The New Buzzword is “Affordability”
It was May 8, 2010, when U.S.
Secretary of Defense Robert Gates fired the first salvo. In a speech at the Eisenhower Library marking the
anniversary of the allied victory in Europe, he quoted President
Eisenhower as saying, “the patriot today is the fellow who can do the
job with less money.” SecDef Gates asserted that the “gusher of defense
spending” that came after the 9/11 attacks “has been turned off, and
will stay off for a good period of time.” SecDef Gates continued—
On one level it’s a simple matter of math. The fact that we are a nation at war
and facing an uncertain world … calls for sustaining the current
military force structure...
This typically requires regular real growth in the defense budget
ranging from two and three percent above inflation. In this year’s budget request, the
Defense Department asked for, and I hope will receive, just under two
percent – roughly that level of growth. But, realistically, it is highly unlikely that we will
achieve the real growth rates necessary to sustain the current force
structure. … The changes we have made in the procurement arena represent
an important start. But
only a start. More is
needed – much more. The
Defense Department must take a hard look at every aspect of how it is
organized, staffed, and operated – indeed, every aspect of how it does
business. In each instance
we must ask: First, is this
respectful of the American taxpayer at a time of economic and fiscal
duress? And second, is this
activity or arrangement the best use of limited dollars, given the
pressing needs to take care of our people, win the wars we are in, and
invest in the capabilities necessary to deal with the most likely and
lethal future threats?
As a
starting point, no real progress toward savings will be possible without
reforming our budgeting practices and assumptions. Too often budgets are divied up and doled out every year as a
straight line projection of what was spent the year before. Very rarely is the activity funded in
these areas ever fundamentally re-examined – either in terms of
quantity, type, or whether it should be conducted at all. That needs to change. … 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. …
Almost a decade ago, Secretary Rumsfeld lamented that there were 17
levels of staff between him and a line officer. The Defense Business Board recently estimated that in some
cases the gap between me and an action officer may be as high as 30
layers. … Finally, this Department’s approach to requirements must
change. Before making
claims of requirements not being met or alleged ‘gaps’ – in ships,
tactical fighters, personnel, or anything else – we need to evaluate the
criteria upon which requirements are based and the wider real world
context. For example,
should we really be up in arms over a temporary projected shortfall of
about 100 Navy and Marine strike fighters relative to the number of
carrier wings, when America’s military possesses more than 3,200
tactical combat aircraft of all kinds? Does the number of warships we
have and are building really put America at risk when the U.S. battle
fleet is larger than the next 13 navies combined, 11 of which belong to
allies and partners? Is it a
dire threat that by 2020 the United States will have only 20 times more advanced stealth fighters than China? … Therefore, as the Defense Department
begins the process of preparing next’s years Fiscal Year 2012 budget
request, I am directing the
military services, the joint staff, the major functional and regional
commands, and the civilian side of the Pentagon to take a hard,
unsparing look at how they operate – in substance and style alike. The goal is to cut our overhead costs
and to transfer those savings to force structure and modernization
within the programmed budget. In other words, to convert sufficient ‘tail’ to ‘tooth’ to
provide the equivalent of the roughly two to three percent real growth –
resources needed to sustain our
combat power at a time of war and make investments to prepare for an
uncertain future. Simply
taking a few percent off the top of everything on a one-time basis will
not do. These savings must
stem from root-and-branch changes that can be sustained and added to
over time.
The Secretary called for trimming $100 billion (actually,
$101.9 billion) from within the Pentagon’s budget. Readers of this
website should not have been surprised at SecDef Gates’ words. We’ve
been posting articles about the state of Defense spending almost since
our inception. This has been a long time coming.
But notice the Secretary’s focus. It is not on contractors,
but instead on the Pentagon’s overhead—what he called the “bureaucracy
that supports the military mission.” SecDef Gates called for the
Pentagon to lean itself down and implement sustainable measures to cut
the DOD’s own overhead costs. Keep that in mind as you read further.
