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Apogee Consulting Inc

Another Peek into the Fraud Files

Nick Sanders
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fraudAs we write this, Hosni Mubarak has just resigned and regime change is in the air. From Tunisia to Egypt to … DCAA? But enough about contract audit. Let’s talk about fraud.

We talk about fraud so much, of course, because there is so much fraud in the public procurement process to talk about. Though we do not always agree with government oversight officials or “independent” gadfly organizations when they accuse government contractors of being war profiteers and/or crooks, the fact is that there are enough crooked contractors to taint them all. (And as we keep pointing out, there seem to be as many crooked government officials in the game. as well.) We write about fraud in the government contracting arena because we think contractors need to learn from the mistakes of others. We think contractors ought to invest in internal control systems, and employee training, and in robust “self-governance” mechanisms to assure themselves that their employees are toeing the straight-and-narrow line of compliant and ethical business practices.

The prevailing zeitgeist in today’s government contracting environment seems to be that simply having a written ethics/business conduct policy, and pushing training videos to employees once or twice per quarter, is a sufficient investment. In these times of intense pressure to cut non value-added overhead spending, we are told, nobody has the budgets to stand-up anything more than a token internal audit department. Besides, we are told too often, companies’ Sarbanes-Oxley certifications are sufficient to demonstrate both adequate controls and compliance therewith. So there’s no budget—and no need—to establish the kind of internal control systems that both detect and prevent employee wrongdoing.

Yeah, we’ve heard that same refrain over the past 20 years, in good times and in bad. Nobody, it seems, wants to spend sufficient money to provide robust assurance that employee wrongdoing is not taking place. We get it. No VP or other corporate executive ever earned a bonus for suggesting. “Hey, you know what? Let’s spend some more overhead.” Quite the opposite in fact—as executives routinely score big incentive comp checks for cutting overhead and “streamlining” back-office processes.

Yet when that first subpoena hits, or when that first DCIS phone call is received—and when that first of many checks to outside investigators and legal counsel gets written—somehow nobody ever thinks to point the fingers back at those company executives who vetoed putting preventive and detective controls in place. In 30 years of this business, we have never, ever, heard about Boards of Directors or Compensation Committees or Audit Committees ever reaching back two or three years and asking for the return of those old bonus checks because the executives’ “innovative out-of-the-box” idea to cut overhead by cutting back on non value-added personnel such as internal auditors and contract compliance personnel ended-up costing the company millions in dollars. (Not to mention the hits to the stock price and to the brand reputation.) We have never heard about companies holding those decision-makers—those that earn the big bucks—accountable for their decisions.

Moreover, what happens over and over is that people get awarded even bigger bonus checks for successfully managing the crisis—the same crisis that could have and should have been avoided in the first place. Instead of being held accountable for shorting the shareholders and the customers by cutting-back on controls, the executives are rewarded for seeing their crisis through to the end (which is typically a DOJ settlement involving a large payment and a deferred prosecution agreement).

And by the way, if our point of view has not been clearly communicated in previous blog articles, we feel very much the same about Federal government agencies as well as military commands, where everybody seems quite happy to spend millions of dollars on large multi-month investigations of suspected miscreants—but nobody wants to put effective controls into place that would prevent wrongdoing in the first place.

So, let’s jump off the soapbox and peek into the fraud files to see which entities failed to implement adequate internal controls.

Foreign Corrupt Practices

You are responsible for the actions of your foreign subsidiaries, as Maxwell Technologies, Inc. learned to its chagrin. According to the Dept. of Justice, “Maxwell Technologies Inc., a publicly-traded manufacturer of energy-storage and power-delivery products based in San Diego, has agreed to pay an $8 million criminal penalty to resolve charges related to the Foreign Corrupt Practices Act (FCPA) for bribing Chinese government officials to secure sales of Maxwell’s products to state-owned manufacturers of electric-utility infrastructure in several Chinese provinces.” According to the DOJ—


Maxwell’s wholly-owned Swiss subsidiary, Maxwell S.A., engaged a Chinese agent to sell Maxwell’s products in China. From at least July 2002 through May 2009, Maxwell S.A. paid more than $2.5 million to its Chinese agent to secure contracts with Chinese customers, including contracts for the sale of Maxwell’s high-voltage capacitor products to state-owned manufacturers of electrical-utility infrastructure. The agent in turn used Maxwell S.A.’s money to bribe officials at the state-owned entities in connection with the sales contracts. Maxwell S.A. paid its Chinese agent approximately $165,000 in 2002 and increased the payments to the agent to $1.1 million in 2008. In its books and records, Maxwell mischaracterized the bribes as sales-commission expenses. According to court documents, Maxwell’s U.S. management discovered the bribery scheme in late 2002. … Maxwell also reached a settlement of a related civil complaint filed by the SEC charging Maxwell with violating the FCPA’s anti-bribery, books and records, internal controls and disclosure provisions. As part of that settlement, Maxwell agreed to pay $5.654 million in disgorgement of profits and nearly $700,000 in prejudgment interest relating to those violations.

Let’s see, how many internal auditors could make how many trips to Maxwell’s foreign subsidiaries for how long for $14 million dollars? We wonder if Maxwell’s shareholders are asking themselves that question.

Corrupt Foreigners

Export controls are burdensome and we understand that the Obama Administration is moving to streamline them in order to facilitate exports (and create jobs). In the meantime, companies need to be careful to whom they sell sensitive items, as this DOJ announcement warns. According to the DOJ—

From about February 2004 through about August 2007 … [Milad] Jafari engaged in a conspiracy to defraud the United States and to cause the export of goods to Iran in violation of the U.S. embargo and without the required U.S. government licenses for such exports.  In carrying out the conspiracy, Jafari and his conspirators allegedly solicited orders from customers in Iran and purchased goods from U.S. companies on behalf of these Iranian customers.  Jafari and others allegedly wired money to the U.S. companies as payment, concealed from the U.S. companies the end-use and end-users of the goods, and caused the goods to be shipped to Turkey and later to Iran.

