Looking for Fraud in All the Wrong Places
Mr. Gregory Garrett, CPCM, C.P.M., PMP, and NCMA Fellow, wrote an article entitled “Risk Management in Government Contracting: Common Myths and Best Practices” in the October 2009 edition of Contract Management magazine. The article was a “modified extract” from his book Risk Management for Complex U.S. Government Contracts (NCMA, 2009). While there was much to commend (and some areas to nitpick), we thought one of his “common myths” was interesting enough to write about.
Myth #8: All government contractors are crooks!
According to Mr. Garrett, “Most government contractors are honest, reliable, and dedicated companies … [u]nfortunately, there is a relatively small percentage of government contractors who do act illegally and their bad actions are frequently and widely publicized … creating a very negative perception of the industry as a whole.”
We think Mr. Garrett is spot-on. Moreover, we think too much Government time, resources and money have been devoted to detecting contractor misdeeds, while not enough time, resources and money have been devoted to detecting misdeeds on the part of government officials. Our perception is that there are nearly as many bad actors in the ranks of the military and civil servants as there are in the contractors that support them. Two recent stories are offered as evidence for our position.
In the first story, on October 20, 2009 the Department of Justice (DoJ) announced that an Army Sergeant who had been deployed at Bagram Airfield in Afghanistan had pleaded guilty to charges of “bribery and a money-laundering conspiracy arising out of her work administering transportation services.”
According to the charges, Ana C. Chavez accepted $90,000 in cash and wire transfers as a bribe from an unnamed DOD contractor in return for Chavez exercising her influence at the Transportation Operations Support Office in the award of contracts and work orders to that contractor’s company. “Chavez gave a portion of the bribe proceeds to another DOD contractor working at Bagram Airfield, with whom she conspired to launder the money through various bank accounts held by Chavez’s associates in the United States. According to the court documents, the alleged conduct began at least in or about February 2005 and continued until September 2006.”
Chavez agreed to pay the $90,000 to the U.S. Government as restitution, and faces up to 35 years in prison, plus a potential fine that could range up to $770,000, depending on circumstances.
In the second story, GovExec.com posted on October 21, 2009 an AP wire story reporting that a State Department program manager was arrested for allegedly “taking tens of thousands of dollars in bribes and kickbacks on contracts for Iraq reconstruction work.” According to the article, Mr. Richard Razo began taking bribes from a subcontractor (Hayder Al Batat starting in 2005 while Mr. Razo worked as a security and logistics manager in Iraq for Innovative Technical Solutions, Inc., (ITSI) a government contractor headquartered in Walnut Creek, Calif. An affidavit filed with the court revealed that "Razo provided H. Al Batat with contract documents, assisted H. Al Batat in preparing his company's bids and shared competitors' bid information with H. Al Batat thereby enabling H. Al Batat to underbid competitors.” Mr. Razo joined the State Department in August 2008, where "continued his scheme to obtain bribes in return for the award of U.S. government contracts to Iraqi contractors,” according to the affidavit.
The article reports that, according to the affidavit:
[Razo] used his new authority to pressure Al Batat's brother, Yahya, who also owned a construction and did work in the area Razo had been assigned to…. In numerous e-mails, Razo told Yahya Al Batat he wanted the $22,500 his brother allegedly owed him ‘prior to his award of any future business.’ The court records also allege that Razo targeted seven contracts worth $2.7 million that would go to Yahya Al Batat's company and another firm. Razo would take a total of $144,000 in fees for the arrangement. The contracts were awarded in that order. It's not clear how much Razo received, however. The affidavit states that while home in the U.S. on leave in late 2008, he made three separate cash deposits into his bank account totaling $13,500.
How was Mr. Razo caught? According to the article, Al Batat “was the subject of a previous federal investigation into alleged kickbacks on construction contracts. That inquiry led investigators to e-mails between Al Batat and Razo.” So it wasn’t any management oversight or internal controls that identified Razo’s wrongdoings; it was old-fashioned detective work.
As savvy readers know, the FAR was recently revised to mandate that contractors have codes of ethics/business conduct, have effective control systems that detect violations, and (when criminal violations related to a contract are detected) mandate reporting of those violations. The Defense Contract Audit Agency (DCAA) recently revised its audit guidance to focus on evaluations of those contractor systems. The Government Accountability Office (GAO) issued a report in which it opined that DOD wasn’t doing enough to verify the effectiveness of those systems. The Commission on Wartime Contracting blasted everybody in sight for ineffective contractor “business systems” that allegedly permitted “millions of dollars” of Iraq/Afghanistan battlefield support contractor overbillings to the DOD. It’s a rare week when somebody (usually a politician) is not attacking DOD contractors for fraud, waste, and/or abuse.
