Historically defense contractors have had two primary customers for their goods and services: the U.S. Department of Defense and the rest of the world. As U.S. defense budgets wax and wane (which is dependent on various factors including the global security situation, Congressional mood, and Presidential intent), contractors either focus on their domestic customer or else look for international sales channels. (Many do both!) For example, take a look at this Raytheon “global presence” webpage. In recent years, nearly one-third of Raytheon’s revenue has been from international sales.

Contractors have two avenues for international sales of defense products. They can contract directly with the buying government (commonly called “direct commercial sales” or DCS) or they can use the U.S. DoD as an intermediary (commonly called “Foreign Military Sales” or FMS). Choosing one avenue over the other is not an easy decision; there are pros and cons with both approaches. Often, the decision is made for the contractor. For example, if a foreign government wants U.S. financial assistance with paying for the weapons it wants, the U.S. Government may insist that FMS be used. (See our article on security assistance here. Further, we have uploaded a 2013 DoD presentation on the topic, intended for DCMA contracting officers, on this site’s knowledge resources page.) Even when the choice is available, the decision can be a tough one to make.

As the Government Accountability Office (GAO) recently wrote: “According to DOD and State officials, FMS provides multiple benefits to foreign governments and the U.S. government. Foreign governments that choose to use FMS rather than direct commercial sales receive greater assurances of a reliable product, benefit from DOD’s economies of scale, improve interoperability with the U.S. military, and build a stronger relationship with the U.S. government … although using FMS is generally not the quickest or least expensive option for foreign governments.”

We want to unpack that last point a bit. Why should FMS transactions be any more expensive than DCS transactions?

One answer to that question is that the Defense Security Cooperation Agency (DSCA)—the DoD component that administers FMS transactions---charges governments a transaction fee for their services. As GAO recently noted, “DSCA charges purchasers certain overhead fees to cover the U.S. government’s costs for operating the FMS program. These fees include the administrative fee, which covers costs such as civilian employee salaries, facilities, and information systems, and the contract administration services (CAS) fee, which covers the costs of quality assurance and inspection, contract management, and contract audits. These fees are collected in separate accounts in the FMS trust fund, which is used for payments received from purchasers and disbursements made to implement FMS.”

In other words, foreign governments that directly contract with U.S. defense contractors are responsible for administrating and managing their contracts; whereas governments that contract through DSCA via the FMS program have those services provided by DoD entities—for a price. That price covers the listed services, and within those listed services one finds contract administration and quality assurance (DCMA) and contract audit (DCAA). Presumably, CAS provides assurance that the foreign customers are getting what they are paying for, and that the price they are paying is considered to be fair and reasonable. GAO reported that “The base CAS fee has three subcomponents, which are currently set at (1) 0.5 percent for quality assurance and inspection, (2) 0.5 percent for contract management, and (3) 0.2 percent for contract audits.”

The U.S. government intends that its FMS administration fee—currently 3.5% of the FMS agreement (or case) value—is a break-even fee. It is not intending to profit from the fee. In fact, GAO reports that the Standard FMS Terms and Conditions “indicates that the U.S. government will not profit from the FMS program.”

The problem is that the U.S. Government is profiting to the tune of billions of dollars.

GAO report GAO-18-401, published May 10, 2018, told Congress and the public that “The FMS administrative account balance grew by over 950 percent from fiscal years 2007 to 2017—from $391 million to $4.1 billion—due in part to insufficient management controls, including the lack of timely rate reviews.” (Emphasis added.) Further, GAO reported that “The FMS CAS account grew from fiscal years 2007 to 2015 from $69 million to $981 million, due in part to insufficient management controls …”

So when DSCA and other DoD officials blithely note that FMS transactions are neither the quickest nor the least expensive option for foreign customers, what they are really saying is that FMS sales do not represent good value for money. FMS transactions take longer than they should and they cost more than they should. FMS transactions do not represent the optimum sales channel, nor do they lead to fair and reasonable prices. It’s not the contractors’ fault: it’s the DoD’s fault. When using the FMS program, DoD expects its foreign partners to pay for the privilege of slowing down weapon system delivery. And DoD is profiting from the situation.

DSCA describes this situation as “building a stronger relationship with the U.S. Government.”

How much profit is DoD making on these transactions? GAO reported “Our analysis indicates that even if the administrative fee rate were reduced to as low as 2.9 percent and administrative expenditures were to increase 15 percent above expected growth, the administrative account balance would likely remain sufficient to pay for projected expenditures while maintaining a reserve balance through at least fiscal year 2024.”

GAO says the excess balance (profit) generated by the excessively high administrative fees could be used to pay for additional expenditures. Sure. That is certainly one possibility.

Or perhaps the U.S. Government could build stronger relationships with its international partners by refunding the excess costs—costs that it was prohibited by contract terms and conditions from collecting—back to the entities that overpaid in the first place.

You think that might generate some goodwill? We certainly do.

Meanwhile, DSCA and DoD continue to charge international customers the excessively high transaction fees that add costs while admittedly slowing down the entire process.

The story continues.

