BAE Systems Charged with TINA Violations
 On June 19, 2015, the Department of Justice announced that it had filed suit in the Eastern District of Michigan, in which it alleged that a subsidiary of BAE Systems located in Sealy, Texas, had violated the requirements of the Truth-in-Negotiations Act (TINA) and, as a result, had violated the False Claims Act. Now, readers of this blog know that we’ve explored the strange relationship between TINA and the FCA before. For example, about a year ago we wrote this article, in which we pondered that relationship.
We wrote –
We are interested in how a TINA violation that has the stated legal remedy of a unilateral contract price reduction plus interest on any overpayments that may have resulted leads to a situation in which every invoice submitted for payment in connection with that defectively priced contract has become a false claim, subjecting the contractor to up to $11,000 per invoice, plus up to treble damages, plus interest. … Now we have a new rule: If the Federal government detects the defective pricing, then it’s a TINA matter. But if the relator detects the defective pricing, then it’s a FCA matter. Which is inconsistent and, on its face, somewhat inequitable. But that’s the way we’re seeing it these days.
We thought then that we’d figured things out pretty well. Instead of the FCA being used as an additional penalty when the Feds encountered an egregious example of defective pricing, we believed that the FCA allegations were the natural result of a qui tam relator (aka “whistleblower”) being the source of the allegations. But now we have to rethink that understanding, because the DoJ hit BAE Systems with allegations of both TINA and FCA violations, and there is no relator in the picture.
We’re confused. Again. Which is probably the natural state of affairs for non-lawyers trying to understand the complex litigation landscape of public contract law.
The factual heart of the allegations is BAE Systems’ certified cost and pricing data submitted to the U.S. Army for a contract awarded in 2008 to build 20,000 trucks. Now these trucks were not your commercial Fords or Dodges; instead, these trucks were “Family of Medium Tactical Vehicles” or FMTVs. The FMTV production contract actually goes back to 1996—nearly twenty years ago—when Stewart & Stevenson originally designed and built them at its plant in Sealy, Texas. Stewart & Stevenson held the contract for ten years (between 1996 and 2006, and then the Sealy plant was merged with Armor Holdings, Inc., who held the contract for two years (2006 to 2007). BAE Systems bought Armor Holdings, Inc. in 2007 and merged it into its Land & Armaments Division (which also included the old United Defense manufacturing operations). BAE Systems continued to hold the Army’s FMTV contract until 2010, when it lost it to Oshkosh. (We wrote about that competition and its aftermath here and also here.) In 2011, the final FMTV rolled-off the Sealy production line and the plant was shuttered in mid-2014.
But the fact that the plant was closed and most employees laid-off didn’t stop the DCAA auditors and the Defense Criminal Investigative Service and the Army Criminal Investigation Command and the DoJ’s Civil Division Commercial Litigation Branch from filing suit against the parent company seven years after the alleged violations took place.
No details were given in the DoJ press release. The only description of the allegations was “The government alleges that BAE knowingly inflated the price of the FMTV contract by concealing cost and pricing data on numerous parts and materials during contract negotiations, despite having certified that the data it had disclosed was accurate, complete and current.” In essence, we were told that Stewart & Stevenson and/or Armor Holdings failed to comply with TINA by not making a full disclosure of all relevant facts that might affect price negotiations. BAE Systems inherited that alleged violation when it acquired Armor Holdings and is now left “holding the bag” (so to speak).
The ironic thing here is that BAE Systems lost the 2010 follow-on contract award to Oshkosh because Oshkosh underbid it. So if BAE Systems was inflating its bids, it already paid a substantial price for doing so. Indeed, all of its employees in the Sealy plant already paid a substantial price for any systemic bidding errors.
But we don’t know the facts of the allegations. We don’t know what cost or pricing data was allegedly intentionally withheld. We don’t know whether it was supplier pricing or the fact that a sale was being contemplated or whether it was known improvements or cost reductions to the production process. So it’s impossible to evaluate the merits of the case.
But we do know that BAE Systems is going to have a very tough time mounting a defense seven years after the fact, without access to the employees who prepared the cost proposal and negotiated it with the Army.