For instance … in July 2006, Sanam Industrial Group – an entity in Iran that is controlled by Iran’s AIO and has been sanctioned by the United States and United Nations for involvement in nuclear and ballistic missile activities -- issued to Jafari’s company, STEP, a request for quote for 660 pounds of a specialized steel welding wire with aerospace applications.  In May 2007, Jafari allegedly caused an order to be placed for 660 pounds of this exact type of welding wire with a Nevada company. The following month, the Nevada firm received more than $38,000 from Jafari’s company, Macpar.

In another instance … in August 2006, Heavy Metals Industries in Iran placed an order with Jafari’s company, STEP, for 3,410 pounds of precipitation hardening steel made in the United States.  The following year, Jafari caused Macpar to place an order with an Ohio company for 4,410 pounds of a high-grade, temperature resistant, stainless steel known to have aerospace applications.  Jafari informed the Ohio firm that the steel would not be shipped to Iran.  In August 2007, the stainless steel shipment was detained by the Department of Commerce’s Office of Export Enforcement before it left the country.

Corrupt Government Employees

Osama Esam Saleem Ayesh, 36, was a resident of Jordan hired by the Department of State as a shipping and customs supervisor at the embassy in Baghdad, who oversaw the shipments of personal property of embassy officials and personnel in Iraq. According to the DOJ’s press release—

Ayesh used his State Department computer to create a phony e-mail account in the name of a real Iraqi contractor and used that e-mail account to impersonate the contractor in communications with embassy procurement officials. He also established a bank account in Jordan under his wife’s name to further his criminal scheme and falsified wire transfer instructions that directed U.S. government electronic funds transfers to that account.

Court records and evidence at trial [where he was convicted] showed that Ayesh was personally involved in establishing and operating blanket purchase agreements for the provision of customs clearance and delivery services to the U.S. Embassy in Baghdad. From November 2008 to June 2010, Ayesh submitted false invoices in the name of an Iraqi contractor – which Ayesh fabricated on blank stationery he kept in his embassy apartment – and caused the U.S. Department of State to wire $243,416 to his wife’s account in Jordan.

Corrupt Corporate Employees

After a three-week trial, the jury found Wen Chyu Liu, aka David W. Liou, 74, of Houston, guilty of one count of conspiracy to commit trade secret theft and one count of perjury. Liu/Liou was a former research scientist with the Dow Chemical Company, where he was employed from 1965 to 1992. According to the DOJ—

Liou conspired with at least four current and former employees of Dow’s facilities in Plaquemine and Stade, Germany, who had worked in Tyrin CPE [chlorinated polyethylene] production, to misappropriate those trade secrets in an effort to develop and market CPE process design packages to various Chinese companies. 

Liou traveled extensively throughout China to market the stolen information, and evidence introduced at trial showed that he paid current and former Dow employees for Dow’s CPE-related material and information. In one instance, Liou bribed a then-employee at the Plaquemine facility with $50,000 in cash to provide Dow’s process manual and other CPE-related information.

So, basically, this former employee was helping to establish a new CPE factory in China, aided by current company employees. That new factory was going to compete with Dow, not only impacting its ability to sell into China, but also to sell its goods globally. We’re guessing his Dow retirement package was not to his liking.

Conclusion

The DoJ doesn’t provide much helpful information that tells us how this malefactors were caught. But we think these vignettes provide evidence that fraud is rampant, both at contractors and in the ranks of government employees. Even retirees seem to be getting into the act!

If you think your workforce is immune to wrongdoing, if you think your government customer is beyond reproach, if you think your foreign subsidiaries are all following your corporate guidance to the letter, well we hope you’re right. But we think it would be a whole lot better, for both you and your shareholders, if you checked once in a while to make sure.

 

OFPP Urges Contracting Officers to Communicate with Industry

Nick Sanders
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In September 2010, DCAA published audit guidance that encouraged its auditors to support DCMA contracting officers during contractor negotiations. A week later, the audit agency published additional guidance (and a training presentation) to its auditors that spelled-out “Rules of Engagement” addressing communication with requestors as well as those being audited. Importantly, DCAA HQ told its auditors that “communicating with the contractor and requestor throughout all phases of an audit is necessary to comply with other GAGAS requirements.”

We were pleased (with some hesitations and concerns that we expressed in the articles linked in the above paragraph) with DCAA’s belated realization that communication reduced errors and led to increased quality in its audit reports. Similarly, we were pleased when Dan Gordon, Administrator for Federal Procurement Policy issued guidance to the Federal government’s acquisition community designed to encourage communication between Contracting Officers and private industry.

As a side note, the Office of Federal Procurement Policy (OFPP) is housed within the Office of Management and Budget. It “plays a central role in shaping the policies and practices federal agencies use to acquire the goods and services they need to carry out their responsibilities.” So when Mr. Gordon tells Contracting Officers to communicate with industry, we trust that they listen to him.

Why is OFPP so concerned with increasing communication? As the memo explains—

Access to current market information is critical for agency program managers as they define requirements and for contracting officers as they develop acquisition strategies, seek opportunities for small businesses, and negotiate contract terms. Our industry partners are often the best source of this information, so productive interactions between federal agencies and our industry partners should be encouraged to ensure that the government clearly understands the marketplace and can award a contract or order for an effective solution at a reasonable price. Early, frequent, and constructive engagement with industry is especially important for complex, high-risk procurements, including (but not limited to) those for large information technology (IT) projects.

The OFPP memo requires Executive Branch agencies to develop a “vendor communication plan” that will—

… discuss how the agency will reduce unnecessary barriers, publicize communication opportunities, and prioritize engagement opportunities for high-risk, complex programs or those that fail to attract new vendors during re-competitions.

The memo lists 10 common “misperceptions” about government/industry communications and dispels each in turn. We’ll list the highlights but readers should refer to the memo for details.

The 10 Myths About Vendor Communication—BUSTED!

