Three years ago, the Armed Services Board of Contract Appeals (ASBCA) sustained Lockheed Martin’s protest of a Contracting Officer’s final decision.  In doing so, the Court ruled on whether Lockheed Martin’s $9.5 billion CPAF contract for F-22 engineering and manufacturing development (EMD) met the CAS and FAR definitions of an “affected CAS-covered contract”.  This was a critical ruling, because “affected” contracts must be included in contractors’ cost impact studies when determining contract costs impacts associated with CAS noncompliances and voluntary accounting changes.

FAR 30.001 defines the term “affected CAS-covered contract” as follows—

‘Affected CAS-covered contract or subcontract’ means a contract or subcontract subject to Cost Accounting Standards (CAS) rules and regulations for which a contractor or subcontractor—

(1) Used one cost accounting practice to estimate costs and a changed cost accounting practice to accumulate and report costs under the contract or subcontract; or

(2) Used a noncompliant practice for purposes of estimating or accumulating and reporting costs under the contract or subcontract.

The CAS Administration regulations at FAR 30.604 and 30.605 require a contractor to submit “information on the estimated overall impact” with respect to the situations noted above, “on affected CAS-covered contracts and subcontracts”.  The requirements (and the definition) are repeated in the CAS contract clauses, notably 52.230-6 (Administration of Cost Accounting Standards). 

Clearly, only affected CAS-covered contracts, as defined in the regulations, are to be included in the contractor’s cost impact analysis, whether the analysis is a “general dollar magnitude proposal” (GDM) or “detailed cost-impact proposal” (DCI) to the “cognizant Federal Agency official”.  The problem the ASBCA had to resolve was whether Lockheed Martin’s F-22 contract was an “affected” contract, or not.  Although the exact cost impact to the contract was uncertain, including the contract in the analysis would mean that Lockheed Martin would owe the Government somewhere between $10 and $15 million.

The facts—briefly—include a program replan and rebaseline effort based on the changing Government funding profile (which increased program costs by more than $1 billion), and a “should-cost” review of Lockheed Martin’s overhead (which recommended movement of some personnel from indirect to direct-charging).  Lockheed Martin agreed with the recommendation, which was a change to its disclosed cost accounting practices, and it negotiated program budgets based on those changed cost accounting practices.  The Court was impressed with Lockheed Martin’s efforts to fully disclose its changes to the Government, noting that the impacts to the F-22 EMD program were “thoroughly discussed and negotiated” and that the discussions were “unusually comprehensive”. 

The Government argued that LockMart and its Air Force customer “understood that they were negotiating a contract change proposal and did not price the equivalent of a new contract” and therefore the contract was not completely repriced by the negotiations.  Because the contract was not completely repriced, it was still an “affected” contract for purposes of calculating the cost impact analysis.  The Court was unimpressed by the Government’s arguments, stating—

The government contentions are based on superficial, mostly irrelevant generalizations relating to the intent, scope and technical revisions of the rephase modifications and negotiations that miss the point. They do not convincingly and substantively address the critical issues inherent in the definition of ‘affected contract,’ i.e., what accounting practices were used in estimating the price of the F-22 contract as rephased. The essential questions are whether the negotiating parties (LASC and the Air Force) knowingly repriced the contract using the changed practices rather than the practices used in pricing the original contract and whether the scope of that repricing effort was sufficiently comprehensive to justify a conclusion that the impact of the changed practices were fully incorporated in the contract price as rephased. … The critical issue is whether the cost impacts of the changed practices were fully integrated into the pricing structure for the entire contract as rephased or solely the discrete technical revisions to the work.

The ASBCA found for Lockheed Martin and the Government appealed to the Court of Appeals, Federal Circuit.

The Federal Circuit was similarly unimpressed with the Government’s arguments.  For example, the Appellate Court found—

The government contends that a contract must be an ‘affected contract’ if the accounting changes were integrated into the contract price and the final estimated costs were not reduced to compensate for those additional expenses. However, the Board did not determine that additional accounting costs were tacked on to the contract estimate; it found that the parties created a wholly new cost estimate incorporating all of the additional expenses. Because those costs were consistently estimated and accrued, the Board concluded that the F-22 contract was not an ‘affected contract.’ Based on the Board’s detailed findings and analysis of the rephase negotiations and the rules applicable to changes in accounting practices, we uphold the Board’s conclusion that the statutory and regulatory provisions governing ‘affected contracts’ were inapplicable to the rephased F-22 contract.

