In November, 2014, we wrote a rather glowing article about the company FLIR Systems and how its internal controls and proactive employee training acted to prevent it from being sanctioned by the SEC when two of its employees “engaged in a doozy of an FCPA violation.” You can read the details of the Foreign Corrupt Payments Act violations in our original story.

We wrote “Because of [its] investments, FLIR was not held liable (at least so far) when two of its employees made bribes and offered gratuities to five officials of the Saudi government.”

Yeah, about that. We may have been a bit hasty.

In April, 2015, it was reported that FLIR had agreed to pay $9.5 million in order to settle bribery charges filed by the SEC.

The SEC alleged that FLIR “earned more than $7 million in profits from sales influenced by the gifts” made by its two employees to the Saudi officials, according to the story.

Rather than laud the company’s internal controls and employee awareness training sessions, as we did, the SEC stated—

“FLIR’s deficient financial controls failed to identify and stop the activities of employees who served as de facto travel agents for influential foreign officials to travel around the world on the company’s dime.”

The SEC made that statement even though it also said that FLIR detected the conduct, reported the wrongdoing, and “cooperated in the investigation.”

In addition to paying $9.5 million, FLIR Systems must “report to the SEC on its efforts to comply with [the FCPA requirements] for a period of two years,” according to the article.

In fact, a $9.5 million fine is pretty small potatoes if the company really made $7 million in profit from its inadvertent wrongdoing. Certainly it should not be allowed to profit from a violation of the FCPA’s requirements. On the other hand, we don’t get what else the company could have done.

The company trained its employees about the requirements of the FCPA. It diligently reviewed expense transactions, seeking to detect FCPA violations. When it detected anomalous activity, it diligently investigated. When it confirmed a problem, it self-reported to the authorities. When the authorities investigated, the company cooperated. What step is missing?

None. There is no step missing. The company did everything it was supposed to do.

Given all that, what does that final aspect of the settlement mean—the part where the company must report on its efforts to comply with the FCPA for two years? This is one of those head-scratchers where we just don’t get it. If the company is already doing everything it should be doing, and has a history of self-reporting violations, then what possible benefit is there to anybody from adding that final aspect to the settlement agreement?

Those are going be mighty short reports, we think. Here’s an imaginary example of what one quarterly report to the SEC might look like:

DATE: Today

PERIOD COVERED: Fiscal Quarter ending Yesterday

PREPARED BY: FLIR Systems General Counsel, typed by GC’s Executive Assistant

SUMMARY OF ACTIVITY IN REPORTING PERIOD:

• We trained 12 new employees in the requirements of the FCPA.
• We conducted annual refresher training for 200 employees via Computer Based Training (CBT).
• We reviewed 120 expense reports submitted by employees working abroad.
• Two of the expense reports reviewed had an inadequate description of activities.
• We investigated the two expense reports. We required that both be resubmitted with adequate descriptions. They were.

That is all.

So, basically, FLIR has to prepare that type of report and submit it to the SEC eight times (assuming a quarterly report). Where’s the value in that to anybody, including the SEC and the taxpayers who fund the SEC’s enforcement efforts?

Anyway, despite our head-scratching, that’s the story on FLIR Systems, a company where two employees engaged in wrongdoing despite their training. A company that would seem to have done everything reasonably expected of it (except, perhaps, hiring the wrong employees).

Did the investments made in internal controls and employee training actually pay-off in this instance? Well, the picture is not as clear as we’d like, but we still think the answer is yes. Although the company had to disgorge its profits from the tainted sales, in fact the additional fine was relatively trivial. And despite our skepticism at the value added by two years’ worth of additional SEC reporting, we don’t think that reporting will be all that onerous for the company. So, yes. It was better for FLIR to have invested in internal controls and employee training, because we believe things would have gone much worse for the company if it had not done so.

Introduction

On April 9, 2015, Under Secretary of Defense (Acquisition, Technology and Logistics) Frank Kendall announced the “next step” in the Pentagon’s efforts to “increase the productivity, efficiency, and effectiveness” in the areas of acquisition, technology and logistics. It was called “Better Buying Power 3.0” (“BBP 3.0”).

As the name implies, it is the latest “iteration” of such efforts. Accordingly, it has much in common with prior iterations. As Mr. Kendall noted in the memo announcing BBP 3.0’s advent, “there is more continuity than change.” (Note for readers who are also members: we are adding the memo to our knowledge resources page.) Among other long-time initiatives, the DoD will continue to focus on driving down the cost of the products it buys through such efforts as “should-cost reviews” and increasing competition.

But USD (AT&L) Kendall noted that BBP 3.0 contains some additional initiatives as well. The Pentagon is looking to emphasize “innovation, technical excellence, and the quality of our products.” How the Pentagon will navigate the Scylla and Charybdis of fostering innovation, excellence and quality, while at the same time fostering competition and awarding to the low bidder remains to be seen.

