Expensive Wire Fraud
It seems as if this is public contracting corruption week. Here’s another story, made remarkable by the sheer size of the legal settlement. The DOJ press release is here.
One sentence summarizes the situation:
SK Engineering & Construction Co. Ltd. (SK), one of the largest engineering firms in the Republic of Korea, pleaded guilty today to one count of wire fraud, in connection with a fraudulent scheme to obtain U.S. Army contracts through payments to a U.S. Department of Defense contracting official and the submission of false claims to the U.S. government.
Well there you go.
And SK pleaded guilty to one count of wire fraud, thus avoiding the messiness of other charges. Nice job, attorneys!
But SK didn’t skate away. The company agreed to:
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Pay $60,578,847.08 in criminal fines, the largest fine ever imposed against a criminal defendant in the Western District of Tennessee
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Pay $2,601,883.86 in restitution to the U.S. Army
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Serve three years of probation, during which time SK agreed not to pursue U.S. federal government contracts
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Separately, SK entered into a False Claims Act settlement with the United States, under which it paid $5.2 million in civil penalties (which the DOJ graciously credited against SK’s criminal fine)
So yeah, it was a bit painful for the company.
What’s the story behind the fines and penalties?
According to plea documents, SK obtained a large U.S. Army construction contract at Camp Humphreys, South Korea in 2008 worth hundreds of millions of dollars. SK paid millions of dollars to a fake Korean construction company named S&Teoul, which subsequently paid that money to a contracting official with the U.S. Army Corps of Engineers. In order to cover approximately $2.6 million in payments to S&Teoul, and ultimately to the contracting official, SK submitted false documents to the U.S. Army.
SK also admitted that its employees obstructed and attempted to obstruct federal criminal investigations of the fraud and bribery scheme. SK admitted that, in April 2015, its employees burned large numbers of documents related to U.S. Army contracts, in order to hamper U.S. and Korean investigators. Further, SK admitted that, in the fall of 2017, its employees obstructed a federal criminal proceeding by attempting to persuade an individual not to cooperate with U.S. authorities.
Readers may recall the prior blog post, about AIS and its relatively favorable resolution with the DOJ. As noted in that article, the DOJ was favorably disposed towards AIS because of its cooperation and willingness to implement corrective actions to reduce the likelihood that similar misconduct would recur. In contrast to its discussion of AIS’s conduct, here the DOJ noted that
… SK frustrated the United States’ investigation by withholding requested documents and information, destroying documents relevant to a pending federal investigation, and attempting to persuade a potential witness not to cooperate with the investigation. In addition, SK did not discipline any employees responsible for the misconduct, either through direct participation or failure in oversight, or those with supervisory authority over the area in which the criminal activity occurred, and failed to retain business records and otherwise failed to prohibit the improper destruction and deletion of business records.
Thus, while AIS paid a total of $1.26 million and received a Non-Prosecution Agreement, SK will pay $62.6 million and will be barred from the Federal marketplace for three years (in addition to the three years that the company has already been suspended). Learn from those differences!
What about the individuals involved?
According to the DOJ, “two SK employees, Hyeong-won Lee and Dong-Guel Lee, were indicted by a federal grand jury in the Western District of Tennessee on charges of conspiracy, major fraud against the United States, wire fraud, money laundering conspiracy, and obstruction of justice for their alleged roles in the scheme.”
The two individuals named above “are currently fugitives of justice.”
DCAA Auditors Asked to Do Less with Less
At the end of May, DCAA published its Annual Report to Congress. Most of the contents might be already known to readers of this blog, since we publish DCAA audit statistics every so often—based on the numbers reported in the DOD Inspector General’s Semi-Annual Report to Congress. Still, there are some interesting factoids in the annual DCAA Report that we’d like to bring to your attention.
First, the numbers. We were interested to compare DCAA’s statistics to the DOD Inspector General’s statistics. It’s a tough comparison. For example, whereas the DOD IG reports Incurred Cost and Special Audits as one statistic, DCAA’s Report splits them out into two statistics. Thus, when we reported that DCAA completed 2,028 incurred cost assignments in GFY 2019, that value included “special audits.” Now we know (from the DCAA Report) that DCAA completed exactly 1,117 incurred cost audits and 822 special audits. We can’t explain why DCAA reported an aggregate total of 1,939 completed audits versus DOD IG’s reported 2,028 completed audits but – as they say – it’s probably close enough for government work.