Authority to Acquire
The phrase “authority to acquire” is not particularly well-known to most government contracting, accounting, and compliance professionals. You really can’t find it in a solicitation provision or in a contract clause. There’s no particular FAR section or subsection that addresses it. Yet the more we work with government contractors, the more we think it’s a phrase that everybody should have familiarity with. It’s a concept that crosses functions and impacts the adequacy of multiple business systems.
So let’s start with the basics. What the heck does it mean?
We’ll start by quoting from the DoD Guidebook for Contract Property Administration (Draft, dated July 28, 2011) –
Contractors acquire property through various means, including purchase, transfer, and fabrication. A contract might call for new property to be purchased by the contractor for use under the contract. The Government might transfer its own property to the contractor for use under the contract. Or, the contract might call for the contractor to produce—or fabricate—property for the Government. The contractor’s acquisition of property is regulated by FAR 52.245-1, Government Property; the applicable Cost Accounting Standards; and FAR 52.216-7, Allowable Cost and Payment.
Most contractors acquire property through an established purchasing system. Material control organizations initiate purchase requisitions (PRs), which are then submitted to the contractor’s purchasing function. Source documents include Military Standard Requisitioning and Issue Procedures (MILSTRIP) requisitions, purchase orders, transfer documents, petty cash documents, and fabrication orders. Supporting documents include purchase requisitions and engineering change proposals (ECPs).
In that Guidebook, the Government Property Administrator (PA) is told to “examine requisition and fabrication procedures,” and is directed to test to ensure that the contractor “has contractual authority for the acquisition of property, including property obtained from Government supply sources.” Thus, we will henceforth call that contractual authority for acquisition of property the “authority to acquire,” meaning that the terms of the prime contract (or higher tier subcontract) gives the entity performing the contract the authority to procure the stuff necessary to execute the contract’s (or subcontract’s) Statement of Work (SOW).
In other words, “authority to acquire” means that what is acquired—and what is charged as a direct contract cost—is within the ambit of the contract’s SOW. Goods and services charged to a contract as direct contract costs must be related to the SOW, as it is the contract SOW that gives the receiving contractor the authority to acquire those goods and services. There must be a clear nexus between the requirements of the contract SOW and the goods or services being acquired and direct-charged to that contract. Conversely, direct-charged goods and services that are unrelated to the SOW thus have been obtained without the requisite “authority to acquire” and, as such, are probably unallowable costs. At least, that’s what we suspect a DCAA auditor would assert.
Goods and services obtained without the authority to acquire are problematic from several different viewpoints. First, they are likely unnecessary costs (in terms of executing the SOW) and drive up costs that might be used as the basis for estimating future costs. In that sense, costs charged to a contract without the authority to acquire could lead to Estimating System deficiencies and/or allegations of defective pricing.
From a financial viewpoint, direct costs that lack authority to acquire can cause significant problems. On fixed-price contracts, such costs erode margin. On cost-type contracts, such costs may (in extreme cases) constitute the basis for an allegation that the False Claims Act has been violated. For either contract type, inappropriately charging direct costs to a government contract creates certain property tax concerns. And we are not even going to mention the cash flow problems.
Acquisitions of goods and services without requisite authority to acquire can also impact other DFARS business systems, including Purchasing and Property Control. For contractors subject to Earned Value Management System requirements, such costs can impact cost and schedule variances as well as estimates-at-complete. To the extent such items were not included in the original program Bill of Materials (BOM), they may create a deficiency in the Material Management and Accounting System.
In sum, goods and services obtained and direct-charged without the requisite authority to acquire can impact every one of the six DFARS business systems. They can impact financial results. They can impact tax reporting. They can, in extreme cases, lead to disputes and litigation. So we think this is kind of a big deal.
Despite the known problems and risks associated with obtaining goods and services without the requisite authority to acquire them, contractors (and their program managers) keep right on doing it. The rationale for continuing the poor behavior ranges from “it’s my program and I’ll buy what I want” to “the customer told me to buy it.” With respect to that latter reason, it’s truly amazing to see the wide variety of items that the customer “told” the contractor to buy. (The direction is rarely, if ever, committed to writing.)
