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Apogee Consulting Inc

A Banner Year for Corruption-Related Settlements

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During 2014, the U.S. Department of Justice collected almost $2.4 Billion dollars in criminal and civil actions, according to a recent DOJ press release. And that was just within the purview of the Eastern District of Pennsylvania – that was not the entirety of the DOJ haul, just one piece of it.

You know it’s going to be a good year for the DOJ as a whole. We know: we’ve seen the daily enforcement summaries.

It gotten to the point that we decided to simply stop reporting on the repetitive stories. We were bored, and we assumed our readers were bored as well. Why continue to make a point about the cost of corruption when there is no apparent deterrence from the story? Why continue to argue for investing in effective internal controls when so few companies seem to listen?

Fraud and corruption are endemic, it seems. Bribery and kickbacks are simply part of how business is done. How else can we explain the same story, repeated over and over, ad nauseum, about corporate wrongdoing?

You think we exaggerate? Deal with the following list:

  • December 8, 2014 – Contractor agrees to pay $1.9 million (plus interest) for compliance failures related to its GSA Schedule contract.

  • December 8, 2014 – Supreme Group and its various affiliated companies agree to pay more than $338 million to settle a bevy of allegations. (This one merited its own write-up.)

  • December 10, 2014 – A Dallas, Texas, aircraft maintenance company admits to FCPA violations and agrees to pay $14 million to resolve the bribery charges.

  • December 12, 2014 – The former President, CEO, and Chairman of the Board of the Louis Berger Group pleaded guilty to “conspiring to defraud the U.S. Agency for International Development (USAID) with respect to billions of dollars in contracts over a nearly 20-year period.” Readers may recall our original story on the questionable cost allocation practices of that contractor. Those who wish closure can read the DOJ press release here.

  • December 15, 2014 – An employee of Day & Zimmerman, International – a large engineering contractor – is found guilty of 8 counts of wire fraud related to his attempts to fraudulently obtain $650,000 by creating fictitious subcontractors. This is actually a fairly humorous story (as these things go). The DOJ press release can be found at this link.

  • December 15, 2014 – Contractor agrees to pay $2.5 million (and to relinquish rights to additional withheld contract funds) to resolve allegations related to violations of The False Claims Act. Apparently the contractor’s employee, the Director of Contracts, accepted kickbacks from potential subcontractors in return for awarding them subcontracts. The contractor submitted invoices on its prime contracts for work that was never performed by the subcontractors. Oops!

  • December 16, 2014 – Former employee of contractor is indicted for bribery related to award of contracts to local Afghan firms. Again, the employee under indictment is the former Director of Contracts. What is it with these people? You would think they would have a good clue about the cost of corruption, wouldn’t you?

  • December 18, 2014 – A former employee of Wackenhut Security is indicted for alleged theft of U.S. Government property and money laundering, related to her work at the East Tennessee Technology Park. According to the allegations, the employee received checks as part of her job and converted more than $214,000 of funds she received to personal use.

  • December 19, 2014 – A subcontractor on a federally funded construction project in New York agrees to pay $1,750,000 to resolve allegations that it fraudulently claimed that a disadvantaged business enterprise (DBE) performed work on the project.

  • December 19, 2014 – A jury finds a civilian Navy employee guilty of obstructing a NCIS investigation and making false statements. According to the DOJ press release, “The evidence at trial showed that the NCIS was investigating Ashton for conflicts of interest and using inside government information to advance his business. When Ashton learned about the investigation, he created fraudulent documentation purporting to show that he had fully disclosed his business to Navy authorities and received approval.”

  • December 19, 2014 – Contractor Iron Mountain agrees to pay $44.5 million to settle allegations under the FCA that it violated the requirements of its GSA Multiple Award Schedule contracts in the areas of commercial sales practice disclosure as well as the Price Reductions clause.

  • December 19, 2014 – Lockheed Martin Integrated Systems agrees to pay $27.5 million “to resolve allegations that it violated the False Claims Act by knowingly overbilling the government for work performed by LMIS employees who lacked required job qualifications.”LMIS allegedly used “under-qualified employees” who were billed “at the rates of more qualified employees.”

  • December 22, 2014 – The former owner of a defense contractor is sentenced to 6 months in prison for defective aircraft parts. “In 2013, the [DoD] discovered that the wing pins … might be defective.…Based on this discovery, auditors were dispatched to Phoenix to interview Markson and inspect Action Machine’s books and records.… Markson supplied auditors with a document that appeared to show that a third-party testing company had conducted all of the necessary safety testing on the wing pins. In fact, this document was a forgery created by Markson.”

When fraud and bribery and product substitution and other corruption become the routine, boring norm for a blog such as this one … well, then you know we are all in trouble from an ethics perspective.

Happy New Year.

May the New Year be less ethically challenged than 2014 was.

