“I’m Not a Large Business, I’m Diversified!”
Ah, the old refrain plays once again, like the coda in “Layla” by Derek and the Dominos.
What are we talking about? We’re talking about misrepresentation of the size of a business—which can land a company in some seriously hot water.
This is not a new issue. For instance, we previously reported on the problems faced by GTSI, a decent-sized Federal contractor that was alleged to have been “an active participant in a scheme that resulted in contracts set-aside for small businesses being awarded to ineligible contractors and with contracts not being performed in accordance with applicable law, regulations and contract terms …”
While we may sometimes cynically comment on the “games” associated with socio-economic reporting, and the various bureaucratic rules that govern how companies claim credit for awarding subcontracts to the various categories of small business entities, the fact remains that the ability to meet one’s small business socio-economic goals can often be a competitive advantage in the Federal marketplace. Not to mention that a large portion of Federal contract awards are set-aside for small businesses. So it clearly behooves a company to claim small business size status when permitted to do so by FAR Part 19 and the SBA regulations at Title 13 of the Code of Federal Regulations.
On the other hand, misrepresentation of business size can be a problem, as two Orlando men have learned (to their chagrin), according to this story in the Tampa Bay Times. The story, penned by William Levesque, reported that Eduardo Blanchet and Daniel Guillan were founders of B.I.B. Consulting—a (legitimate) small business that won a $50 million contract from the U.S. Special Operations Command (SOCOM) to provide foreign-language instruction services. (Apparently the Defense Language Institute Foreign Language Center at the Presidio of Monterey was unavailable to provide those services.)
So far so good. The two men and their company were within the bounds of propriety. But then (allegedly) the two men formed another company—MiLanguages—to compete for another $100 million SOCOM language service contract. Together, the two (allegedly) ran both companies and even established MiLanguages as a B.I.B. Consulting subcontractor; but together, the two affiliated companies no longer qualified for treatment as small businesses. Unfortunately MiLanguages (allegedly) certified to SOCOM that it was a small business when bidding on the new contract, and it was (allegedly) awarded to them on that basis.
According to Mr. Levesque’s story—
The indictment said the men made false representations and submitted false information to the Small Business Administration to win designation as a small business eligible to receive the SOCom contract.
In 2007, the men instructed an attorney to ‘send a letter to the SBA size program manager relaying that MiLanguages and B.I.B. had no common officers, shareholders or employees … and that a 'clear line of fracture' existed between B.I.B. and MiLanguages,’ the indictment said.
In reality, the indictment said, the two men set up MiLanguages bank accounts in which they were the only signatories.
The government has moved to seize the assets of the company and two men, including more than $7 million in bank accounts, property and vehicles. The government said it also will seek a $100 million forfeiture judgment against them.
Yeesh! The Feds sound upset, don’t they?
Readers of this website blog should be clear that affiliated entities under common control count together when determining business size. Businesses that do not qualify as small businesses under the applicable NAICS code should not certify that they are small businesses. Period.
Further, FAR Part 19 is tricky and needs to be read in conjunction with the SBA regulations that lie outside of the FAR. When in doubt, have a knowledgeable and experienced attorney guide you through the calculations—lest you wind up as our two friends from Orlando did.
Disclose Internal Audit Reports at Your Own Risk
Recently we wrote about how Fluor Hanford’s own internal audit reports were used against it, in order to support allegations that the company’s management was well aware that its “weak internal control systems” created opportunities for its employees to misuse purchase cards (and to receive supplier kick-backs). We asserted that—
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Internal audit reports are important. Internal auditors should be of high quality and so should their reports. Internal audit reports that report bad facts should not be ignored; indeed, management should take quick and decisive action to address the findings.
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Internal audit reports that point out lax internal controls, which management ignores, become really effective “smoking guns” that will be used against the organization in a court of law.
But we were reminded that there’s another aspect of internal audit reports that must be considered during litigation. Our readers understand that some internal audit and/or compliance reports are prepared under privilege for internal and/or external counsel. Disclosure of such reports can prove problematic.
Karen Manos, writing in the May 2011 edition of West’s Government Contract Costs, Pricing & Accounting Report, reported that—
A U.S. Magistrate Judge ruled from the bench that Oracle’s disclosure of a privileged report in response to a General Services Administration Inspector General subpoena resulted in a broad subject matter waiver of all communications related to the report. … Oracle provided the IG a copy of the report of its outside counsel’s compliance review [related to compliance with the GSA Price Reductions clause]. … The Judge [found that] 'Defendants attorney-client privilege is waived with respect to all communications between defendants and [outside law firm] relating in any way to the contract in issue and/or the review performed.' ...