Which brings us back to our original point: Where is a similar focus on Governmental wrongdoing? Why does the spotlight only point at contractors, and not those who manage them? For every stone cast at a contractor, it seems that another one could be thrown at the Federal government’s house of glass. Yet the magnifying glass of scrutiny and accompanying outrage seems directed solely in one direction. We think that situation needs to change. We think the Federal government needs to get serious about cleaning its own house, by implementing and enforcing strong internal controls designed to detect and deter wrongdoing committed by its employees. When both contractor and Government manager are subject to the same level of scrutiny and outrage, we might see a real reduction in procurement corruption.
Lockheed Martin and EADS Add to Executive Ranks While Boeing and Honeywell Shuffle Deck Chairs
 We have previously reported on recent executive departures at both Boeing and Honeywell. In those articles, we questioned the wisdom of letting seasoned veterans depart while the aerospace and defense industry was facing significant challenges. Now comes word that, while some companies were reducing executive ranks of their defense subsidiaries, both EADS and Lockheed Martin were augmenting their executive leadership teams to prepare for the upcoming challenges.
In Boeing’s case, the company moved the head of its defense business (IDS) over to its commercial aircraft business (BCA) in order to cover the early departure of Scott Carson—leaving a vacancy that was filled by Jim Albaugh, who transferred over to BCA from his previous role leading Boeing’s IDS business. Replacing Mr. Albaugh was Dennis Muilenberg (who was promoted after leading IDS’ global after-market services unit). In Honeywell’s case, it lost both the CEO and CFO of its aerospace business in the same week, as each left to pursue other (potentially more lucrative?) opportunities. The Honeywell Aerospace CEO was replaced by Mr. Tim Mahoney, the unit’s former Chief Technology Officer.
Now we are not saying that the executive replacements named above are any less competent than the men they replaced. What we are saying that the new leaders don’t have the deep experience and strong customer relationships that their predecessors had built up over time. Given the current economic pressures facing the industry, and likely near-term downturn, those relationships would seem to be more important than ever. The executive departures would seem to impact the ability to win new work and to provide program execution assurance.
In contrast to those two entities, Lockheed Martin and EADS are adding to their executive leadership teams. On October 15, 2009 Lockheed Martin announced the creation of a Chief Operating Officer (COO) position, to be filled by Chris Kubasik, who will also be given the title of President. Effective January 1, 2010 Lockheed Martin will also reorganize its management structure. Currently, the top six highest leadership positions all report to Bob Stevens (CEO). After the reorganization, they will all report to Mr. Kubasik, enabling Mr. Stevens to “devote greater attention to high-level customers and partners and to shape domestic and international business strategies. I also intend to increase my efforts to strengthen the corporation strategically, operationally and financially." According to Lockheed Martin, the new COO position and management structure is being created to “strengthen oversight of program performance across the corporation and take operational excellence to an even higher level as we support our customers in their global security missions. … [C]onsidering the budget climate and priorities of the administration and the need to pay really close attention to what our customers are saying, that we need at this time in history to have a COO again. … [The change] is going to enable Bob [Stevens] to focus at a higher level to the needs of the customers, and it would mean that Chris would then be able to oversee the business operations, day to day."
On October 20, 2009 the European Aeronautic Defence and Space Company (EADS) announced it was making former GE Aviation Vice President Sean O’Keefe the CEO of its North American subsidiary, replacing Ralph Crosby. Importantly, Mr. Crosby “will retain his position as Chairman of EADS North America” and will “devote the ‘lion's share’ of his time to winning the competition for the next U.S. Air Force refueling tanker.” EADS Global CEO Louis Gallois stated “"It's not only continuity, because Ralph is staying with us. It's more than that. It's reinforcement of EADS North America, because we have big ambitions in the U.S."
What makes the hiring of Mr. O’Keefe interesting is his background, and what that background tells us about EADS’ intentions. At GE Aviation, Mr. O’Keefe was head of the company’s Washington operations. As astute readers realize, such a position is generally a euphemism for lobbyist. Indeed, one report calls him GE Aviation’s “top lobbyist.” Mr. O’Keefe also served as NASA Administrator during President George W. Bush’s first term. Before that, he “served as a top deputy at the White House Office of Management of Budget in 2001 and Secretary of the Navy from 1992-93.” In other words, he is the epitome of a Washington insider.
