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DOD Contractors Look to Get “Affordable” While Pentagon Adds Bureaucracy

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We’ve previously discussed the latest fad amongst Pentagon leadership:  the notion that the DOD needs to focus on weapon system “affordability”—and that the primary means for doing so is to focus on cutting contractor overhead.  In this article, we reported that DOD intends to “identify and eliminate non-value-added overhead and G&A charged to contracts” (among other actions), so that affordability will be “restored” to defense goods and services.  It’s as if the entire national security leadership woke up one morning and suddenly realized they all were overdrawn at the bank. 

“Gosh!  How could this have happened to such outstanding managers?” they would have cried.  “Our defense goods and services are no longer affordable!  Since it can’t be our fault, then obviously it must be the fault of all those greedy contractors!” 

We reply to that hypothetical (yet all too real) assertion using the immortal words of Cher Horowitz (played by Alicia Silverstone) in the 1995 movie, “Clueless”—

“As If!”

Lt. Gen. Larry Farrell (USAF, Retired), recently used the cliché “perfect storm” to describe the situation facing the military services and their contractors.  General Farrell, who currently serves as President of the National Defense Industrial Association (NDIA), wrote—

The wars in Iraq and Afghanistan are now consuming in the neighborhood of $200 billion a year, which despite a defense budget just north of $700 billion, have dragged funds away from needed modernization. Recall that Congressional Budget Office projections from 2005 even then indicated that Defense Department funding was running $100 billion a year short of what it needed to fund the modernization programs planned at that time.


Then came the 2007 recession, now extending past 31 months, which is the most protracted since World War II. Along with the downturn are unsustainable federal budgets and projections of more than $1 trillion in annual deficits out through 2020. The national debt is approaching $20 trillion and interest on the debt will be around $900 billion per year in 2020 — larger than the ‘projected’ defense budget that year. The unsustainable nature of this budget projection has now been recognized as a national problem that can no longer be ignored.


In response, President Obama this year appointed a National Commission on Fiscal Responsibility and Reform. The so-called Deficit Commission is due to report in December. In anticipation, Congress has deferred action on the 2011 budget, which is normally scheduled to become law Oct. 1. …

Senate Finance Committee Chairman Max Baucus, D-Mont., said he sees three areas of focus: ‘the tax gap, the spending gap and the productivity gap.’ Since it’s fairly certain that government doesn’t directly legislate productivity, it is a safe bet that specific tax and spending recommendations will come from the Deficit Commission in December. …

All of these developments could begin to cause turbulence around December. The major unstoppable weather vector is the dire financial condition of the United States. The other converging elements — tax and spending reform and defense spending and reorganization — are minor by comparison.

Recognizing the “turbulence” coming their way, we’ve noted that defense contractors have been moving and restructuring, and re-org’ing and trimming, while nervously eyeing the Pentagon as if it was their sugar-daddy who had recently found a brand-new—younger—mistress to support.  That trend continues unabated.

The mega-sized provider of professional services, Accenture, recently reported that, “Pressures to reduce costs will be the primary drivers of decisions by aerospace and defense (A&D) companies to use external engineering services during the next two-to-three years.”  The firm issued a report entitled “Engineering Services in Aerospace and Defense:  Meeting the Sourcing Challenge,” available here.  The Accenture report stated—

Ninety percent of the executives interviewed cited cost reduction pressures as their top challenge, followed by supplier consolidation (52 percent) and increased competition from new players (36 percent). Consistent with these findings, the research revealed that 61 percent of these executives are buying engineering services to better manage production costs; 65 percent of them cited the need for improved efficiency and productivity.

Accenture’s bottom-line conclusion was that A&D companies will move to source engineering expertise and services from low-cost global providers—though the report acknowledged that the strategy contained challenges that would need to be overcome.  The benefits include lowering costs, shoring-up scarce skill sets, and more easily fulfilling offset obligations, while challenges include concerns about potential compromises of confidentiality and quality.  To those concerns we would add the worry about compliance with export controls.  Nonetheless, Accenture seems confident that A&D companies will embrace those challenges in order to lower their program costs.

Meanwhile, Navistar, the hugely successful (formerly) commercial manufacturer of Mine-Resistant Ambush-Protected (MRAP) vehicles, has announced “another round” of layoffs at its Mississippi production facility.  The linked-to article reports that—

John Munro, plant manager for Navistar in West Point, said the plant has some contracts which will last until 2013, but the high-volume MRAP production will end in 2011, leading to an unknown number of layoffs. The plant currently employs 505 workers.