 

 

In Which NASA Prepares to Jettison DCAA Out the Nearest Airlock

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NASA
Kind of a smug headline, we suppose. It’s an exaggeration of course; hyperbole that probably doesn’t accurately reflect the true reality of the situation. And yet it may not be all that far off the mark either. The signs are all pointing that way.

Do you read them the way we read them?

For some time now we have been telling readers that choices made by DCAA’s leadership were going to have consequences. We told readers that DCAA’s new approach to “risk-based” audit selection was going to generate repercussions. We’ve been pointing out that Executive Branch agencies such as the United States Postal Service have deemphasized use of DCAA on a reimbursement basis because of concerns over timeliness and audit quality. We’ve noted that the Department of Defense has started to look for ways to finalize contractors’ billing rates and close-out contracts without waiting for an official DCAA audit report. We’ve reported that the DoD Inspector General has recommended that the Defense Contract Management Agency learn to manage DCAA in a more tailored fashion, with respect to audits of contractors’ Forward Pricing Rate Proposals. We’ve reported that the DoD IG has recommended that DCMA enhance processes and staff training with respect to negotiating new contract awards, because DCAA doesn’t audit as many of those as it used to audit. And we’ve also told readers that the DAR Council is seeking to reduce DCAA’s role in reviews of contractor business systems because reducing DCAA’s role will lead to increased “efficiency and effectiveness” of those reviews.

But that’s not all. We’ve also reported that DCMA has taken on reviews of contractors’ CASB Disclosure Statements for adequacy. We’ve also reported that DCMA Contracting Officers will issue Forward Pricing Recommended Rates on their own if DCAA cannot issue an audit report in time to support the analysis of contractors’ FPRPs. In short, we’ve fairly well documented the diminishment of the universe as measured by DCAA audit scope, and we’ve opined that the tide will continue to ebb in that respect. We’ve even gone so far as to suggest it’s time to let the 50 year-old audit agency go, and replace it with something better.

Thus: this opinion of ours, this reading of the signs and portents, this belief that DCAA is going the way of the dinosaurs and the Dodo Bird—it is really nothing new. It’s been our position on the matter for several years. Sometimes we rant and rave about DCAA ineptitude, and other times we shake our heads and mutter in despair as the state of the Pentagon’s contract audit agency. But we’ve been convinced for some time that the only thing that’s going to save DCAA is a complete regime change.

So when we tell our readers that the NASA Office of Inspector General has issued a report in which it found that “NASA is at increased risk of paying unallowable, unreasonable, and unallocable incurred costs and of losing the opportunity to recoup improper costs because Agency contracting officers rely too heavily on DCAA’s incurred cost audit process,” you may simply mark it up to more of the same ranting and raving in which we’ve been engaging for some time. Or you can read our summary and thoughts of the NASA OIG report and, perhaps, conclude that we may be on to something. Or you can read the report yourself and ignore our thoughts.

It’s all good.

The OIG reported that NASA spends more than $8 Billion each year reimbursing contractors via cost-type contracts. The report noted that contractors with such contracts are required to submit, annually, “an incurred cost proposal outlining their direct and indirect costs.” It noted that “Under the FAR, NASA generally has 6 years to recover unallowable costs from the date the contractor’s adequate incurred cost proposal is submitted.” Since 1969 DCAA has audited NASA contractors’ “incurred cost proposals” and DCMA has provided contract administration services for NASA on a reimbursable basis.

The support DoD provides to NASA does not come cheaply. The OIG reported that “From FYs 2009 through 2013, NASA paid DCMA approximately $204.8 million for contract administration and support services and DCAA approximately $77.5 million for audit services. For FY 2014, NASA anticipates paying DCAA $17.7 million for 150,000 hours of work. Based on DCAA’s 2013 work, we estimate approximately 71 percent of this figure, or $12.6 million, will pay for incurred cost audits.”

What does NASA get from DCAA? According to the OIG: “Between FYs 2009 and 2013, DCAA performed 337 incurred cost audits of proposals submitted by NASA contractors and identified $313.5 million in questioned costs. … Since 2009, the rate of sustainment for questioned costs in NASA contracts has fluctuated between 6 and 71 percent.’

Well, that seems like a good deal, doesn’t it? NASA is paying DCAA roughly $18 million a year and, in return, DCAA is questioning roughly $60 million in contractor costs, of which somewhere between 6 and 71 percent end up as bona fide cost reductions and taxpayer savings. (Even if the average sustainment rate was 40 percent, that would still be a good return on investment for NASA.) So what’s the problem, then?

The problem, according to the NASA OIG, is that “NASA contracting officers relied almost exclusively on DCAA’s incurred cost audit process to identify unallowable, unreasonable, and unallocable costs. Contracting officers we spoke with pointed to these audits as their only means of identifying questioned costs.” And the problem with that reliance, according to the OIG, is that DCAA’s new “risk-based” audit approach “substantially decreases” the number of contractor “incurred cost proposals” that are audited. Many contractor annual proposals to establish final billing rates are never audited because DCAA deems them to be “low risk.”

