Procurement Fraud Never Gets Old
Corruption in the public procurement process? Say it ain’t so!
Over at DOE’s Savannah River site, contractor CB&I AREVA MOX Services LLC (MOX Services) has been in the news recently. And it’s not for the ASBCA decisions that keep going their way. Recently, the Department of Justice announced that it had filed suit against MOX Services and one of its subcontractors, Wise Services, alleging violations of the False Claims Act and the Anti-Kickback Act. Between 2008 and 2016, MOX Services awarded multiple subcontracts to Wise Services. As alleged in the filing, “Wise Services’ Senior Site Representative Phillip Thompson paid kickbacks to MOX Services officials with responsibility for the subcontracts [in order] to improperly obtain favorable treatment from MOX Services.”
Consequently, the government alleged that “Wise Services falsely claimed reimbursement under its subcontracts with MOX Services for construction materials that did not exist, and that in turn MOX Services knowingly submitted $6.4 million in claims to NNSA for the fraudulent charges submitted by Wise Services.”
Let’s unpack those allegations a bit.
The MOX Services’ subcontract manager (or whatever they are called) accepted kickbacks from Wise Services.1 Wise Services submitted invoices for costs incurred under its illegally obtained subcontracts. Some of the costs were never, in fact, incurred. MOX Services paid the invoices anyway, and then billed the NNSA/DOE for the monies it paid to Wise Services.
Let’s look at the keyword in the allegations: “knowingly.” Did MOX Services “knowingly” invoice NNSA/DOE for fraudulent invoices it paid to Wise Services? The government will say “yes”—because MOX Services’ subcontract manager accepted kickbacks and that subcontract manager represented the company. Even though the person preparing the invoice, and also perhaps the person reviewing and certifying the invoice, had no knowledge of the kickbacks, an official company representative did have knowledge. So that’s going to be a problem.
Let’s look at the notion of inflated prices being invoiced by the subcontractor. In this instance, the government alleged that Wise Services invoiced MOX Services for “construction materials that did not exist” and thus inflated its invoice values. We don’t know the basis for that allegation; however, we are fairly sure (as non-lawyers) that it wouldn’t matter. A long time ago we were involved in a similar matter, where the government alleged the subcontractor inflated its invoices in order to recover the cost of its bribes. At that time, we were told that, when bribes are made or kickbacks are accepted, the government’s presumption is that the resulting invoices are always inflated—because otherwise how would the crooks profit from their corrupt payments? We were hired to help rebut that presumption. We were hired to find evidence that the invoices prices billed to this one prime contractor varied from invoice prices billed to all other prime contractors (where there had been no corruption alleged).2
This is a fairly common story that government contractors would do well to think about. When there is a corrupt payment made/accepted between a subcontractor and the contractor’s purchasing agent, it is like a domino that keeps on moving throughout the life of the prime contract. As a prime contractor, it’s very hard to recover from that corrupt act—especially if your controls never detected it. Prime contractors must work hard to prevent corrupt dealings, and to detect them if/when they happen. It’s not really hard to bolster controls; but it does take an investment of time and resources. We strongly suggest that such an investment will more than pay for itself.
In our next story of procurement fraud, we have another tawdry tale of corruption between a prime contractor and a government official, courtesy of another recent DOJ press release. According to allegations reported in that announcement—
From 2010 through 2018, Dombroski [long-time Government employee at Picatinny Arsenal] and Nayee [“Company A” Division Director, in charge of “Company A’s” Picatinny Arsenal branch office] conspired with other federal employees at Picatinny Arsenal and employees of Company A to seek and accept gifts and other items of value, such as Apple products, luxury handbags, Beats headphones, and tickets to a luxury sky box at professional sporting events, valued at $150,000 to $250,000, in exchange for government contracts and other favorable assistance for Company A at Picatinny Arsenal.