EAD’s strategy is fairly clear: adding O’Keefe to the executive leadership team positions the company to build on his deep Washington relationships as it attempts to win the next US Air Force tanker competition. This was confirmed by Mr. Crosby, who commented—
The expansion of our senior team and the assumption of leadership of our activities in the United States by Sean does mark another key milestone in the development of the company. He obviously brings the kinds of experience, capability, strategic mindset and focus that will add materially to taking us forward. I have the leadership on the tanker campaign, and that's the leadership of the tanker activity. That's an expansion of the team.
According to an article on www.defensenews.com, Mr. O’Keefe commented: "Ralph's task is to win this. … My task is to make sure that we perform when that is accomplished."
To sum up, we have tried to present a contrast between several companies in transition. All four companies are entering into rough waters containing potential storms and icebergs. While entering these risky waters, two companies have thinned their executive ranks while two other companies have augmented theirs. Time will tell who has made the correct strategic choice, but our money is on the companies focusing on deepening the experience of their executive leadership teams and enhancing their customer relationships.
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Another CAS 413 Case Helps Unravel the Gordian Knot of CAS Compliance
 As we have previously opined, complying with the requirements of CAS 413’s segment-closing pension adjustment requirements (codified at 48 C.F.R. § 9904.413-50(c)(12) for those interested) is just about the hardest thing to attempt in the world of government contract cost accounting. Adding to the inherent difficulty is the ambiguity of the requirements: trying to figure out how to apply the complex and arcane rules to fit individual facts and circumstances is challenging in the best of circumstances, but is made more so when the parties (Government and contractor) disagree on how the calculations should be made. Protracted litigation is almost always the outcome when CAS 413 is involved.
We have also noted that the Court of Federal Claims almost always gets it right, at least when Judge Nancy Firestone is presiding. She has a tendency to cut through the tangled knot of adversarial arguments to reach decisions with the Wisdom of Solomon, in our view. And once again, another recent Firestone decision helps us to better understand how CAS 413 is supposed to operate, so that contractors have a better chance of complying with its requirements. We’re talking about her decision in DIRECTV Group, Inc. v. The United States (Fed. Cl. 04-1414C, Oct. 14, 2009), in which, as part of a divestiture, the seller (DIRECTV, formerly Hughes Electronics Company, formerly Hughes Aircraft Company) transferred to the buyers (Raytheon Company and The Boeing Company) more pension assets than pension liabilities. The question before Judge Firestone was how to calculate the benefit that the U.S. Government received in such circumstances, and whether that benefit could be used by the seller (DIRECTV) to offset monies it would otherwise owe the Government by operation of the CAS requirements, as well as the Allowable Cost and Payment contract clause (52.216-7), and the Credits Cost Principle (31.201-5).
In a previous case—General Electric Co. v. United States, 84 Fed. Cl. 129 (2008) (aka “GE II”)—Judge Firestone ruled that—
… the government must consider the surplus pension assets that GE transferred to the buyer when settling up GE’s CAS 413 payment obligation to the government. … [W]here the government was aware of the transfer of the pension asset surplus and approved the transaction through an advance agreement or novation agreement, the seller may count the value of the surplus pension assets it transferred to the buyer toward meeting its CAS 413 segment closing payment obligation to the government. … [S]atisfaction of the [seller’s] CAS 413 segment closing adjustment obligation may be achieved through the cost reductions the government will receive from its contracts with the buyer.
In the current DIRECTV case, DIRECTV divested two segments: in December 1997 it sold its Defense business to Raytheon, and in October 2000 it sold its satellite business to Boeing. At the time of the sales, DIRECTV had a pension surplus (as measured by the fair market value of pension plan assets exceeding projected actuarial pension liabilities at the time of the segment closing, i.e., the date of the sale). In connection with the Raytheon transaction, DirectTV transferred nearly $2.5 billion more in pension assets than pension liabilities; while in the Boeing transaction, it transferred nearly $807 million of “surplus pension assets”. Using the Teledyne and GE II methodologies together, the litigating parties stipulated that the amount DIRECTV owed the Government at the time of the sales was (in aggregate) $273.4 million—a value far less than the surplus pension assets it had transferred to the two buyers.
The Government argued that the Court’s previous holding in GE II was in error, and thus summary judgment in the DIRECTV case was not appropriate. The Government conceded, however, that “[i]f the GE[ II] case is the law of this case, then we do not dispute that the cost reduction to the Government was [more] than DIRECTV’s CAS 413 segment closing obligation to the Government under the GE[ II] decision, and the Court need not spend its time resolving the extent, if any, by which DIRECTV’s calculation overstates the cost reduction to the Government resulting from the transferred surplus.”