Because the NASA Contracting Officers rely on DCAA, and because DCAA is letting a substantial number of contractor proposals through unaudited, that means that nobody is looking for unallowable costs. The OIG is (rightfully) concerned that millions of dollars of contractor costs that would previously have been audited and questioned by DCAA are getting through with zero scrutiny, and that NASA will be in the position of reimbursing contractors for costs for which they are not entitled to reimbursement.

Here is the conclusion from the NASA OIG audit report:

NASA contracting officers place an unhealthy reliance on DCAA audits to identify unreasonable, allocable, and unallowable costs charged on NASA’s cost-type contracts, performing little to no additional oversight of costs on the 20 contracts in our sample. In addition, this reliance on DCAA – which has an approximately 6-year backlog in conducting incurred cost audits – has delayed NASA’s ability to timely close contracts and deobligate funds. Moreover, the delays and 6-year time limit to recover funds may affect NASA’s ability to recoup funds improperly charged by contractors. DCAA’s revised incurred cost audit methodology reduced the number of incurred cost audits performed on NASA contracts and under the new procedures only a sample of vouchers submitted for payment on NASA’s cost-type contracts receive a high-level review. Accordingly, NASA cannot afford to rely solely on DCAA to determine whether incurred costs are allowable, allocable, and reasonable and should revise its current processes or develop additional procedures and oversight mechanisms to better safeguard the billions of dollars it spends annually in contract funding.

The NASA OIG made five recommendations intended to help address the foregoing situation. Among those recommendations, we noted the following –

Revise the NASA FAR Supplement 1815.404-2(a)(1)(F)(1) to allow independent public accounting firms to provide supplemental audit coverage for NASA contracts where DCAA currently conducts any contract audit services but cannot be responsive to NASA’s need for an audit.

In other words, revise the regulations to permit auditors other than DCAA to do the job that DCAA has been performing for NASA since 1969.

Are we reading too much into this audit report? Perhaps. Or perhaps we are correctly seeing this audit report as being yet one more indication that DCAA’s management decisions are putting it out of business.

 

The DFARS Forward Pricing Rate Proposal (FPRP) Checklist

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The hard part of any accounting system implementation – especially implementation of an ERP or large-scale accounting system at an entity running a complex business – is not actually implementing the new software. Running the new software may actually be the easiest part of the implementation. The conversion of legacy data is also not likely to be the hard part. Same thing with respect to mapping the old organizational structure to the new org structure. Those tasks are not particularly challenging.

What’s the hardest part of a complex ERP implementation? Just ask anybody who’s been through one of those multi-month wire brush sessions. They’ll almost certainly tell you that the hardest part of their job was change management. We bet they’ll tell you that the hardest part of the accounting system implementation was identifying how the entity would operate in its post-implementation “future state” and then selling those changed practices to affected employees.

Change is hard, which is why meeting the CAS-mandated requirement to disclose changes to cost accounting practice 60 days in advance of their effectivity date is such a challenge.1 For example, say you want to make a prospective voluntary change to cost accounting practice – or what the kids today call a “unilateral change” – and that you want that changed practice to be effective on January 1, which is the start of your new fiscal year. That desired timing means you have to have your revised Disclosure Statement out the door and in the hands of your cognizant Federal Agency Official (CFAO) by not later than November 1.2 Which means, generally, that you have to have your changed practices identified, and the impacts quantified (at a high level), before then—often well before then.

You can’t disclose what you can’t describe, and you can’t describe what hasn’t been identified and approved. Thus, as a general rule of them you need to have the cost accounting practices you will be using next year decisively determined before the end of this year’s Q3. That gives you a month to go from management decision to Disclosure Statement revision and submission.

The problem with the foregoing is that decisions to change cost accounting practices often go hand-in-hand with other budgetary decisions. Frequently, it is an entity’s budgetary constraints that drive the need to make changes to the methods used to measure, assign and/or allocate costs.

From where do an entity’s changed cost accounting practices originate? The notions almost always originate from the top of the entity. Management gets a bright idea to make the changes, either to align with the strategic needs of the business or to adapt to changed business conditions … or (more likely) because somebody’s budget got cut. Although we would like to be charitable and tell you that these high-level strategic and tactical decisions are made throughout the year -- based on monthly variance analyses and dynamic changes to the business environment -- experience forces us to be honest and to write that these types of decisions are very often made at the last-minute in the heat of budgetary battles. That is to say, typically these issues are raised and decided in late November/early December, and not in Q3.

Because the decisions that lead to changes in cost accounting practice are very often made at the last minute, it is unfortunately too often impossible to meet the 60 day advance notification requirement. The regulations assume you have all your financial and accounting ducks in a row, lined up with precision, ready to disclose, on November 1st. But the reality is that, far too often, November 1st comes and goes, and management still hasn’t come to an agreement on how the entity will operate on January 1st. Asking the management team to agree, in advance, on future state run rules, often before any budgets have been discussed (let alone issued) or any financial impacts to the entity from the changes have been calculated, is a very difficult task indeed.