As per the DOJ press release, “Dombroski … is charged by complaint with one count of conspiracy to commit wire fraud and four counts of making false statements. Indra Nayee … is also charged by complaint with one count of conspiracy to commit wire fraud.”
No details were provided regarding how this alleged corruption came to light. However, we note that the government contractor was not identified by name; we are guessing that means that “Company A” either discovered the wrongdoing and reported it, or else cooperated with government investigators to such an extent that it was thrown a bone that might keep downstream shareholder suits from bothering company executives.
We expect to read a future DOJ press release, announcing that “Company A” has settled allegations that it illegally obtained contracts by disgorging all related profits. Meanwhile, “the count of conspiracy to commit wire fraud carries a maximum penalty of 20 years in prison. The false statement charges each carry a maximum penalty of five years in prison.”
1 In fact, the DOJ announcement included this tidbit: “On Feb. 27, 2017, Mr. Thompson entered a guilty plea on charges of conspiring to commit theft of government funds.” Nice plea deal.
2 We did our job and were able to show that the (alleged) crooks—our clients—did not recover their bribes through inflated pricing to the prime contractor. To this day, I’m not sure what happened after we turned in our report to defense counsel. I’m happy to be rid of those clients.
DCAA Retreats on Subcontractor Assist Audits
It’s a notable day when DCAA publishes a new MRD (Memorandum for Regional Directors). It’s not like that happens very often anymore.
In February, DCAA published a new MRD (19-PIC-001) entitled “Audit Guidance on Revised Policies and Procedures for Auditing Incurred Subcontract and Inter-Organizational Transfer Costs.”
Readers of this blog know that we have, in the past, taken issue with DCAA’s approach to auditing subcontractor costs. DCAA is in a tough spot. They don’t have privity of contract with the subcontractor, so they have to work through the prime contractor’s costs. That means that if they question subcontractor costs during the audit of the subcontractor, and they believe the subcontractor’s invoices to the prime were inflated by those questioned costs, then the method for recovering the inflated costs is to then question the prime contractor’s claimed subcontractor costs. Which then puts the onus on the prime (not the government) to have the subcontractor make it whole by paying it (and not the government) the questioned costs.
That approach has a number of problems, not the least of which is the timing of the whole thing. Too often, when DCAA is reviewing the prime contractor’s claimed costs the audit team reviewing the subcontractor’s claimed costs isn’t anywhere near to issuing its report. The timing situation leads to qualification of audit opinion, which doesn’t help the contracting officers in the slightest.
Moreover, the entire Schedule J of the standard proposal to establish final billing rates is fundamentally flawed in concept and execution. According to the Allowable Cost and Payment clause (52.216-7, Aug. 2018), Schedule J is required to list “subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor (include prime and subcontract numbers; subcontract value and award type; amount claimed during the fiscal year; and the subcontractor name, address, and point of contact information).”
Seems simple enough, right?
Let’s start with: what is a subcontract? You want me to list it; so tell me what it is. Since the clause is prescribed by FAR Part 16, you would think that the definition would be found in that Part. Nope. No such luck. What about FAR Part 42? Since indirect rates are covered by 42.7, maybe the definition of subcontract can be found there? Oops! Not there either. Okay. Maybe the definition can be found at FAR 2.101 (Definitions). Nope. Not there either. So what’s a poor contractor, seeking to comply with the requirements of 52.216-7(d)(2)(iii)(J), to do?
At that point, the increasingly desperate contractor will probably beeline over to the DCAA website and download the “Checklist for Determining Adequacy of Contractor Incurred Cost Proposal.” Looking that that document, the contractor may learn that Schedule J must include “all types of subcontracts (e.g., cost-type, T&M/LH, IDIQ with a variable element, and FFP) and inter-company costs claimed by the contractor on flexibly priced prime contracts and/or upper-tier subcontracts.”