Typically, the customer asks the contractor to buy goods and deliver them because the customer lacks the funding to otherwise acquire them. Or the paperwork is too bureaucratic and the easier solution is to just ask the contractor to take care of it. Computers and cell phones are two items that come immediately come to mind. The customer can’t get the computer he wants when he needs it, so he specs it and tells the contractor to buy it and deliver it. Problem solved! And really, when one is looking at a $10 million (or $100 million) contract, what’s a couple of thousands of dollars more? It’s barely a drop in the bucket; it probably won’t even show up in the variance analysis. So: no harm, no foul. That’s the normal way of such things – even though many rules and regulations exist to prevent just that type of transaction from taking place.
From the contractor’s perspective, the number one job is to keep the customer happy. Is there a contract clause that expressly prohibits providing an extra computer or cell phone? Is there a statute? Does doing so constitute a false claim? If nobody can point to a statute or rule that expressly prohibits doing what the customer requests, the contractor is almost certainly going to say “yes” and acquire the requested computer or cell phone, even though the goods are not strictly required in order to perform the SOW. Again: no harm, no foul. And it may even lead to a better CPARS rating!
But sometimes things go wrong.
We want to tell you an illustrative story of what happens when the contractor goes too far in trying to make the customer happy, when the customer goes too far in requesting goods that never should have been requested. In this particular case, there was harm so there was a foul.
We know there was harm because the Department of Justice told us so.
The DoJ announcement told us that “Two Men Plead Guilty in U.S. Department of State Contracting Fraud Scheme and Contractor Cover-Up.” Now, that headline is not particularly unusual these days; we got so tired of writing about procurement fraud that we stopped doing so, except for the very few instances were there may be a lesson to be learned. This is one of those rare instances.
According to the DoJ press release, Tony was a Department of State Contracting Officer’s Representative (COR). In addition to his day job of being a COR, Tony was also an authorized representative for a nutritional supplement company—one of those multi-level marketing companies where people can earn commissions from their sales as well as the sales of others they have enrolled into the pyramid. That wasn’t necessarily a problem for Tony, but he created a problem for himself when he involved one of the Department of State contractors in his sales pyramid. That situation created a prohibited conflict of interest for Tony.
With respect to the contractor, Marvin was a supervisor whose employees purchased the nutritional supplement. Marvin’s problem was that he got his employees reimbursed by his company for the cost they incurred in purchasing the nutritional supplement. The employees were reimbursed and the reimbursed costs were claimed as being allowable direct costs of the Department of State contract, even though there was no authority to acquire and even though the nutritional supplements were obviously unallowable personal expenses. To make matters worse, Marvin “caused false invoices to be made and submitted to the State Department for the cost of the nutritional supplements.” That created a problem for the company.
Getting back to Tony, his conflict of interest became a bigger problem when he “approved the majority of the false invoices” in his official capacity as COR. The value of the false invoices was more than $170,000. Tony “earned commissions in excess of $25,000“ from the purchases made by Marvin’s employees.
To the contractor’s credit, an internal investigation uncovered the foregoing scheme and the company reported it pursuant to the Mandatory Disclosure Program. However, a further problem arose when the company (former) President, Curtis, allegedly decided to edit the disclosure made to the State Department so as to “omit facts related to the fraud,” such as Tony’s role in approving the false invoices. Allegedly, Curtis did not timely disclose all relevant facts and that created a problem for him.
To sum this story up, the COR requested that the contractor obtain goods for which there was no authority to acquire. Indeed, these goods were not only unnecessary for contract performance, they were unallowable personal items. The company supervisor approved reimbursement for the employees’ expenses and direct-charged the costs to the contract, and then submitting invoices to the Government that included the unallowable costs. The Government COR approved the invoices, knowing they included the unallowable costs, and personally profited by doing so. When the company discovered the scheme, the company President allegedly edited the disclosure letter to omit facts that would have pointed to the COR’s role, presumably in the name of maintaining good customer relationships.
What happened to Tony, Curtis and Marvin?
