In early December 2009 the Department of Defense Inspector General (DOD IG) issued its 9/30/2009 semiannual report to Congress.  As the name implies, the report is issued every six months in accordance with Public Law.  While the report is interesting reading, our primary interest lies in what it reports about DCAA activities during that time period.  But before we get into the DCAA discussion, let’s take a moment and note some highlights.

 

 

 

 

• The DOD IG staff is reported to be 1,570 with a budget of $272 million.
• In the six month reporting period, the DOD IG pursued many investigations, obtaining 197 indictments, 175 convictions, 55 suspensions, and 81 debarments.
• 224 subpoenas were issued.
• 1,153 hotline cases were opened, and 909 cases were closed.
• 53 official audit reports were issued. In addition, 78 “other oversight” reports were issued—among which was the IG’s assessment of DCAA’s work environment (D-2009-6-009), as well as a review of DCMA’s follow-up actions in response to DCAA audit reports on CAS compliance and contractor internal control system adequacy with respect to contractors involved in Iraq reconstruction activities (DD-2009-6-004).
• Roughly 1,000 vouchers representing more than $90 million in payments “were provided to [the Defense Criminal Investigation Service, DCIS] and its partners to support seven investigations.”

 

The report includes several anecdotes of fraud and corruption.  Among them are allegations of bribery, bid steering, false statements, false claims, wire fraud, money laundering, etc.  All of the items reported were related to Defense Department contracts, contractors, and/or Pentagon employees. Contracting activities were primarily (though not solely) in Southwest Asia, and covered such areas as construction, trucking/logistics, and even acquisition of bottled water.

 

For example:

 

On April 17, 2009, three DoD contractor employees were each sentenced to a total of 125 months imprisonment and three years supervised release, and ordered to pay more than $1.1 million in restitution for major fraud against the government, theft, mail fraud, and conspiracy.  The defendants defrauded the government and two other victims by submitting false time and material bills for reconstruction work during the post-9/11 reconstruction of the Pentagon. Some of the falsely billed labor and materials represented work on a newly constructed bar and restaurant owned by two of the defendants.  On May 1, 2009, a subcontractor involved in the scheme was sentenced to two years probation and fined $10,000 for conspiracy to defraud the government. The subcontractor received home remodeling materials and labor that he charged to the Pentagon reconstruction contract.

 

Another example:

 

Between May and July 2009, four U.S. Army civilian employees, a former Army major, and a DoD contractor were sentenced to serve a combined 121 months imprisonment and ordered to pay more than $116,000 in restitution to the government for conspiracy to defraud the United States. Acting as public officials on behalf of the Army, the coconspirators circumvented the government’s competitive bidding process to influence and steer the award of lucrative government computer contracts to an information technology company in return for cash and merchandise.  The co-conspirators provided the IT company with internal procurement information related to impending U.S. Army acquisitions, which allowed the company to submit the lowest bid and obtain contract awards in lieu of fair and open competition. In addition to influencing the bidding process, the co-conspirators engaged in a scheme where they shipped undamaged government property from the Tobyhanna Army Depot to the IT company for repairs, but the items were misbranded as new equipment and resold to the government.

With respect to contractor disclosures (about which we’ve written before), the reports notes that DOD IG is in the process of “closing out” disclosures made under the now-defunct Voluntary Disclosure program, and has received 81 disclosures under the new Mandatory Reporting program through the end of the reporting period.  According to the report, the majority of the disclosures have involved labor mischarging.  A chart from the report, illustrating the breakdown of contractor disclosures under the new program, is shown below.

 

Appendix D of the report is devoted to DCAA activities.  According to the report, DCAA completed 11,688 audit assignments in the six month period reporting period.  Of that amount, 76 reports were related to post-award (defective pricing) audits, and 708 audits were related to compliance with the Cost Accounting Standards (CAS). In the reporting period, DCAA examined $133.5 billion dollars.  Of that amount, auditors questioned $971.4 million (0.73%). With respect to forward priced proposals, DCAA recommended negotiation savings of $9.572 billion. There was no discussion regarding amounts of questioned costs sustained or successfully negotiated by the recipients of the audit reports.