Ms. Manos, a widely respected Government Contracts attorney with Gibson Dunn, cited the case as: U.S. ex rel Frascella v. Oracle Corp., No. 1:07 cv529 (E.D. VA Mar. 30, 2011), ECF No. 186. A client advisory from McKenna, Long & Aldridge can be found here. The MLA attorneys wrote, “… as the Oracle case demonstrates, clients and counsel must carefully consider the potential implications -- both good and bad -- of disclosing to the government any compliance-related information prepared by counsel. “
On a related note, Francine McKenna posted an article on her Forbes blog discussing the interplay between the Sarbanes-Oxley Act of 2002 (SOX), internal controls, and fraud. In that article, she reported a KPMG conclusion that, “Companies with weak or non-existent internal controls over financial reporting are more susceptible to fraud and they take longer to uncover.“ She also noted a recent Financial Executives International (FEI) survey that, “the primary owner of Sarbanes-Oxley compliance initiatives in most organizations is still the internal audit function.” She quoted Richard Chambers (CEO of the Institute of Internal Auditors or IIA) as saying—
While nothing about that contravenes our professional standards, the best role for Internal Audit to play in Sarbanes-Oxley compliance initiatives is to provide overall assurance on the effectiveness of the organization’s documentation and testing of internal controls and Section 302 certification process, rather than to be down in the weeds doing the actual documentation and testing of controls instead of management.
To wrap this up, we want to emphasize the importance of performing internal audits and testing internal controls. That said, we think companies ought to distinguish between internal audits that test SOX-related controls over financial reporting, and internal compliance reviews that test the operational controls embedded in contractor “business systems”. We are skeptical that the knowledge and skill sets between the two are easily transferable.
And, as noted by Ms. Manos and by the MLA attorneys, there’s a third category of internal reviews—the extraordinary internal reviews performed under attorney-client privilege. Such reviews should only be provided to outsiders (including government personnel such as DCAA auditors or Agency Inspectors General) under very carefully considered circumstances, lest the door be opened for qui tam relators and opposing counsel to obtain a bounty of documents that would have otherwise been protected.
Ask yourself how your company addresses its internal audit function, and whether there is a separate group that evaluates your “business systems”. Are you investing enough into detecting wrong-doing or, like other contractors in the news, are you pretending there’s no risk to your company or its shareholders?
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NAVAIR Can’t Manage UCAs, According to DOD Inspector General
We’ve been toying with writing another article about the on-going DOD Oversight Wars, focusing (again) on Senator Grassley’s attacks on the DOD Inspector General and the DOD IG’s response to those attacks. But frankly, POGO is all over it and there’s not much new to report. So instead we’ll discuss a recent (June 8, 2011) DOD IG audit report that calls into question NAVAIR’s management of Undefinitized Contract Actions (UCAs). What caught our eye was how the DOD IG pointed the finger of blame at NAVAIR’s contractors.
The DOD IG reviewed 52 UCAs worth $1.6 Billion at the Naval Air Systems Command (NAVAIR) and found the following—
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4 UCAs were inadequately justified in terms of urgency; i.e., why couldn’t NAVAIR have just issued actual priced contracts?
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29 UCAs were not definitized within the statutory/regulatory timeframe (180 days)
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5 UCAs were definitized, but at unsupported contractor profit rates
As we noted above, what caught our eye was the IG’s finding that 29 UCAs were definitized late “because the contractor submitted untimely or inadequate proposals, Government personnel changed requirements after UCA issuance, and additional contributing factors.”
This is not the first time we’ve addressed Government management/administration of UCAs. See, for example, this article in which we generally discussed UCAs and reported that the U.S. Air Force was addressing the problem of untimely definitization of UCAs by better partnering with contractors through what it called a “proposal kick-off meeting” that was to be chaired by the cognizant Contracting Officer and supported by DCAA. We reported that DCAA issued MRD 10-PSP-016(R) that directed its auditors to “attend these meetings to obtain an understanding of the contractor’s proposal, including supporting data.” We also opined (as we usually do) on the Air Force’s approach, posting—
We generally endorse any process that would definitize UCAs within the required timeframes, but we wonder if the foregoing Air Force and DCAA direction might not be avoiding addressing the real problem—which is insufficient identification of Government requirements, and subsequent changes to those requirements—which prevents contractors from submitting timely and comprehensive proposals. (See the GAO reports linked above, which show the lack of defined requirements is a much a problem as any lack of cost or pricing data.) Focusing on enforcing timely contractor provision of requested data to support fact-finding and negotiations seems to be a fundamentally misplaced management emphasis—particularly since the Air Force is now endorsing DCAA’s arbitrary and punitive ‘denial of access to records’ process.