Judge Firestone also summarized the other prong of the Government’s argument as follows: “if the government does not expressly agree to accept a cost reduction from the buyer in satisfaction of the seller’s CAS 413 payment obligation, then it is entitled to receive both (1) cash from the seller and (2) a cost reduction from the buyer that equals or exceeds that same amount. The choice, the government contends, belongs to the government.” Unsurprisingly, DirectTV’s counsel argued that the Government’s arguments were without merit and, in particular, that the Government was not entitled to a “double payment” by operation of the Credits Cost Principle.
(We note that the parties consistently describe the Cost Principle as a “clause”—which it is not. In one of Judge Firestone’s rare errors, she writes “... the Allowable Cost and Payment Clause is implemented through the Credits clause …” which is exactly the converse of the actual situation, which is that the Allowable Cost and Payment Clause invokes the FAR Part 31.2 Cost Principles, which include, inter alia, the Credits Cost Principle.)
Judge Firestone was not persuaded by the Government’s arguments. In her decision, Judge Firestone wrote:
[t]he court agrees with DIRECTV that the government’s reading of the Credits clause is too narrow and that the Credits clause does not require double payment where the evidence establishes that the seller’s segment closing payment obligation was satisfied by the cost reduction the government received under its contracts with the buyer due to the pension asset surplus transferred by the segment seller. The court also finds that none of the other FAR provisions cited by the government require the court to reconsider the GE II decision.
In addition, Judge Firestone held that “The government has conceded in this case that it has received more in pension cost savings from Raytheon and Boeing because of the transfer of a pension asset surplus from DIRECTV than DIRECTV would owe the government under any proper CAS 413 calculation. ... As such, the government has acknowledged that it would receive a windfall if it were to collect cash from DIRECTV after it has received cost reductions from Boeing and Raytheon. The CAS authorizing legislation does not allow this result.”
Finally, Judge Firestone addressed the Government’s argument that DIRECTV must have received express permission from the Government in order to reap the benefit of the pension surplus transfer. She held that—
The court agrees with DIRECTV that in this case, where the undisputed evidence demonstrates that the government received the value of DIRECTV’s CAS 413 segment closing obligation through a cost reduction from the successor contractors, the existence of a government agreement in which the government protected its interest in the pension asset surplus through a novation agreement or other means is not material. The government concedes that under any CAS 413 calculation, it has received cost reductions that exceed DIRECTV’s CAS 413 payment obligation to the government. The government is not entitled to an additional “cash” payment of an equal amount. DIRECTV has satisfied its CAS 413 payment obligation to the government and is entitled to summary judgment.
So the “state of the art” of understanding the operation of the CAS 413 segment-closing pension adjustment is advanced a bit more. It is perhaps a small victory in the eyes of some, but in the world of government contract cost accounting, it’s a hardfought and meaningful step forward. Unless, of course, it is subsequently reversed by the Court of Appeals, Federal Circuit. See the entire decision here.
Aerostats, Blimps, and Dreaded Zeppelins
The latest advance in battlefield intelligence, surveillance, and reconnaissance (ISR) is not the unmanned aerial vehicle (UAV). No, it’s the use of tethered aerostats as a platform for cameras, radars, and other surveillance equipment that monitor wide areas around important locations. In contrast to a blimp, which is a lighter-than-air powered vehicle, an aerostat has no ability to move under its own power and is tethered to the ground at a single location. Blimps (or dirigibles or zeppelins) were used on the battlefield in World War I, and aerostats were used in World War II as defenses against aerial assault, but such craft have rarely been seen on a battlefield since that time—until recently, when the US Military deployed them in Southwest Asia to enhance ISR systems. According to this story, something floating in the sky over Kandahar is “making the locals uneasy.” The article continues, “’Many people believe it's a spy blimp that can see through walls to look at our women,’ said [one Kandahar local] ‘People don't like it … some are saying they are going to shoot at it.’” The Afghan local is correct: it is a spy blimp—or, more accurately, an aerostat. And it’s not alone. It’s part of the RAID ISR system.
