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Apogee Consulting Inc

New DCAA Audit Guidance

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Each month DCAA publishes new or revised audit guidance, known as “open audit guidance.”  The form of the audit guidance is a “Memorandum for Regional Directors” or MRD.  Recently DCAA issued a couple of MRDs that we want to bring to your attention.

On February 16, 2010, DCAA issued MRD 10-PAS-003(R), entitled “Audit Guidance Related to Audits Performed by Foreign Auditors under Reciprocal Agreements.”  By way of background, the Defense Department has executed agreements with several countries, agreeing that audits of companies headquartered in those countries will be handled by local auditors.  As the MRD states—

The United States Department of Defense (DoD) has agreements with the Governments of certain foreign countries to provide contract audit services and other contract administration services without charge. Under these agreements, DCAA performs audits of U.S. companies performing or bidding on contracts of the foreign country. In return, the auditors of the foreign country perform audits of the foreign companies performing or bidding on U.S. Government contracts. The U.S. currently has reciprocal audit agreements with five countries: Canada, United Kingdom, France, Netherlands, and Germany.

The MRD directs its auditors that, notwithstanding such agreements, “the results of audits performed by foreign auditors are not to be incorporated into DCAA audit reports” because DCAA can no longer rely on the opinions of the foreign auditors.  The audit guidance recommends that the DCAA auditors tell the contracting officer to get the necessary audit reports directly from the foreign auditors, because DCAA won’t have anything to do with those foreign audit reports.

Another step in DCAA’s two-year long mission to paralyze the Defense acquisition process?  You be the judge.  But before you decide, remember that many large defense programs have large percentages of international suppliers in their supply chains.  Some major defense acquisition programs (MDAPs) are primed by the likes of BAE Systems (headquartered in the UK) or EADS or Thales or AugustaWestland.  We expect that making a contracting officer go through the assist audit process to negotiate forward pricing rates or a new business proposal will add months to an already overlong process.

Next, on February 18, 2010, DCAA issued MRD 10-PAS-005(R), entitled “Audit Guidance on Performing Internal Control Follow-up Audits and Limited Scope Audits.”  This MRD supersedes prior audit guidance regarding audits of contractor internal control system reviews (now called “business system” reviews) and, in particular, performance of limited-scope “follow-up” audits designed to confirm initial findings related to system deficiencies—i.e., failed control objectives.  The MRD confirms what we previously reported months ago, which is that DCAA is rewriting its entire approach to performing internal control systems reviews and has stopped performing any new audits until “the revised audit process is tested and distributed to the field audit offices.”  (Which, by the way, will take months to accomplish.)

The MRD tells auditors that, even though no new ICAPs reviews are being performed, “FAOs should perform follow-up audits to verify the contractor’s correction of previously-reported internal control deficiencies.”  The MRD states that “the scope of the follow-up audit will be limited to determining if the contractor corrected the previously-reported deficiencies.”  [sic]   Moreover, the MRD directs that—

If the contractor has not corrected all of the previously-reported deficiencies, the report should state that the examination noted significant deficiencies that are considered to be material weaknesses and provide details in the Statement of Conditions and Recommendations section of the report. The report should also recommend that the contracting officer pursue or continue the suspension of the percentage of progress payments or reimbursement of costs and, if applicable, disapprove the affected portions of the system.

DCAA may have a more prominent role to play in reviews of contractor “business systems” and imposition of mandatory payment withholds.  See the proposed DFARS rule here.  It is apparent that the audit agency is in the process of rethinking its approach to conducting such reviews.  Meanwhile, the House Armed Services Committee’s Panel on Defense Acquisition Reform has recommended that DOD consider “shifting the responsibility for certification of contractor business systems to independent teams within or outside of DCAA” and that DCAA should “allocate its audit resources on the basis of risk.”  Clearly this entire area—which is of paramount importance to contractors—because it can affect cash flow, competitive standing, and even lead to allegations of violations of the False Claims Act—is in flux and contractors need to keep a vigilant eye (or two) on changing DCAA audit guidance in this area.




 

DFARS Case 2009-D038 Business Systems—Definition and Administration

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Mr. Mark Gomersall

OUSD (AT&L) DPAP (DARS)

IMD 3D139

3062 Defense Pentagon

Washington, DC 20301–3062.