Not to be outdone, Northrop Grumman issued a press release that announced “consolidation” of its Louisiana and Mississippi shipyards, a “winddown” of production at its Avondale, Louisiana shipyard, and closure of two more Louisiana yards.  Any remaining work (i.e., that related to the LPD-17 ships) will be performed at NGC’s Pascagoula, Miss. shipyard, according to the linked-to article.  The article reports that—

Northrop Grumman is considering a possible spinoff of its shipbuilding business, including a yard at Newport News, Va., into a separate company. Credit Susse has been hired as lead financial adviser on alternatives for the shipbuilding unit.

What’s driving Northrop Grumman’s decision-making?  According to the NGC press release (link above)—

‘Our decision to consolidate the Gulf Coast facilities is driven by the need for rationalization of the shipbuilding industrial base to better align with the projected needs of our customers. The consolidation will reduce future costs, increase efficiency, and address shipbuilding overcapacity. This difficult, but necessary decision will ensure long-term improvement in Gulf Coast program performance, cost competitiveness and quality,’ said Wes Bush, chief executive officer and president.

The consolidation of Gulf Coast ship construction is the next step in the company's efforts to improve performance and efficiency at its Gulf Coast shipyards, which began with the integration of its shipbuilding operations in early 2008.

As a result of the consolidation, the company expects higher costs to complete ships currently under construction in Avondale due to anticipated reductions in productivity and, as a result, is increasing the estimates to complete LPDs 23 and 25 by approximately $210 million. Of this amount $113 million will be recognized as a one-time, pre-tax cumulative charge to Shipbuilding's second quarter 2010 operating income. The balance will be recognized as lower margin in future periods, principally on the LPD 25. The company also anticipates that it will incur substantial restructuring and facilities shutdown-related costs including, but not limited to, severance, relocation expense, and asset write-downs. These costs are expected to be allowable expenses under government accounting standards and recoverable in future years under the company's contracts. The company estimates that these restructuring costs will be more than offset by future savings expected to be generated by the consolidation.

Obviously, Northrop Grumman is willing to invest a significant fraction of a billion dollars in order to trim future operating costs.  As it notes in its press release, it expects to recover much of its “investment” against its current and future government contracts as “allowable expenses.”  We wonder what the Pentagon leadership thinks of that plan?

While industry is undertaking these significant cost-cutting actions, the Pentagon is taking some of its own actions.  On July 13, 2010, Brett Lambert (Director, Industrial Policy) issued a Memorandum to the Defense Industrial Base.  When last we discussed Mr. Lambert’s Directorate, he stated his focus was on early identification of “points of failure” in the defense industrial base, so that the Pentagon might avoid “costly rescues of failing companies.”  In addition, his Directorate was focused on “the financial health of critical suppliers,” as well as the need to preserve “skills necessary to support our war fighters in the near term and long term.”  How’s that going, Mr. Lambert?

Mr. Lambert’s Memorandum to the Defense Industrial Base of July 13 did not address any of those prior focus areas.  Instead his new focus is on learning “to do more without more”—i.e., implementing the DOD’s new “Efficiency Initiative.”  Toward that end, Mr. Lambert announced a strategy involving “interacting parallel tracks, with close coordination.”  The effort will “drive fact-based recommendations” to Dr. Carter (USD, AT&L) for consideration and action.  Mr. Lambert’s plan involves five “issue focus groups,” an Industry Working Group (IWG), various Military Department Groups (MDGs), two Executive Directors, and a Senior Integration Group (SIG), which will be chaired by Dr. Carter.  In the words of Mr. Lambert’s Memorandum to the Defense Industrial Base—

There will be five government focus groups reporting to the Senior Integration Group (SIG) through two Executive Directors; Military Department Groups for each service will solicit ideas for the five Focus Groups to analyze; and I will lead an Industry Working Group that will collect ideas from industry and provide a feedback mechanism for industry to comment on the ideas we are considering. The groups will be comprised of government employees, although the Center for Strategic and International Studies (CSIS) will assist in administrative functions.

The five Focus Groups will address the following areas:

  • Affordability
  • Sharpening Contract Terms
  • Reward Productivity Growth
  • Measure Productivity Growth
  • Create Tradecraft in Services Acquisition

Mr. Lambert’s Memorandum to the Defense Industrial Base concludes with the following request for industry participation in the Efficiency Initiative—

In order to reach the broadest possible base and ensure that we are inclusive of those in our industrial base willing to assist us in this effort, we will begin the process by asking that a simple form be filled out, which will be available on our website (http://www.acq.osd.mil/ip/). The form can be submitted directly to our offices via email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it . Please note that this form is not a survey and participation by industry is undertaken as a voluntary act, without direction by the Department.