In fact, as long-time readers know, we have been skeptical of the efficacy of the Better Buying Power initiative (in all of its many iterations) since inception. While SECDEF Gates called for one thing five years ago, the Pentagon bureaucracy has seemed determined to deliver something else. Recently the Government Accountability Office (GAO) issued a report that seemed to clearly show that BBP has failed to meet its goals. It’s been five years; at what point do we throw in the towel and look for other approaches that don’t involve adding additional processes to fix the processes that most observers admit are broken?

Need a more concrete example of what we’re talking about? Sure. Let’s talk about commercial items.

Buying Commercial Items: Process on Top of Process

During the first Gulf War (“Desert Shield/Desert Storm”) the Pentagon had trouble obtaining communications equipment. It was easier for the troops to go to Radio Shack and buy a radio than it was for the Department of Defense to buy that same radio and issue it to the troops. As Jacques Gansler wrote in his book Defense Conversion—

… the U.S. Army found that it urgently needed a large number of modern radios. The model that Motorola was producing for city police forces was ideal to satisfy the army’s … requirements … However, since U.S. law makes it a crime for a company to sell an item to the government at anything but the lowest price offered to any other purchaser, and since Motorola could not guarantee that the army was getting the lowest price offered anywhere to anyone (because of discounts given to police by local sales distributors), it could not sign the necessary certificate. The army attempted to get someone at a high political level in the army to sign a waiver … but was unsuccessful. No one was authorized to violate the law without congressional approval. The solution to this dilemma was to have Japan purchase the radios from Motorola and then supply them to the U.S. Army as part of Japan’s contribution …

In 1987, the Defense Science Board had identified the need to use more commercial procurement practices in the acquisition of Defense supplies (though GAO and some politicians pushed-back on some of the DSB’s recommendations). In 1994, Coopers & Lybrand published an analysis which asserted that the Pentagon paid as much as a 20 percent premium for insisting on MILSPEC descriptions, obtaining cost or pricing data, and imposing Federal regulatory requirements on supplies that were readily available in the commercial marketplace. Finally the message started to seep into the heads of policy-makers and, as a result, the Federal Acquisition Streamlining Act of 1994 was signed into law. That led to the current FAR Part 2.101 definition of “commercial item” and the FAR Part 12 reduced regulatory requirements applied to the acquisition of such items.

Flash-forward two decades and it’s obvious that Pentagon buyers—and policy-makers—are still uncomfortable with the notion that regulatory requirements should be reduced for items readily available in the commercial marketplace. Contractors face great difficulty in convincing Contracting Officers (and OIG auditors) that their items (or services) meet the criteria for commerciality found in FAR Part 2.101. Contractors still face great difficulty in convincing CPSR reviewers and DCAA auditors that their subcontract awards meet the criteria. As a result, there is a well-founded concern that it is riskier to assert commerciality (and be second-guessed later) than it is to simply treat the commercial items and services as not being commercial. It is easier to obtain certified cost and pricing data than to look at pricing history. And comments (and policy guidance) from the Pentagon confirm this bias.

To address contractors’ concerns about the perversion of Congressional intent, the DoD Director of Pricing recently committed that Contracting Officers would review and confirm (or deny) claims of commerciality within 10 days. To accomplish this feat (which is really no feat at all) the DoD is creating a new centralized group of cost and pricing specialists to assist Contracting Officers in making the decision. In other words, each instance will have to be transmitted to a central location for review and then the call will be transmitted back to the individual Contracting Officer. So much for training.

The Pentagon has so much faith in the training and professionalism of its Contracting Officers that it has taken away from them the discretion to make a commerciality determination on their own.

And there are other concerns with this approach, as Stan Soloway wrote recently..

He wrote –

On the surface it sounds like a step toward greater efficiency and consistency in the acquisition process. But the new cadres are being trained by, and will report through, the very offices within the Pentagon that have taken the hardest line on commercial items. And they tend to see the issue primarily through a major weapons systems’ aperture, rather than through a much broader technology perspective.

Moreover, the initiative perpetuates a central point of dispute: whether an item or service is commercial is determined by what it is, not by how it is priced or what it costs. Price is important, of course, but it is not relevant, in law or in practice, to determining ‘commerciality.’ Yet, that is precisely how some in DOD continue to construe the issue. For them, it is largely about audit access and the use of the government-unique cost principles. Hence, making this new cadre part of the department’s cost and pricing offices would seem to bias the issue in the wrong and potentially disruptive direction.

To sum this up, here is a great example of how the Pentagon fixes a broken process by adding more process on top of it, perhaps leading (as Mr. Soloway warns) to unintended consequences.

BBP 3.0: More of the Same and Worse

We’re not going to dive into BBP 3.0 in this article (which has already grown too long in any case) but we do want to address one worrisome point.

Independent Research and Development. IRAD. IR&D. It’s clear that BBP 3.0 is targeting how contractors spend their precious IR&D funds and we need to warn our readers about that targeting.

BBP 3.0 has established a goal of “Increase the productivity of corporate R&D”. To a great extent, this is a continuation of the original BBP goal, established in 2010 by Dr. Ash Carter, of improving the IR&D investment made by industry and government. A couple of years later, we commented on how that initiative was playing out.