 

With respect to audit reports issued to various commands and entities that are being tracked in the DOD’s Contract Audit Follow-up (CAFU) database, the report states that 2,020 audit reports are being tracked. Of this amount, 403 audit reports were closed in the reporting period.  The 403 closed audit reports included $468.1 million in questioned costs.  Of that amount, $176.6 million was sustained, representing 37.7% of total questioned costs.

 

In addition, DCAA reports that 153 of the CAFU reports are in litigation (47 of which are under criminal investigation).  DCAA estimates that the questioned costs in the litigated findings are valued at $1.826 billion.

 

Were one of an analytical mindset, one could find a series of DOG IG reports and plot some trendlines that would look at audit reports issued by DCAA, amount of dollars examined, costs questioned, and questioned costs sustained.  We’ll leave that exercise for the reader.

 

See the entire semiannual DOD IG report here.

 

 

Issued on December 10, 2009 Federal Acquisition Circular (FAC) 2005-038 implemented several revisions to the Federal Acquisition Regulation (FAR).  Included among the revisions were two changes to FAR Part 31 cost allowability rules—the Cost Principles.  One change impacted relatively few contractors, while the other change will impact all contractors subject to the Cost Principles.

 

 

Changes to PRB Rules

 

The first change (FAR Case 2006-021) impacts contractors that maintain postretirement benefit plans other than pensions (PRBs).  According to the FAC—

 

Currently FAR 31.205-6(o) allows contractors to choose among three different accounting methods for PRB costs; pay-as-you-go (cash basis), terminal funding, and accrual basis using generally accepted accounting principles by applying Statement 106 of Financial Accounting Standards (FAS 106). The FAR also requires that any accrued PRB costs be paid to an insurer or trustee. This final rule amends the FAR to permit the use of Internal Revenue Code sections 419 and 419A contribution rules as an alternative method of determining the amount of accrued PRB costs on Government cost-based contracts.

 

The full rule can be found here.  As the FAR Councils note, “the total measured PRB costs over the life of the PRB plan would be the same whether the contractor chose to apply the criteria in FAS 106 or IRC sections 419 and 419A [and] the Government will not pay higher PRB costs, since the resulting difference from contractors previously funding the lower IRC amount rather than the full FAS amount will continue to be an unallowable cost. This final rule does permit contractors to electively switch to the IRC 419 accrual basis and avoid any current or future disallowances.”

 

 

Changes to Air Fare Allowability Rules

 

The second change (FAR Case 2006-024) changes the cost allowability rules applied to air fare.  The current rule based the allowable cost of air fare on “the lowest customary standard, coach, or equivalent airfare offered during normal business hours” but the FAR Councils assert that this language was ambiguous and led to “inconsistent interpretations” and “confusion regarding what costs are allowable.”  Consequently, the language was amended to set the allowability standard as “the lowest priced airfare available to the contractor.” (The revised rule eliminates any reference to airfare class, such as economy or coach.)

 

This change is going to affect all contractors subject to the Cost Principles—and is going to be problematic. In fact, we’ll go so far as to say that the new rule introduces more ambiguity than the prior rule and raises a host of new questions.  It’s a cure that is worse than the disease.  Moreover, from personal experience it’s clear that there never was any disease in the first place; any ambiguity was in the minds of the rule-makers and there was no need for this revision in the first place.

 

Let’s look at the rule.  Effective January 11, 2010, the travel Cost Principle at FAR 31.205-46(b) will read as follows:

 

(b) Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements. However, in order for airfare costs in excess of the above airfare to be allowable, the applicable condition(s) set forth above must be documented and justified.