So what is one to make of the foregoing?  We have a couple of thoughts to share with you, if you will.

  1. It is clear, from this article and from others we’ve posted over the past year or two, that the defense industrial base is already moving to cut overhead and increase productivity.  We don’t see what value the Pentagon adds to the efforts that are already in process, and to those that will be undertaken in the coming months.

  1. Note the new bureaucracy announced by Mr. Lambert.  Were one to read SECDEF Gates’ original remarks at the Eisenhower Library, one might reasonably conclude that SECDEF Gates was less concerned with contractors’ overhead and efficiency, than he was with the overhead, bloated bureaucracy, and lack of efficiency within the Pentagon.  He said, “Another category ripe for scrutiny should be overhead – all the activity and bureaucracy that supports the military mission. According to an estimate by the Defense Business Board, overhead, broadly defined, makes up roughly 40 percent of the Department’s budget.”  He also said, “The private sector has flattened and streamlined the middle and upper echelons of its organization charts, yet the Defense Department continues to maintain a top-heavy hierarchy that more reflects 20th Century headquarters superstructure than 21st Century realities.” That doesn’t sound to us as if he were overly concerned about contractors’ overheads.

  1. Moreover, SECDEF Gates wanted the Pentagon to clean-up its own house.  He said—

Going forward, some questions to be considered should be:

  • How many of our headquarters and secretariats are primarily in the business of reporting to or supervising other headquarters and secretariats, as opposed to overseeing activity related to real-world needs and missions?
  • How many executive or flag-officer billets could be converted to a lower grade, with a cascading effect downward – where two-star deputies become one-star deputies, assistant secretaries become deputy assistant secretaries – to create a flatter, more effective, and less costly organization?
  • How many commands or organizations are conducting repetitive or overlapping functions – whether in logistics, intelligence, policy, or anything else – and could be combined or eliminated altogether?

In considering these questions, we have to be mindful of the iron law of bureaucracies – that the definition of essential work expands proportionally with the seniority of the person in charge and the quantity of time and staff available – with 50-page power point briefings being one result.

So, instead of focusing on cutting bureaucracy, Mr. Lambert’s Memorandum for the Defense Industrial Base announces the creation of more bureaucracy.  The action being taken is exactly the opposite of what is being sought by the SECDEF Gates, as if to prove by direct action his reference to the “iron law of bureaucracies.” 

We see quite a bit of activity throughout the defense industrial base as contractors prepare for the upcoming “turbulence” noted by General Farrell.  We see quite a bit of activity at the Pentagon, as the bureaucracy gears up to assist the contractors do what they are going to do anyway.  (In fact, General Farrell wrote, “Carter has invited the defense industry to participate in the coming decision-making and execution process. We intend to do so.”)   What we fail to see is any activity by the DOD bureaucracy and military services to address the very issues that the Secretary of Defense directed them to address.



 

ASBCA Discusses Prompt Payment Act

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We have noted before that the DOD has attempted to wiggle out of complying with the requirements of the Prompt Payment Act (Public Law 97-177, or PPA) when involved in military contingency operations.  In August 2009, DOD issued a “class deviation” to evade requirements of FAR 32.9 with respect to such operations.  On July 13, 2010, DFARS 232.908 was revised and a related contract clause was implemented (252.232-7011 “Payments in Support of Emergencies and Contingency Operations”) to permanently exempt such operations from the requirements of the Prompt Payment Act.

These actions concerned us.  As we said in our previous article on the topic—

The purpose of the Act, and its implementing regulations in the FAR, was to protect contractors from a government bureaucracy that was notoriously slow to pay, and from the cash flow hardships caused by such slow payments. These contractors, who generally must follow all direction given to them by authorized government representatives, and who generally must continue to perform their government contracts regardless of any losses they may be incurring, had little if any recourse available to them for such contract breaches, short of litigation. But under the Prompt Payment Act, contractors could typically expect to receive payment for properly prepared invoices within 30 days (often sooner), or else receive an additional interest payment automatically--i.e., without making another request.

But this article isn’t really about the DOD evading its statutory obligations to pay its contractors timely.  It’s more about a recent decision by the Armed Services Board of Contract Appeals (ASBCA), who were asked to decide a contractor’s claim for interest due it pursuant to the requirements of the Act.  Before the Court was a request for summary judgment, with the Government moving for a dismissal – i.e., the Government asserted that it was entitled to a decision without a trial because it was clearly going to prevail as a matter of law.  Judge Peacock wasn’t so sure.