The Federal Circuit also dealt with the Government’s contention that the F-22 Contracting Officer lacked authority to agree to accept additional contract costs stemming from LockMart’s change in cost accounting practice.  The Court wrote—

Because the PCO properly exercised the author-ity to negotiate and integrate the additional accounting costs into the modified contract, no adjustment was required under the relevant regulations, and the DACO’s authority to perform that adjustment was not necessary.

In addition, the Court noted—

… the government disputes the Board’s finding that the Air Force validly agreed to the additional accounting costs. The government points to the clause in the rephased contract stating that ‘[a]ward of this contract does not constitute a determination [that Lockheed’s practices are CAS compliant],’ and reserving the government’s right to an adjustment if Lockheed’s practices are ultimately determined to be non-compliant. That clause, however, does not create a right to an adjustment or demonstrate a disagreement over contract costs. It merely indicates that the Air Force was not waiving whatever adjustment rights it may have had. Because the rephased F-22 contract was not an ‘affected contract,’ the government did not have any adjustment rights to retain.

To sum up, the Appellate Court upheld the ASBCA’s finding that a contract that has been repriced using the changed cost accounting practices should not be included in a contractor’s cost impact analysis.  Once the contract’s estimated cost and/or price had been renegotiated to include the cost impact, it was no longer an “affected contract” and was properly excluded from the various cost impact analyses negotiated between the CFAO and the contractor.

This is an important series of court decisions that should be studied by serious practitioners of the art of complying with the Federal Cost Accounting Standards.

It’s rarely dull when the Commission on Wartime Contracting in Iraq and Afghanistan (CWC) holds a hearing.  Our past stories have included—

• “New Report Blasts DOD Management of Contractors Deployed on the Battlefield”
• “Testimony Blaming Contractor Internal Controls”
• “CWC – Out of Touch with Reality?”
• “DOD Responds to CWC’s Concerns”

On May 24, 2010, the Commission was back at its oversight job, this time evaluating “the challenges and issues that confront law-enforcement officials as they attempt to discover and successfully prosecute fraud in a contingency environment,” and also hearing about “the work of the Inspectors General for USAID, State, and Defense” regarding their efforts to combat the unholy trinity of waste, fraud, and abuse in the Southwest Asia (SWA) theater of operations.  This was a follow-up hearing to one held in February, 2009.

Co-Chair Shays opened the hearing by saying—

Testimony at that first hearing established that billions of taxpayer dollars have been lost to waste, fraud, and abuse. The inspectors general told us that contributing causes included: … insufficient numbers of adequately trained contract officers and auditors, poorly written contracts with haphazard record keeping … as the DoD witness put it, ‘continual exposure to offers of bribes, gratuities, and kickbacks.’

In his discussion of fraud, Mr. Shays was careful to be evenhanded.  He said—

Let me emphasize that our outrage is not directed solely at misbehaving contractor employees. More than a third of the 477 subjects of open investigations tabulated by the International Contract Corruption Task Force in May were U.S. government employees or military personnel.  … [Therefore] [w]e are particularly interested in seeing expanded anti-fraud initiatives and actions, unity of effort among federal agencies, recognition that many peacetime ways do not work in wartime, balancing between accelerated contracting and appropriate safeguards, and greater accountability.