And that’s just the “business as usual” fiscal planning environment; the typical tension between leadership and compliance that exists in “normal” transitions from one fiscal year to the next. The regulations expect and require a 60 day advance notification of all changes to cost accounting practice, whereas the reality of the business environment is that reaching an internal agreement 60 days in advance of the changes is an extremely difficult undertaking and, in some circumstances, damn near impossible.

Which brings us (perhaps by rather circuitous means) to the discussion of the new DFARS FPRP Adequacy Checklist. Let us start by linking to the Federal Register notice. Next, let us remind you that we told you this new Checklist was coming, and we invited you to offer comments to the DAR Council regarding its implementation. In that previous article, we offered some mild criticisms of the proposed DFARS rule. We wrote –

This is another example of bureaucrats fixing a problematic process by adding more processes. We discussed that unfortunate phenomenon right here. DCMA would be better off, in our view, by training up its contracting workforce to restore the lost expertise, and then giving the trained personnel discretion to enter into FPRAs without the burdensome and time-consuming oversight of the current process. DCAA would be better off, in our view, by admitting that contractor FPRPs are not the same as cost proposals submitted to enter into a priced contract, and permitting auditors more flexibility in audit approach. (Establishing firm deadlines wouldn’t hurt either.) Taking an incurred cost audit approach to a SWAG is never going to work out well for either DCAA or the contractor.

The proposed rule is now a final rule and, effective immediately, cognizant DoD Administrative Contracting Officers “shall require contractors to comply with the submission items in Table 215.403-1 in order to ensure that their forward pricing rate proposal is submitted in an acceptable form in accordance with FAR 15.403-5(b)(3).” Moreover, the ACO “should request that the proposal be submitted to the Government at least 90 days prior to the proposed effective date of the rates.” The ACO “shall request that the contractor complete the Contractor Forward Pricing Rate Proposal Adequacy Checklist at Table 215.403-1 and submit it with the forward pricing rate proposal.”

Perhaps some of you read our invitation to offer comments to the DAR Council. Certainly, the rulemakers received public input and discussed it amongst themselves. It seems as if the comments might have actually impacted the final rule in at least one respect, which is always nice even if we believe the final rule is still problematic in some very significant respects that might have been resolved had the Council listened to the imput it received.

As is our wont in such matters, we want to focus less on the final rule and the final Adequacy Checklist and, instead, focus more on the rulemakers’ comments about the public comments. Why? Because you can read the FPRP Adequacy Checklist for yourself – we provided a link for you – but a year from now too many readers are going to forget about the comments. Our approach memorializes the rulemakers’ comments. (It also provides a better opportunity for us to write snarky stuff about their comments, which is more fun for us!)

As you might have guessed from the long-winded introductory paragraphs, our fundamental issue with the new DFARS requirement is the timing. Indeed, according to the promulgating comments—

… respondents claimed that the proposed rule creates unintended and harmful liabilities for contractors. … Requiring companies to submit forward pricing rates at least 90 days in advance of their effective date directly conflicts with TINA and the False Claims Act. … key bases for estimates such as budgets or sales projections may simply not be available 90 days prior to submission of rate proposals. [Ed. Note: We think the DAR Council meant 90 days prior to the effective date.] Beyond that, the budgetary and factual data upon which FPRPs are based (1) may simply not be available 90 days in advance, (2) may be subject to more current data, or (3) may be affected by certain large proposals that may require a resubmission of rates when a contract award would have a significant impact on bases/rates.

The DAR Council pondered those concerns and, with a blasé air typical of those who don’t actually have to live with the rules they write, responded as follows –

Submitting FPRPs 90 days in advance of their effective date is reasonable. The parties (Government and contractor) need time to negotiate forward pricing rates prior to their effective date, which is often the start of the contractor’s fiscal year. Prior to the start of their fiscal year, contractors have established strategic plans and put budgets in place to manage their business. [With respect to concerns about TINA and FCA compliance] [i]t should be understood by the parties that the proposed rates are based on forecasts and contractors must provide updates whenever the validity of the agreement may be affected.

The DAR Council’s position, as expressed in the foregoing paragraph, is ignorant. We don’t mean to be unnecessarily disparaging; we mean that the position is literally based on ignorance. The individuals espousing the position likely have not ever investigated how the FPRP process works from a contractor’s perspective (or, if they did, they have ignored what they learned). As a result, the DAR Council’s position is based on ignorance of the challenges inherent in the contractor’s process of establishing budgets and it is based on ignorance of the timing of how budgets are turned into forward pricing rates. The position is based on ignorance of the number of iterations and the number of management reviews and the input of the Business Development Marketeers and the impact of forward pricing rates on provisional billing rates and the impact of forward pricing rates on contract Estimates-at-Completion (which impacts revenue recognition). Because the DAR Council members are ignorant of all those things (or seem to be), they have espoused a position in which “submitting FPRPs 90 days in advance of their effective date is reasonable.”