Tony pleaded guilty to one count of conspiracy to commit wire fraud and a conflict of interest. He is facing a maximum of 25 years in Federal prison.
Curtis also pleaded guilty and faces a maximum of 5 years in Federal prison.
Marvin pleaded not guilty to charges of wire fraud and conspiracy to commit wire fraud, and is awaiting trial.
Any charges and/or settlements pertaining to the contractor were not disclosed in the DoJ press release.
This is not a good story. But it is an illustrative story. It’s an extreme example of the slippery slope a contractor is on, when it elects to obtain goods and/or services, and treat the costs of those goods and/or services as direct contract costs, when the contractor (or subcontractor) lacks “authority to acquire.”
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The Allowability of Airfare
The allowability of contractor travel costs has long been a source of dispute between the Federal government and the contractors it hires to perform work. This issue often stems from the fact that the travel rules differ between Federal employees and employees of private sector contractors. That’s not the entirety of the situation, of course, but those differences seem to spark feelings of … envy or jealousy (for lack of better terms). Government employees have so many difficult and complex rules that govern their reimbursable travel costs, and they so often lose money when in TDY travel status, that they seem to feel private sector employees should suffer as they do. Misery seems to love company.
And thus the rules governing the allowability of contractor travel costs are similarly complex and difficult, and what should be relatively straightforward rules become somewhat Byzantine and even self-defeating to a large extent—where the cost of compliance outweighs any potential travel savings. Yet regardless of compliance (or not), the perception that contractors are living large while billing the government persists: Contractors’ travel-related costs receive extraordinary scrutiny from Contracting Officers, Contracting Officer Representatives, and from auditors.
The cost of airfare is one of the areas of extraordinary scrutiny.
Now in truth contractors do often seek to obtain upgrades to business or first class seats. Why that should be a problem goes to the heart of the differences in travel philosophy between the Feds and their contractors. Most Federal employees don’t make a distinction between contractor executives and run-of-the-mill contractor employees. But contractors see a vast difference between those hierarchical levels, in terms of compensation and other perquisites. For example, most contractor executives expect to fly in first class, if they are not flying in the corporate jet. But because just about all government employees have to travel coach, they don’t understand why any contractor employee, regardless of rank, should do otherwise. Consequently, both modes of air travel (first class and use of corporate jets) are heavily regulated and, as a result of the regulation, both generate a healthy share of unallowable costs.
But the equivalence is false. Not all contractor employees are the same, just as not all employees of the Federal government are the same. Secretary of Defense Ash Carter, for example, flies around the world in a large airplane owned by the Federal government. Military executives (e.g., generals and admirals) fly around in aircraft owned by the Department of Defense. Why can’t contractor executives be extended the same courtesies?
Regardless of the lack of logic involved, the fact of the matter is that the rules governing the allowability of contractor airfare do not distinguish between contractor employees and contractor executives. They don’t distinguish between direct-charged travel costs and the travel costs incurred by indirect employees. They make little distinction between casual TDY travel and the constant travel of salespeople and business development folks. It’s a one-size-fits-all approach, and it’s designed to put contractor employees on a general par with employees of the Federal government. Contractors who want to upgrade (at cost) or fly corporate jets do so at the cost of generating unallowable costs. See the Cost Principle at FAR 31.205-46, especially (b) and (c).
The Federal government’s concern with contractor airfare costs soared to new heights (or fell to new lows) in late 2009, when the cost allowability rules were changed to limit allowable airfare costs to the lowest fare available to the contractor (instead of the standard coach fare offered to the public). We wrote about the rule change here. In that article, we said—
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.
While the FAR rule-makers were adding complexity to the airfare cost allowability criteria, the Department of Defense was asking for the rules to be relaxed for its employees on TDY travel, as we reported in this article. Remember that false equivalency in the travel rules we noted earlier? Yeah, it didn’t get any better no matter how much pain the Federal government tried to put its contractors through. Indeed, the complex rules of contractor airfare cost allowability continue to generate questions, disputes, and litigation five years later.
One example of the issues generated by the rule change is the litigation between the Department of Defense and the giant defense contractor, The Raytheon Company. Now, we’ve known about this litigation for a while, but were unable to discuss it until there was something publicly available to discuss. And now there is, courtesy of the ASBCA in a ruling on dueling motions for summary judgment.