Re:  DFARS Case 2009-D038

Business Systems—Definition and Administration

Dear Mr. Gomersall,

This letter provides comments in response to the proposed rule that would “clarify” the definition of contractor business systems, and DOD’s administration thereof.  First, let me state that I provide these comments as an individual and any opinions I express are my own.  Although I am employed by a Top 5 Defense contractor, my opinions do not necessarily reflect the opinions of my employer.  Moreover, although I have provided consulting services to the defense industrial base for more than a decade, my opinions do not necessarily reflect the opinions of my clients.

As a threshold matter, I agree that the existing regulatory framework governing contractor systems needs to be updated and clarified.  There has been little in the way of guidance for contractors seeking to implement effective systems of internal control since the publication of the Defense Contractor’s Risk Assessment Guide (CRAG) in 1988.  CRAG identified five systems of contractor internal control:  (1) preparation of indirect cost “claims” (i.e., proposals to establish final indirect cost rates), (2) timekeeping and labor charging, (3) material management and accounting systems (MMAS), (4) estimating, and (5) purchasing.  The Defense Contract Audit Agency (DCAA) subsequently expanded the CRAG list to develop its list of ten key contractor internal control systems, which included (in addition to those mentioned in the CRAG list):  (1) Electronic Data Processing general controls, (2) Billing, (3) Budgeting/Planning, (4) Compensation, and (5) Indirect/Other Direct Costs. 

More recently, in November 2008 FAR contract clause 52.203-13(c) implemented a requirement that contractors have an internal control system that “facilitate[s] timely discovery of improper conduct in connection with Government contracts; and … [e]nsure[s] corrective measures are promptly instituted and carried out.”  The lack of guidance and, in particular, the lack of an independent source for a determination of what control activities constitute an “adequate” system, has been a barrier to those contractors desiring to implement effective systems of internal control that would provide assurance that they are complying with applicable statutory, regulatory, and contractual requirements.

While I agree that it is past time to update and clarify the existing regulatory guidance, I have several objections to the proposed rule.  Fundamentally, the proposed rule is unnecessary, creates potential conflicts with existing FAR language, and it would be applied to contract financing payments that are expressly exempt from requirements of certain business systems.  In its likely effect on contractors, it is punitive, arbitrary, and capricious.  Following are my specific comments:

1.    This should be a FAR rule and not a DFARS rule.  Promulgating the rule within the DFARS will lead to confusion as to which framework applies to contractors with both DOD and non-DOD contracts.  DOD contractors that are under the administrative cognizance of another Executive Branch Department or agency, or that have both civilian and defense contracts, will be potentially subject to multiple frameworks—i.e., they may have to comply with the “business systems” requirements in their DOD contracts while concurrently having to comply with business system adequacy rules of their cognizant non-DOD agencies.  Subjecting contractors to multiple, potentially conflicting, lists of standard “business systems”—and varying (potentially conflicting) standards of adequacy—will generate administrative confusion, create implementation problems, and will increase compliance costs.  The solution is to make this a FAR (i.e., government-wide) rule.  If that is not feasible, then the final rule should clearly state that a contractor are subject to the “business system” rules of its cognizant agency; and that in the case of conflict between the requirements of an individual contract’s clause(s) and the requirements of the cognizant agency, the requirements of the cognizant agency—and not the requirements of the individual contract’s clauses—shall prevail.  Failure to address this potential requirements conflict is a fatal flaw in the proposed rule.

2.    Exempt contracting financing payments from the final rule.  Although I support the notion that DOD implement payment withholds when a contractor ignores or fail to implement actions to correct identified deficiencies, there is no need to implement contract financing payment withholds via a new DFARS clause because the FAR already provides sufficient protection for the Government.  DOD contracting officers already have authority to reduce or suspend such payments when it is determined that “the Contractor’s records or controls are determined … to be inadequate for administration” of contract financing payments.  (See, e.g., the language at 52.232-32(h).)  With respect to progress payments, the relevant clause (52.232-16) provides that the Contracting Officer may “reduce or suspend progress payments” when it is determined that the contractor does not “maintain an accounting system and controls adequate for proper administration of this clause.”  Consequently, it should be clear that adding the proposed language to DFARS does nothing to provide additional protection to the Government with respect to contract financing payments; doing so merely sows confusion in the contract administration process and creates potential conflict between the applicable DFARS and FAR clauses.