Six weeks later, Under Secretary of Defense (Acquisition,
Technology, and Logistics) Dr. Ashton Carter met with several defense
industry leaders “to discuss policy, process and workforce changes that
will help the Defense Department buy things more efficiently,”
according to this article. The Federal
Times article reported that “On June 4, Deputy Defense Secretary William
Lynn said a goal will be to find two-thirds of the money, about $66.3
billion over five years, from support programs.” It also noted that the
senior defense industry executives were “not exactly sure what to
expect,” because of the short-fuse timing of the meeting.
On June 28 and 29, details quickly emerged from the meeting.
First, Dr. Carter released a Memorandum addressed to “Acquisition
Professionals” entitled, “Better Buying Power: Mandate for Restoring
Affordability and Productivity in Defense Spending.” The Memo called
for “delivering better value to the taxpayer and improving the way the
[Defense] Department does business.” USD (A,T&L) Carter wrote that—
Deputy Secretary Lynn expects that two-thirds of
the savings … can be found within [current] programs and activities. …
We need to restore affordability to our programs and activities … by
identifying and eliminating unproductive or low-value-added overhead; in
effect, doing more without more. The Department is spending … $400
billion on contracts issued to entities outside the Department of
Defense. … Each of these contracts contains a statement of the services
or products it is procuring; an arrangement between the government and
the contractor for how the costs of those items will be paid; and the
overheads, indirect charges, and fees that complete the business
transaction and make it possible for the defense industry to be
economically viable. The guidance memorandum I plan to issue will
require each of you … to scrutinize these terms to
ensure that they do not contain inefficiencies or unneeded overhead. …
The guidance will focus on getting better outcomes, not on our
bureaucratic structures. … Most of the rest of the economy exhibits
productivity growth, meaning that every year the buyer gets more for the
same amount of money. So it should be in the defense economy.
Accompanying the Memorandum was
several PowerPoint slides providing additional details on the foregoing
and establishing six overall objectives. Among those objectives were:
“Restore affordability to defense goods and services,” “Improve defense
industry productivity,” and “Maintain a vibrant and financially healthy
defense industry.” To incentivize industry and accomplish the
objectives, the DOD will—
- Phase-out award-fee
contracts and favor fixed-price or cost-type incentive contracts …
- Phase-out Time and Material and sole-source ID/IQ
contracts wherever possible.
- Identify
and eliminate non-value-added overhead and G&A charged to
contracts.
- Limit B&P
allowable costs in sole source contracts and encourage effective use of
IRAD.
- Adopt “should-cost” and
“will-cost” management to inform managing of programs to cost
objectives.
- Improve consistency
and quality of government audits, and focus them on value-added content.
- Mandate affordability as a [contract award]
requirement by having cost considerations shape requirements and design.
What is one to make of these initiatives? Our first thought
is that “everything old is new again,” as much of the foregoing seems to
be a rehash of prior initiatives. For example, remember the CAIV initiative of the mid-90’s? In addition, the idea of
limiting B&P and IR&D spending is a revisiting of pre-FASA
ceilings on such costs—an idea that was repealed by Congress in order to
foster innovation in the defense industry. Moreover, the idea that
contract budgets can be controlled solely by contract type (e.g.,
fixed-price types) without focusing on better definition of requirements
and specifications is provably wrong.
There will
be more on this topic, yes indeed. But one final thought for this
piece. Look again at SecDef Gates’ original remarks. Notice his focus
was on the Pentagon, not the contractors.
Now look at Dr. Carter’s Memorandum and the accompanying slides. Notice
his focus is on the contractors, not the
Pentagon. We wonder how that metamorphosis took place within a mere six
weeks’ time. Maybe the sound bite just played better in media and in
front of Congress. But somehow, instead of fixing itself, the Pentagon
has decided to launch a major initiative to fix its contractors.
Stay tuned. More on this to follow, we’re quite sure.