It’s important to note that the decision linked to above is not precedential; it’s merely a ruling on the motions before the Board. Indeed, Judge Dickinson’s ruling is such that there will need to be a trial on the merits. But we want to explore the Judge’s ruling because it provides such a great example of how the FAR Council’s 2009 rule-change mucked-up the waters for defense contractors such as Raytheon.
The issue at hand is certain airfare costs incurred by Raytheon in 2005. In 2009, the DCAA questioned “certain of Raytheon’s airfare costs” and, in 2012, the DCMA Corporate Administrative Contracting Officer (CACO) issued a Contracting Officer’s Final Decision (COFD) found those costs to be expressly unallowable, and demanded penalties and interest on those unallowable airfare expenses. According to the CACO, there were four types of unallowable airfare costs. Judge Dickinson quoted the COFD at length to describe two of the four types, and so will we.
In the first category, based upon the review of the selected sample items, it was found that Raytheon did not always use the negotiated corporate discounts with airlines. There were a number of flights on which the traveler was on coach and that fare was incurred and charged by Raytheon, instead of the negotiated discounted airfare amount. When there was a discount airfare available and not used for those flights, the difference between the discount fare and coach fare is unallowable under FAR 31.205-46(b), 31.201-5 and 3l.201-2(d). The difference between the discount and coach fares is also unallowable under FAR 31.201-3, Determining Reasonableness. Fares charged in excess of those available to Raytheon through its negotiated corporate discounts are unreasonable. They exceed that which would be incurred by a prudent person in the conduct of competitive business.
In the second category, based upon the review of the selected sample items, Raytheon did not remove as unallowable additional amounts when premium airfares, for first class or business class seats, were not justified by the FAR travel cost principle. For the airfare costs which did not meet the requirements of the cost principle cited above, the unallowable cost is the difference between the premium airfare incurred and the standard coach fare based upon FAR 31.205-46(b). Raytheon incurred and included in its claimed costs airfare in excess of standard coach costs without meeting the requirements of the exception in FAR 31.205-46(b). Since the exception in FAR 31.205-46(b) is not applicable, the claimed costs are unallowable.
Obviously, one important issue is whether the 2009/2010 FAR revisions to 31.205-46 were, in fact, revisions—of if they were merely clarifications. If they were clarifications, then Raytheon (and all other government contractors) were limited to the airfares they had negotiated, and not by the standard coach fares available to the general public. Judge Dickinson found there was ambiguity in the differing interpretations of the regulations, and declined to rule on the matter (motions for partial summary judgment denied).
Raytheon also argued that the government had not provided any evidence that it had failed to apply (to its contract costs) all airline discounts to which it had been entitled, and that “DCMA improperly relied on a misstatement of Raytheon policy” in disallowing otherwise allowable airfare costs. Judge Dickinson similarly declined to rule on those matters (motions for partial summary judgment denied).
The one victory for Raytheon was an uncontested motion for partial summary judgment on the issue that “Raytheon's airfare costs for commercial business are allocable to the Department of Defense contracts.” The Government did not oppose Raytheon’s partial motion for summary judgment on that issue, and Judge Dickinson granted it.
In conclusion, this case presents an outstanding illustration of the complexity involved in determining a contractor’s allowable airfare costs. It also illustrates the lengths to which the auditors, contracting officers, and government attorneys will go when they believe a contractor has treated its employees (of whatever rank) better than the rank-and-file Federal employees.
Regardless of your feelings on the merits of the parties’ positions, we suspect you’ll agree with us that it seems difficult to understand how the parties can be litigating costs incurred in 2005 ten years after the fact. Hopefully, Judge Dickinson’s future rulings in this case will put these issues to bed for other contractors, so that they don’t have to make similar arguments on airfare costs ten years from now.
Accounting for Offsets
Offsets are hard.
But before we get into the hows and whys and wherefores of accounting for offsets, we’d better start by defining them.