In particular, linking contract financing payment withholds to accounting system deficiencies defeats a key benefit of Performance-Based Payments (PBPs)—DOD’s “preferred method” of contract financing for fixed-price contracts.  One of the Government’s key benefits when using PBPs is reduced government oversight because “the contractor’s accounting system is not relied on to determine payment amounts.”   (Source:  DOD User’s Guide to Performance-Based Payments, November, 2001, page 2.) In other words, the rule as drafted extends oversight into an area in which there is no nexus between the Government’s risk of improper payments and adequacy of the contractor’s business system, and it also extends oversight into an area that, by Congressional intent and DOD policy, was expressly exempted from such oversight.  If the DAR Council proposes to require Contracting Officers to reduce PBP amounts based on deficiencies in the contractor’s accounting system, it may as well eliminate use of PBPs altogether—because will have defeated a key benefit from their use.

3.    The proposed rule is punitive, arbitrary, and capricious.  As previously stated, I applaud the notion that contractors should be held accountable for the adequacy of their business systems.  And as previously stated, the existing FAR and DFARS language already provides much if not all of the authority Contracting Officers need to implement such withholds when it is appropriate to do so.  The proposed rule would mandate payment withholds ranging from 10 to 100 percent when the Administrative Contracting Officer determines that one (or more) business system contains “deficiencies”.  Glossing over my belief that such payment reductions would be found by a Court to be excessive to the Government’s risk and therefore punitive in nature, I would like to focus on the proposed language.

The term “deficiencies” is vaguely defined as “failure to maintain an element” of an acceptable system.  There is no mention of materiality, or of risk, or of proportionality, or of use of judgment.  There is no discussion of control objectives versus control activities.  There is no discussion regarding the fact that some system deficiencies can be “technical” with no impact to payment amounts (e.g., a lack of formal policies and procedures), while others can be significant and pose great risk to the Government.  There is no acknowledgment that human error (i.e., a simple mistake) is not at all the same as a systemic flaw.  Moreover, the proposed language (e.g., “the contractor’s accounting system shall be in compliance…”) actually conflicts with the existing policy at DFARS 242.7501, which states that the goal of an accounting system is “reasonable assurance” of compliance—and not absolute assurance.  Because the proposed language is vague and conflicts with existing policy language, it should be withdrawn, or at least significantly rewritten to address various types of deficiencies and the fact that no control system is perfect (nor would DOD want to pay for a system that achieved perfection, as it would be cost-prohibitive).

Moreover, the system requirements are similarly ill-defined.  For example, the proposed rule would state that one requirement of an adequate accounting system is the ability to provide “cost accounting information as required.”  Required by whom I wonder?  Required by the contractor itself (for its own use), or by DCAA auditors, or perhaps by DCMA functional specialists?  And exactly what cost accounting information is the requirement addressing?  This is simply one example of many that could be discussed.  The conclusion is obvious:  the proposed rule is vague, lacks any linkage of system “deficiency” to actual risk, and simultaneously removes Contracting Officer discretion in favor of mandatory withholds that are excessive to any possible risk to the Government. As drafted, the proposed rule is the very definition of “arbitrary and capricious”.

4.    The proposed rule fails to address key steps in the process.  The proposed rule lacks key details regarding the administrative process—a process whose steps and overall duration will affect the financial stability of the defense industrial base.  (I note that contractors must continue to perform their contracts, even if 100 percent payment withholds are imposed.  Impacting contractor cash flow so significantly, for an indefinite duration, surely will lead to impacts on financial stability and financial capacity.)

For example, the proposed rule states that “the ACO, in consultation with the auditor or cognizant functional specialist, shall evaluate the contractor’s response and make a final determination” regarding system adequacy, but fails to define how the consultation will take place.  Is a formal DCAA audit report required to determine that a business system has a deficiency?  Does an ACO require another formal DCAA audit report in order to determine that a deficiency has been corrected by the contractor? Can the consultation take place via email, as current Defense Procurement and Acquisition Policy (DPAP) guidance would suggest?  Given that DCAA frequently takes a full year to conduct a system review, and that current audit guidance requires auditors to wait “several cycles” before initiating follow-up reviews to determine whether corrective actions have been implemented, this proposed process easily could lead to contractors being forced to perform on DOD contractors for more than a full year without being paid, simply because DCAA hasn’t scheduled the follow-up audit or timely issued its audit report.  The unintentional consequence of this open-ended process might well be to force contractors into bankruptcy and terminations for default—which will require buying commands to reprocure the goods and/or services they need.  Additionally, the proposed rule requires the ACO to provide the contractor a report in sufficient detail to “allow the Contractor to understand what actions are necessary to correct the deficiencies,” but what happens if the contractor alleges the report lacks the requisite detail?  The administrative process, as drafted, could easily lead to a contractor being caught in a kind of “Catch-22” wherein it lacks sufficient information to correct a system deficiency, but cannot receive payment until it corrects the ill-defined problem to the satisfaction of the DCAA and ACO.  Surely this absurd and counterproductive result cannot be the intention of the DAR Council.