Two More Contractors Settle False Claims Suits
We’ve
reported on quite a number of military servicemen and civilian
employees of the DOD who’ve been accused, indicted, and/or convicted of
corruption and bribery charges. But we also understand that defense
contractors are just as frequently accused of similar crimes: either
attempting corrupt actions or violating one of the myriad requirements
of the typical government contract. Today’s article concerns two
different defense contractors—two of the largest in the industry—who
separately settled suits under the False Claims Act.
First,
on June 10, 2010, the Department of Justice (DOJ) announced that Pratt & Whitney-Rocketdyne, Inc. (PWR) “has
agreed to pay the government almost $3 million to resolve allegations …
rising out of a dispute over fees charged on a contract with NASA after
Pratt & Whitney merged with Rocketdyne in 2005.” As the DOJ
announcement reports—
Prior to the merger, Rocketdyne had subcontracted with Pratt &
Whitney for work on a Space Shuttle flight support services contract
Rocketdyne had with NASA. Following the August 2005 merger, Pratt &
Whitney Rocketdyne billed NASA fees under the pre-merger subcontract. In
December 2006, the Defense Contract Audit Agency questioned whether
those subcontract fee billings allowed the merged company to reap excess
profits.
This case raises a very
interesting question: whether a subcontract in place prior to an
acquisition should continue to be treated in the same manner after the
acquisition, or whether it should then be treated as an
inter-organizational transfer. If the latter, then profit should be
stripped-out pursuant to the requirements of the Cost Principles found
at 31.205-26(e). Clearly, we know how DCAA and DOJ felt about the
proper treatment. And just as clearly, it would be cheaper for PWR to
settle the matter rather than to litigate the question.
The
second matter involved Northrop Grumman. Before we delve into
Northrop’s issue, let’s also note that on June 3, 2010, the DOJ announced that the company had agreed to pay
$700,000 to resolve allegations that it billed the government “for
lodging expenses for Northrop employees who actually stayed in
accommodations provided by the government” related to two “defense
procurement contracts.” But that’s not really a news-worthy item, in
our view. What’s seems more interesting (at least to us) are the
various news stories reporting that the company agreed to pay $12.5
million in order to settle false claims allegations related to
commercial items used in military navigation systems. Reportedly,
Northrop Grumman failed to properly test those items “to ensure that
they would function at the extreme temperatures required for military
and space uses.” According to this
article at Bloomberg
BusinessWeek, “the U.S. alleged that the failures to test parts
continued from November 1998 until February 2007.” Moreover, this LA Times article notes that the settlement relates to a
whistleblower suit filed in May 2006 by Allen Davis, a former quality
assurance manager for Northrop. The article reports Mr. Davis will
receive roughly $2.4 million of the settlement.
Under
the False Claims Act, companies are liable for up to $11,000 per false
claim, plus up to treble damages. In Northrop’s case, the allegedly
fraudulent testing went on for nearly six-and-a-half years, and involved
multiple military departments—and presumably multiple contracts, each
with its own set of invoices. Looks to us like Northrop (as with PWR),
settled very smartly for perhaps pennies on the dollar—which is usually a
good indication that the Government’s case was perceived to be weak or
too complex to be confidently brought before a jury. Where the
Government believes it has a strong or easily litigable case,
settlements are typically much higher.
We
have reported on the recent emphasis on contractor past
performance and the revitalization of the notion that a “responsible”
contractor is one with a good record of integrity and ethics. Although
these two companies appear to have made smart business decisions to
avoid costly litigation, it is not clear how these settlements
ultimately will affect their ability to win new work from their Defense
customers.
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Miscellaneous Morsels of Misadventures
We’ve been saving up some news
tidbits: each one not really worth an individual article but still
somewhat interesting (to us, at least). Here we go—
- Bagram Update –
We’ve written about “issues” at Bagram Airfield before. We wrote, “we perceive an inequitable distribution of
iniquity, with Bagram seemingly receiving more than its fair share of
noteworthy corruption stories.” Now comes word that “Two Afghan trucking companies pleaded guilty today to
paying multiple bribes to U.S. public officials in exchange for unfair
advantages in procuring contract work at the Bagram Airfield in Afghanistan.” The news story continued—
Afghan International Trucking (AIT) and Afghan Trade
Transportation (ATT) each pleaded guilty in the Eastern District of Virginia to one count of bribery.