Offsets (according to the DFARS) are “the entire range of industrial and commercial benefits provided to foreign governments as an inducement or condition to purchase military supplies or services, including benefits such as coproduction, licensed production, subcontracting, technology transfer, in-county procurement, marketing and financial assistance, and joint ventures.”
Offsets arise in the context of Foreign Military Sales (FMS). We’ve written a primer on FMS-related stuff on this blog before (link here). There is also a DPAP slide presentation on the role of FMS in national security available in our Knowledge Resources (to members of the site). In essence, offsets are the part of the deal that’s other than the item or service being provided.
Typically an offset involves a requirement to purchase of something from the country that’s buying the goods/services from the U.S. contractor. Often the U.S. contractor is expected to enter into a contract with the foreign company as part of the overall FMS deal. When the contract between the U.S. contractor and the foreign company is a subcontract (i.e., in support of the prime FMS contract) then we are dealing with a “direct” offset agreement. When the contract is not a subcontract, then we are dealing with an “indirect” offset agreement.
But offset agreements can include requirements other than an agreement to acquire good and/or services. Offset agreements can also include coproduction, licensed production, technology transfer, marketing and financial assistance, and joint ventures. Some of that stuff is easier to account for than other stuff. For example, marketing costs are fairly easy to handle—though we strongly suspect there will be some significant FCPA hurdles to leap over. But from an accounting view, the effort should be easy to handle.
Challenges arise when the offset agreement requires in-country procurements (use of local businesses) or subcontracts under the “prime” FMS contract. The primary challenge is in the pricing of the FMS deal that includes the offset subcontracts. The DFARS (at subpart 225.70303) requires that FMS contracts must be priced “using the same principles used in the pricing of other defense contracts.” The DFARS states –
If the contractor has made sales of the item required for the foreign military sale to foreign customers under comparable conditions, including quantity and delivery, price the FMS contract in accordance with FAR Part 15.
The DFARS also provides that the contractor can include “the reasonable and allocable costs of doing business with a foreign government … even though such costs might not be recognized in the same amounts in pricing other defense contracts.” In particular, “A U.S. defense contractor may recover all costs incurred for offset agreements with a foreign government or international organization if the LOA [Letter of Offer and Acceptance] is financed wholly with customer cash or repayable foreign military finance credits.” Clearly, then, the reasonable and allocable costs of direct offsets, including some costs not normally recognized as being fully allowable in other circumstances, will be deemed allowable in FMS sales.
However, problems have arisen when contractors attempt to price the cost of indirect offsets. While pricing the FMS deal and any direct offsets is a fairly straightforward effort, pricing indirect offset has proven to be a tough challenge because the DoD Contracting Officer lacks the necessary information to determine that the proposed price is fair and reasonable. If the price cannot be determined to be fair and reasonable, then the contractor risks having the indirect offset costs challenged, and disallowed, as being unallowable.
On June 2, 2015, the DAR Council attempted to remedy those problems by revising the DFARS via an interim rule – i.e., one promulgated without the benefit of public input. The necessity of issuing an interim rule was explained by the DAR Council as being related to the “recent and foreseeable trend of increasing numbers and complexity of indirect offsets….” According to the rulemakers—
Contracting officers must follow these regulations even though no DoD appropriated funds are being used to pay for the effort, and DoD contracting officers have no insight to pricing of the indirect offset. In the past several years, compliance with regulations has resulted in an inability of contracting officers to finalize FMS contract negotiations.
Accordingly, the interim rule –
… affirms that all offset costs that involve benefits provided by a U.S. defense contractor to an FMS customer that are unrelated to the item being purchased under a Letter of Offer and Acceptance (LOA), i.e., indirect offset costs, are deemed reasonable for purposes of FAR part 31. The rule provides that no additional analysis is necessary on the part of the contracting officer, provided that the U.S. defense contractor submits to the contracting officer a signed offset agreement or other documentation showing that the FMS customer has made the provision of an indirect offset of a certain dollar value a condition of the FMS acquisition. Finally, the rule provides that the FMS customer shall be notified through the LOA that indirect offset costs are deemed reasonable without any further analysis by the contracting officer.
And so one challenge associated with offsets has been solved.
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