The proposed rule states that payment withholds will be withdrawn when the contractor has “substantially corrected” them, but fails to define what that phrase means.  For example, does DCAA need to re-audit the business system and reach that conclusion in order for an ACO to make that determination?  (See my comment, above, regarding the lack of timeliness associated with DCAA follow-up reviews.  If the contracting parties are waiting for DCAA to issue a follow-up report—even from a “limited scope” audit—they will have a very long wait indeed.  A full year’s wait would be a good guess of the length of time the parties would be awaiting DCAA’s input.)  Moreover, what is the difference between “substantially” corrected and “fully corrected” or even “partially corrected”?  Unless these terms are clarified for the benefit of the ACO and contractor, as well as DCAA auditors, it is difficult to understand how and when the payment withholds will be withdrawn.  The situation will create uncertainty and risk, and contractors will seek to increase prices in order to protect themselves from such uncertainty and risk.

Additionally, the proposed rule states that payment withholds will be withdrawn when the contractor has “substantially corrected” its deficiencies (proposed policy 234.201 at (7)), when the contractor has “corrected all deficiencies” (proposed direction at 242.70X1(b)(3)), and when the contractor has “corrected all deficiencies” (proposed clause at 252.242-7xxx(e)(2)(ii)).  Which direction does the DAR Council intend that the parties follow?  It is internal contradictions such as these that will impede efficient contracting oversight and administration.

To address these concerns, the DAR Council needs to clarify the process in great detail, including how disagreements between the contractor and DCAA, or DCAA and the DCMA ACO, will be handled in a manner that is fair to the contracting parties.

5.   The proposed rule is premature and DOD is not ready to implement it at this time.  The proposed rule as drafted imposes significant burdens on DCMA ACOs and functional specialists, as well as on DCAA auditors.  They are not ready to implement it.  If implemented now, the results will be an administrative paralysis that will harm the defense industrial base and, ultimately, the warfighters.  All stakeholders agree that both DCMA and DCAA are under-resourced to execute their current oversight missions, let alone the additional burdens imposed by the draft rule.  The Commission on Wartime Contracting in Iraq and Afghanistan (CWC) reported—

Poor alignment of personnel to meet wartime needs has resulted in a spiraling down of business-system oversight in contingency contracting. There have been too few experts to conduct reviews and too few personnel to validate that contractor corrective action was properly implemented.  As a result of personnel shortfalls, DCAA system reviews and follow-ups are not always timely; therefore, the real-time status of contractor business systems cannot always be determined. (Source:  CWC Special Report No. 1, page 6.)

In the same report (page 7) the CWC concluded that “DCAA is under-resourced for comprehensively reviewing all contingency contractors’ business systems on a timely basis.”  If DCAA cannot address the needs of a handful of contingency contractors, how can it possible address the needs of each defense contractor this proposed rule will affect?  The CWC conclusion was confirmed in September 2009, when then-Director April Stephenson testified before the Senate Committee on Homeland Security and Governmental Affairs that—

Based on the audits required under laws and regulations and an estimate of the audits required to meet contracting officials’ demand requests, the field audit offices developed the hours necessary to accomplish the workload, taking into consideration the risk of the various contractors, the skill level of the audit staff and an estimate of the additional hours required to comply with the auditing standards. Based on the hours, we developed Agency-wide priorities. Since our funding provides for only about 65% of the audits that are required to be completed, we based the FY 2010 priorities on the audits of highest risk. [Emphasis added.]

It is not only DCAA that is under-resourced.  The CWC also noted in its Special Report No 1 (page 7) that “The number of [DCMA] personnel assigned to perform CPSR reviews has decreased from 102 in 1994 to 70 in 2002, to 14 in 2009. … This steep decline in personnel, combined with the exponential increase in contracting activity, demonstrates a diminishing level of DCMA critical analysis of contractor purchasing systems.”  It is well and good to require timely analysis (including follow-up analysis) of contractor business systems; but the fact is that DCMA currently (and for the foreseeable future) lacks the ability to do so.