No, it is not reasonable. In many cases it is going to be impossible.

And now you may see why we started this article the way we did. We wanted to share just a hint of the challenges involved. Just the tip of the iceberg, so to speak. We didn’t even talk about DCAA audits of forward pricing rates and DCMA reviews of next year’s Disclosure Statement. Those are governmental processes and, as we’ve written before, we believe they are broken. No FPRP Adequacy Checklist is going to fix those broken governmental processes.

While we are on the topic of timing, consider this info-nugget: The CAS regulations and the FAR regulations and the CAS clauses require that voluntary/unilateral changes to cost accounting practice must be disclosed at least 60 days in advance of their effectivity date.3 The intent of that requirement is to give the government sufficient time to review the changed practices and determine whether a cost impact is required. (Let’s be clear that nobody really expect the government folks to actually make that determination within 60 days, but that’s what the regulations say.) Sixty days is deemed to be sufficient time for DCMA to review, for a DCAA audit to be requested if judged necessary, for DCAA to complete its audit and report back to the CFAO, and for the CFAO to make his/her determination regarding how to proceed.

Sixty days.

Yet, the DAR Council wants the contractor to submit its FPRP 90 days in advance.

Ninety days.

Let’s be clear: If the contractor is going to make changes to its cost accounting practices, this new DFARS rule requires the contractor to understand the impact of those changes on its indirect rates at least 30 days before it has to disclose them to the CFAO. It has to know the impact of its management decisions on its cost structure and calculate the resulting indirect cost rates 30 days before it tells the CFAO about them.

And this process seems “reasonable” to the DAR Council.

That’s the big one, at least in our minds. There was some other stuff as well.

To the commenter who “stated the rule does not address the issues associated with the DCAA’s inability to audit industry submissions in a timely fashion,” the DAR Council replied: “Establishment of comment expectations … will promote adequate initial submissions … which will shorten the acquisition cycle making for more efficient negotiations for both contractors and Government.”

Way to respond to the comment directly, DAR Council.

To the commenter who “suggested DCAA should begin auditing the most recent incurred cost submission to gain a thorough understanding of the contractor’s operations necessary to best opine on contractor forward pricing estimates,” the DAR Council replied—

… The Government employs multiple avenues to obtain an appropriate understanding about the contractor’s operations. The Government has a responsibility to perform appropriate review of contractor proposals to establish well-supported negotiation positions and to negotiate effectively to wisely use taxpayer money and to ensure that contract prices are fair and reasonable to both the contractor and the Government. Taxpayers receive a direct tangible benefit from the auditing of FPRPs. Meanwhile, DCAA is working to reduce the inventory of incurred costs audits to become current.

We have so many comments about that paragraph – all of them sarcastic and snarky – that we are literally unable to choose which ones to type. So we’ll just leave that turd of a response here for posterity. Feel free to make your own sarcastic and snarky comments to yourself.

One commenter stated that “DCAA should conduct better and more accurate transaction testing. … Unable to rely on contractor business systems and coupled with not having audited recent contractor incurred cost submissions, DCAA has made detailed testing of large samples of recent incurred cost transactions a part of their FPRP audit program.” Apparently, the thrust of the comment was that, if the DAR Council wanted to make the FPRP negotiation process more efficient and timely, one good place to start would be to have DCAA auditors do “better and more accurate transaction testing” so that the audit cycle time could be reduced. To that cogent suggestion, the DAR Council replied, “… the purpose of the rule is to provide guidance to contractors for the submittal of FPRPs. DCAA’s audit approach is to design cost audits within FPRP audits. DCAA is working to reduce its backlog of incurred cost audits so that the agency can conduct the audits more promptly.”

We swear we are not making this stuff up. They really published that in the Federal Register. Go check and see for yourself if you don’t believe us.

The problem with the response (or at least the most obvious problem) is that it utterly ignores the role played by DCAA in delaying FPRP negotiations. The problem is not that contractors lack guidance regarding how to prepare nicely formatted SWAGs of future years’ costs and indirect rates. No, the problem is that “DCAA’s audit approach is to design cost audits within FPRP audits.” If you fix DCAA’s audit approach instead of worrying about the contractor, you will have gone a long way to solving the problems inherent in the process. Check out the plank in your own eye, DoD, before you worry about the speck in the contractor’s eye.