MYTH: “We can’t meet one-on-one with a potential offeror.” FACT: Government officials can generally meet one-on-one with potential offerors as long as no vendor receives preferential treatment.

MYTH: “Since communication with contractors is like communication with registered lobbyists, and since contact with lobbyists must be disclosed, additional communication with contractors will involve a substantial additional disclosure burden, so we should avoid these meetings.” FACT: Disclosure is required only in certain circumstances, such as for meetings with registered lobbyists. Many contractors do not fall into this category, and even when disclosure is required, it is normally a minimal burden that should not prevent a useful meeting from taking place.

MYTH: “A protest is something to be avoided at all costs - even if it means the government limits conversations with industry.” FACT: Restricting communication won’t prevent a protest, and limiting communication might actually increase the chance of a protest – in addition to depriving the government of potentially useful information.

MYTH: “Conducting discussions/negotiations after receipt of proposals will add too much time to the schedule.” FACT: Whether discussions should be conducted is a key decision for contracting officers to make. Avoiding discussions solely because of schedule concerns may be counter-productive, and may cause delays and other problems during contract performance.

MYTH: “If the government meets with vendors, that may cause them to submit an unsolicited proposal and that will delay the procurement process.” FACT: Submission of an unsolicited proposal should not affect the schedule. Generally, the unsolicited proposal process is separate from the process for a known agency requirement that can be acquired using competitive methods.

MYTH: “When the government awards a task or delivery order using the Federal Supply Schedules, debriefing the offerors isn’t required so it shouldn’t be done.” FACT: Providing feedback is important, both for offerors and the government, so agencies should generally provide feedback whenever possible.

MYTH: “Industry days and similar events attended by multiple vendors are of low value to industry and the government because industry won’t provide useful information in front of competitors, and the government doesn’t release new information.” FACT: Well-organized industry days, as well as pre-solicitation and pre-proposal conferences, are valuable opportunities for the government and for potential vendors – both prime contractors and subcontractors, many of whom are small businesses.

MYTH: “The program manager already talked to industry to develop the technical requirements, so the contracting officer doesn’t need to do anything else before issuing the RFP.” FACT: The technical requirements are only part of the acquisition; getting feedback on terms and conditions, pricing structure, performance metrics, evaluation criteria, and contract administration matters will improve the award and implementation process.

MYTH: “Giving industry only a few days to respond to an RFP is OK since the government has been talking to industry about this procurement for over a year.” FACT: Providing only short response times may result in the government receiving fewer proposals and the ones received may not be as well-developed - which can lead to a flawed contract. This approach signals that the government isn’t really interested in competition.

MYTH: “Getting broad participation by many different vendors is too difficult; we’re better off dealing with the established companies we know.” FACT: The government loses when we limit ourselves to the companies we already work with. Instead, we need to look for opportunities to increase competition and ensure that all vendors, including small businesses, get fair consideration.

Note to Readers: In what is of course a completely unrelated news story, GovExec.com has reported that bid protests “are on the rise at GAO, reaching a 15-year high in fiscal 2010.” Robert Brodsky told readers that—

During the past three years, GAO protest filings have skyrocketed 39 percent, reaching 2,220 in fiscal 2010, the highest point since 1995. There are several explanations for the increase, most notably the agency's expanded jurisdiction to task-and-delivery order protests of more than $10 million. In 2010, 189 task order contracts were protested.

However, simply filing a protest is not enough to change the government’s contract award decision. As Mr. Brodsky reported—

While protest filings are on the rise, the percentage of cases GAO sustained has remained flat at roughly 20 percent. Most cases never get to that point as contractors find other ways to settle disputes in their favor. Agencies often will eliminate the middleman and renegotiate directly with the contractor.

The article discussed fears of an even steeper increase in bid protests. It said—

With contract spending expected to decline in the coming years, particularly at Defense, and the larger economy still in slow recovery, some analysts believe the incentives for filing protests will only grow stronger. ‘Companies are concerned about being locked out of the market and may think it makes more sense to protest,’ says Rich Rector, chairman of the government contracts practice and partner at the Washington law firm DLA Piper. ‘With the decline in spending, these are tough economic times, and they are getting tighter in the government space. It could drive people not to be as sanguine when they lose a contract.’

The article discussed Mr. Gordon’s efforts to stem the tide of bid protests. It reported—

 

Some agencies, however, might be going overboard to protect against protests. Too often, contracting officers issue awards based on initial proposals without conducting further dialogue with bidders for fear that discussions are a ‘protest-rich area,’ Gordon says. The result, he says, is the government might be missing out on better or less expensive proposals. In recent months, OFPP has begun meeting with contracting officers in an attempt to ‘myth bust’ the idea that talking with vendors will lead to protests.  

 

‘We need to talk with vendors early and often in our acquisitions,’ Gordon says. ‘And not talking with them to avoid protests only hurts the government, particularly when more communication could help the agency better figure out what it needs and how to buy it.’

This brings us all back full-circle to the beginning of our article. Whether it’s auditors talking to those they audit or contracting officers talking to bidders, communication is a good thing. And that is the official policy of the U.S. Government.

 

Oracle Settles Sun Microsystems’ GSA SNAFU for $46 Million

Nick Sanders
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On January 31, 2010, the U.S. Department of Justice announced that Oracle America had agreed to pay $46 million in order to settle a False Claims Act lawsuit filed against Sun Microsystems (whom Oracle acquired in 2010), related to Sun’s federal contracts, including its contracts with the General Services Administration (GSA).

As the DOJ reported in its announcement—

This settlement resolves allegations under the False Claims Act (FCA) and Anti-Kickback Act that Sun knowingly paid kickbacks to systems integrator companies in return for recommendations that federal agencies purchase Sun’s products. Sun executed agreements with consulting companies that provided for the payment of fees each time the companies influenced a government agency to purchase a Sun product. These kickback allegations are part of a larger, ongoing investigation of government technology vendors that has resulted in settlements to date with six other companies.