In addition to the lack of resources, there is a real question as to whether the DCAA is prepared to execute its role to evaluate contractor business systems, to determine the risk associated with system deficiencies, and to evaluate whether contractors have implemented appropriate corrective actions. 

In September 2009, GAO issued audit report GAO-09-468 that reported “audit quality problems at DCAA offices nationwide, as demonstrated by serious quality problems in the 69 audits … we reviewed, DCAA’s ineffective audit quality assurance program, and DCAA’s rescission of 80 audit reports in response to our work.”  Almost simultaneously, the DOD Inspector General issued Audit Report No. D-2009-6-009, that provided an independent confirmation of GAO’s 2008 findings that DCAA audit reports prepared in the Western Region lacked professional judgment, contained inadequate documentation or insufficient evidence to support conclusions reached, and/or lacked adequate supervision.  Moreover, GAO also issued audit report GAO-09-921 in September 2009, in which it advised DCMA contracting officers not to rely on DCAA audit procedures to implement contract cost surveillance.  GAO warned DCMA that “The effectiveness of DOD’s cost surveillance process depends, to a large extent, on the adequacy of [ ] DCAA procedures. Our recent work has raised concerns in this regard.”

The proposed rule requires the following—

The auditor or other cognizant functional specialist shall document deficiencies in a report to the ACO. The report shall describe the deficiencies in sufficient detail to allow the contracting officer to understand what the contractor would need to correct to comply with the applicable standard or system requirement, and the potential magnitude of the risk to the Government posed by the deficiency.

The proposed rule ignores the findings of GAO and the DOD Inspector General, and blithely assumes that DCAA is capable of issuing reports adequate to support DCMA contracting officer determinations.  Quite clearly, DCAA is not ready to do so at this time.  At the very least, the DAR Council should wait until GAO and/or the DOD Inspector General report significant audit quality improvement at DCAA, before implementing a system that is so dependent on the quality of DCAA audit reports.

Earlier this month, the House Armed Services Committee’s Panel on Defense Acquisition Reform issued its interim report after 12 months of effort.  Among the Panel’s recommendations was that the DOD should consider “shifting the responsibility for certification of contractor business systems to independent teams within or outside of DCAA” because of “methodological difficulties experienced at multiple DCAA field offices and on multiple DCAA audits” that have “led to audit conclusions that are unsupported by evidence.”  (Source:  Interim Report, page 47.)  DOD may or may not choose to accept the Panel’s recommendation in this area, but it should be given the opportunity to consider the recommendation and reach a decision without having the decision forced on the Department by hurried rule-making.

Finally, I understand that DCAA is currently reevaluating its approach to how it conducts its audits and reports findings with respect to contractor business systems.  I applaud the agency’s efforts to address problems caused by its current “pass/fail” approach that has been publicly criticized by many parties, including the CWC.  Many planned contractor business system audits have been deferred pending implementation of the new audit guidance.  This proposed rule, if implemented as written, would significantly affect DCAA audit procedures, as many areas that are currently treated as separate business systems would be aggregated into fewer systems.  (E.g., the accounting system would include labor accounting/timekeeping and indirect/other direct cost accounting, which are currently audited as separate systems.)   My point is that the DAR Council should delay this rule until DCAA has new audit guidance in place sufficient to conduct audits under the new business system adequacy regime.  Implementing the new regime before DCAA is ready to conduct its audits will only exacerbate the issues regarding audit quality and timeliness I have previously noted.

To sum up, neither DCMA nor DCAA is currently ready to implement this proposed rule, and implementing it now, while the oversight agencies are under-resourced, lack the necessary direction, and are still addressing audit quality problems, risks chaos.  The stakes are high—they are the financial stability of the defense industrial base.  Does the DAR Council want to take the risks I’ve outlined above?  Clearly the better course is to delay implementation of the final rule, however drafted, until there is some indication that the oversight agencies are positioned to successfully implement it.

Thank you for the opportunity to comment on the proposed rule.  I sincerely hope that the DAR Council and its support staff consider my comments and either withdraw or significantly rewrite the proposed rule to address the concerns I’ve raised.  In any case, I hope implementation will be timed so that the oversight agencies can effectively comply with the final rule without penalizing defense contractors because they lack adequate resources or direction.

Sincerely,

Nicholas Sanders

Principal Consultant

Apogee Consulting, Inc.