Obviously, then, we were already sensitized to any assertions that the root cause of untimely UCA definitization was untimely or inadequate contractor cost proposals. Indeed, as we reviewed this DOD IG audit report, we saw that (despite the IG’s soundbite quoted above) there were a number of causes for NAVAIR’s inability to timely definitized its UCAs.
For example, on page 13 of the audit report, the IG stated that there were “multiple contributing factors” including “a lack of contracting personnel to complete definitization, contractors not submitting adequate proposals in a timely manner, or Government personnel changing contract requirements after NAVAIR contracting personnel issued the UCA.” In addition, “the contractors’ proposal pricing updates and extended contract negotiations with Government personnel also impacted NAVAIR contracting personnel’s ability to definitize UCAs within the required time frames.” On page 21 of the audit report, the IG stated that another causal factor was “untimely Defense Contract Management Agency and Defense Contract Audit Agency response times.” In addition, “NAVAIR administration delays, and a contractor’s sale of part of its business” were also listed as causal factors.
The DOD IG audit report also reported the following:
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The contracting officer also stated that it took about 3 months to prepare the business clearance memorandum (BCM) for negotiations because of the contract specialist’s heavy workload and the need to examine a major subcontractor’s proposal for the UCA definitization.
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Contracting personnel also cited slow Defense Contract Management Agency and Defense Contract Audit Agency response times as a contributing factor for late definitization. NAVAIR contracting personnel explained that the two Government agencies were slow to submit questions to the contractor and that the questions submitted were vague. In addition, NAVAIR contracting personnel stated that the contractor was even slower to respond to the information requests and, ultimately, NAVAIR contracting personnel had to act as an intermediary between the two parties. As a result, NAVAIR contracting personnel definitized the UCA 588 days after receipt of a qualifying proposal.
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Contractors had to prepare and certify enormous amounts of cost or pricing data before definitization or altered the pricing of the proposal, which required additional Government review. Specifically, contractors updated or rescinded forward pricing rate agreements that were in place with the Defense Contract Management Agency during the undefinitized period or provided updated actual costs incurred that significantly changed the proposal price. NAVAIR contracting personnel also delayed negotiations to jointly definitize two UCAs that enabled the contractor to obtain better sub-vendor pricing for increased quantity.
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The contracting officer stated that the contractor withdrew from the agreement due to changes in its cost accounting system and disclosure statements. The contracting officer stated that negotiations were impacted because contracting personnel not only had to negotiate differences in direct inputs, such as for hours and materials, but also significant differences in rates. NAVAIR contracting personnel were required to update the negotiation position to reflect the Defense Contract Management Agency’s December 16, 2009, forward pricing rate recommendation. The contracting officer also attributed late definitization to the program office’s delayed release of its technical evaluation. As a result, NAVAIR contracting personnel definitized the UCA 252 days after receiving a qualifying proposal.
To be fair, the DOD IG also reported problems with contractors, including finding that “Contractors were slow to submit counteroffers and disagreed with Government personnel on contract terms, cost reasonableness, and profit.” On page 22 of the audit report, the IG stated that, “NAVAIR contracting personnel did not receive adequate contractor proposals or timely submittals, which contributed to the late definitization of seven UCAs.” The IG also reported that—
The contractor proposals were inadequate because the contracting officers determined that they did not contain sufficient information to enable DoD personnel to conduct complete and meaningful audits or determined the proposals contained questionable costs. Contractors use of multiple subcontractors and proposal resubmissions also added time to the undefinitized period. Contractor proposal resubmissions sometimes required that Defense Contract Audit Agency personnel perform additional audit work. If the revised proposal is deemed inadequate then the revision process starts again. If the contractor does not submit a timely qualifying proposal, the contracting officer should suspend or reduce payments to the contractor in accordance with DFARS Subpart 217.74 and NAVAIR Instruction 4200.33D.