We’ve previously reported on this series of lawsuits. See, for example, this article or maybe this one. We’ve even ranted about commercial high-tech companies and their apparent propensity to be accused of fraudulent activities in connection with their government contacts (e.g., right here). So this latest settlement is not really a news flash to us.

The DOJ also noted that—

The settlement also resolves claims under the FCA that Sun’s 1997 and 1999 GSA Schedule contracts were defectively priced because Sun provided incomplete and inaccurate information to GSA contracting officers during contract negotiations, as well as claims that the incomplete and inaccurate information resulted in defective pricing of Sun’s contract with the U.S. Postal Service and GSA Schedule contracts held by two resellers of Sun products. At the time Sun entered into its contracts with GSA to sell information technology products and services to federal agencies, applicable regulations and contract provisions required Sun to fully and accurately disclose to GSA how it conducted business in the commercial marketplace so that GSA could use that information to negotiate a fair price for government customers using the GSA contracts to purchase Sun products and services. The defective pricing information that Sun disclosed to GSA was subsequently relied on by the Postal Service in negotiating a contract with Sun, as well as by GSA in negotiating contracts with two resellers of Sun products.


We wonder whether Oracle was aware of these cases when it acquired Sun Microsystems, and whether its “due diligence” properly valued these contingent liabilities. Of course, $46 million is just a small blip on Larry Ellison’s massive radar screen of revenue but, nonetheless, it’s got to sting a little.

 

Is it Time to Disband DCAA? Media Pundits and PWACs Weigh-in

Nick Sanders
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We love seeing comments from our members. We also love hearing from readers who are moved to write us—whether to argue with us or ask questions. But we don’t necessarily publish everything we receive. For example, you never heard about “Jimbo”—a warranted DCMA contracting officer who wrote seeking advice on how to resolve a dispute between DCAA and one of his contractors regarding some typically bizarre auditor assertions.

Similarly, though we’re going to dedicate this article to “San Francisco Fan,” you are not going to see the various emails that led to it. Except we’ll quote one of SFF’s last comments—“Ok, gotta run.  Thanks for listening to me rant.  This may make a good article for your website.“ Well, yes.

We happen to agree with San Francisco Fan’s comments and, indeed, we were already gathering some info that would lead to this article—though SFF’s comments really added some edginess to what we were thinking. So we dedicate this article to “San Francisco Fan” and all those government contracting and accounting professionals who continue to fight for their principles in the face of mounting evidence that the DOD’s acquisition environment is breaking down around them.

Now, on to today’s article, in which we ponder the question, “Is it time to disband DCAA?”

Background

Recently we posted an article on the a hearing conducted by the Senate Committee on Homeland Security and Governmental Affairs (HSGA) and its ad hoc Subcommittee on Contracting Oversight, Co-Chaired by Senators Claire McCaskill and Scott Brown. While ostensibly the hearing was to focus in a broad sense on how the Federal government conducted audits of its contractors, we noted that particular attention was paid to the Defense Contract Audit Agency (DCAA) and its role in auditing non-DOD agencies (such as NASA and the Department of Energy). The question on everybody’s mind was, “Since DCAA is already auditing so many non-DOD contracts, why not go ahead and simply pull DCAA out of the DOD and make it the Federal Contract Audit Agency?” Perhaps unsurprisingly, answers to that question varied.

Our article focused on the written testimony of three panelists: DCAA Director Patrick Fitzgerald, Inside-the-Beltway Government Contracts Attorney Sandy Hoe, and the Project-on-Government-Oversight (POGO’s) Nick Schwellenbach. We’ll summarize the key points, since they directly bear on today’s question.

  • DCAA’s productivity has dropped in recent years. And by “dropped” we mean “plummeted like a big boulder plunging off a steep cliff in a high-gravity environment.” We first reported on DCAA’s audit report statistics here. (In fact, we included that damning chart in our letter to the DAR Council commenting on the latest proposed DFARS “business systems rule.”) It was noted by Mr. Schwellenbach that, in GFY 2010, for the first time in recorded history, DCAA actually cancelled more audits than it completed.

  • Mr. Fitzgerald publicly confirmed what most of us already knew—that DCAA had put audits of contractor incurred cost submissions and final indirect cost rate proposals on the back-burner, choosing instead to focus on more “high risk” areas such as contractor cost proposals in excess of certain dollar thresholds.

  • And, while audits were being cancelled and final rates were not being audited and funds were expiring, DCAA was devoting “between 9 and 13 percent” per year of its audit resources to auditing non-DOD agencies.

Media Reports

Let’s look at what the media (mainstream and otherwise) are saying about the situation.

First, the Center for American Progress published this on the same day of the hearing—

The senators will consider whether DCAA should be replaced by a more powerful independent agency—perhaps a Federal Contract Audit Agency—that reports to Congress and the White House. Such a move would not be unprecedented: The U.S. Treasury and subsequently the General Accounting Office, which is now the Government Accountability Office, once audited all federal contracts. … The subcommittee’s research suggests most contracts are audited by DCAA. This makes a powerful case to create one single federal audit agency. … If nondefense agencies are deterred from using DCAA services because they have to pay DCAA for its services, it may also make sense to create an independent agency available to the entire federal government. … Allowing DCAA or an FCAA to report directly to Congress may allow auditors freedom to examine contractors more critically.

Progressive-leaning Common Dreams.org posted this article on the hearing, which essentially restates the testimony of Mr. Schwellenbach—

Rather than creating a new bureaucracy, Congress could simply expand the duties of the existing Defense Contract Audit Agency (DCAA), while making it independent of the Department of Defense (DoD)…. Unlike most agencies, a new Federal Contract Audit Agency (FCAA) could save more money each year by uncovering waste and fraud than it would cost to run it. The FCAA would provide a needed check on contractors, ensuring that the government is not overcharged for goods and services.