Calvary Security Group (CSG) supplied equipment and supplies to the Iraqi police forces under an ID/IQ contract, originally with the Coalition Provisional Authority (CPA).  The contract provided that—

Inspection and acceptance was to be ‘conducted by DCMA QAR’ at a third Baghdad warehouse and … ‘Invoices are submitted to the contracting officer, end user for approval certification and submission to the USACE Finance Center [in Tennessee] in conjunction with the receiving report (DD250).’

CSG submitted a certified claim to the contracting officer in the amount of $196,640 alleging that the government owed it PPA interest penalty for late payments for deliveries made under the contract. CSG was asking only for the interest that was payable ‘automatically’ under the regulatory provisions implementing the PPA (which were recited at length by the Judge in the decision). 

The Government contended that “payments were timely issued within 30 days of actual acceptance of the supplies” and, therefore, CSG was not entitled to any interest under the PPA.  The Government asserted that the contract required inspection by the DCMA QAR and that Government acceptance took place only upon the QAR’s execution of the Form DD250.  According to the government, the 30 day PPA payment period did not commence until the date of the QAR’s completion of the form for each of the deliveries in dispute. The government asserted that payments generally were made within 30 days of the actual acceptance/signature dates indicated in the DD250 forms and, therefore, the payments were not subject to PPA interest. 

Judge Peacock, writing for the Court, disagreed with the Government’s position, stating—

OMB regulations establish as a general rule that PPA interest penalty begins to accrue 30 days following the later of the date of actual receipt of the invoice if annotated or seven days after delivery of the supplies ordered, or the invoice date if not annotated, absent circumstances and exceptions not germane to disposition of the present motion. The actual acceptance date is relevant to the extent that it occurs prior to the end of the “constructive acceptance” period of seven days for this contract.  … The government’s interpretation of the Prompt Payment clause ignores ¶ (a)(5)(i) of that clause which states that ‘acceptance is deemed to occur constructively on the 7th day (unless otherwise stated in this contract) after the Contractor delivers the supplies….’ Although FAR 32.908(c)(1) and FAR 32.904(b)(4) authorize extension of the seven day ‘constructive acceptance’ period if justified, no such modification of the date was specified here or permitted for this … contract. The ‘constructive acceptance’ provision in the clause is reiterated in FAR 32.904. See also DFARS 232.905(1). Of course, the government is entitled to take reasonable and appropriate actions to ensure conformance of the delivered supplies with contractual requirements. However, inspection delays extending beyond the prescribed seven days do not postpone accrual of interest penalty where there are no disagreements regarding quantity, quality or contractor compliance with contractual requirements.

The Government’s motion for summary judgment was denied.

We think this case is illustrative of some of the mechanics of the Prompt Payment Act.  In our experience, contractors are often reluctant to assert their right to interest on late payments.  This case shows that contractors may have a good chance of prevailing in litigation when they assert their rights under the Act.
 

DCAA Director Patrick Fitzgerald Discusses His First Eight Months

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On July 8, 2010, Robert Brodsky of GovExec.com interviewed Patrick Fitzgerald, Director of DCAA.  It was Mr. Fitzgerald’s first interview since taking the helm of the drifting auditing agency back in November, after the departure of April Stephenson.  The interview, which was characterized by Mr. Brodsky as being “upbeat, but occasionally guarded,” focused on the changes undertaken by the new regime.  According to Mr. Fitzgerald, “the agency has … increased training, revamped the promotion and hiring process, and introduced a pilot program that will put a single DCAA manager in charge of major contractor audits.” 

The article states that Mr. Fitzgerald attributes lingering audit problems to the “crushing workload” facing the audit agency.  To address the workload issues, DCAA “has hired 500 new auditors and will add 1,000 more by fiscal 2015, a 37 percent staffing increase. DCAA also is planning to shed several low-priority services and place more emphasis on high-risk contracts.”

Despite the foregoing, the article notes that the number of audits DCAA expects to accomplish this year will be “dramatically lower” than in prior years.  The article reports that, “In fiscal 2008, the average time to complete a contractor pricing review was 28 days, compared with 72 days in fiscal 2010.”  So perhaps it’s not really the workload that’s causing “lingering audit problems,” but might be instead the process by which audits are being executed? 

Rank and file auditors “remain skeptical about the agency’s course,” according to the article.  (We reported on this skepticism several months ago, here.)  The article reported that—

They [auditors] said managers have overreacted to the GAO reports and now are obsessively focused on documenting their audit opinions and submitting perfect working papers. In some cases, DCAA employees said they were being told to fix minor typos or grammatical errors, bogging down the process. In addition, Stephenson introduced a policy that requires a field office manager to sign off on all audits, which employees said has compounded delays that hamper price negotiations with contractors.

