15 million related to the BACN criminal matter in its final indirect cost proposals. Of this amount, $10,120,681 had been allocated to covered contracts and had been reimbursed through interim billings. He assessed a penalty in this amount, plus interest of $1,432,201, for a total claim amount of $11,552,882.”

Note that this amount was in addition to the $31.65 million that Northrop Grumman had already agreed to pay through its False Claims Act settlement.

The CO determined that Northrop’s costs were expressly unallowable under the 31.205-15 cost principle, which states that—

Costs incurred in connection with, or related to, the mischarging of costs on Government contracts are unallowable when the costs are caused by, or result from, alteration or destruction of records, or other false or improper charging or recording of costs. Such costs include those incurred to measure or otherwise determine the magnitude of the improper charging, and costs incurred to remedy or correct the mischarging, such as costs to rescreen and reconstruct records.

(Emphasis added.)

In addition, the CO found that the costs would also be unallowable under the cost principle at 31.205-47 (Legal Proceedings).

You may be wondering why Northrop claimed the costs in the first place. The answer is that the costs may have been allowable when incurred, but only became unallowable at a subsequent point in time. This is why the issue of allowability is so challenging: costs may be retroactively unallowable, based on what the contractor learns and how it interacts with the government.

For example, if you were to locate and read the FAR Council’s promulgating comments on 31.205-15, you’d learn that the cost principle does not make the normal operation of a contractor’s internal control system unallowable. The cost of evaluating internal controls and assessing whether transactions violated those controls is entirely allowable. Even when the outcome of such evaluations is a disclosure to the government under the contract clause 52.203-13 (“Contractor Code of Business Ethics and Conduct”), all the costs of getting to that disclosure (and supporting that disclosure through government review) are still normal operations and 100% allowable. (Despite what certain DCAA auditors may assert.)

It is only when the matter moves into the legal arena that the costs become unallowable. For example, if the government files a suit under the False Claims Act and the company enters into settlement agreement discussions, then those costs become unallowable from that point forward. And if the company enters into a settlement agreement, then it needs to look backwards at the costs it has incurred, and stratify those costs between allowable internal controls analyses and unallowable litigation support. Apparently, Northrop didn’t do that in this situation, leading to the COFD.

The requirement to assess allowability retroactively is especially important when, as in this case, the settlement agreement expressly addressed the issue, and stated—

Within 90 days of the Effective Date of this Agreement, NGSC shall identify and repay by adjustment to future claims for payment or otherwise any Unallowable Costs included in payments previously sought by NGSC or any of its subsidiaries or affiliates from the United States. NGSC agrees that the United States, at a minimum, shall be entitled to recoup from NGSC any overpayment plus applicable interest and penalties as a result of the inclusion of such Unallowable Costs on previously-submitted requests for payment . . .

So here we are, in 2021, dealing with costs incurred between 2012 and 2016, related to alleged wrongdoing that took place between 2010 and 2013—wrongdoing that was the subject of an FCA settlement agreement in 2018. Lovely to see justice more forward so swiftly, isn’t it?

Northrop appealed the COFD and, in its appeal, made a motion for summary judgment. In June, the ASBCA denied that motion. (ASBCA No. 62596, June 21, 2021.) The denial took only 11 pages.

At this point, the parties look to be moving towards a trial on the merits. However, given the Board’s quick dismissal of Northrop’s arguments, we suspect it’s more likely that the next Board decision we’ll be seeing is a statement that the dispute has been settled and is being dismissed with predjudice.

This story is, unfortunately, a great example of how time charging problems can expand into a full-blown False Claims Act litigation matter. It also provides some insight into how government accounting and compliance folks ought to be looking at the costs incurred in evaluating internal control failures and supporting outside counsel.

As with so many of the blog articles on this website, the objective is to provide readers with lessons learned by other contractors, so that the readers can avoid similar situations. And, perhaps, save themselves a few million dollars in the process.

Last Updated on Wednesday, 15 September 2021 17:09

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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.