 

In addition to the foregoing, paragraph (c)(2) will be amended to replace the term “standard” with the word “allowable” wherever it appears.

 

The FAR Councils explain in the promulgating comments that “lowest-price airfare” includes the cost of non-refundable tickets.  Moreover, the Councils assert that “the requirement for supporting documentation and justification for airfare costs in excess of the ‘lowest coach airfare available’ should include documentation justifying purchase of a higher-cost refundable ticket in those instances when a non-refundable ticket is available.” The Councils also clarified that the costs of cancelling or changing restricted air fares is allowable.

 

The Councils explained the need for this rule as follows—

 

This amendment is intended to prohibit the contractor's practice where it has negotiated airfare agreements with travel providers and uses those agreements to purchase first class or business class seats but does not use the lowest priced airfare available under the agreements to determine the allowable cost baseline for the first class or business class seats, but instead determines the allowable cost based on the lowest airfare available to the general public instead of the lowest airfare available to the contractor under the agreements. This amendment will require the contractor to use the lowest airfare available to the contractor.

 

The revised air fare rule can be found in its entirety here.

 

Problems

 

The key problem with the new rule is that there are many more types of less expensive air fare available to contractors than the ones they have negotiated.  For instance, use of discount airlines such as Southwest or Air Trans or Jet Blue may result in cheaper fares, but also may require use of alternate airports.  Of course, where use of a discount airline results in “increased cost that would offset the transportation savings” the contractor need not use it—but that conclusion will need to be documented and justified for each trip.  Moreover, the rule doesn’t address use of Expedia, Travelocity or other internet-based discounter.  Are contractors now supposed to jettison their traditional travel agents in favor of such internet entities in the search for the “lowest priced airfare available to the contractor”?  One would tend to assume the FAR Councils did not mean to require that, yet the words say what they say.

 

In addition, the rule seems to create a new class of unallowable air fare, which is fares paid in excess of that elusive “lowest priced airfare” that was available at the time of booking.  If the FAR Councils did not mean to create this new unallowable air fare, then the rule was crafted poorly.  As written, each air fare incurred for each trip must be compared to the platonic ideal of a “lowest priced airfare”—as that ambiguous term is interpreted by the contractor and its auditors.

 

One could take the position—supported by the words of the promulgating comments quoted above—that any airfare incurred pursuant to a negotiated corporate agreement is fully allowable unless it is for a first class or business class seat.  If a premium seat is purchased, the unallowable amount is calculated by comparing the actual fare paid to what would have been paid had a non-premium seat been purchased pursuant to that same agreement.  That would be a reasonable interpretation that would certainly minimize confusion and implementation costs.

 

But that’s not what the words say.  And based on our experience with Government auditors, that is not how the rule will be interpreted in audits of such costs.  Accordingly, if the Government desires truly to implement the rule in accordance with the FAR Councils’ comments, as opposed to the actual words, then they will need to implement clear audit guidance to that effect.

 

We are not optimistic.

 

We believe this rule is unnecessary, ambiguous and poorly crafted.  It will not accomplish the stated intent of the FAR Councils and might very well lead to additional unallowable costs.  At a minimum, it imposes an additional documentation and justification requirement that add to contractors’ travel accounting efforts, which are already too high.

 

 

A Simple Solution?

 

A final thought.  If the rule is interpreted by auditor based on the words rather than the promulgating comments, one quick solution is to stop negotiating corporate agreements with airlines.  Simply pay the same price the public pays, which eliminates the issue raised by the FAR Councils as the impetus for the rule change.  Such a step will not fix the other ambiguities and problems we’ve noted, but should immediately reduce the auditors’ interest in this area.

 

Of course, if contractors take that simple step, the Government will pay more—perhaps far more—than it currently does for contractor air fares.  It would be a great example of the operation of the Law of Unintended Consequences.  But it would reduce unallowable air fare costs and thus increase the corporate bottom-line.  And it would serve the bureaucratic rule-makers right, in our view.