According to the companies' plea agreements, AIT will pay $3.36 million in criminal fines and ATT will pay $1.04 million in criminal fines. … AIT made
corrupt payments of more than $120,000 to military
officials in Afghanistan, including James Paul Clifton, Ana Chavez and a third, unnamed individual. ATT made corrupt payments totaling more than $30,000 to Clifton. According to the
statement of facts, employees for AIT started offering money to
officials in the transportation office beginning in 2004. At one point, AIT paid Chavez with a candy box stuffed with $70,000. … in mid-2008, AIT was paying Clifton $20,000 a month for preferable treatment. In May 2008, ATT entered into a similar illegal
agreement with Clifton by which ATT paid bribes of $15,000 a month in exchange for Clifton assigning ATT an
additional day of trucking service a month.
- Oil for Food Corruption – The Department of Justice reported that “Canadian/Lebanese
dual national Ousama M. Naaman pleaded guilty today to participating in
an eight-year conspiracy to defraud the United Nations Oil for Food
Program (OFFP) and to bribe Iraqi government officials in connection
with the sale of a chemical additive used in the refining of leaded
fuel.” According to the DOJ release, “He pleaded guilty today to a
two-count superseding information filed June 24, 2010, charging him with
one count of conspiracy to commit wire fraud, violate the Foreign
Corrupt Practices Act (FCPA), and falsify the books and records of a
U.S. issuer; and one count of violating the FCPA.” The release
continued—
From 2001 to 2003, acting on behalf of Innospec, Naaman offered
and paid 10 percent kickbacks to the then Iraqi government in exchange
for five contracts under the OFFP. Naaman negotiated the contracts,
including a 10 percent increase in the price to cover the kickback, and
routed the funds to Iraqi government accounts in the Middle East.
Innospec inflated its prices in contracts approved by the OFFP to cover
the cost of the kickbacks. Naaman also admitted that from 2004 to 2008,
he paid and promised to pay more than $3 million in bribes, in the form
of cash, as well as travel, gifts and entertainment, to officials of
the Iraqi Ministry of Oil and the Trade Bank of Iraq to secure sales of
tetraethyl lead in Iraq, as well as to secure more favorable exchange
rates on the contracts. Naaman provided Innospec with false invoices
to support the payments, and those invoices were incorporated into the
books and records of Innospec. Naaman faces a maximum prison sentence
of 10 years. His sentencing has not yet been scheduled.
- Aerovironment –
Last (but not least), we have to follow-up our very recent article on a couple of False Claims settlements with news that
another defense contractor, Aerovironment, reported that the Department of Justice is investigating “certain of its
billing practices” and that the company “is voluntarily cooperating”
with the investigation. According to the report, the investigation is
focused on three matters: (1) the
appropriateness of certain expenses included in AV’s fiscal year 2006
Incurred Indirect Cost Claim, (2) billing labor rates associated with
time and materials government contracts, and (3) billing rates for Small
Unmanned Aircraft Systems maintenance and repair contracts. In
addition, the company denied that the recent departure of its CFO was
unrelated to the investigation. Let’s hope the company comes through
the DOJ investigation as well as the other companies did—i.e., by
settling the matter quickly.
DOD Blames Contractors for Lack of Contract Definitization, Establishes New Process Groundrules
To
meet urgent needs, the Department of Defense (DOD) can authorize
contractors to begin work and incur costs before reaching a final
agreement on contract terms and conditions, including price. Such
agreements are called undefinitized contract actions (UCAs). UCAs are
binding commitments used when the government needs the contractor to
start work immediately and there is insufficient time to negotiate all
of the terms and conditions for a contract. UCAs can be entered into via
different contract vehicles, such as a letter contract (a stand-alone
contract), a task or delivery order issued against a pre-established
umbrella contract, or a modification to an already established contract.