To the commenter who “suggested” that the DCAA audit process could be made more efficient by relying on “relevant auditing and analysis by others,” such as “the contractor’s internal audit department, other Government oversight organizations … or even other DCAA auditors,” the DAR Council replied, “In order to comply with [GAGAS], DCAA’s audit opinion must be derived from the results of sufficient audit procedures performed on the underlying contractor data.” Again, the response ignored the elephant in the room, which is that somebody in authority needs to be asking whether or not DCAA audits of FPPRs should even be subject to GAGAS. DoD could take the reasonable and supportable position that such reviews will not be performed in accordance with GAGAS requirements, which would be a significant improvement.

On the positive side, the references to FAR Table 15-2 were deleted in the final rule. That’s one nice thing to balance out the negatives we have listed herein.

Other comments received and published by the DAR Council addressed concerns with adding more administrative burdens. The DAR Council was not swayed by those comments. We know that Executive Branch leadership is concerned about the complexity of government contracting and how that complexity acts as a barrier to keep out contractors and thus reduce competition. We wrote about efforts to reverse the situation here. The new OFPP Administrator called for “opportunities for contractors to provide ‘frank, open assessment feedback’ to agencies regarding the agencies’ acquisition practices.”

Meanwhile, the DAR Council continues to add more complexity to existing processes, to add more administrative burdens to an already burdensome process. The DAR Council continues to ignore the real drivers in the process and, instead, continues to focus on the contractor’s role as if that were the sole – or the most impactful – problem.

And while the OFPP calls for “frank, open assessment feedback,” the DAR Council continues to cavalierly dismiss public input, to ignore astute suggestions for process improvement, and to engage in hand-waving instead of pursuing the fundamental and quite necessary job of improving the defense acquisition system. If the Executive Branch leadership really desires a “frank” and “open” dialog with industry, one important step to take might be to make sure public comments are listened to and dealt with in a forthright manner. The DAR Council’s comments on this final rule are a good – but by no means the only – example of why industry is rightfully cynical of the value of that dialog.

 

1 Okay. We admittedly kind of fudged that for the general readership. We know that you know that the actual requirement, as found in contract clause 52.230-6, is “not less than 60 days (or such other date as may be mutually agreed to) before the effective date of the proposed change.” We just thought that was too much detail for the article.

2 Unless you are not a CAS-covered contractor -- in which case, you have a lot more freedom to choose your timing.

3 Yeah, we know. See Note 1, above.

 

Lessons from Sikorsky Aircraft Corp. v. United States

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This is one of those times where we are required to remind our readers that we are NOT attorneys. Our analyses of legal matters are limited to those of laypersons. Any criticisms we level, any fingers we point, at jurists, jurors, or attorneys are likely the result of our limited perspective. Do not rely on our blog articles for legal analysis. (Or much of anything else, really.)

With those caveats in mind, let us now discuss the recent decision by the U.S. Court of Appeals, Federal Circuit, in the appeals of Sikorsky Aircraft Corporation v. United States.

You remember the case, don’t you? We have blogged about the original case before. In fact, there are at least six articles on the case in our news archive. You can use the site’s keyword search feature to find them. To get you started, here’s a link to one article, in which we discuss Judge Lettow’s March, 2013, decision at the U.S. Court of Federal Claims. The title of that article was “Sikorsky Wins CAS 418 Case, But Other Contractors Lose.” The Appellate decision continues that trend.

The Appellate decision was authored by Judge Dyk. You remember Judge Dyk, don’t you? We’ve published some mild criticisms of his CAS-related decisions before. In fact, we were tempted to title this article “Dyk Strikes Again” but we didn’t know how to pronounce the Judge’s last name. Does “Dyk” rhyme with “Strike”? We didn’t know, so we went with the title we went with.

We are not going to recapitulate the gravamen of the parties’ CAS 418-related dispute. A link to our prior article on the dispute is provided above. Sikorsky prevailed at the Court of Federal Claims and the Government appealed to the Federal Circuit. Judge Dyk authored an opinion that affirmed Judge Lettow’s original decision.

But there’s more to the story.

The Appellate decision affirmed several points that are relevant to government contract-related litigation. First, Judge Dyk clearly confirmed that “the government bears the burden of proving Sikorksky’s noncompliance.” This is important because too often DCAA and Contracting Officers want the contractor to prove its cost accounting practices are CAS compliant. Not so. The burden is on the government to prove they are not compliant. That is a critical distinction.

Second, Judge Dyk dismissed the government’s argument that “internal government documents concerning the history of the CAS provisions and other materials which were not published provide support for the government’s argument about the rule’s meaning.” Judge Dyk decided that “those unpublished materials are not relevant to our interpretative task. The CAS standards, like any other regulation, must be interpreted based on public authorities.” (We were interested to see Judge Dyk cite to his own opinion in the infamous Rumsfeld/UTC/Pratt decision as support for his finding today. Stare decisis in action, we suppose.) Further, the Judge declined “to rely on the ambiguous language from the ‘preamble’ to contradict the plain language of the rule itself.’ As we see it, the Judge was saying that, where helpful in interpretation, text from a Standard’s preamble could be used; but in any conflict between a Standard and its preamble, the plain language of the published Standard will control.