Mr. Fitzgerald recognized that he has a problem at the field auditor level.  The article reported that—

To address morale problems, [he] established an internal review division to tackle complaints from employees and has subsequently beefed up the office's staff to 23 employees, including a senior executive. The director also has taken to the road during the past two months to hold 17 town hall meetings.

‘One of our big challenges is that we have to restore the trust between DCAA management and the workforce,’ he said. ‘I sense that's not there today. And it's going to take some time to do that.’

One only need examine the comments on the GovExec.com website, submitted in response to the article, to see that Mr. Fitzgerald has deeper issues to address than simply auditor morale problems.  For example, here are two comments from DCMA contracting officers:

  • DCAA no longer provides a useful service for contracting officers. It takes less time to justify why I do not need a DCAA audit than it takes to wait months for the audit. It might be worth the wait if the report had useful information. But no more. The reports are so highly qualified with too much unsupported costs to be useful. So I just provide the request to DCAA and when they give me a due date of 90 days for a proposal audit, I document the file that the audit could not be completed in time for award and cancel the audit request. I have 10 contracts to be awarded by the end of September, 6 for sole-source fixed price. I could have used an audit, but given the 72 average days mentioned in this article, I will just document the file and move on. Thank you Fitzgerald for the documentation that DCAA takes at least 72 days for forward pricing. With this type of cycle time, DCAA will be out of the forward pricing audit business in no time. Sad because I used to get useful reports with a lot of questioned cost.

  • I am appalled that the Director would think that 72 days for an audit of a forward pricing proposal is something to be proud of. The 72 days is an average and I can attest that I usually receive reports in about 3-4 months. The proposal is outdated by the time I get the report. The report usually had too much unsupported costs to be useful. In the end, I waste a lot of time waiting for an audit that is not useful. To put the 72 days in perspective, for any awards that need to be made by the end of FY 2010, the audit report would already need to be in our hands. This is not feasible. Often times we do not get the requirements until May or June and then to factor in 72 to 120 days for an audit is not practical or useful. DCAA had some documentation issues and then went way overboard and now is not a useful organization. DCAA is not the GAO or IG that can take months for audits. Awarding contracts is very time sensitive and Mr. Fitzgerald needs to retool DCAA to complete audits in 30 days or less. Frankly, contracting officers liked the prior metric of 30 days or less for proposal audits. It provided a more useful report. In the end, many COs will be like me and any contracts that are negotiated this summer will be without the benefit of DCAA audits. We just cannot delay the awards waiting for the audit. Please someone resolve the lack of a sense of urgency with DCAA audits for forward pricing proposals.

But yes, it is true that auditors have some concerns with the lack of progress made by Mr. Fitzgerald in charting a new course.  Here are a couple of many comments submitted by (alleged) DCAA auditors (unedited)—

  • Fitzgerald, let me clue you in on something regarding the depth of the audits. The reason audits are taking longer is that we are spending more time on working paper documentation and responding to reviewer comments, not that we are performing a more comprehensive audit. In fact, I believe we are doing the opposite. Auditors are performing more superficial audits because it is easier to document the findings and judgements than when we use criticial thinking and more analytical skills. It is also eaiser to get the audit through management review. It is much more time consuming and difficult to pass the QA reviews when we reach conclusions based on in-depth analysis. Not to mention that the skill level of the auditors is much lower than needed and as a consequence, the auditors are more of a verifyer and spent their time ticking and tieing numbers rather than actually performing more in-depth auditing analysis. You should perform a few audits and then you will get a better idea of just how superficial DCAA has become. Town hall meetings may be fine, but spend several weeks on an audit and then you may get it.

  • During the Bill Reed administration at DCAA, the montra was "more with less" as DCAA downsized, performed more audits and had higher questioned cost and net savings. Pat Fitzgerald will be known for "less with more." Staffing will be increased to new levels while the number of audits will be less than the past 20 years, questioned cost will be less as well as net savings. Good job Fitzgerald, what a way to protect the taxpayers dollars. By the time you get done, auditors will be performing about 2-3 audits per year rather than 2-3 audits per months. You will get a pat on the back from Congress and the Pentagon because contractors will no longer be complaining about DCAA. Contractors will be happy as a clam and you will get many rewards. You will go down in history as the Director that instituted the "perfect" audit and guess what, DCAA effectiveness will be nonexistent. Contractors will sing your praises and they will probably offer you a well paying job when you retire. Good legacy to leave on the Agency. What a way to protect the taxpayers dollars. Might as well just give the money away to contractors, it would cost less.