Similarly, when we reported that DCAA was closing audit assignments via Memo at a rate that was three times higher than via actual audit report, we were interested to see that the DCAA Report stated that of the 6,047 Incurred Cost assignments closed in GFY, 4,930 (81.5%) were closed via Memo—such that closure via Memo was actually four times more likely than closure via audit report. Closure via Memo essentially means that no “real” audit was performed (i.e., audit by use of transaction testing to determine the allowability of claimed contractor costs). Thus, in our view, this is an indication that DCAA is not really doing incurred cost audits (in the traditional sense of the term) on the vast majority of annual proposals to establish final billing rates that it receives each year.
Readers of this blog understand the lack of traditional audit is an intentional outcome from a DCAA leadership decision to adopt a “risk-based” approach to determining which contractor proposals it audits and which it choses to close via Memo. We’ve written about that approach at some length. In our view, “risk-based” means “ROI-based,” such that DCAA doesn’t want to spend a lot of auditor staff hours auditing smaller dollar proposals, because the agency doesn’t get as much “bang for the buck” in terms of Return on Investment that it can report to Congress. Speaking of ROI, the DCAA Report noted that the agency’s GFY 2019 ROI on taxpayer funding was $5.50 for each dollar “invested” in funding the agency. That’s a metric that agency leadership is proud of—and one that they don’t want to see decline by performing lengthy audits on small dollar proposals.
Also, it should be recognized that DCAA changed the method in which it reported audit duration a few years ago. Instead of measuring the duration from the date a contractor’s proposal to establish final billing rates was received to the date on which an audit report (or Memo) was issued, DCAA began measuring the duration from the date of the entrance conference to the date on which an audit report (or Memo) was issued. The new methodology cuts out all that time spent determining that a contractor’s proposal is adequate for audit, and cuts out all that time spent performing risk analysis and required audit planning. Thus, instead of taking literally three years to perform an audit of one year’s costs, DCAA is now proud to report to Congress that it takes the agency only an average of 88 days. That’s not an improvement; that’s the result of a change in measurement technique.
That being said, DCAA has managed to tackle a large number of incurred cost assignments, such that by the end of GFY 2019, there were only 48 contractor proposals that had been languishing for more than one year past the determination that they were adequate for audit. That is a real improvement that should be acknowledged by all. As DCAA reported to Congress, “Of those currently pending, half are from reimbursable customers delayed due to customer funding and the rest are primarily on hold due to investigations.” So kudos to DCAA for that.
Another interesting aspect of the Report to Congress is that DCAA is now reporting statistics about contractor spend on IR&D and B&P. (This reporting area is required by a recent Public Law.) According to DCAA, on average, a contractor spends six percent of its total indirect expenses on IR&D and three percent of its total indirect expenses on B&P. The statistic is not particularly useful, because indirect expenses can include many things such as fringe benefits, overhead, and other G&A expenses. However, it does provide a benchmark for you to measure your own company’s spending in these two areas, should you wish to do so.
Finally, let’s look at DCAA staffing and productivity. Both the DOD IG’s Semi-Annual Report and the DCAA Annual Report agree that DCAA issued exactly 2,948 audit reports in GFY 2019. The DCAA Report told Congress that “in addition to issuing audit reports, DCAA reviews and closes thousands of assignments with low risk memos, which contain rate information allowing contracting officers to efficiently close contracts by setting rates.” However, DCAA does not actually report the exact number of Memos issued. But the DOD IG Report does! Using the DOD IG Report’s statistics, we know that DCAA closed a total of 11,214 assignments in GFY 2019.
How does the GFY 2019 value compare to prior years?
Not so well.
For as long as we’ve been tracking DCAA statistics, the lowest quantity of assignments ever closed was in 2011, when 10,844 assignments were closed in that fiscal year. The GFY 2019 value is higher—which is good! But it’s not a lot higher. Moreover, in 2010 DCAA closed 17,159 assignments, which is roughly one-third more output than was reported in GFY 2019. That’s not so good. But that was a long time ago, so let’s look at more recent statistics.
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In 2016, DCAA closed 13,520 assignments
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In 2017, DCAA closed 11,068 assignments
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In 2018, DCAA closed 11,857 assignments
Thus, DCAA has closed an average of 12,148 audit assignments annually—but in GFY 2019 DCAA managed to close and issue only 11,214 assignments, even though more than 80 percent of those assignments were closed via issuance of a Memo, and did not involve any traditional audit procedures such as transaction testing.
