DCAA has published some significant audit guidance recently, much of which we have discussed on this website. We usually get access to new audit guidance (issued in the form of Memoranda for Regional Directors) a couple of weeks in advance of publication on the DCAA’s website. Recently, however, DCAA has experienced delays in putting its new audit guidance on the Internet; publication of some guidance has been delayed as much as six weeks. Typically, we wait to discuss new guidance until it’s available to the public, but now we’ve lost patience—and so we have some things to discuss with you.

First, you may remember that we’ve taken issue with the latest DCAA audit guidance that provides direction to auditors on how to evaluate contractors’ estimates of future indirect cost rates. For example, we had very few nice things to say about MRD 10-PSP-021(R) and many negative ones. Prior to that, we had even fewer things--and many more negative things—to say about MRD 10-PSP-018(R). Our overarching thought, based on the recent guidance, is that, in essence, DCAA as an organization has gone insane.

You can’t have worked in the arena of government contract cost accounting for the past two years and not noticed the intense barrage of criticism leveled at the audit agency—much of it politically driven, unwarranted, and based on flawed review methodology. One of the more frequent criticisms has been that DCAA has not met the independence standards imposed by generally accepted government auditing standards (GAGAS). That accusation hasn’t been true—or at least, it’s been rarely true—but it has driven the audit agency into a virtual obsession with maintaining independence. That obsession has impacted auditor interactions with contractors, DCMA contracting officers, and buying commands. As a result, issuance of audit reports has slowed to a crawl. And those reports that have been issued, generally have been riddled with factual errors and other quality shortcomings, because (a) auditors are afraid to openly communicate with those they are auditing (as well as those agency customers requesting the audits), and (b) once the auditors reach a preliminary finding, everybody (from the auditor to the supervisory auditor to the branch manager to the regional audit manager) is afraid to change it—even when confronted by facts that would lead a reasonable person to a different conclusion.

As we’ve noted many times on this website, it now takes roughly three times longer for DCAA to issue its audit reports, and those it does manage to issue don’t provide much value to anybody. We know DCMA is working hard to dissolve its dependence on the audit agency, and we recently noted some criticism from the DOD IG regarding DCMA’s efforts in that regard. Perhaps sensing that something must be done to turn the tide, DCAA issued MRD 10-PSP-023(R) on September 9, 2010.

Entitled, “Audit Alert on Auditor Attendance at Negotiations,” the audit guidance “encourages” DCAA auditors to support DCMA contracting officer negotiations—but also puts limits on that interaction. Following are a selected few quotes from the audit guidance—

• It is DCAA’s policy to support contracting officers at negotiations where DCAA has issued an audit report on the contractor’s submission (e.g., price proposals, incurred cost submissions, termination claims), especially for complex submissions with significant audit issues. Attendance at pre-negotiation meetings with the contracting officer when requested to discuss audit report results is also encouraged.

• Providing support and technical advice based on the auditor’s technical knowledge and expertise to help the contracting officer understand audit report results does not impair auditor independence. Answering questions about audit rationale/computations or giving advice regarding contractor rebuttals to reported results helps the contracting officer understand audit conclusions.

• At times, contractors provide information and/or data directly to the contracting officer as a means to support their proposed positions in anticipation of or during negotiations. … The contracting officer may request DCAA assistance in understanding how that data impacts the reported audit conclusions. Auditors should support the contracting officer, to the extent possible, by providing advice on this data. This may include, for example, providing advice on the contractor’s rationale for a revised estimate, verifying data to the contractor’s books and records or other supporting data, or running various Government position scenarios using the data through audit report schedules and underlying spreadsheets, where appropriate.

The MRD includes a Frequently Asked Questions (FAQ) section. Here is a quote from that section of the MRD—

[The auditor] should answer the cost analyst’s questions to help him understand the audit conclusions and rationale. Providing such explanations is a normal part of any audit and does not impair your independence or otherwise violate GAGAS. … On occasion, it may also be appropriate to provide selected working papers which support complex audit computations to facilitate the contracting officer’s understanding.

The foregoing sounds good and would appear to be aimed at facilitating negotiations. However (as we noted above), the guidance also limits auditor interaction with the negotiating parties. In particular, the MRD discusses circumstances in which the auditor should seek to issue a “supplemental report” instead of supporting negotiations. The audit guidance says—

… if the data is complex and/or represents a significant update to the audited proposal, and requires extensive review or analysis, the auditor would generally need to issue a supplemental report. … When a supplemental report is not issued, any documentation provided to the contracting officer of the work performed should be clearly marked to distinguish it from audit report results. For example, it should include a statement noting that the documentation contains advice provided in support of negotiations and does not represent audited data, nor a revised audit opinion. Nothing short of a supplemental report will result in a revised audit opinion.

We note that, once again, DCAA refuses to let new facts get in the way of its prior audit findings—leaving the contracting officer and buying commands stuck in limbo awaiting a supplemental report in order to have DCAA officially alter its original opinion based on receipt of new facts. The FAQ emphasizes this audit guidance, stating that, where the new facts require “extensive review or analysis,” then the auditor should—

… recommend in writing that the contracting officer delay the negotiations for that part of the proposal to allow time for [a supplemental report to be issued]. … in the meantime, the contracting officer [should] proceed with the negotiations for the other parts of the proposal. [Emphasis added.]

The MRD also directs that auditors cannot review data provided by contractors during negotiations unless they have first performed sufficient audit work to support an opinion on that data. In such circumstances, the audit guidance directs auditors to “recommend to the contracting officer that the FAO audit the costs and issue a supplemental report.” That supplemental report, as you readers know, will take roughly 90 days to issue. Meanwhile, negotiations are stalled, the contract schedule becomes unattainable, and the resulting delay leads to increased costs. Not to mention, somebody somewhere doesn’t get what they need to accomplish their mission.