There are plenty more comments where those came from – go see them at the link above.  But before we move on, here’s another perspective.  The highly respected Government Contracts attorneys over at Sheppard Mullin Richter & Hampton have this to say about Mr. Fitzgerald’s interview—

Just three months ago … DCAA Director Patrick Fitzgerald told contractors and acquisition agencies that his agency’s new mode of operations would aim at developing ‘mutually beneficial relationships’ with both contractors and DOD acquisition agencies. DCAA would spring ‘no surprises’ on contractors; it would conduct ‘more frequent communication with’ them; DCAA would assure the provision of ‘responsive and timely services to agency stakeholders’; and – in a marked sea change from its traditional attitude, DCAA would abide by DOD direction that, while ‘the contracting officer and auditor work together… it is the contracting officer’s ultimate responsibility to determine fair and reasonable contract values.’

Some contractors hoped that Director Fitzgerald’s purported ‘new mode’ would actually lead to reasonably cooperative relationships and more frequent communication with agency auditors, to include continuing communications through interim conferences during and informative exit conferences upon completion of the auditor’s fieldwork. .... [But] within weeks of Director Fitzgerald’s announcement, DCAA began shutting down communications with contractors, forcing at least some to fight just to have interim conferences with auditors, and informing others that post-audit exit conferences will now be held only after the auditor has written the draft report and it has been reviewed and approved by the Supervisory Auditor and the Branch Manager or Regional Auditor – in other words only after the report’s conclusions are set in stone and impossible for the contractor to change, even when shown to be based on erroneous factual conclusions. …

Those contractors and acquisition agency personnel who entertained hopes that Director Fitzgerald would keep his promises were not being entirely foolish – those promises were, after all, wonderfully consistent with provisions of the DCAA Contract Audit Manual (“CAM”) Chapter 4-300 … which, like the Director’s promises, were published within the last three months. …

It is difficult to know what to make of an agency that describes itself on its home page as ‘Dedicated To Providing Timely and Responsive Audit and Financial Advisory Services In Support of Our National Defense,’ yet behaves in a manner directly contrary to its own explicit—and newly-minted—instructions.

So while Director Fitzgerald speaks about progress being made and changes being implemented, his own auditors question his motivations and effectiveness while DCMA contracting officers are learning to do their jobs without auditor input.  Even knowledgeable attorneys—who might be expected to be a bit more academic and objective about the situation—think there’s a major disconnect between the platitudes that Headquarters publicly proclaims and the actions its auditors are directed to take in the field.  Washington, we have a problem here.
 

DCAA Throws Another Monkey Wrench Into DOD Acquisition

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We (and others) have lamented before and yet again about the sad state of the current DOD acquisition environment.  This time around, we’ll try to avoid overly dramatic wailing and gnashing of teeth.  But permit us a level-setting sentence or two, if you will. 

Ever since DCAA came under fire from nearly every stakeholder in the defense acquisition process, it has reacted by circling the wagons, battening-down the hatches, and hunkering down while waiting for the political firestorm to pass.  Auditors must now document every audit step (including audit steps not taken) to a demanding level of detail.  And multiple layers of management review every aspect of the audit before a draft report is issued to the contractor.  If observed in an individual (as opposed to an entire agency), such a reaction might well be sufficient to obtain a clinical diagnosis of Obsessive-Compulsive Disorder (OCD).  (We would have said paranoia but the paranoia was probably justified, given that so many were actually out to get the agency.) 

The effect of such behavior on the acquisition process is clear:  DCAA is now issuing fewer audit reports, and those it does issue take dramatically longer to reach the customers.  (See our article, containing unedited opinions of (alleged) DCMA Contracting Officers, here.) 

Not to be outdone by DCAA’s “conservatism,” the Defense Contract Management Agency (DCMA) has instituted multiple “Boards of Review” (BoRs) that must be convened to review and approve key Contracting Officer decisions before they are implemented.  As a result, Contracting Officers are subject to a vastly increased workload (as they must document and prepare for multiple BoRs), while being simultaneously hamstrung, since they cannot issue decisions without the required approvals.  What used to take 60 or 90 days, now takes a C.O. as much as six or nine months—and that’s assuming all the required BoRs approve the proposed action.  We’ve heard of one situation where three separate BoRs (meeting over many months) approved a proposed action, but that the proposed action subsequently was disapproved at the Defense Procurement and Acquisition Policy (DPAP) level and remanded back to the C.O. for a redo.

The DOD acquisition system is breaking-down, gentle readers, and we’re watching it happen in slow motion, just like a train-wreck shown on a reality TV show.  But perhaps that’s getting a bit overly dramatic, so let’s get to the meat of this article.   Here’s the punchline:  If you thought the process was slow now, you ain’t seen nothing yet.