That’s not so good.
The decrease in productivity may have been caused by a decrease in auditors. DCAA’s Annual Report states that audit staffing was 3,994 heads. That’s down from the GFY 2018 level of 4,148—about a four percent drop in auditors available to perform work. However, if one compares assignments completed and headcount, one might calculate that in GFY 2019 DCAA closed 2.81 assignments per auditor.
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In GFY 2018, DCAA closed 2.86 assignments per auditor
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In GFY 2017, DCAA closed 2.66 assignments per auditor
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In GFY 2016, DCAA closed 3.36 assignments per auditor
Thus, while in GFY 2019 DCAA closed 2.81 assignments per auditor, in the prior three years DCAA closed an average of 2.96 assignments per auditor—nearly 3 assignments per auditor. So the GFY 2019 productivity statistics do not tell a great story, in our view.
In summary, DCAA is doing less with less. It is closing few assignments than has been the historical norm. And for those assignments it closes, it is closing them via Memo at the extraordinary rate of 4-to-1. In fairness, audit staff is down. But the staffing drop seems very much insufficient to explain the drop in productivity.
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“Happy Ending” for Procurement Fraud Story
It only cost Alutiiq International Solutions LLC (AIS), a subsidiary of Afognak Native Corporation (Afognak) and an Alaskan Native Corporation, $1.26 million to resolve allegations that its personnel engaged in a kickback and fraud scheme related to a multi-million-dollar GSA contract to modernize the Harry S. Truman Federal Building in Washington, D.C. As part of the resolution, AIS was permitted to enter into a Non-Prosecution Agreement (NPA), in which further charges against the company would be waived. Here’s a link to the DOJ press release.
$1.26 million seems like a lot of money. It is a lot of money! But compared to what could have happened to AIS, this is about as happy an ending as one could have hoped for.
Let’s discuss.
According to the DOJ—
[Starting in] June 2010, the AIS project manager … began receiving kickbacks from a subcontractor on the project in exchange for steering work to the subcontractor. These kickbacks initially were paid in the form of meals, vacations, and other things of value but, by 2015, the AIS project manager began demanding cash kickbacks equivalent to 10 percent of the value of contract modifications that were being awarded to the subcontractor. At the same time, the AIS project manager billed the GSA for services purportedly provided by an on-site superintendent when there was no superintendent on site. The AIS project manager’s false and fraudulent billings caused the GSA to pay $568,800 to AIS that it should not have paid. Additionally, when making contract modification requests to the GSA, the AIS project manager illegally inflated the estimated costs that AIS received from its subcontractor, resulting in $690,644 in monies paid by GSA to AIS.
Bribery. Kickbacks from subcontractors. False statements. False claims. The mind boggles at the world of hurt that AIS was facing, should the DOJ have decided to play hardball with the company.
Those were our first thoughts. Then we began to try to imagine how the scheme was perpetrated. It seems clear that the project manager had to run roughshod over the AIS buyers/subcontract administrators assigned to the project. The project manager (allegedly) awarded inflated contract modifications to the subcontractor, and that doesn’t happen when somebody other than the project manager formalizes the modifications. That shouldn’t happen if somebody was performing independent cost/price analyses on the subcontractor’s Requests for Equitable Adjustment (REAs) to make sure the subcontractor was receiving only the amount to which it could support entitlement. It seems to us as expected purchasing system independent checks and balances were missing. Further, this (alleged) misconduct seems to have been perpetrated over a period of at least five years. Thus, our thoughts went to: “where was the purchasing department when all this was going on?”
It has got to be a red flag when the project manager tells the buyer(s) or subcontract administrator(s) that they don’t need to do any kind of analysis, just award the mod in the value requested. Just as it’s also a red flag when the project manager tells the purchasing department to award a subcontract to one named source without bothering to get competition or to analyze whether the subcontract price is fair and reasonable. If we were going to set up an internal control or management surveillance function, we would definitely look for those red flags, and others like them.
It is possible that AIS learned of the (alleged) project manager misconduct through its normal internal control and/or management surveillance functions, because the DOJ noted that “AIS fully and completely cooperated with the investigation from the moment it became aware of the conduct” and “as soon as AIS and Afognak learned of the misconduct, the companies engaged in extensive remedial measures.”