As
the Government Accountability Office (GAO) reported to Congress—
The FAR and the Defense Federal Acquisition Regulation Supplement
(DFARS) govern how and when UCAs can be used. The regulations also
establish requirements as to how quickly UCAs must be definitized.
Although each regulation contains two criteria, they are not the same.
The FAR states that a letter contract needs to be definitized within 180
days after the award date or before 40 percent of the work is complete,
whichever occurs first. While the DFARS includes the 180-day time
frame, it addresses all UCAs (including undefinitized task and delivery
orders and contract modifications) and adds a requirement to definitize
before more than 50 percent of funds are obligated. … The definitization
time frame can also be extended an additional 180 days when a
qualifying proposal is received from the contractor. The contractor does
not receive profit or fee during the undefinitized period, but can
recoup it once the contract is definitized.
In
June 2007, GAO reported on DOD’s use of UCAs. Fundamentally, GAO
found that the Government’s timeliness in “definitizing” the UCAs—i.e.,
negotiating a final contract price played a key part in controlling
costs (and profits) paid to contractors. In particular, GAO found that—
We reported that DOD contracting officials were more likely to
adhere to the Defense Contract Audit Agency’s advice regarding the
disposition of questioned and unsupported costs when negotiations were
timely and occurred before contractors had incurred substantial costs
under UCAs. On the other hand, contracting officials were less likely to
remove questioned costs from a contract proposal when the contractor
had already incurred these costs during the undefinitized period.
The
majority of UCAs reviewed by GAO were not definitized within the
required timeframes. GAO further reported that the number one reason
for delays was an “untimely receipt of a qualifying proposal” from the
contractor. Among the other reasons cited were “protracted
negotiations” between DOD and its contractors and “delays in obtaining
certified cost and pricing data” (sic).
In
January, 2010, GAO issued a follow-up
report, in which it noted
improvement by DOD in this area. However, GAO also reported that
“local commands are generally not meeting DOD’s management standards”
with regard to UCA definitization and documentation of contractor
negotiations. GAO found that—
According to DOD regulations, contracting officers are required to
consider any reduced cost risk to the contractor for costs incurred
before negotiation of the final price. Further, contracting officers
must document this risk assessment in the contract files. Sixty-six of
the 83 contract actions we reviewed were definitized and should have
documented a risk assessment in their contract file and used the weighted guideline worksheet
or an alternative method to determine allowable profit or fee for
negotiation purposes. About half of the cases we reviewed—34 of 66—did
not use the weighted guidelines or document any consideration of cost
risk to the contractor during the undefinitized period when establishing
profit or fee negotiation objectives. Instead, we found these
contracting officers based their profit or fee negotiation objectives on
previously negotiated rates under contracts for similar work or other
factors. None of these included the required consideration of any
reduced cost risk to determine whether the contractor’s proposal
included fair and reasonable prices. … In the remaining 32 of 66 UCAs
we reviewed, the contract files included weighted guideline worksheets,
but it was not always clear whether the contracting officers considered
any reduced cost risk to the contractor during the undefinitized period
as a factor when determining allowable profit or fee as required.
Based
on the foregoing, it was not surprising when, on March 24, 2010, the US
Air Force issued a memo to its Major Commands entitled, “Timely
Undefinitized Contract Action (UCA) Definitization/Negotiated
Awards—Contractor Responsiveness.” The memo focused on completing
definitization within the required 180-day period, and asserted that
open lines of communication and completion of established due dates
would be key to meeting that objective. The memo stated—
… it is imperative that we work effectively with our industry
counterparts to receive quality documentation and data in a timely
manner. … Documentation supporting a contractor’s proposal should be
readily available and should be provided upon request. However, there
may be circumstances where the requested data is not immediately
available and reasonable timeframes should be established to provide
such requested documentation.