We wrote—

Looking at the bigger picture, we wonder if naysayers weren’t correct in worrying that the Defense Department’s renewed focus on contractor IR&D expenses wouldn’t tend to stifle innovation and technology development. If the Pentagon’s vision is an implementation of centralized planning and control that will act to channel contractors’ technology development efforts into only approved channels, then we don’t think that’s going to work out in the long run. Just ask the former Soviet Union how that centralized planning and control thingee worked out for them.

In BBP 3.0, the means by which the productivity of corporate R&D will be increased in found on Page 11 of the implementing memo. It states—

Reviews of IRAD spending indicate that a high fraction of IRAD is being spent on near-term competitive opportunities and on de minimis investments primarily intended to create intellectual property. A problematic form of this use of IRAD is in cases where promised future IRAD expenditures are used to substantially reduce the bid price on competitive procurements. In these cases, development price proposals are reduced by using a separate source of government funding (allowable IRAD overhead expenses spread across the total business) to gain a price advantage in a specific competitive bid. This is not the intended purpose of making IRAD an allowable cost.

The intent of the actions below is to ensure that IRAD meets the complementary goals of providing defense companies an opportunity to exercise independent judgement on investments in promising technologies that will provide a competitive advantage, including the creation of intellectual property, while at the same time pursuing technologies that may improve the military capability of the United States. The laissez faire approach of the last few decades has allowed defense companies to emphasize the former much more than the later [sic]. The goal of this initiative is to restore the balance between these goals.

In order to achieve the stated goal, the memo then describes three specific actions to be taken. The second of the three specific actions was described as follows:

Director DPAP, with ASD(R&E), will recommend to USD(AT&L) new guidelines for allowable [sic] of IRAD expenses by May 2015. The new guidelines will include: identification and endorsement of an appropriate technical DoD sponsor from the DoD acquisition and technology community prior to project initiation; and provision of a written report of results obtained following the completion of the project, or annually if the project spans multiple years. Following USD(AT&L)’s approval, the new guidelines will be implemented through a standard rule making notice and comment process.

If we understand the action correctly, it said that in order for IR&D expenses to be allowable, the contractor’s IR&D project must be “sponsored” by some unnamed person within the USD (AT&L) community “prior to project initiation. At the end of the IR&D project (or annually if the project’s duration is more than one year) a report must be submitted to that unnamed USD (AT&L) sponsor.

Well, there you go.

If that’s not adding more process on top of process, then we don’t know what would be.

Rather than let the market dictate the appropriate level of contractor IR&D spending, the USD (AT&L) intends to reverse decades of “laissez faire” market freedom and, instead, require centralized planning and control. The definition of “laissez faire” is “abstention by governments from interfering in the workings of the free market” and thus Mr. Kendall and Dr. Carter have declared their intention to overturn free market capitalism in favor of a Stalinist approach.

The third of the three specific actions was described as follows:

Director DPAP, with ASD(A), will develop a proposed regulatory or statutory change that would preclude use of substantial future IRAD expenses as a means to reduce evaluated bid prices in competitive source selections and provide it to USD(AT&L) by July 2015.

We almost don’t know what to say to that one. We cannot count the number of programs that have benefited from contractors “carving out” certain development tasks and performing them instead on IR&D. This specific action will lead to a situation where DoD will realize (perhaps for the first time in history) how much its weapon systems actually cost taxpayers. There is no budget for these weapon systems if all the development costs are included. Nunn-McCurdy breaches are just waiting to happen. Congressional and taxpayer criticism will manifest quickly. We predict disaster will follow for DoD if this specific action is successfully implemented.

So let’s wrap this up.

Conclusion: The Triumph of Bureaucracy

Dr. Carter and Frank Kendall and a number of other Pentagon leaders are on record as saying they want new technology, innovative technology, and that they don’t think they are currently getting it from traditional Defense contractors. But when they say they want access to commercial and “non-traditional DoD” technology, what they are really saying is that they don’t want to pay for the R&D efforts to develop it. Instead, they want the Googles and Facebooks and Palantirs of the world to develop their innovative technologies on the backs of their investors and venture capitalists, and only after that happens will then then they want that technology—technology for which they intentionally did not pay—given to them on a silver platter.

As for those traditional Defense contractors, they want to micromanage the R&D spending, making the word “Independent” in “Independent R&D” a sad oxymoron. They want to micromanage the spending and they want to ensure that nobody invests in R&D so as to obtain a competitive advantage from those investments. If this doesn’t chill contractors’ R&D spending, we don’t know what will. More to the point, if you say you want innovation, then you need to get out of the way of the people trying to give it to you. Central management is the death knell of innovation, as the downfall of the USSR should have taught us all.

BBP 3.0 is much the same as its predecessors: More bureaucratic management and more bureaucratic processes. Processes designed and implemented by bureaucrats for bureaucrats in order to achieve bureaucratic ends. Lest we forget, the original SECDEF Gates speech called for an initiative to reform, streamline and, ultimately, downsize that bureaucracy so that the warfighters received what they needed to execute their missions.

Instead, what we have here is a triumph of bureaucracy.