On June 4, 2010, DCAA issued revised audit guidance via the usual method—a Memorandum for Regional Directors (MRD).  Published to the audit agency’s website (and to the public) five weeks later, it details how the audit agency will handle the situation where a contractor uses indirect cost rates not yet audited in a cost proposal.  Here’s the MRD in full.

Let’s summarize some of the key points –

  • Where an audit of the contractor’s proposed indirect cost rates has not yet been performed (or completed) by DCAA, then “the auditor should disclaim an opinion on the proposal taken as a whole.” 
  • Auditors should take care not to opine on any forward pricing rates “that are significant to the proposal” unless a DCAA audit of the rates has been completed.  “The results of audit section (including the opinion and exhibits) will not address or contain amounts associated with those rates.”
  • Where forward pricing indirect cost rates are significant to the proposed costs, and DCAA has not yet completed its audit of the rates, then the DCAA audit report should “recommend that contract price negotiations not be concluded until the audit of the rates is completed and the results are considered by the contracting officer.”
  • When the contractor’s proposed rates are based on a Forward Pricing Rate Agreement (FPRA) or Forward Pricing Recommended Rates (FPRR), but those rates have not yet been audited by DCAA, then the rates “should be audited as part of the current pricing proposal audit, if possible.”  Moreover, “An examination of forward pricing rates includes detailed testing of the contractor’s assertion (i.e., proposal and basis of estimates) and, when appropriate, analytical procedures (e.g., regression or trend analysis).”
  • “In cases where DCAA has performed an audit of forward pricing rates and DCAA’s audit was utilized by the ACO in negotiating the FPRA, the FAO may opine on these rates in the pricing proposal audit report. This is true even if there are differences attributable to the negotiation process between the rates per DCAA’s audit and the FPRA rates.”
  • But where the auditor “believes the ACO did not fully consider the DCAA audit results and there are significant differences between the DCAA recommended rates and the FPRA or FPRR,” then the auditor should elevate the disagreement pursuant to the DCAA/DCMA dispute resolution process.
  • “If the pricing proposal audit report must be issued prior to resolving this disagreement, the audit opinion should reflect the DCAA recommended rates.”

So why does this particular MRD upset us?  Well, let’s recap, shall we?  We already know that DCAA audits are taking three times as long as they ever did and that the audit reports are less useful to DCMA Contracting Officers than they’ve ever been.  (See the link in paragraph 3, above.)  Now DCAA has decided it can’t issue an audit report to DCMA on a contractor’s cost proposal, unless it has performed appropriate “detailed testing” and other “analytical procedures” on the indirect rates being utilized in the bid.  Moreover, if the DCMA Administrative Contracting Officer (ACO) disagrees with DCAA’s opinion on the correct rates that the contractor should be bidding, then the auditor is to drop a dime on the ACO and “elevate” the dispute.  Moreover, DCAA will continue to utilize its “recommended rates” in its audit reports, even though the ACO (the person with the authority) may have negotiated different rates.

Wow.

The only good news—if there is any—is the little ray of hope provided at the end of the MRD.  It says—

If requested, FAOs may provide available unaudited rate data to contracting officers to assist them in their negotiations generally following the procedures in CAM 9-107. This information should be furnished in a separate memorandum and it should clearly state that the rate data provided has not been audited.

So the burden is now on the DCMA Contracting Officer to request “unaudited rate data” – which we suspect the contractor has already provided as part of its submitted “cost or pricing data” – so that negotiations can commence.  Meanwhile, the DCAA auditor will be on the phone, whining to Fort Belvoir and perhaps to the Pentagon about being ignored.

We predict this MRD will paralyze the DOD acquisition process even more.  The average DCMA Contracting Officer will be caught between meeting the needs of its buying commands (and the warfighters) by negotiating contracts timely, and waiting for DCAA to finish its audit of the contractor’s indirect cost rates—which could take months.

The train wreck continues.
 

FAR Revised to Enhance Transparency and To Add Additional Mandatory Reporting Requirements

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On July 8, 2010, FAC 2005-44 was published in the Federal Register, implementing FAR Case 2008-039 (“Reporting Executive Compensation and First-Tier Subcontract Awards”) as an interim rule, “to implement section 2 of the Federal Funding Accountability and Transparency Act of 2006, as amended by section 6202 of the Government Funding Transparency Act of 2008, which requires the Office of Management and Budget (OMB) to establish a free, public, website containing full disclosure of all Federal contract award information.”  Well, then.

What does the rule require?  There are two fundamental requirements:

  1. Prime contractors will need to report “executive compensation” (see 31.205-6(p) for limitations on the allowability of executive compensation) for its five most highly compensated executives.  In addition, the prime will need to report the compensation for the top five most highly compensated executives of its first-tier subcontractors.
  2. Prime contractors will need to report all first-tier subcontract awards valued in excess of $25,000.