Other actions that DOJ reported with approval included:
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AIS … committed to paying full restitution to compensate for the GSA’s losses and, at the time of the offense conduct, provided its profits from the relevant contracts to Afognak, which uses these profits to support Afognak’s Alaskan Native shareholders, who are members of severely economically disadvantaged villages.
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… The companies engaged in extensive remedial measures, including enhancing their compliance program and internal controls by, among other things:
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Revising their policies and procedures to complete the separation of the contract procurement and contract execution functions
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Conducting annual risk assessments related to government contracting
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Conducting regular audits of a sampling of all procurement files and reviewing all procurements over certain cost thresholds
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Introducing additional management controls for prime contracts, subcontracts, and government projects that includes requiring higher levels of management to approve contract awards and budget changes
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Requiring additional trainings specific to the Anti-Kickback Act, including training quizzes, ethics publications, and additions to the annual Code of Conduct training
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Tracking all compliance reports received through a third-party hotline and email accounts
Now one could argue that AIS should have been doing all those things already as a part of its government contracting compliance program. But better late than never! Compare your own company’s controls to the list of corrective actions that AIS agreed to implement. How do you stack up? If you are not doing at least those things, you may have compliance risks of which you are unaware.
Finally, let’s discuss the situation of the (now former) AIS project manager whose alleged misconduct led to AIS’ favorable settlement and NPA. According to the DOJ press release—
A federal grand jury in the District of Columbia returned an indictment charging the AIS project manager … with conspiracy to violate the Anti-Kickback Act, and four counts of wire fraud, in May 2019. Trial is currently scheduled for Dec. 7, 2020, before U.S. District Court Judge Amy Berman Jackson. An indictment is merely an allegation, and a defendant is presumed innocent until proven guilty beyond a reasonable doubt in a court of law.
We are not lawyers here, but a Google search seems to indicate that a violation of the Anti-Kickback Act subjects the perpetrator to a fine of up to $25,000, felony conviction punishable by imprisonment up to five years, or both. In addition, each count of wire fraud may carry with it a penalty of up to $250,000, imprisonment of up to 20 years, or both. Thus, it seems to us that the (former) AIS project manager is facing spending the rest of his life in a Federal prison, should he be convicted of the charges in December.
We urge our readers to learn from this real life story.
CDA Statute of Limitation Works Both Ways
Over the past decade we have devoted many words to the Contract Disputes Act’s Statute of Limitations. In our view, the CDA Statute of Limitations represents one of the most significant legal issues to impact contractors during that time frame. Or at least it did, before the Federal Circuit turned it from a jurisdictional issue into an affirmative defense about six years ago. Regardless, the CDA Statute of Limitations can still come into play during disputes and litigation.
This article is a reminder that the CDA Statute of Limitations can work to the advantage—or disadvantage—of either party. A failure of either party to file its claim within the six-year statute of limitations very likely will lead to that claim being denied by the courts.
We were reminded of this truism once again, when the ASBCA heard an appeal by Parsons Government Services with respect to its 2011 indirect cost rates, which were unilaterally established by its DCMA Corporate Administrative Contracting Officer (CACO).
In summary, Parsons owned its own corporate headquarters building until 2011, when it entered into a sale/leaseback arrangement. Prior to 2011, the building had been depreciating, and Parsons had claimed that depreciation as an allowable cost. But the sale/leaseback changed the situation. (See the cost principles at 31.205-11, 31.205-16, and 31.205-36. As you might guess, it’s a bit complicated.) When Parsons calculated its 2011 indirect rates, in September 2012, it included a credit for the gain on the sale of its building as well as the actual lease expenses it was now paying. Arguably, the cost principle(s) required an adjustment of the actual lease expenses; the previous depreciation amount (plus other ownership costs) as adjusted by the gain or loss recognized on disposition established a ceiling on the amount of allowable costs that could be claimed. From the ASBCA decision, it seems that Parsons did not make the required analysis to determine how much of its lease payments were allowable.
Apparently, Parsons realized its error after completion of the DCAA audit, when the parties were negotiating final indirect cost rates (also known as “final billing rates”). In March or May 2018 (the decision cites both dates), Parsons noted that it had under-claimed allowable lease expenses and “respectfully request[ed] that the Government recalculate lease cost allowability, as well as the separate allowability of the other building costs the company incurred in 2011 and 2012.” Judge D’Alessandris, writing for the Board, noted that “Parsons did not submit a revised indirect cost rate proposal incorporating the costs asserted in the letter, and did not include a claim certification.” Which makes some sense to us, because Parsons thought they were negotiating with the CACO, not filing a claim.