A very important aspect of the decision was to better define the nebulous phrase “material amount” with respect to interpreting CAS 418. Sikorsky argued that “material amount” refereed to comparing the costs of supervision or management in the indirect cost pool to the total amount of costs in the cost pool, whereas the government argued that the phrase referred to comparing the amount of the costs of supervision or management to the total amount of supervision or management costs in the entity as a whole. Judge Dyk wrote –

Sikorsky argues … that the relevant inquiry is whether the costs of management or supervision are a material part of the pool as a whole, not whether a given pool contains all of the related management or supervision costs. We agree with Sikorsky that the proper inquiry is whether the costs of supervision and management comprised a material amount of the material overhead pool at issue. …

The next question is whether the costs of management and supervision here were a material amount of Sikorsky’s materiel overhead pool. The government argues that ‘material’ means more than a de minimis amount. We agree with the Claims Court that ‘material’ refers to a significant amount. Sikorsky argues that, applying the correct standard for materiality, managers and supervisors comprised seven percent of the materiel logistics workforce and fourteen percent of the purchasing group staff, and that the costs of management and supervision were [therefore] not a material amount. The government does not argue that these costs … were a significant portion of Sikorsky’s total pool, or that other factors should be used in considering materiality. Therefore, we affirm the finding of the Claims Court that the costs of management and supervision were not a material amount of the total pool costs.

Based on the foregoing, we have a strong legal decision that costs comprising as much as fourteen percent of a single indirect cost pool are not material in amount. This is a significant finding. (Pun intended.)

Judge Dyk also addressed the CDA Statute of Limitations in his decision, though his discussion might be characterized as obiter dicta rather than as being precedential. Readers may recall that we have pleaded for a “bright line” regarding when the CDA SoL clock starts to tick. We didn’t get that bright line in this decision. Instead, we got a bit of a bombshell, as Judge Dyk found that the six-year limitation period is not jurisdictional. Sikorsky argued that the Judge needed to decide on the CDA SoL issue before deciding on the merits of the case; but Judge Dyk disagreed. He wrote –

To be sure, we have previously characterized the six-year limitation in the CDA as jurisdictional … However, our decision … was effectively overruled by the Supreme Court’s more recent decision in Sebelius v. Auburn Regional Medical Center … the latest in a series of Supreme Court opinions that have articulated a more stringent test for determining when statutory time limits are jurisdictional.

Judge Dyk interpreted the CDA SoL as being a filing deadline, which made it a “claim-processing rule” and not jurisdictional. He wrote, “The context of the [CDA] statute also does not suggest that it is jurisdictional. Insofar as it applies to claims by the government, the statute pertains to the submission of a claim by a contracting officer to a contractor, rather than to a government body.” Judge Dyk spent more than 3 pages of the 19 page opinion discussing why his interpretation was correct, but then mooted his discussion by writing “Because we affirm the Claims Court on the merits, we do not address whether § 7103 was satisfied in this case.” Thus, in our view, the effect of the dicta is to muddy the waters even further with respect to interpreting the CDA SoL.”

Sikorsky won once again and, in doing so, helped us better understand how the concept of “materiality” will be applied in CAS-related litigation. However, Sikorsky’s victory did other contractors no favors with respect to better defining and developing a “bright line” for applying the Contract Disputes Act’s Statute of Limitations.

 

 

A Supremely Large False Claims Settlement

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As we recently mentioned, we don’t care for posting articles about routine FCA settlements. It seems that nearly every day some poor government contractor is settling with the Department of Justice for some alleged false claim or inflated contract price or failure to adhere to the GSA Price Reductions Clause … or something similar. Some less-than-fully-gruntled former employee has filed a qui tam suit and is looking to get paid, or to right a wrong … or something similar. We got bored. So many FCA settlements, all so very much the same. If we were bored with the continuous litany of FCA violation stories, we figured our readers must be bored as well. We stopped writing articles about such allegations and settlements.

The only time we get motivated to write about another FCA settlement is when the story offers something novel or interesting … or perhaps offers a lesson for our small (yet deeply disturbed) readership. Such is the case with today’s story about a Defense Logistics Agency contractor, named Supreme Group B.V., that, along with several subsidiaries each bearing the moniker Supreme somewhere in their corporate names, have entered into such a massive fraud settlement that we deemed the situation worthy of note. So here you go.

First, the link. It takes you to the DoJ press release. If one were simply to read the title (“Defense Contractor Pleads Guilty to Major Fraud in Provision of Supplies to U.S. Troops in Afghanistan”) it would not seem especially newsworthy. Well, maybe the “Major Fraud” part, because routine FCA allegations rarely reach that level.

According to the DoJ announcement –

  • Supreme Foodservice GmbH (formerly known as Supreme Foodservice AG), a privately held Swiss company related to Supreme Group B.V., pleaded guilty to a “major fraud” against the United States (as well as conspiracy to commit major fraud and wire fraud.