The new rule revised FAR Part 4.14 (including renaming the section from “Reporting Subcontract Awards” to “Reporting Executive Compensation and First-Tier Subcontract Awards”) and implemented a new solicitation provision/contract clause (52.204-10, “Reporting Executive Compensation and First-Tier Subcontract Awards”).  The solicitation provision/contract clause is to be included in all solicitations and contracts valued at $25,000 or more, except for classified contracts and contracts with individuals.

Qualifying contractors must report annually on the executive compensation of the entity’s top five most highly compensated employees to http://www.ccr.gov.  Qualifying contractors include those who, in the preceding fiscal year—

  • Received 80 percent or more of its annual gross revenues from Federal contracts (and subcontracts), loans, grants (and subgrants) and cooperative agreements; and
  • Received $25,000,000 or more in annual gross revenues from Federal contracts (and subcontracts), loans, grants (and subgrants) and cooperative agreements; and
  • The public does not have access to information about the compensation of the executives through periodic reports filed under section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a), 78o(d)) or section 6104 of the Internal Revenue Code of 1986.

Prime contractors must also report the executive compensation of their qualifying first-tier subcontractors top five most highly compensated employees to http://www.fsrs.gov.  First-tier subcontractors qualify for reporting based on the same three conditions listed above.

With respect to the second requirement (i.e., reporting awards of first-tier subcontracts), the new rule provided—

  • Until September 30, 2010, any newly awarded subcontract must be reported if the prime contract award amount was $20,000,000 or more.
  • From October 1, 2010, until February 28, 2011, any newly awarded subcontract must be reported if the prime contract award amount was $550,000 or more.
  • Starting March 1, 2011, any newly awarded subcontract must be reported if the prime contract award amount was $25,000 or more.

The following information must be reported (subject to the above phase-in requirements)—

  • Unique identifier (DUNS Number) for the subcontractor receiving the award and for the subcontractor's parent company, if the subcontractor has a parent company.
  • Name of the subcontractor.
  • Amount of the subcontract award.
  • Date of the subcontract award.
  • A description of the products or services (including construction) being provided under the subcontract, including the overall purpose and expected outcomes or results of the subcontract.
  • Subcontract number (the subcontract number assigned by the Contractor).
  • Subcontractor's physical address including street address, city, state, and country. Also include the nine-digit zip code and congressional district.
  • Subcontractor's primary performance location including street address, city, state, and country. Also include the nine-digit zip code and congressional district.
  • The prime contract number, and order number if applicable.
  • Awarding agency name and code.
  • Funding agency name and code.
  • Government contracting office code.
  • Treasury account symbol (TAS) as reported in FPDS.
  • The applicable North American Industry Classification System code (NAICS).

The new rule applies to contract actions below the simplified acquisition threshold, acquisitions of commercial items, and acquisitions of commercially available off-the-shelf (COTS) items.  Failure to comply with the new reporting requirements—

The contracting officer shall exercise appropriate contractual remedies. In addition, the contracting officer shall make the contractor's failure to comply with the reporting requirements a part of the contractor's performance information under Subpart 42.15.

We also note that the new rule has a powerful definition of first-tier subcontract.  Historically, the FAR has lacked such a definition; there is a definition in Part 44 but it is not especially useful.  Accordingly, we were pleased to see the FAR Councils tackle the potentially contentious issue.  Here is how the new rule defines “first-tier subcontract”—

First-tier subcontract means a subcontract awarded directly by a Contractor to furnish supplies or services (including construction) for performance of a prime contract, but excludes supplier agreements with vendors, such as long-term arrangements for materials or supplies that would normally be applied to a Contractor's general and administrative expenses or indirect cost.

Here’s a great write-up of the new rule, published by the law firm Crowell & Moring.

When we looked at the rule, on first blush it appeared that the new requirements are going to be burdensome.  But on second look we’re not so sure.  First, most of the larger contractors will be exempted from the compensation reporting requirements because they already publish executive compensation information to the Securities & Exchange Commission.  Second, some of the commercial contractors will be exempted from the compensation reporting requirements because they don’t receive more than 80 percent of their revenue from the Federal government.  Finally, the very smallest contractors will be exempted from the compensation reporting requirements because they receive less than $25 million in annual Federal revenue.  Those exemptions are going to reduce significantly the number of entities for whom exemption compensation information will need to be reported.  That will leave the requirement to report first-tier subcontract awards, which will be borne by the prime contractors.  And they should be able to handle the additional reporting requirements.  We hope.



 
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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.