The first panel included several government investigators.  They discussed various topics, including the International Contract Corruption Task Force (ICCTF), which is an outgrowth of the National Procurement Fraud Task Force.  For example, James Burch (Department of Defense Office of Inspector General, Deputy Inspector General for Investigations) testified—

Contract administrators focused primarily on timely mission accomplishment versus ensuring strict adherence to traditional contract administration procedures, many of which are designed to reduce the risk of corruption and abuse. When engaging in contingency contracting, administrators typically do not consider the risk of increased levels of fraud resulting from lower levels of oversight, as the mission is to provide goods and services as promptly as possible. When left unchecked, this mind set can become pervasive to the extent contract administrators begin to view oversight responsibilities as unwelcome burdens conflicting with their ability to effectively perform their duties. This factor has been especially prevalent when exploring allegations of corruption and abuse related to funds administered via the Commander’s Emergency Response Program (CERP), which was designed to fund development of local programs and institutions.

He also testified that “As of May 1, 2010, 106 DCIS agents (approximately 33% of the DCIS workforce) are involved in investigating a total of 223 Overseas Contingency Operations (OCO) cases. The volume of criminal cases has increased by roughly 18 percent over the past year.”

Mr. Kevin Perkins (Assistant Director, Criminal Investigative Division, Federal Bureau of Investigation) testified that—

Since 2004, the ICCTF has initiated nearly 700 investigations in Afghanistan, Iraq, and Kuwait. To date for FY 2010, the ICCTF has 273 pending cases. Only seven months into the fiscal year, the ICCTF has already generated 80% of the prior year’s case load. In FY 2009 alone, the ICCTF obtained over $3.3 million in forfeitures/seizures, over $1 million in fines/penalties, and over $1.1 million in restitution. To date in FY 2010, the ICCTF has obtained over $47 million in restitution, and $1 million in forfeitures/seizures.

The CWC also heard from SIGAR (Special Inspector General for Afghanistan Reconstruction, which is a parallel organization to SIGIR, who also provided a representative to testify before the CWC).  They heard that “SIGAR currently has 42 pending investigative matters, 57 percent of which are focused primarily on contract and procurement fraud, 31 percent on corruption, and the remainder on theft of government property.”

Here is a link to a two-and-a-half-hour long C-SPAN video of the first Panel.

As noted above, the second panel was all about the various Inspectors General.  The IG for the USAID testified that the agency had found “poor contract and program management practices.”  He also told the CWC that—

From February 2009 to date, we have issued 12 performance audits with 84 recommendations for USAID improvement and completed 19 financial audits that identified $206 million in questioned costs, of which $180 million were sustained. Over the same term, we opened 43 civil and criminal investigations, closed 17 investigations, effected 10 arrests and 3 convictions, and secured $141 million in investigative savings and recoveries for the Government.

The USAID Inspector General also testified that—

We cannot measure the full extent of waste, fraud, and abuse in Iraq and Afghanistan but can provide information on what we have found. From 2003 to the present, we have submitted $4.9 billion of the $17 billion USAID has obligated in Iraq and Afghanistan to in-country financial audits. These audits questioned $282 million in costs, or approximately 6 percent of the total audited. Over that period, we identified an additional $166 million in waste, fraud, and abuse in USAID’s Iraq and Afghanistan program portfolio in the form of investigative savings and recoveries.

Last year, the amount of waste, fraud, and abuse that we identified increased. Thus far, our FY 2009 investigative leads and referrals have led to $101 million in investigative savings and recoveries—more than all of our leads and referrals from FY 2003 to 2008 combined. A similar pattern emerged with our audits, as the percentage of questioned costs arising from in-country financial audits increased in FY 2009. This increase in observed waste, fraud, and abuse is primarily associated with a small number of contracts with a few firms, but some of it may result from the growing prevalence of contract and program management issues we have witnessed during our performance audits.

The Department of State Deputy Inspector General told the CWC that his team found “an insufficient number of U.S. Government contracting personnel in the field, which led to weak oversight and management of programs. This situation is a root cause of poor ‘ground truth’ monitoring of contractors, incomplete contract files, and untimely or inadequate review of invoices.”

The DOD Deputy Inspector General for Auditing told the CWC about “10 systemic issues related to deficiencies in the contract management process.”  The 10 areas of concern were:  “requirements, contract documentation, contract type, source selection, contract pricing, oversight and surveillance, inherently governmental functions, property accountability, award fees, and financial management.”

Here is a link to a two-and-a-half-hour long C-SPAN video of the second Panel.