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EADS Reaches Agreement on A400M Program—But at a Price

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The EADS Airbus A400M military transport aircraft was supposed to be Europe’s answer to Boeing’s C-17 Globemaster and Lockheed Martin’s C-130.  According to this article, “the A400M was supposed to be a low-risk concept”—so low-risk, in fact, that the company and its customers agreed on a fixed-price for the planes even before development had started.  (Readers of this site should know how a fixed-price development story will end—i.e., not well.)  As the article summarizes—

The program took longer and cost a great deal more than planned due to problems with the engines and software. The first flight took place in December 2009, two years behind schedule, and the first deliveries won’t be until 2012, three years late. EADS has for the last two years been burning through about $100 million of its own each month and taken total charges for the program of $3.6 billion.

As we have written about before, Airbus has been trying to convince its international customers (some of whom are also shareholders in EADS) to pay for the program’s cost growth.  The negotiations have dragged on for more than a year.  As we noted, EADS needed a resolution by February 1, 2010 so that it could book its final share of the program’s loss on its 2009 financial statements. 

The final negotiated agreement has been hammered-out. A Seattle P-I article reports that the agreement includes the following provisions—

  • Increase the contract price by 2 billion euros;
  • Waive monetary damages related to current delays;
  • Provide an additional 1.5 billion euros in exchange for a participation in future export sales;
  • Accelerate pre-delivery payments in the 2010-2014 period, with a new schedule to be finalized in the amended contract.

The first article (linked to above) reports that—

EADS will receive $2.04 billion in direct aid to offset losses that would have been reported for the 2009 earnings year. The company will also get a ten percent increase in the price of the aircraft to about $194 million each. If all of the planned sales go through this will generate another $2.7 billion in revenue to help make up for the money EADS spent on the program.

The deal did not solve all of the company’s financial problems.  Reportedly, EADS booked a €1.8 billion loss “provision” on the program, which led the company to report a FY 2009 loss of €763 million compared to a 2008 profit of €1.57 billion.  Meanwhile, this Reuters article reports that “South Africa is still waiting for a 2.9 billion rand repayment from European plane maker Airbus, which has not acknowledged a cancelled deal.”  (We wrote about the cancellation of South Africa’s A400M order here.)

The Reuters article contains this quote from the South African Defence Ministry—

’We await the response of Airbus on the cancellation of this contract so that we can facilitate the return of the money that has already been paid out in line with the agreement we have with them,’ Defence Minister Lindiwe Sisulu told journalists. ‘The recovery of the money obviously is important because it allows us to bid further for any other capacity that is available,’ she said.

Airbus refuses to acknowledge that South Africa cancelled its A400M order and has been holding on to roughly $400 million of its customer’s money for four months?  Awkward….

To conclude, the first article (linked to above) notes—

The A400M has demonstrated, once again, that defense development and acquisition is not easy. Agreeing to a fixed-price contract for a program that ended up being more difficult and complex then planned hamstrung EADS and its buyers. They were faced with a stark choice of writing off seven years of effort and billions of dollars or working out a way to keep the program alive despite stretched budgets. In the end it looked like keeping the aircraft and the 10,000 jobs related to it trumped other considerations.

Seems like a good summary of the situation to us.


 

Thinking About Stealing Fuel from the U.S. Army in Iraq? Not a Good Idea!

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On March 12, 2010 the Department of Justice announced that Michel Jamil (age 60, of Annandale, VA) was sentenced to 40 months in prison for his participation in a scheme “to steal approximately 10 million gallons of fuel” from the U.S. Army in the Iraq Theater of Operations.

Napoleon Bonaparte famously said, “An army travels on its stomach.”  In a more general sense, the success of military forces in faraway lands is obviously dependent on the quality its supply chain management and logistics skills.  Oil and gasoline are also obviously key supplies for the modern army.  As this 2006 report notes, “The U.S. military is the biggest purchaser of oil in the world.”  In 2004, the U.S. Defense Department spent $8.2 billion purchasing more than 100 million barrels of fuel.  A 2001 Defense Science Board Task Force reportedly stated that “Because DOD’s consumption of oil represents the highest priority of all uses, there will be no fundamental limits to DOD’s fuel supply for many, many decades.”  A May 2005 article in Atlantic Monthly reportedly said—

The U.S. military now uses about 1.7 million gallons of fuel a day in Iraq. …each of the 150,000 soldiers on the ground consumes roughly nine gallons of fuel a day. And that figure has been rising. … The Third Army (of General Patton) had about 400,000 men and used about 400,000 gallons of gasoline a day. Today the Pentagon has about a third that number of troops in Iraq yet they use more than four times as much fuel.