An independent, central auditor would be more efficient than the current system, under which contract audits are performed by the DoD’s DCAA, small auditing offices in other agencies, contracted auditors, and various Inspectors General. Non-DoD agencies, which currently can utilize the DCAA for a fee, would have a greater incentive to use a central auditor.

It is essential that a new FCAA be given enough resources and authority to succeed. The DCAA is woefully understaffed, and there are also concerns that it is ‘risk-averse,’ not having issued a subpoena to a contractor in more than 20 years.

The website ExecutiveGov reported—

The terms of the debate couldn’t be clearer: should Congress consider a more robust, single agency to handle audits on contracts, which account for $530 billion in federal spending. Or, should it keep on with DCAA. And, if DCAA stays, will it be given a shorter or a longer leash?

Robert Brodsky at GovExec.com, writing the day after the hearing, reported—

The Defense Department conducted nearly 90 percent of all federal contract audits in fiscal 2009, and there appears to be little support for creating an audit unit to support civilian agencies, witnesses told a congressional panel on Wednesday. … The subcommittee found Defense conducted more than 15,000 contract audits that year, averaging one audit for every $24.7 million in procurement spending. The Pentagon, which accounted for 70 percent of total governmentwide contract spending in 2009, used DCAA for its audits.

Civilian agencies, meanwhile, conducted fewer than 1,900 audits in fiscal 2009, for an average of one audit per $511.4 million spent on contracts. Among the federal agencies conducting the fewest audits as a percentage of their total contract spending were the General Services Administration, and the Justice and State departments. DCAA performed 76 percent of civilian contract audits. The remaining 24 percent of civilian federal contract audits were performed either by the agency's inspector general, or by contractors.

Some civilian agencies, such as the Health and Human Services Department, used DCAA for 90 percent of their contract audits, the subcommittee found. But, reliance on DCAA could start to decline because the agency has seen its backlog of contract audits grow in recent years -- a byproduct of reform efforts following a series of Government Accountability Office investigations.

DCAA's pileup has led several agencies to look to the private sector for support. In fiscal 2009 and fiscal 2010, the Energy Department used DCAA for a combined 649 audits at a cost of $19.2 million. Ingrid Kolb, director of Energy's Office of Management, said the department now pays $150 per hour for a private sector accounting firm to conduct some contract audits, compared to $114 per hour for DCAA. ‘But, DCAA is stretched thin, so we had to go to an independent auditor,’ Kolb said. … Several witness testified that DCAA has been understaffed, overworked and underresourced for more than a decade.

FederalTimes.com had a quick blurb about the hearings, noting that civilian agencies aren’t deterred from using DCAA because they have to pay for audit services (as the Center for American Progress story—quoted above—suggested). The problem for non-DOD agencies is that DCAA simply isn’t responsive enough to meet their needs. The FederalTimes.com story stated—

Increasing backlogs and limited resources at the Defense Contract Audit Agency have caused non-defense agencies to seek contract audits elsewhere, agency officials told a Senate subcommittee last week.


‘One of the big issues for us is timeliness,’ Ingrid Kolb, the Energy Department's Office of Management director, told the Ad Hoc Subcommittee on Contracting Oversight. ‘And DCAA is stretched fairly thin. Sometimes it's very difficult for them to free up auditors to perform high-priority work.’

 

While DCAA charges agencies outside DoD for its services, the fee is still cheaper than hiring a private auditor, Kolb said.

POGO Weighs In

In our prior story, we were not especially kind to the Project-on-Government-Oversight’s Director of Investigations, Mr. Nick Schwellenbach. We didn’t have an issue with his facts, but we emphatically disagreed with his assertions that government contractors were taking advantage of the turmoil at DCAA, that they wanted DCAA to be risk averse, and that they wanted DCAA not to issue audit reports. We thought his otherwise interesting testimony was tainted by his unwarranted attacks on government contractors. So what did POGO have to say about the hearings?

In this article, POGO focused on DCAA’s questionable decision to stop performing audits of contractors’ “incurred costs” (also known as final indirect cost rate proposals), as well as the agency’s growing backlog of unfinished contract audits. The POGO article quoted Senator Scott Brown (Ranking Minority Member) as follows—

‘The current system is not working the way it was intended and this is evidenced by the backlog in audits that prevents contracts from being closed on in a timely manner,’ Brown said. ‘This delay in closing out contracts increases cost to contractors and to the government.’


DCAA Director Patrick Fitzgerald said the backlog of incurred cost audits has quadrupled over the last ten years. Fitzgerald, however, said he did not know the actual amount of the backlog at the hearing—a bit shocking considering how significant the problem is.

POGO published a chart that graphically illustrated how few incurred cost dollars DCAA has recently audited.

As POGO noted—

If DCAA was conducting two to four times as many incurred cost audits in years prior to FY 2010, then the slowdown to only $34 billion in incurred cost audits in FY 2010 means the backlog is getting bigger at a faster clip. Why? Because DoD contracting hasn’t slowed down, whereas DCAA has put the brakes on doing audits. In FY 2010, the DoD alone awarded $104 billion in cost-reimbursement contracts, and $162 billion was awarded government-wide…


According to Shay Assad, a high-level DoD acquisition official, a huge backlog and untimely incurred cost audits are a bad thing because it gets harder to do the audit well. ‘An incurred cost review that is not completed in a reasonable period after the costs are incurred loses contemporaneous support—employees of the contractor and the Government leave, some records are lost or are placed in deep storage,’ Assad said in written testimony in 2009…

The POGO article also quoted Department of Energy official Kolb, as follows—

‘Over the past few years, as DCAA has experienced challenges with an increasing workload and fewer resources, which have caused some concern for the Department of Energy, our ability to obtain cost-incurred audits in a timely manner has diminished,’ Kolb said. ‘In some instances at some procurement sites this has caused a backlog of closeouts for our contracts.’

The POGO article also quoted a very illuminating exchange between DCAA Director Fitzgerald and Senator Brown, which we think our readers ought to check out. So go to the POGO article (link above) and see what you think. Note that Senator McCaskill (long-time DCAA critic) was actually defending Director Fitzgerald from Senator Brown’s pointed questions!