The
Air Force memo directed that “for all sole source contract actions
greater than $50 million and any UCA greater than $1 million,
contracting officers shall schedule a proposal kick-off meeting.” The
kick-off meeting should include all stakeholders, including the Air
Force and contactor, DCAA auditors, DCMA functional specialists and, “at
the prime contractor’s discretion,” major subcontractors. The memo
also directs that—
… after proposal submittal and preliminary review … the contracting
officer shall require the contractor to provide a proposal walk-through
for the Government to ensure an understanding of the proposal
composition, validate or revisit the definitization/award schedule, and
establish action items for any obvious data omissions.
Significantly,
the Air Force memo focuses on contractor responsiveness, stating, “If
the requested data is not provided by the requested date or … the
agreed-to date, and an acceptable resolution cannot be achieved, the
issue shall be immediately elevated to the appropriate senior management
for both the government and the contractor.” Even more significantly,
the Air Force memo then notes that “DCAA has issued guidance for
handling denial of access to contractor’s records IAW 15.404-2(d). We endorse the procedures …” (Emphasis added.)
On
May 25, 2010, DCAA issued the Air Force memo under MRD 10-PSP-016(R). The audit guidance directs auditors to
cooperate with the Air Force’s process. Among other actions, the audit
guidance states—
The proposal
kick-off meeting will occur soon after the contracting officer’s release
of the RFP. The meeting will focus on procurement schedule
requirements, expectations of timely contractor support, and the
identification of expected major subcontracts. DCAA auditors should
attend these kick-off meetings to get an understanding of the
acquisition milestones and general nature of the proposal. It should be
clearly communicated at this meeting that contractor supporting data should generally be readily
available once the proposal is submitted. … DCAA should attend these meetings to obtain an
understanding of the contractor’s proposal, including supporting data.
The contractor should also identify the contractor personnel responsible
for the underlying data and estimates. DCAA will require access to
these individuals during the audit process. … During these meetings, the
auditor should identify any apparent proposal inadequacies. If data
omissions are so significant as to render the proposal inadequate for
analysis, the auditor should recommend that the Contracting Officer
reject the proposal. Audit report due dates for the particular proposal
should be established after the completion of the audit risk assessment.
The audit guidance further cautions
auditors to avoid “comments that could be construed as advising the
contractor on how to develop its proposal” so as to avoid any
allegations that the auditors are participating in an Integrated Process
Team (IPT), an activity which has been prohibited as it has been
alleged to impair auditor independence.
Well,
then. We generally endorse any process that would definitize UCAs
within the required timeframes, but we wonder if the foregoing Air Force
and DCAA direction might not be avoiding addressing the real
problem—which is insufficient identification of Government requirements,
and subsequent changes to those requirements—which prevents contractors
from submitting timely and comprehensive proposals. (See the GAO
reports linked above, which show the lack of defined requirements is a
much a problem as any lack of cost or pricing data.) Focusing on
enforcing timely contractor provision of requested data to support
fact-finding and negotiations seems to be a fundamentally misplaced
management emphasis—particularly since the Air Force is now endorsing
DCAA’s arbitrary and punitive “denial of access to records” process.
(We criticized DCAA’s approach, which focuses on timeliness at the
expense of factual accuracy and audit quality, in our article that was
republished in West’s The
New Landscape of Government Contracting.)
We also note that DCAA has
(once again) attempted to extend its audit access to contractor
personnel, despite regulatory direction (supported by settled case law)
that limits auditor access to cost, accounting, and financial records—as
well as other cost or pricing data identified by the contractor.
Finally,
despite DCAA’s cautious directions to the contrary, this smells very
much like an IPT-like process and we smirk at DCAA’s protestations to
the contrary. Candidly, auditors should participate in IPTs and DCAA
should tell those who criticize that participation to stuff it.
It
is becoming an open secret that DCAA’s temper tantrum (stemming from
GAO findings and well-publicized Congressional criticism) is starting to
paralyze the Defense acquisition process. This guidance strikes us as a
small Band-Aid that looks good, but which fails to address fundamental
problems at the audit agency that continue to impair timely issuance of
quality audit reports, leaving DCMA and DOD buying commands in limbo as
they attempt to award, administrate, and manage contracts.
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