Undersecretary of Defense (A,T&L) Dr. Ashton Carter recently emphasized the importance of schedule in program execution. As this interview of Dr. Carter at DefenseNews.com reports—

Q. What's most important: requirements, cost, schedule?

A. The variable we pay the least attention to is time. And time is money. The default way of dealing with a program that is costing too much is to buy it more slowly. The default way of dealing with a program that is not meeting its requirements is to keep working on it until it does. So a five-year program stretches 10 years, and a 10-year program stretches to 15. That costs money. Those stretches don't cost more money per year, and no one feels a cost increase over 15 years. We need more programs with a philosophy of meeting a strict schedule.

Dr. Carter, if you want to see programs embrace a philosophy of meeting a strict schedule, you might want to start with evaluating why negotiations drag on so long and program delivery dates have already slipped before the first labor hour has been incurred. And should you do so, you might want to review the impact of DCAA’s recent audit guidance on that process.

We’re just saying.

It’s hard to keep from shaking the head and saying, “Tsk, tsk,” when we keep reading stories about contractors who fail at government contracting. Or as their attorneys might argue, “who find themselves in a difference of opinion with the Department of Justice regarding the propriety of certain contract-related billings.” Let’s remember that all contractors are innocent until proven guilty in a court of law—or until they reach a negotiated settlement with the DOJ.

Our first story today concerns the company, U.S. Foodservice. The company is based in Rosemont, Illinois, and was formerly owned by Royal Ahold NV, a giant supermarket conglomerate based in Europe. In 2007, the company was sold to private equity firms Clayton Dubilier & Rice Inc. and Kohlberg Kravis Roberts & Co. for $7.1 billion.

According to this story at Bloomberg Businessweek, U.S. Foodservice agreed to pay the U.S. Government $30 million in order to “settle a fraud lawsuit claiming it used shell companies to overcharge the Defense Department and the Department of Veterans Affairs for products at military bases.”

The article reported that U.S. Foodservice was awarded multiple contracts from 2000 through 2005 to supply military installations. The article reported these were “cost-based contracts,” but also reported that “under the contracts, U.S. Foodservice was only allowed to charge the price it paid for acquiring each product the government ordered, plus a pre-determined ‘add-on fee.’” Given that cost-plus-percentage-of-cost contracts are illegal, it’s not exactly clear what the contractual billing arrangement was supposed to be.

Apparently, something very like the requirements of FAR 31.205-26(e) were in place. Readers may remember our previous story about Bell Textron, who in May, 2010, agreed to pay the U.S. Government $16.6 million for overcharging the government from improperly billing its affiliated entities.

According to the Bloomberg story (which quoted the DoJ press release)—

U.S. Foodservice created shell companies, which were known within the company as ‘third-party billing entities’ and later called ‘value-added service providers,’ or ‘VASPs.’ … At U.S. Foodservice’s direction, the VASPs were told to ‘resell’ the same goods to the company and the government was billed for the higher amount shown on VASP invoices… The shell companies passed back to U.S. Foodservice the difference between the actual cost of the food products and the inflated amount they charged the government...

The Bloomberg article noted that—

More than a dozen people were charged in a related criminal case brought by the U.S. Attorney’s office in Manhattan. They included U.S. Foodservice’s former finance chief, Michael Resnick, who pleaded guilty to conspiracy and was sentenced to six months of house arrest.

According to this article at the Wall Street Journal—

U.S. Foodservice was previously at the center of a fraud case that alleged the company overstated the amount it was receiving in supplier rebates, known as promotional allowances. The company allegedly overstated those rebates by hundreds of millions of dollars to meet income targets.

That same article noted that—

In 2004, Ahold settled U.S. Securities & Exchange Commission charges that accounting issues led it to overstate net sales by about $30 billion from fiscal 2000 through fiscal 2002, including artificially inflating payments to U.S. Foodservice by vendors. Ahold cooperated with the SEC and wasn't fined.

In 2005, Ahold agreed to pay $1.1 billion to shareholders to settle a separate civil lawsuit in the U.S. over its accounting.

In 2007, Ahold agreed to sell U.S. Foodservice to a group of private-equity investors.

We should note that the company has its own view of the situation. The Bloomberg article reported that—

U.S. Foodservice said in an e-mailed statement that it fully cooperated in the probe. ‘We deny any wrongdoing and stand behind our pricing policies and practices, which have always been consistent with the terms of our federal government contracts and industry standards,’ the company said. ‘We settled because we want to close this chapter in our past.’

In somewhat related news, a couple of former Department of Energy contractors are in the process of learning about the wheels of justice, first-hand. This DOJ announcement reported—

… a scientist and his wife, who both previously worked as contractors at the Los Alamos National Laboratory (LANL) in New Mexico, have been indicted on charges of communicating classified nuclear weapons data to a person they believed to be a Venezuelan government official and conspiring to participate in the development of an atomic weapon for Venezuela, among other violations.

The 22-count indictment … charges the defendants with conspiring to communicate and communicating ‘Restricted Data’ to an individual with the intent to injure the United States and secure an advantage to a foreign nation. They are also charged with conspiring to and attempting to participate in the development of an atomic weapon, as well as conspiring to convey and conveying classified ‘Restricted Data.’ The indictment further charges Mascheroni with concealing and retaining U.S. records with the intent to convert them to his own use and gain, as well as six counts of making false statements. Roxby Mascheroni is also charged with seven counts of making false statements.

Misbilling the U.S. Government is one thing. Corporations can settle with the U.S. Government; CFOs can receive six months of house arrest. But selling secrets can be an entirely different issue, as these two individuals are about to learn.