Schwellenbach’s Testimony Critiqued

Our correspondent, San Francisco Fan, had a few things to say about Mr. Schwellenbach’s sworn testimony before the Senators. Part of his testimony included an assertion that DCAA auditors were unhappy with their agency’s leadership. Well, he didn’t have to convince us. But POGO did include an entire article dedicated to supporting that assertion. You should check out the comments. Here’s one—

I don't think many people from outside the agency have any idea just how really bad things are. There is a total state of paralysis and stagnation. Every audit file is being sent back and forth and over again from the staff to the supervisors second guessing every word and sentence. Should we say this or that ? How might this word be interpreted ? Change this font, center your initials, it is absolutely crazy. I get sick when I think of our brave men and women in the military who place their lives on the line in Iraq and Afghanistan and yet the management in DCAA are too ‘afraid’ to issue an audit report because they may get gigged by the IG or CIGIE for not being compliant with some insignificant administrative details. I have never seen such a pathetic cowardly management staff anywhere. Our military is not being well served by this agency. They are not saving any money and they are not doing any audits, they are only trying to make administratively critically perfect audit files motivated by fear of being gigged.

But San Francisco Fan didn’t dispute that part of Mr. Schwellenbach’s testimony (nor do we). SFF’s issues were with the assertions that government contractors were denying auditors access to information necessary to complete their audits, which was a cause of the growing backlog.

San Francisco Fan noted that Mr. Schwellenbach’s assertion was supported by this November 2008 article by USA Today. (Note that this was the time period of the original attacks on DCAA.) That article used a few examples of alleged denial of access to records (including that of the Bechtel Corporation) and extrapolated to the entire defense industrial base. The article reported—

The Bechtel episode illustrates how tolerant the agency can be when defense contractors slow the government's access to paper records and databases. There is no way to know how often DCAA withholds payments because it does not keep track. And it has not used its subpoena power in 20 years.


‘We have been basically on the trust system for years,’ said the auditor who attended the May meeting. ‘It did not work on Wall Street and it is not working for federal contracts,’ said the two-decade veteran of the agency who spoke on condition of anonymity because DCAA employees are not allowed to publicly discuss their work.


Negotiation, not confrontation, is the usual method for prying hard-to-get data loose from companies that make weapons or support troops in Iraq and Afghanistan. But the numbers show that approach is too cozy when the need for tough oversight is greater than ever.

The article also noted problems at Boeing, saying, “Boeing, a defense giant, did not give auditors the necessary detail to trace costs on a $1 billion space-launch contract.”

San Francisco Fan noted that not everybody felt that denial of access to records was a critical problem. In that same USA Today article, one can find the following—

In an e-mailed response to questions, Pentagon spokesman Darryn James said contractor delays and refusals to provide records are not extensive problems. He acknowledged there are times when contractors have to be reminded to provide information. Records disputes are handled at the lowest possible level by the nearly 3,500 defense auditors in the U.S. and overseas, James said. Officials at the agency's headquarters at Fort Belvoir, Va., have had to step in just four times since 2003, he said. All four disagreements were settled without going to court.

 

‘It should be considered a success that DCAA has been able to get the information it needs without having to resort to subpoena authority,’ James said. James described the Bechtel situation as an unusual case that was resolved after the agency and the company worked out a way to answer auditor requests for records more promptly.

Moreover (as SFF pointed out), the Boeing situation was not exactly as described by USA Today. SFF wrote—

The Boeing paragraph makes it sound like they wouldn’t provide any data to support the proposal.  …  This is actually based on the July 2008 GAO report, and the report says ‘At the end of the audit, the workpapers indicated that Contractor A had not responded to several requests for information that would have helped the auditors identify costs related to lost commercial business. For example, Contractor A did not provide information on the cost of excess and obsolete materials, excess production facility capacity, and excess equipment.’ (A far cry from ‘not giving the auditors the necessary detail to trace costs on a $1B program’...)

So we have to ask, did Mr. Schwellenbach knowingly misrepresent the situation regarding auditor access to contractor records in his sworn testimony before the Senators? Did he knowingly misrepresent the lack of DCAA subpoenas as a problem when DOD asserted it was strength of the process?

Or did he simply rely on a weak and misleading news report from three years ago, and hope nobody would check the sources? Or (as San Francisco Fan suggested), did he have his fingers crossed behind his back when he took the oath? You be the judge.

DCAA—Time to Go?

So where does the DOD’s premier audit agency go from here? It has a growing backlog of unfinished audits, a demoralized workforce, and customers who are turning to outside audit firms (and paying more) in hopes of getting more timely audit reports. What should be done?

Look, we make our living dealing with DCAA auditors and helping contractors successfully pass DCAA audits. The status quo keeps us busy and puts money in our pockets. But in all intellectual honesty, we are forced to say, this agency needs to immediately turn a 90 degree course correction. If it can’t do that, then we think another agency needs to take its place.

Your comments on this topic are welcome.

 

DCAA in Senate Crosshairs (Again)

Nick Sanders
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It’s déjà vu all over again as the Senate Committee on Homeland Security & Governmental Affairs (HSGA) and its “ad hoc Subcommittee on Contracting Oversight” held a hearing on February 1, 2011 entitled, “Improving Federal Contract Auditing.”

Chaired by long-time DCAA critic Claire McCaskill (D-MO), the hearing—

… examined how federal agencies use contract audits to detect and prevent waste, fraud, and abuse in government contracts. In particular, the hearing reviewed the findings of the Subcommittee’s ongoing investigation of the type and number of contract audits at federal agencies. The hearing also examined the role played by the Defense Contract Audit Agency (DCAA) in performing contract audits for agencies other than the Defense Department.

Not expressed in the foregoing description was the notion that DCAA may have outlived its usefulness and should be folded into a new, organizationally independent, Federal Contract Audit Agency. As we shall see, opinions on that notion were divided.