But wait a second. How did we get from listing subcontracts (whatever they are) to listing subcontracts plus inter-company costs? When did that get added to the required list? (We note for the record that various pieces of DCAA information for contractors are schizophrenic on this point: some guidance says inter-company costs should be included and other guidance doesn’t. Further, if one looks at the example Schedule Js provided as an aide to contractors, none of those examples ever shows inter-company work.)
To sum this digression up, contractors are being asked to comply with the requirements of 52.216-7 by listing something that’s never been defined and that may (or may not) include inter-organizational transfers. Objectively, compliance is not possible. But don’t worry, because DCAA no longer audits three-quarters of the final billing rate proposals it receives. As a contractor, you only have a one-out-of-four chance of having an auditor dig into your Schedule J.
At this point, we’re moving on.
Of course, the problem is bigger than Schedule J. The problem is that DCAA (and others) have been telling its auditors that prime contractors have responsibilities not found anywhere in regulations. Again, this assertion will not be news to readers of this blog.
See, for example, this article we wrote in 2016, taking issue with DCAA direction to auditors and contractors that, somehow, prime contractors were responsible “to obtain an adequate incurred cost submission from subcontractor.” Yeah, that was made-up bovine fertilizer, as we told our readers at the time.
And then, about six months later, we wrote about the ASBCA decision in the matter of Lockheed Martin Integrated Systems (LMIS), in which the Board sustained LMIS’s appeal of a COFD demanding some $117 million because the government’s case was predicated on a “plainly invalid legal theory” that was “originated by a [DCAA] auditor.” That LMIS case is important and, if you haven’t read it, you really should. Part of the recital of facts included some bits about how DCAA questioned $13.9 million of LMIS subcontractor costs (based on assist audit reports) but provided no details. Some amount of questioned (prime contractor) costs was based on differences between amounts claimed by LMIS in its annual proposal and amounts claimed by the subcontractors in their individual final billing rate proposals. All those issues were dismissed by the Board in its decision because the government’s case “provided no allegations of fact.” The decision stated—
Our pleading standard requires factual assertions beyond bare conclusory assertions to entitlement. The audit report, which was incorporated into the complaint, states that some assist audits questioned costs but does not explain on what grounds. It also states there were differences between amounts in LMIS's proposal and costs under subcontracts but provides no facts regarding these differences. More importantly, the COFD does not cite a single actual fact, only the audit report's unsupported conclusions.
Why didn’t DCAA (and the contracting officer) have more facts to offer in support of their claim against LMIS?
One theory is that the government ran out of time. The COFD was issued just one day before LMIS might plausibly argue that it was time-barred by the Contract Disputes Act’s Statute of Limitations. Another theory is that the subcontractor refused to allow DCAA to release its audit findings to the prime contractor. Chapter 10 of the Contract Audit Manual (CAM) briefly discusses this situation. The situation is also discussed in CAM Chapter 6 (Incurred Costs Audit Procedures) at 6-802.6. The CAM states—
When a DCAA subcontract assist audit is contemplated, the higher-tier contractor normally will have made satisfactory arrangements for its unrestricted access to the subcontract audit results so that it will be able to fulfill its responsibilities for settling any audit exceptions. In rare cases, this may be impracticable. … Before beginning a subcontract audit, determine whether the subcontractor will have any restrictions or reservations on release of the resulting audit report(s) to the higher-tier contractor. A significant reservation exists if the subcontractor desires to withhold its decision on release of an audit report pending review of the audit results or report contents. If the subcontractor does not assure unrestricted report release at the outset, refer the matter to the requesting higher-tier contract auditor.
Readers, we have been doing this for 35 years now. And we have got to tell you, in all those years we have never, ever, seen a DCAA auditor refer a subcontractor denial of release to a higher-tier contract auditor, to the cognizant contracting officer, or to the prime contractor for resolution. But that’s what the guidance says is supposed to happen.
In essence, the entire framework of DCAA’s audit of subcontractor costs is predicated upon the subcontractor granting release of audit findings to the prime contractor. In our experience, that happens only very rarely. Thus, if the subcontractor objects to release of the audit findings to the prime (as is the norm), then what is DCAA to do? Nothing. All the auditor can do is simply provide the amount of questioned costs without detail.