Since 2003, the Rapid Aerostat Initial Deployment (RAID) program has deployed more than 60 airborne systems (as well as 300 RAID towers) in Afghanistan, protecting Forward Operating Bases (FOBs) and other critical locations as part of the US’ “persistent surveillance and dissemination system” (PSDS), used primarily by the Army and Marine Corps. The RAID system utilizes a 50-foot long aerostat carrying a 200 pound payload at heights of 1,000 feet. According to this article at Defense-Update.com:
RAID generally utilizes EO/IR sensors, radars, flash and acoustic gunshot detectors, to provide persistent, panoramic surveillance of the covered area, [that provide] timely warning of potential threats and other events …. The main sensor is an EO/IR payload, carrying a laser rangefinder, designator and target marker. In some configurations, radar, RF signal interceptors or gunshot detectors are employed, providing a primary scanning sensor pointing the EO/IR payload to points of interest, where movement or suspicious actions are detected. Other sensors can cue the RAID as well, including counter mortar radars such as the LCMR, which detects mortar attacks and can cue the RAID in seconds.
RAID sensor data is fed through standard radio links (SINCGARS and EPLRS) to the RAID ground control system, also known as Persistent Surveillance and Dissemination System (PSDS2) and Enhanced Tactical Automated Security System (eTASS). RAID systems provide essential situational awareness necessary for improved security and daily operations in and around the FOB. For example, convoy leaders check with RAID operators for 'road clear' indication before leaving the FOB.
Modern use of aerostats in the battlefield goes back at least 20 years to the early 1980’s, when (according to this report by the Congressional Research Service or CRS), “the Tethered Aerostat Radar System (TARS) [began] operating … at eight sites along the southern U.S. border and in the Caribbean. Currently, TARS’ primary mission is surveillance for drug interdiction. Each aerostat can lift 2,200 lbs of radar or other sensors to a height of 12,000 feet, and can detect targets out to 230 miles. The aerostat can stay aloft for months at a time.”
Another aerostat program called JLENS is an Army-led joint program that “seeks to use advanced sensor and networking technologies to conduct cruise missile defense.” According to the CRS report, “JLENS is seen by some to be an important test case for DOD’s network centric warfare approaches, because it is the centerpiece of a larger attempt to seamlessly link together numerous sensors across services to build a “single integrated air picture,” that will enable effective cruise missile defense.” (Emphasis in original.)
The High Altitude Airship or HAA is a Missile Defense Agency-funded Advanced Concept Technology Demonstration project focused on homeland defense. The CRS report states that “The HAA would operate at very high altitudes, up to 70,000 ft, and has been likened to a low flying, and relatively inexpensive satellite. This altitude might enable a small number of airships to surveill the entire United States.”
CRS also reports that “Since 1999, the Navy has explored a return to airships via the Littoral Airborne Sensor Hyperspectral (LASH) airship program. The LASH airship might be used for existing Navy missions such as anti-submarine warfare, search and rescue, detecting chemical and biological weapons attacks, or mine countermeasures operations. Domestic agencies such as the Coast Guard may also be interested in LASH for antiterrorism and border security roles.”
On October 7, 2009 Lockheed Martin received a $133 million contract award for eight additional Persistent Threat Detection Systems (PTDS) to be added to the nine already deployed in theater. A PTDS aerostat is smaller than a TARS craft, according to an article at www.defenseindustrydaily.com. It is “115 feet long with 74,000 cubic feet of helium and a 1,102 pound payload.”
Meanwhile, Lockheed Martin proceeds with development of the Long-Endurance Multi-Intelligence Vehicle (LEMV) in anticipation of a future contract award. Based on its existing P-791 design, the LEMV will be a 250 foot-long blimp (i.e., able to move under its own power) and will be designed to loiter at 20,000ft for up to 21 days carrying a 2,500lb ISR payload. The contract will require deployment within 18 months of award.
According to the linked AviationWeek.com article:
The LEMV is a hybrid airship - it's heavier than air, 80% of its lift coming from buoyancy and 20% from aerodynamics. Propulsion comes from six thrusters - three per side - powered by individual turbo-diesels for take-off and climb, and electrically from a central turbo-generator for loiter. And it's non-rigid, structural stability results from the three-lobe envelope design. The airship is also optionally piloted - flown manned for self-deployment and unmanned for persistent ISR missions.
An air cushion landing system allows the airship to be maneuvered for taxiing and take off, and sucks the vehicle down on to the ground - or sea surface - for landing, loading and unloading.
Hanging under the envelope, behind the sometimes-occupied cockpit, is a payload bay 40ft long, 15ft wide and 6-8ft tall - more than enough room to mount either a ground moving-target indication radar or multi-camera wide-area motion imagery sensor, plus a signals-intelligence payload and multiple EO/IR sensors.
It seems ironic that the latest ISR advance may harken back to century-old military technology. But sometimes old school is the way to go. (Though hopefully some lessons have been learned since then …)
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