So when the DoJ says 10 million gallons of fuel was stolen “for subsequent sale on the black market” it is not only talking about pedestrian theft of government property; it is also talking about an attempt to sabotage the military efforts and to harm the warfighters.

What was going on?  According to the DoJ—

Jamil admitted that in March 2007, he and two of his co-conspirators arranged for the creation of a false memorandum for record (MFR) authorizing individuals, purportedly on behalf of a company serving as a contractor to the U.S. government, to draw fuel from the Victory Bulk Fuel Point (VBFP), Camp Liberty, Iraq, which was owned and operated by the United States. The VBFP supplies aviation and diesel fuel to both military units and U.S. government contractors operating in and around the Victory Base Complex. Jamil admitted that he and his co-conspirators used this false MFR and others to steal large quantities of fuel from the U.S. Army for subsequent sale on the black market. Jamil admitted that he escorted the trucks to retrieve fuel from the VBFP using a false MFR on approximately 10 to 15 occasions. As a result of the scheme, Jamil received between $75,000 and $87,500 in personal profits.

The DoJ announcement continued—

In related cases, Robert Jeffery was convicted … of one count of conspiracy and one count of theft of government property for his role in the fuel theft. Evidence at trial established that Jeffery served as an escort for the fuel trucks and illegally retrieved hundreds of thousands of gallons of fuel from the VBFP. … Jeffery was sentenced to four years in prison. Robert Young pleaded guilty … to participating in the same scheme. …Young admitted that he and his co-conspirators employed several individuals to serve as drivers and escorts of the trucks containing the stolen fuel. Young admitted that he received approximately $1 million in personal profits from the scheme. …Young was sentenced to 97 months in prison. Lee William Dubois pleaded guilty … to participating in the same scheme. …Dubois admitted that he obtained government-issued common access cards for the drivers and escorts of the trucks and also presented false documents to the VBFP authorizing his co-conspirators to draw fuel. Dubois admitted that he received at least $450,000 in personal profits from the scheme. …Dubois was sentenced to three years in prison.

Given the importance of fuel to the warfighters in Southwest Asia, we think these conspirators got off very lightly.


 

Use (and Misuse) of Consultants

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We were recently reminded of the myriad contract compliance issues associated with the use of outside consultants by Government contractors.  (Disclaimer:  Apogee Consulting, Inc. is one.)  First, most companies have difficulty identifying who is (and who is not) a consultant.  The DCAA Contract Audit Manual (CAM) defines consulting services as “services rendered by persons who are members of a particular profession or possess a special skill and who are not officers or employees of the contractor. Such costs include those of outside accountants, lawyers, actuaries, and marketing consultants.”  The applicable FAR cost principle (discussed below) adds, “Professional and consultant services are generally acquired to obtain information, advice, opinions, alternatives, conclusions, recommendations, training, or direct assistance, such as studies, analyses, evaluations, liaison with Government officials, or other forms of representation.”  Those definitions may or may not work for you; but it’s critical that some “command media” somewhere in your company define the term, else you may run afoul of one of the aforementioned contract compliance issues.

Next, the form of the consulting agreement will create some problems for many contractors (and for the consultants too).  For example, some consultants are hired to address specific program-related technical issues and the resulting costs will be treated as direct costs of the benefitting contract.  Does that make the consultants “subcontractors” as that term is used in FAR Part 44, and thus require advance contracting officer consent as well as inclusion of company-standard terms and prime contract flow-down clauses into the executed consulting agreement?  Maybe—depending on how the contractor worded its purchasing system policies and procedures.  If not, does the company then issue a Purchase Order to the consultant?  Can the consultant insist that its “standard” contract be used?  Who decides?

More likely, consulting costs will be indirect costs—but that doesn’t really address the questions we raised above.  As you read this article, consider how your company contracts with its consultants, what terms and conditions it incorporates into its agreements, and how it assures that its consultants are performing in a compliant manner.  As importantly, consider what detail you expect the consultants to provide in their billings, in order to maximize the amount of allowable costs you incur.  For example, how will your consultants support billings for out-of-pocket costs such as travel-related and/or miscellaneous expenses?  Will you require copies of detailed receipts, copies of credit card statements, or other supporting documentation?  Why or why not?  Who decides?