And we’ve seen how the ASBCA felt about that.
Now, having taken way too long to set the stage, we can take a look at the latest piece of DCAA audit guidance. (Hey, remember how we started this article? It does seem like a long time ago!)
The new audit guidance states—
Subcontract assist audits will no longer be requested for the life of the subcontract; instead, auditors will evaluate risk every year and request subcontract assist audits as needed. … The prime auditor will no longer request assist audits for the life of the subcontract based on the total expected subcontract value at the time of award. Rather, the prime auditor, in coordination with the subcontractor auditor, will assess the risk and need for assist audit effort based on subcontract costs included in the prime contractor’s annual incurred cost proposal.
Further (and in reference to the LMIS discussion, above), the new audit guidance states “… auditors should not question subcontract costs based solely on deficiencies in the prime contractor’s subcontract management process.” It seems DCAA got the message. Finally.
In addition to the above, the MRD announced revisions to the 10100 Incurred Cost Audit Program (Post Year-end Audit) that “incorporate suggestions from the field and stress the importance of clear communication between prime and subcontract auditors.”
The revised audit program now includes the following steps:
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Where the contractor is performing subcontract or inter-organizational effort (as a lower-tier contractor, coordinate with the prime DCAA office(s) on whether an audit of the subcontractor or inter-organizational transfer cost is needed and if so, coordinate the timing of the audit and expected completion date. If the prime DCAA office does not require an audit, exclude the subcontract / inter-organizational costs from audit and adjust audit scope and auditable dollars (ADV) accordingly.
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Adjust government participation for risk assessment purposes taking into consideration contracts already closed, non-DoD contracts and subcontracts for which the civilian agency (reimbursable customer) does not participate in our audit, subcontract cost where the prime / upper-tier auditor does not require an assist audit, T&M contracts, settled cost reimbursable terminations, and contracts subject to the class deviation pilot for innovative technology projects. (Emphasis added.)
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Calculate the materiality of direct costs for contracts subject to audit. Remove dollars associated with contracts that are closed, non-DoD contracts/subcontracts where agency is not participating, dollars associated with subcontracts / IOTs that prime / upper-tier auditor does not require an audit, and contracts subject to the class deviation pilot for innovative technology projects. (Emphasis added.)
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Assess the need for an assist audit on significant lower-tier subcontract and inter-organizational transfer (IOT) costs included in the prime/higher tier contractor’s (contractor under audit) ICP based on documented risk. This assessment should include coordination with the auditors cognizant of the lower-tier contractor / performing segment and should take place prior to sending a request for assist audit.
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Due care should be taken to ensure both the prime / upper-tier and lower tier subcontract audits are completed within the required timeframe (i.e. one year) for any adequate submission received December 12, 2017 or later.
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The prime / upper-tier and lower tier auditors should communicate known risks from their perspective early to design the nature, extent, and timing of appropriate audit procedures.
There may be other relevant audit steps, but those were the ones we saw.
Let’s wrap this up. Recognizing the difficulties in which it placed its auditors with respect to audits of subcontractor claimed costs, Fort Belvoir has made changes to its audit program. Those changes should go a long way toward addressing the difficulties. However, had the auditors been following CAM direction, the additional audit guidance may not have been necessary.
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Getting Serious About UCAs
Undefinitzed Contract Actions (UCAs) are “any contract action for which the contract terms, specifications, or price are not agreed upon before performance is begun under the action. Examples are letter contracts, orders under basic ordering agreements, and provisioned item orders, for which the price has not been agreed upon before performance has begun.” UCAs are discussed at DFARS Subpart 217.74.
UCAs are a pain.
We have written about them before. See, for example, this article (written in 2017), in which we advised contractors to “try very hard to avoid them.”