However, Parsons’ request was unavailing. In September 2018, the CACO was done negotiating, and issued unilateral final indirect cost rates. The unilateral rate determinations rejected certain lease costs included in Parsons’ indirect cost rate proposals, and did not address Parsons’ claimed additional costs. The CACO determined that Parsons (via its subsidiaries) had claimed millions of dollars in unallowable lease expenses in its 2012 final billing rate proposal, and directed Parsons to submit adjustment vouchers for all affected contracts if the unilaterally determined rates differed from the rates used in Parsons’ interim billings. That determination was received by Parsons on September 13, 2018.
Notably, the unilateral determination did not inform Parsons of its appeal rights, as it probably should have. However, Parsons is a big corporation, a long-time government contractor, and it has top-notch administrative personnel who are well-versed in government contracting requirements. Thus, it should not have needed to be reminded of its appeal rights.
It took six months for Parsons to file a claim with its CACO regarding the unilaterally determined 2011 indirect cost rates. It filed its claim on March 24, 2019 and the CACO denied the claim on May 24, 2019. Parsons subsequently appealed the denial at the ASBCA on July 1, 2019.
The chronology related above proved fatal for Parsons’ appeal.
First and foremost, Judge D’Alessandris found that Parsons did not need to file another claim with the CACO after receiving the unilateral rate determination. We are going to quote the Judge (legal citations omitted) because it’s that important:
It is well settled that a unilateral rate determination is a government claim. See FAR 52.216-7(d) (4) (‘Failure by the parties to agree on a final annual indirect cost rate shall be a dispute within the meaning of the Disputes clause.’). Upon receipt of the unilateral rate determination, Parsons could either accept the determined indirect cost rate as the final rate, or appeal the unilateral rate to this Board or the Court of Federal Claims within the time permitted by the CDA. Parsons did not appeal within the allowable time period (90 days for appeals to the Board) and the FY2011 unilateral rate determination became Parsons’ final indirect cost rate. See FAR 2.101 (‘Final indirect cost rate means the indirect cost rate established and agreed upon by the Government and the contractor as not subject to change.’).
Based on that language, the Judge found that Parsons’ failure to submit its appeal to a judicial forum (either the Court of Federal Claims or ASBCA) within the Contract Disputes Act’s deadlines was fatal to the Board’s jurisdiction. (“As Parsons did not file its appeal within 90 days of its receipt of the unilateral rate determination, its claim pertaining to the FY2011 lease costs is barred by the statute of limitations.”)
Parsons argued that its new costs (raised in March or May 2018) were not included in the CACO’s unilateral rate determination and thus could be heard by the Board. However, the Board didn’t accept that argument, writing –
Parsons further asserts that the additional lease costs first raised in its May 2018 letter were not considered by the government in the September 2018 unilateral rate determinations. According to Parsons, these costs were raised in its March 2019 certified claim, and thus, are properly before the Board. … However, even if Parsons were correct that it could raise a claim for new indirect costs after the establishment of the final indirect cost rates by the unilateral determination, Parsons’ claim here would be barred by the six-year statute of limitations. Parsons’ claim asserts a sum certain for FY2011 costs, but not for any later years. Thus, to be timely, Parsons’ claim would have had to have been submitted by the end of 2017, but it was not submitted until March of 2019.
(Emphasis added.)
The point of this article is not to beat up on Parsons. The point of this article is to reinforce the idea that contractors must be aware of the statute of limitations language in the Contract Disputes Act, and that they must be aggressive in asserting their rights before the statute of limitations kicks-in. Each of us needs to watch that timeclock and, when it approaches the deadline, we need to take the appropriate action.
For example, if you submitted your proposal to establish final billing rates in July, 2019, then you have until July, 2025 to establish final billing rates. (Unless the parties agree to “toll” the statute of limitations.) If it is January, 2025 and the rates haven’t yet been finalized, it’s time to discuss next steps with your legal counsel. It may be appropriate to submit a claim at that time in order to preserve your right to appeal.
If you don’t submit a proactive claim and you let the CDA statute of limitations timeclock expire without having done so, then you may have to live with whatever decision your ACO, or DACO, or CACO makes.
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