Use of consultants is subject to special cost allowability rules found at the cost principle 31.205-33.  Generally, costs of consultants are allowable where costs are “reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the Government.”  But the cost principle also defines several circumstances where consultant costs are unallowable. 

For example, the following consulting services are unallowable.

(1) Services to improperly obtain, distribute, or use information or data protected by law or regulation (e.g., 52.215-1(e), Restriction on Disclosure and Use of Data).

(2) Services that are intended to improperly influence the contents of solicitations, the evaluation of proposals or quotations, or the selection of sources for contract award, whether award is by the Government, or by a prime contractor or subcontractor.

(3) Any other services obtained, performed, or otherwise resulting in violation of any statute or regulation prohibiting improper business practices or conflicts of interest.

(4) Services performed which are not consistent with the purpose and scope of the services contracted for or otherwise agreed to.

In addition to the foregoing, the DCAA CAM also notes that consultant costs may be made unallowable under the provisions of other cost principles, and lists seven specific situations (e.g., costs related to legal or other proceedings) and two generic situations (e.g., reasonableness or allocability).  Contractors should be sensitive to those areas in addition to the four situations listed above.

The cost principle also requires that, in order to be allowable, “Fees for services rendered [must be] supported by evidence of the nature and scope of the service furnished.”  Contractors must provide “evidence necessary to determine that work performed is proper and does not violate law or regulation,” including—

(1) Details of all agreements (e.g., work requirements, rate of compensation, and nature and amount of other expenses, if any) with the individuals or organizations providing the services and details of actual services performed;

(2) Invoices or billings submitted by consultants, including sufficient detail as to the time expended and nature of the actual services provided; and

(3) Consultants’ work products and related documents, such as trip reports indicating persons visited and subjects discussed, minutes of meetings, and collateral memoranda and reports.

The DCAA CAM provides additional details regarding the third evidentiary prong above (i.e., the need to provide evidence of work performed).  The CAM says that the third prong “is intended to provide support for the work actually performed by the consultant (in contrast to the first category of evidence regarding the work planned to be performed). Although a work product usually satisfies this requirement, other evidence may also suffice. If the contractor provides sufficient evidence demonstrating the nature and scope of the actual work performed, the … requirements are met even if the actual work product (for example, an attorney’s written advice to the contractor) is not provided. The auditor should not insist on a work product if other evidence provided is sufficient to determine the nature and scope of the actual work performed.”

The CAM also notes that “The contractor is responsible for producing adequate evidential matter to support the claimed costs.”  Accordingly it is important to come to an agreement with the consultant—before the first invoice is submitted—regarding what support will need to be provided, whether work product or other evidentiary matter will be included with each invoice, who at the company will review and approve the invoices, and how such documentation will be retained to support future DCAA audits.

Also, don’t forget to establish the consultant in your vendor master file to speed payment processing.  Trust us—your consultant will thank you for that….

That addresses cost allowability, but there are other matters to consider as well.  In the March 2010 issue of National Defense magazine, two attorneys from The Boeing Company address some of the ethical issues associated use of consultants.  As they note, “consultant missteps may be grounds for civil and criminal liability, organizational conflicts of interest, and reputational damage.”  Following are some of the thorny scenarios listed in the article—

  • A company’s consultant also advises the DOD and has access to source selection information for a contract your company wants to bid on.
  • A consultant who is not a registered lobbyist meets with a lawmaker regarding your company’s program.  Does this meeting need to be reported under the Lobbying Disclosure Act?
  • Your consultant also has a consulting contract with your biggest competitor, and has access to your proprietary information.
  • A consultant meets a foreign government official on behalf of your company and gifts are exchanged.  Did you just violate the Foreign Corrupt Practices Act?
  • Your consultant just hired a former DOD official who resigned a couple of months ago and will be providing advice to you on an upcoming bid.  Are there any post-employment restrictions on that consultant?  How do you know?

The fact of the matter is that your company will very likely be held responsible for the actions of your consultants.  Doing sufficient due diligence before executing the agreement is of paramount importance, as is staying aware of all activities the consultant is performing on your behalf.  The article’s authors recommend “use of express contractual provisions spelling out the consultant’s responsibilities for legal and ethical compliance” to address some of the risks listed above.

The article ends with a nice axiom:  “The bottom line is to recognize the compliance risks that accompany [use of] consultants.”  We couldn’t agree more.




 
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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.