UCAs are a pain for government contracting officers, as well. Often, they are under pressure to definitize the UCA, which tends to mean they are trying to evaluate the contractor definitization proposal, prepare a Pre-Negotiation Memo, get business clearance, confirm funds are available AND monitor the contractor’s ongoing performance—all at the same time. It ain’t fun and it ain’t pretty … as a rule.
And speaking of rules, on June 29, 2018, the DAR Council published a final rule (implementing DFARS Case 2015-D024) that modified weighted guidelines profit analysis for UCAs. It stated—
If the contractor demonstrates efficient management and cost control through the submittal of a timely, qualifying proposal (as defined in 217.7401(c)) in furtherance of definitization of an undefinitized contract action, and the proposal demonstrates effective cost control from the time of award to the present, the contracting officer may add 1 percentage point to the value determined for management/cost control up to the maximum of 7 percent.
Whoohoo!
(That comment immediately above was sarcasm.)
That same final rule also stated: “If a substantial portion of the costs have been incurred prior to definitization, the contracting officer may assign a [weighted guidelines profit] value as low as 0 percent, regardless of contract type.”
Thus, the DAR Council giveth and the DAR Council taketh away. And lo, it was done.
As part of the finalization of the rule, the DAR Council received public comments (as is required). A couple of the comments pointed out that the DAR Council was ignoring Congress’ direction with respect to UCA definitization, as codified in Section 811 of the 2017 National Defense Authorization Act (NDAA). Section 811 required that contractor profit be based on its situation at the time it submitted a “qualifying” proposal, not on the situation at the time the UCA was definitized. In typical DAR Council fashion, the rule-makers hand-waved the comment away, by stating that DFARS Case 2017-D022 had been opened to implement the requirements of Section 811.
But DFARS Case 2017-D022 was never issued. In another typical bureaucratic maneuver, DFARS Case 2017-D022 was “merged” into DFARS Case 2018-D008, such that the requirements of Section 811 of the 2017 NDAA were combined with the requirements of Section 815 of the NDAA “relating to commercial items.”
Yeah, that makes no sense to us either. It’s probably a typo, because Section 815 didn’t deal with commercial items. Instead, Section 815 made it much harder for contracting officers to unilaterally definitize a UCA—which is what happens if negotiations break down. If you follow the first link above, you can find an example of that unfortunate and unpleasant situation.
With us so far?
If so, you are ready to hear about DFARS Case 2018-D008, a proposed rule issued on February 16, 2019.
Remember, the proposed rule is supposed to combine requirements from two NDAAs into one. Let’s see how the DAR Council did.
The proposed rule, if implemented as drafted, make three significant revisions, as follows:
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If a UCA is definitized after the end of the 180-day period beginning on the date the contractor submits a qualifying proposal, the head of the agency shall ensure profit reflects the cost risk of the contractor as such risk existed on the date the contractor submitted the qualifying proposal.
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The definitization of a UCA may not be extended by more than 90 days beyond the maximum 180-day definitization schedule negotiated in the UCA without a written determination by the Secretary of the military department concerned, the head of the defense agency concerned, the commander of the combatant command concerned, or the Under Secretary of Defense for Acquisition and Sustainment, that it is in the best interests of the military department, the defense agency, the combatant command, or the Department of Defense, respectively, to continue the action.
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Contracting officers of the Department of Defense may not enter into a UCA for a foreign military sale unless the contract action provides for definitization within 180 days and the contracting officer obtains approval from the head of the contracting activity. The head of the agency may waive this requirement if necessary to support a contingency or humanitarian or peacekeeping operation.
Those three points above came from the 2017 NDAA. In addition, the proposed rule states:
Contracting officers may not unilaterally definitize a UCA with a value greater than $50 million until—
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The end of the 180-day period beginning on the date on which the contractor submits a qualifying proposal to definitize the contractual terms, specifications, and price; or the date on which the amount of funds expended under the contractual action is equal to more than 50 percent of the negotiated overall not-to-exceed price for the contractual action;
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The service acquisition executive for the military department that awarded the contract or the Under Secretary of Defense for Acquisition and Sustainment if the contract was awarded by a defense agency or other component of the Department of Defense, approves the definitization in writing;
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The contracting officer provides a copy of the written approval to the contractor; and
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A period of 30 calendar days has elapsed after the written approval is provided to the contractor.