  • Supreme Foodservice FZE (formerly known as Supreme Foodservice KG), a privately held UAE company, pleaded guilty to major fraud against the United States.

  • Together, the two Supreme Foodservice companies agreed to pay US$48 million in restitution, US$10 million in criminal forefeiture, US$96 million in criminal fines, plus an additional US$38.3 million in refunds related to overpayments. That’s a total of US$192.3 million to resolve the criminal fraud allegations.

The DoJ announcement told the story of how these two Supreme Foodservice companies were awarded a contract to provide food and bottled water to US troops serving in Afghanistan, and how these two companies “devised and implemented a scheme to overcharge the United States in order to make profits over and above those provided in the $8.8 billion subsistence prime vendor (SPV) contract.” They did this by using a third UAE company (JAFCO)—which they controlled—as a false middleman subcontractor to fraudulently mark-up costs for local market ready (LMR) food and bottled water that were then sold to the two Supreme Foodservice companies for resale to the US Government.

According to the DoJ press release –

[The owners of the two Supreme Foodservice companies] made concentrated efforts to conceal Supreme’s true relationship with JAFCO, and to make JAFCO appear to be an independent company. They also took steps to make JAFCO’s mark-up on LMR look legitimate, and persisted in the fraudulent mark-ups even in the face of questions … about the pricing of LMR.

Even though the SPV contract stated that the Supreme food companies should charge the government the supplier’s price for the goods, emails between executives at the companies … reveal the companies’ deliberate decision to inflate the prices. … On or about Feb. 16, 2006, during a discussion about supplying a new product to the U.S. government, one Supreme executive wrote to another, ‘I am very sure the best option is to buy it from Germany and mark up via [JAFCO], like [non-alcoholic] beer.’

In early March 2006, after a … contracting officer told the Supreme food companies that she wanted to see a manufacturer’s invoice for specific frozen products, Supreme Foodservice GmbH lowered its prices for those products to prices that did not include a JAFCO mark-up. On March 14, 2006, instead of disclosing that the initial pricing had included a mark-up, a Supreme executive misled the [contracting officer] by saying, ‘Based on more realistic quantities, we have been able to negotiate a better price,’ to explain the change in pricing. 

In June 2006, when a … contracting officer raised questions about pricing focusing on four specific items, Supreme executives again misled the DSCP, claiming that the high prices were for a high quality of product, and offering to sell lower quality products for lower prices. Supreme Foodservice GmbH did this even after analyzing its JAFCO margin on the four items in question and finding its profit margins were between 41 and 56 percent.

So that little scheme cost the two companies nearly US$200 million. But that’s not the end of the story.

In addition to the foregoing criminal settlement, the DoJ also reported that Supreme Group “agreed to pay another $101 million to settle a whistleblower lawsuit, filed in the U.S. District Court for the EDPA by a former executive, which alleged that Supreme Group, and its food subsidiaries, violated the False Claims Act by knowingly overcharging for supplying food and water under the SPV contract.” Apparently, the qui tam relater alleged that the company failed to pass on “rebates and discounts it obtained from suppliers,” which as we know would be a problem. But that’s not the end of the story.

The DoJ also reported that –

Supreme Site Services GmbH, a Supreme Group subsidiary, agreed to pay $20 million to settle allegations that they overbilled for fuel purchased by the Defense Logistics Agency (DLA) for Kandahar Air Field (KAF) in Afghanistan under a NATO Basic Ordering Agreement.  The government alleged that Supreme Site Services’ drivers were stealing fuel destined for KAF generators while en route for which the company falsely billed DLA.

But that’s not the end of the story. The DoJ also reported that –

Supreme Group’s subsidiary Supreme Logistics FZE also has agreed to pay $25 million to resolve alleged false billings by Supreme Logistics in connection with shipping contracts between the U.S. Transportation Command (USTRANSCOM), located at Scott Air Force Base in Illinois, and various shipping carriers to transport food to U.S. troops in Afghanistan during Operation Enduring Freedom.  The shipping carriers transported cargo destined for U.S. troops from the United States to Latvia or other intermediate ports, and then arranged with logistics vendors, including Supreme Logistics, to carry the cargo the rest of the way to Afghanistan.  The United States alleged that Supreme Logistics falsely billed USTRANSCOM for higher-priced refrigerated trucks when it actually used lower-priced non-refrigerated trucks to transport the cargo. 

And now we have reached the end of the reported story. To sum it all up:

  • $192.3 million criminal settlement

  • $101 million civil FCA settlement

  • $20 million overbilling settlement

  • $25 million false billings settlement

For a grand total of US$338.3 million in settlement expenses. Of course, that value does not include attorneys’ fees, which we suspect were considerable. All in all, a very large haul for the Federal government. And we suspect a fairly painful lesson for the companies involved.

 


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Newsflash

Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.