It started with the 2018 National Defense Authorization Act (NDAA), a piece of legislation focused on the Department of Defense and NASA. The 2018 NDAA directed DoD (and NASA) to make a number of changes to the acquisition regulations. We told you about many of those changes. Notably, the 2018 NDAA changed the threshold at which contracting officers (and contractors) must obtain certified cost or pricing data—commonly known as “the TINA threshold” (referring to the Truth-in-Negotiations Act). The 2018 NDAA raised the TINA threshold from $750,000 to $2 million.

Again, the NDAA language was focused on DoD and NASA, but that focus created a problem. The problem is that the TINA language—e.g., FAR 15.403-4(a)(1)—applies to all Federal agencies, not just to DoD and NASA. Essentially, then, Congress was telling the DAR Council (one of the two FAR Councils who writes the acquisition regulations) to make special language in the Defense Federal Acquisition Regulation Supplement (DFARS). That would be an enormous undertaking, since the DAR Council would not only have to create regulatory language that paralleled the existing FAR language, but would also have to create new solicitation provisions and contract clauses that paralleled existing FAR provisions and clauses. That would be hard and take a long time, a duration perhaps measured in years. In the meantime, DCMA contracting officers would be stuck, forced to choose between complying with statute and complying with the existing FAR regulatory language. We wrote about that challenge in this article.

We followed-up that article with another one, one that discussed how the Civilian Agency Acquisition Council (CAAC)—the sister entity to the DAR Council—had issued a Class Deviation that authorized civilian agencies to adopt some of the 2018 NDAA acquisition thresholds. This was a significant step because it was a strong indication that the 2018 NDAA changes were going to be adopted across the entire FAR, and not just adopted within the DFARS. However, we noted that the CAAC Class Deviation was silent with respect to the TINA threshold. We speculated that it might be the subject of a future CAAC communication.

In yet another article on the topic, we discussed in some detail the quandary faced by both DCMA contracting officers and contractors, because the existing FAR language and associated solicitation provisions and contract clauses all referenced a specific dollar value ($750,000) as the TINA threshold, rather than the value in the statute. Thus, if the statute changed but the regulatory language did not, then there was going to be a conflict between the two. Further, the CAS threshold (which is the contract value at which CAS is applied, unless an exemption is available) is tied to the TINA statute rather than to the regulation. That created yet another compliance quandary for people. We wrote—

By ‘slow-rolling’ the implementation of the 2018 NDAA threshold changes into the acquisition regulations, the FAR Councils have created a problem for contractors. If the contractors wait for the regulatory implementation, then they must disconnect CAS coverage from TINA coverage. They will end up requesting certified cost or pricing data from subcontractors that are, by statute, exempt from CAS. This helps nobody and may well lead to increased procurement costs.

In our view, the only rational approach is to apply the statutory threshold changes now. The FAR Councils should immediately issue a Class Deviation to FAR 15.403-4(a)(1) to implement the new TINA threshold, even if formal rule-making takes a bit longer. If you are a contractor, you should discuss this quandary with your cognizant contracting officer and try to get some relief.

Then, in two other (brief) articles, we noted that the DoD had issued Class Deviations to implement the 2018 NDAA acquisition threshold changes in advance of formal rulemaking. (See here.)

Just to recap, by this point the CAAC had issued a Class Deviation to permit civilian agencies to implement some of the 2018 NDAA threshold changes—in particular, those associated with the Simplified Acquisition Threshold (SAT) and the Micro-Purchase threshold—but they had not addressed changes to the TINA threshold. The Department of Energy (DOE) had jumped on that permission and had issued its own Class Deviation. But of course DOE could not address the TINA threshold, because the CAAC had not addressed it in its Class Deviation. The DoD had issued two Class Deviations addressing the SAT, the Micro-Purchase threshold, and the TINA threshold.

Now we are all up to date.

And you should not be surprised to learn that on May 3, 2018, the CAAC issued a Class Deviation via CAAC Letter 18-003, that addressed the TINA threshold. The CAAC Class Deviation authorizes civilian agencies to “raise[ ] the threshold for requiring Certified Cost or Pricing Data from $750,000 to $2,000,000.” So there you go.

Importantly, the CAAC Letter also addressed how the threshold increase is to be implemented on existing contracts. The CAAC Letter stated “contracts entered into on or before June 30, 2018 are excluded from this threshold increase.” That sounds like another problem, doesn’t it? Contractors are supposed to have one Purchasing System, with a single set of requirements and thresholds, and not two separate ones (one for old contracts and another for new contracts).

Fortunately, the CAAC Letter also offered a way out of the problem. It stated “contractors for those [old] contracts can request to modify such contracts, without consideration, to use the new threshold.” Note the key phrase – “without consideration.”

At this point, contractors should be moving briskly to revise their Purchasing/Subcontracting procedures to implement the new 2018 NDAA thresholds. They should also be preparing letters to their procuring contracting officers to have their existing contracts modified to adopt the new acquisition thresholds. Contractors with DoD and/or NASA contracts should have already sent those requests, and contractors with civilian agency contracts should be looking to do the same.