That part above came from the 2018 NDAA.
So far, so good.
In addition, the definition of “qualifying proposal” would be revised (again). If the proposed rule is implemented as drafted, then a qualifying proposal would be one that “contains sufficient information to enable DoD to conduct a ‘meaningful audit’.” The former language defined it as a proposal that contains sufficient information to enable DoD to conduct a “complete and meaningful audit.” That change is nice, but we continue to point out that the definition is hella squishy. What happens if the contracting officer determines that field pricing assistance isn’t necessary? What happens if the auditor doesn’t like the proposal, but the contracting officer believes they can negotiate a fair and reasonable price? What happens if the customer requires the contractor to submit a proposal over and over and over again, using the pretext that it is not auditable?
Call us cynical, but we have concerns.
Anyway, that’s the proposed rule. With background that was curiously omitted. As always, public comments may be submitted. If you have some UCAs, consider commenting on the proposed rule.
Hanford Contractors Back in the News
There is no Department of Energy site about which we have written more than the Hanford site. Once critical to the nation’s security, home of the plutonium that was used in the bomb that ended World War II, the nearly 600-mile site in southeastern Washington now seems to breed more corruption than isotopes.
A few months ago (August, 2018) we wrote about a reported settlement between the US Government and the former Vice President of Finance for Mission Support Alliance (MSA), which was a joint venture between Lockheed Martin Integrated Technology, LLC, Jacobs Engineering, and Wackenhut Services—though the entity now appears to be run by Leidos.
The issues go back to a 2016 audit report by the DOE Office of Inspector General. If you want to understand the history and players, click on the link in the paragraph above.
In that 2018 article, we wrote “we assume the corporate entities resolved their issues because we can’t find any more about the situation.”
Well, that may have been a trifle optimistic.
Now comes word that the corporate entities likely did not resolve their issues, because the Department of Justice has filed a suit under the False Claims Act, alleging that MSA, Lockheed Martin Corporation (LMC), Lockheed Martin Services Inc. (LMSI), and Jorge Francisco Armijo (current Vice President of LMC, who served as a President of MSA during the time period in which the wrongdoing is alleged to have taken place) conspired to make false statements, submit invoices containing inflated costs associated with inter-organizational transfers between affiliated entities under a common control, and to violate the Anti-Kickback Act by making large payments to MSA executives “in order to obtain improper favorable treatment from MSA with respect to the award of the LMSI subcontract at the inflated rates.”
Yeah, that’s going to be expensive.
So here’s the thing:
Companies that treat inter-organizational transactions between affiliated entities under a common control as if they are arms-length transactions are making a big mistake. Huge.
If you are dealing with affiliated entities, and you are billing the inter-organizational transfer costs to a government contract, then you’ve got to get this right. FAR 31.205-26(e) establishes the rules for how the cost accounting is to be done. With only one exception, such costs must be transferred on the basis of actual, allowable, costs. (We’ve written about the exception on our blog, if you’re interested.)
People are going to try to tell you that their CPSR rules require inter-organizational transfers to be treated as if they are arms-length transactions, in terms of contract type, or prime contract flowdowns, or whatnot. Don’t let them persuade you. Don’t let them award anything other than cost-plus-no-fee subcontracts (unless the sole exception applies).
Better yet, don’t award a subcontract. Period. Instead, create a separate vehicle for transferring work tasks, budgets, and associated costs, between the two organizations under common control.
We’ve seen this too many times now. If you haven’t gotten the message then you are not competently performing your job. Follow FAR 31.205-26(e) or risk the same fate as has befallen these Hanford site contractors.
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