We are worried that the foregoing opinion—that if a contractor fails to submit a timely “qualifying” proposal then payments under the UCA should be reduced or suspended—fails to acknowledge the role that DCAA plays in determining proposal adequacy. Though the audit report stated that “contracting officers determined” the proposals lacked sufficient information to enable “complete and meaningful audits,” we all know that DCAA made that call for the CO. It is highly unlikely that any Contracting Officer is going to determine, on his or her own, whether a proposal is adequate for audit. That means that the DCAA auditor made the call. And in our experience, that DCAA auditor determination may not be as objectively based as one would care for.
In conclusion, as in the case of the GAO reports we have previously discussed, we don’t agree that the more important causal factor for untimely UCA definitization is contractor proposal problems. Instead, the body of this DOD IG report revealed multiple causal factors—many of which one might reasonably think were up to the DOD oversight bureaucracy (including DCMA and DCAA) to fix.
So again, instead of beating-up defense contractors, we would suggest that the DOD IG focus on its own shop and recommend staffing enhancements and the streamlining of existing overly bureaucratic processes.
Fluor Settles False Claims Allegations for $4 Million
On June 17, 2011, the U.S. Department of Justice reported that Fluor Hanford, Inc., a wholly owned subsidiary of Fluor Federal Services, Inc. and Fluor Corporation, had agreed to pay the U.S. Government $4 million to resolve allegations of violations of the False Claims Act. Flour Hanford is the entity that operates and manages mixed radioactive waste at the Department of Energy’s Hanford Nuclear Site in Hanford, Washington.
According to one website—
Hanford is one of five major Department of Energy nuclear processing plants and R&D laboratories in the United States. It has more than ten industrialized areas (most with reactors of some kind) located on a 562 square mile site on the Columbia River in eastern Washington. Originally built in secret to produce plutonium for the Manhattan Project, the installation manufactured nuclear materials used in bombs for decades after the war, and it has become one of the most contaminated sites in the country, with millions of gallons of radioactive waste, much of it migrating through the soil towards the Columbia River. More than 10,000 people work on clean-up issues at the reservation, most of which continues to be closed to the public.
According to the DOJ press release—
Between 2003 and 2008, Fluor employed individuals known as material coordinators, whose job responsibilities included purchasing supplies for use by Fluor on its DOE contract. Between 2003 and 2008, three such material coordinators, Susanna Zuniga, Gregory Detloff and Paul Kempf, made hundreds of fraudulent purchases using government purchase cards, using their positions and exploiting weaknesses in Fluor’s internal control system to funnel DOE funds to themselves. … Additionally, between 2005 and 2008, at least 14 Fluor material coordinators solicited, received and accepted kickbacks from a Hanford-area vendor known as Fast Pipe and Supply Company and its owner, Shane Fast. These kickbacks, which took the form of cash, tickets to sporting events, gift cards and other things of value, were intended to influence the material coordinators to purchase from Fast rather than competing vendors. In return for these kickbacks, the 14 Fluor material coordinators did more than $3.5 million in business with Fast.
Notice that the DOJ went out of its way to note that Fluor’s internal controls were weak and permitted the miscreants to execute their fraudulent acts. Readers should remember that the False Claims Act permits either civil or criminal prosecution (or both, we suppose). The civil False Claims Statute explicitly provides that violations include reckless conduct and/or deliberate ignorance of the truth. In other words, no specific intent to defraud the Government is necessary. (NOTE: This is a layperson’s interpretation.) In other words, if the DOJ could prove that Fluor’s management was aware of lax internal controls but did nothing to address the issues, it would be well on its way to a conviction.
So you’ll understand why the DOJ not only pointed out allegedly the weak internal controls, but also announced to the world that—
As early as 2001 and repeatedly between 2001 and 2008, internal audits conducted by Fluor alerted it to weaknesses in its purchase card controls, weaknesses exploited by the three material coordinators. Nonetheless, Fluor failed to address these weaknesses, allowing these schemes to go undetected for years.
Oops! Those are some troubling facts ….
And about those material coordinators – the DOJ also announced that, “Five former Fluor employees have been indicted for their participation in the fraudulent schemes. Four of the individuals have pleaded guilty, with the fifth awaiting trial.”
Lessons learned for the rest of us?
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Internal controls are important and enhancing them is an investment in lowering your future litigation (not to mention settlement) costs.
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Internal audit reports are important. Internal auditors should be of high quality and so should their reports. Internal audit reports that report bad facts should not be ignored; indeed, management should take quick and decisive action to address the findings.
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Internal audit reports that point out lax internal controls, which management ignores, become really effective “smoking guns” that will be used against the organization in a court of law.
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