Obviously, DCAA would be represented at the hearing by its Director, Patrick Fitzgerald. In fact, Mr. Fitzgerald received an invitation to the hearing two weeks in advance, from Senators McCaskill and Scott Brown (Ranking Minority Member). In addition to Mr. Fitzgerald, other Federal government employees providing testimony included:

  • Thomas Skelly, Acting CFO, U.S. Department of Education

  • Ingrid Kolb, Director, Office of Management, Office of Deputy Secretary, U.S. Department of Energy

  • Brian Miller, Inspector General, U.S. General Services Administration

  • Jeanette Franzel, Managing Director, Financial Management and Assistance, U.S. Government Accountability Office

You can find the written testimony of the above-named individuals at the HSGA Subcommittee website, along with 110 minutes of archived video goodness. But we don’t want to discuss the testimony of those folks. We want to discuss Mr. Fitzgerald’s written testimony, along with the written testimony of Sandy Hoe and Nick Schwellenbach. Sandy Hoe is a partner with the very respected law firm of McKenna, Long & Aldridge (and testified on behalf of the U.S. Chamber of Commerce) while Mr. Schwellenbach testified on behalf of the Project on Government Oversight (POGO).

Mr. Fitzgerald’s testimony can be found here.

Sandy Hoe’s testimony can be found here.

Mr. Schwellenbach’s testimony can be found here.

Looking at Mr. Fitzgerald’s written testimony, we can see the usual fact-based information regarding his audit agency. Nothing new there. Next, Mr. Fitzgerald discussed DCAA’s “reimbursable work” for non-DOD agencies. He noted that, historically, the percentage of DCAA’s audit effort devoted to such activities ranged from 9 to 13 percent of its total workload. To clarify, that means that, at any given time, roughly 10 percent of DCAA’s resources are devoted to auditing non-Defense contracts. Of that effort, about one-third is for NASA contracts and another 20 percent is for the Department of Energy. Mr. Fitzgerald testified that DCAA charges the civilian agencies a rate of $113.84 per hour for its auditors’ time.

We were struck the following statement by Mr. Fitzgerald—

During the past year, DCAA has developed a risk-based approach to performing contract audits. This approach has allowed DCAA to focus on the highest-risk areas with the biggest payback to the U.S. taxpayer. DCAA uses this risk-based approach when performing reimbursable audit effort. In general, this has meant DCAA has expended more resources in the forward pricing area (audits of contractor proposals) at the expense of resources devoted to the incurred cost area.

As expected, Mr. Fitzgerald defended the terrible drop in recent audit productivity by focusing on audit “quality” and compliance with Generally Accepted Government Auditing Standards (GAGAS), saying, “The additional audit procedures ensure the acquisition community is getting the best possible product.” We trust our readership sees through that thin rationale. If not, there are plenty of articles on this website that will paint a different picture and posit different reasons for the growing backlog of uncompleted contract audits.

Mr. Fitzgerald’s written testimony also discussed recommendations to strengthen civilian contract audits. He advocated expanding the pending DFARS business systems rule to all Federal government agencies, and expanding DCAA’s current DCMA contracting officer dispute resolution process to civilian agencies. He also advocated applying DCAA’s recent change in proposal audit thresholds to civilian agencies. Each of these areas has been discussed on this website, and (of course) we had an opinion on the desirability of such initiatives. Suffice to say, we opined that room for improvement existed.

Also as expected, Mr. Fitzgerald defended the status quo, and asserted that there was no need to create a new Federal Contract Audit Agency.

Next Sandy Hoe testified about contractor concerns with recent encroachments by DCAA and the Inspector General into contracting officer authority, noting that such authority conflicts with both Federal regulations and case law. He testified that—

The FAR mandates that the corporate administrative contracting officer (“CACO”) is unilaterally responsible for determining a contractor’s proposal and billing rates, and for determining whether to accept an FPRA as being in the government’s interest, or, alternatively, to issue an FPRR. Decisional authority has further established that DCAA’s role is to be advisory, and that the contracting officer may exercise discretion in deciding whether to follow DCAA audit recommendations. ELS Inc., B-283236, et al., 99-2 CPD ¶ 92, 1999 WL 993094 (Oct. 25, 1999); see also OAO Corp., B-228599.2, July 13, 1988, 88-2 CPD ¶ 42, at 6 (“DCAA audits are only advisory; the degree to which they are used is a matter for the contracting officer to decide”). This balance of authority is appropriate, given the contracting officer’s authority to administer contracts and “make related determinations and findings,” FAR § 1.602-1; § 2.101, as well as the contracting officer’s “wide latitude to exercise business judgment” in requesting and considering the advice of audit specialists. FAR § 1.602-2.

The January 4 DPAP memorandum indicates that contracting officers will apparently now issue final rates as determined by DCAA without the contractor having the opportunity to demonstrate to the Administrative Contracting Officer (“ACO”) why such rates may be unreasonable. Unless the contractor elects to contest the rates by submitting a claim under the Contract Disputes Act (“CDA”), it will, at a minimum, lose the ability to recoup the lost amounts allocated to fixed price contracts based upon the DCAA-determined rates. This approach would be unfair to contractors and directly conflict with established regulatory law.

Sandy also criticized DCAA, testifying that—

Some in industry have noted a sharp upturn in DCAA’s reluctance to engage in rational discussion of audit issues since 2008 and 2009 about the same time when the Congress and the GAO demanded improvements to DCAA. While DCAA took many specific and warranted actions in response to the criticism, a less tangible response has been for DCAA to take a no risk approach to addressing audit issues.

The FAR cost principles and other cost and price compliance regulations are relatively explicit, but still cannot and do not cover every circumstance that may arise. Judgment often is necessary in applying the regulations to resolve issues. Unfortunately, since 2008/2009, DCAA seems to have lost its appetite for analysis of the intent of a regulation versus its literal application. Once it has applied the literal language, DCAA seems little moved by any argument that the result reached is nonsensical or that it could not have been what the drafters intended. This has confounded some in the contractor community who believe that the goal of the regulations, and of government contracting generally, is to reach rational results. Combining DCAA’s recent stridency with the enhanced authority it is being given for FFPA’s and FFPR’s produces a potentially toxic mix for contractors.

(We note for the record that we’ve made many of those same points on this website—but never with such felicitous language.)

Finally, POGO’s Nick Schwellenbach advocated doing away with DCAA and, instead, implementing the Federal Contract Audit Agency that Mr. Fitzgerald asserted was unnecessary. He testified—

We need a contract audit agency that is not afraid of its own shadow. We need an independent and muscular audit agency that protects the taxpayers’ interests. … There are other possible benefits to pulling DCAA out from the DoD and transforming it into an FCAA, the most significant being the independence issue. Currently the DCAA reports to the DoD Comptroller, who is the Chief Financial Officer of DoD, and who in turn reports to the Deputy Secretary of Defense. We have grave reservations whether this structure ensures adequate independence for DCAA, particularly as DCAA’s work often establishes issues with how DOD works with contractors.

Furthermore, it is apparent to us that the DCAA Office of General Counsel is not independent—its attorneys are evaluated by the Pentagon’s Defense Legal Services Agency. It should therefore come as no surprise that some of these attorneys are responsible for the gag letter sent to one of the DCAA whistleblowers. A similar independence problem previously existed with the

Pentagon Inspector General (IG) and in 2008 the IG Reform Act gave the Pentagon IG its own independent general counsel and severed its tie to the Defense Legal Services Agency.

Mr. Schwellenbach also criticized DCAA, as well as the defense contractors that he asserted had taken advantage of the “current turmoil” at the audit agency. He testified—

As Congress weighs the pros and cons of an FCAA, we need to improve DCAA as much as possible. We are concerned about the current direction of DCAA. I have to mention that many current and former DCAA employees and knowledgeable observers believe that companies have taken advantage of the current turmoil at DCAA. In addition, you only have to read the hundreds of comments posted on the Government Executive website by people claiming to work at DCAA to understand that there is at least some part of the DCAA workforce that is deeply angry with the direction of their agency. Many, if not most, of the comments hammer home the belief that the agency has become risk-averse. Of course, contractors want DCAA to be risk-averse, and afraid to issue reports. Congress must make sure that does not happen. Unfortunately, despite its many good auditors and cases where it defended the taxpayers’ interests, there have been signs that the agency is not reaching its full potential. For instance, DCAA has not issued a subpoena to a contractor in over two decades despite long-standing access to records problems they have faced from contractors. That, by definition, is risk aversion and contractors know this.

I believe the subcommittee needs to learn more about why, in FY 2010, far more assignments were canceled at DCAA than were completed, according to records POGO has obtained through the Freedom of Information Act. This is the first time this has happened for at least the past five years, and possibly ever. …

We are concerned by the general decline in contract dollars audited and reviewed by DCAA. In particular, there has been a massive decline in the number of Truth In Negotiations Act assignments conducted by DCAA: in FY 2006 they conducted 468, in FY 2007 438, in FY 2008 348, in FY 2009 148, and in FY 2010 only 59.

[Emphasis added.]

Well, we agree with Mr. Schwellenbach that DCAA is headed in the wrong direction, has become risk averse, and recently has experienced a startling drop in productivity. We agree that many DCAA auditors are embarrassed—and even angry—with the continued leadership failures and bizarre audit guidance issued by DCAA HQ in the past couple of years.

We were startled to see in his testimony an assertion of something we have long suspected—that the number of DCAA’s cancelled audits has grown substantially and potentially represents a huge example of governmental waste. (See the italicized portion of the testimony, above.) We have issues with Mr. Schwellenbach’s credibility (see our comments below). But if true, it is an amazing statistic that DCAA cancelled more audits that it completed in its FY 2010. Along with our previous work showing the huge drop in completed audit reports, it paints the picture of an audit agency in death throes.

Here is Mr. Schwellenbach’s footnote supporting his assertion—

DCAA in FY2010 canceled assignments (including assignments with ‘no report issued’) far more often than it completed assignments with reports: 16,298 assignments were canceled or ‘no report issued’ versus 11,788 assignments with reports issued in FY2010, according to assignment data in the DCAA Management Information System provided by DCAA through FOIA to POGO. From FY2006 through FY2009, DCAA finished more assignments with reports issued than assignments that were canceled/no report issued, in most of those years it issued far more. For example, in FY2006, DCAA canceled (or had ‘no report issued’) 16,690 assignments and completed 26,698 assignments where reports were issued.

Overall, there has been a massive decline in the number of DCAA reports issued. According to the database, it has gone from 26,698 assignments with reports issued in FY 2006 to 11,788 in FY 2010 with a drop every single year, but especially large decreases in FY 2009 and FY 2010.

Wow. Go back and read that again. And remember, this is the Federal government’s premier audit agency, the one all the others look to as a role model for how to conduct contract audits.

Getting back to Mr. Schwellenbach’s testimony, we emphatically do not agree with him that contractors want this sad situation and are taking advantage of it. We do not agree that there are “long-standing” access to records “problems;” nor do we agree that DCAA is not aggressively addressing contractor delays in responding to audit requests. We don’t know from what remote ivory tower Mr. Schwellenbach is viewing the current DOD contract audit environment, but from the viewpoint of people on the ground, dealing with DCAA audits and DCMA contracting officers every single day, we can say with a very high degree of certainty that he is flat-out wrong.

Contractors don’t want inaccurate audit reports, nor do they want unconscionable delays in performing audits, nor do they want ridiculous delays in publishing audit reports after completion of field work. They want the same thing everybody in the defense (and civilian) acquisition community wants. They want high-quality contract audits, performed and issued timely—so that everybody can get back to the business of supporting the nation’s national security and other objectives.

 
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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.