Pension Benefit Curtailment and The Aftermath
CAS 412 and 413, both gifts that keep on giving job security to actuaries, accountants, attorneys, and administrative law judges.
Which is to say, they are both complex Standards with a myriad of potential non-compliance pitfalls—especially for those few contractors that continue to maintain defined benefit pension plans. In addition—as we are about to discuss—a decision by a contractor to terminate or curtail its defined benefit pension plan can carry its own risks.
Let’s start with the basics.
As many contractors do, Northrop Grumman maintained additional benefits for its senior executives. In this case, the company maintained an Officers’ Supplemental Executive Retirement Plan (OSERP), which was a Rabbi trust where funds were put away for these executives, invested on their behalf, and then was made available (upon retirement) for those executives to supplement their other retirement pay and other retirement investments.
We like the old joke about such things: When executives tell employees that people are their most important resource, that’s a lie. In reality, their supplemental retirement plan benefits are their most important resource.
Okay. We’ll work on that one.
Anyway, Northrop curtailed the OSERP in 2014, after about 11 years of activity. The verb “curtailed” (or alternatively “froze”) was explained as “ending further contributions to the plan and curtailing increased benefits based on such contributions. Persons entitled to the pension would still receive it upon retirement, but their payments would be based upon their years of service as of the date of the curtailment, rather than their years of services as of their retirement date.”
As CAS 413 requires, when Northrop decided to curtail its plan, it calculated the plan’s assets and liabilities. If the assets are greater than the present value of the obligations, it means the government “overpaid” the pension plan expenses in prior years and is entitled to a refund. But if the assets of the pension plan are calculated as less than the present value of its obligations, then the contractor is entitled to a proportionate payment from the government to remedy the situation, because the prior years’ expenses were too low.
Here, Northrop did the actuarial math and calculated that the government owed it $75.7 million. Unsurprisingly, the government objected to both Northrop’s math and the resulting value. According to the government, when it did its own math and adjusted for Northrop’s inappropriate adjustments, it still owed the contractor some money—about $28.1 million—but nowhere in the neighborhood of $76 million. And that difference of $47.6 million became the amount of a claim and then a dispute, to be decided by the ASBCA.
Say what you want about the Cost Accounting Standards, but they certainly can generate some large-dollar controversies.
The funny thing—as noted by Judge Prouty—the Contracting Officer (or CFAO, as this function is called in the world of CAS) rejected Northrop’s claim in full, even though she agreed the government owed $28.1 million. Why? Because she said “she did not have the authority to pay this money.” That’s quite a puzzling statement and Judge Prouty noted “In our memory, we have never encountered a CO denying, in full, a claim that she determined to be partially owed to a contractor on the grounds of lack of authority. It is potentially problematic, to say the least ….” Of course, she had the authority and a failure to compensate Northrop for the amount she agreed was owed to the company teetered on being arbitrary, capricious, and/or an abuse of discretion. What does a Certificate of Appointment mean? Who’s training these government folks?
So there were pages and pages of discussion about mortality tables and the appropriate use of interest expense deductions when calculating the final settling-up amount. One issue was that CAS 412-50(a)(5) explicitly states that tax liability may not be used to recalculate rates of return even as it allows taxes as an expense. However, Judge Prouty noted that the pension settlement calculation was being made pursuant to the requirements of CAS 413—and CAS 413 did not contain an equivalent prohibition. Judge Prouty found that Northrop’s treatment of income tax payments on the OSERP assets was not compliant with CAS 412, but that it did not constitute a material noncompliance because “consideration of taxes as an expense was permissible and leads to the same result.”
Readers may recall that CAS does not deal with immaterial costs. You cannot be in non-compliance with CAS if the calculated value of the non-compliance is immaterial. As Judge Prouty correctly summed-up: “… we conclude that considering taxes in estimating the OSERP’s actuarial accrued liability was not CAS-compliant, but that the result here, of calculating them as a discount to the interest rate applied to the plan’s investments, was not material and generated an identical result, which we need not revisit.”
Having discussed and disposed of all government arguments against Northrop’s calculations, Judge Prouty declared—
The appeal is sustained in whole. We understand that the government has already begun compensating NG for some of the funds that the CO acknowledged were due and owing to it. This appeal is remanded to the parties to calculate the amount currently due and owing from the government to NG.
CAS 412 and 413, both complex Standards that have generated a more-than-fair-share number of disputes with respect to defined benefit pension plans. If you are not subject to Full CAS coverage or do not have a defined benefit pension plan, be thankful.
The CASB Preambles
I’ve been doing CAS for many, many years. First, I was a student, trying to figure out what the Standards and the Regulations meant, then I was a consultant (working for somebody who was on the original CAS Board), and later I became an instructor. Now I’m the Editor of the LexisNexis reference book addressing CAS compliance.
The point is, I think I know something or two about the Federal Cost Accounting Standards.
When I teach CAS, I attempt to make clear that just reading the Standards is not sufficient. To get a good understanding of what a Standard means and how it is to be applied, you need to study three things:
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The Standard itself (there are 19 of them)
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The CAS Board Preambles associated with that Standard, which explain why the Standards and related Rules and Regulations were written, and provide a rationale for positions taken relative to issues raised in the public comments
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Any judicial opinions regarding disputes on how a contractor interpreted and/or applied the Standard
Until you’ve studied those three things, you don’t really know what any particular Standard means. Note I said “studied,” not skimmed, or scanned, or reviewed. If you are serious about gaining an understanding, you need to look carefully at each sentence. You may need to highlight and underline and draw arrows connecting concepts. You may need to diagram the sentence to ensure you really understand it.
You need to do the same thing with the Preambles and the judicial interpretations. You can’t just run through them in five minutes. You need to take your time and think about what you’re reading. If you’re not doing that, you’re not studying; you are simply reading. And that won’t get you where you need to go.
Now, many business people don’t have the time, or the inclination, to do all that. That’s where consultants come into play. (Hello!) Consultants have—at least in theory—spent the time studying so you don’t have to.
But assuming you want to put in the time and diligence, the FAR Councils just made it harder to do so.
On October 23, 2020, the FAR Councils published a final rule that ostensibly removed any references to a “FAR Appendix” (also known as “Appendix A to Part 30,” “Appendix B,” and “the Appendix). In addition, references to a FAR “loose-leaf” edition were also removed because “the FAR loose-leaf version is now published online at https://www.acquisition.gov. It is no longer published as a paper loose-leaf version.”
Well, that sounds innocuous, doesn’t it? No need for a loose-leaf FAR version when you can get it online. And why reference a “FAR Appendix” when people can “access 48 CFR chapter 99 easily online at the electronic Code of Federal Regulation (eCFR) website (https://www.ecfr.gov).”
Who could complain?
I could.
See one thing people may not know is that the FAR Appendix used to contain the CAS Board Preambles. You could look them up and study them, if you had a mind to. At one point, you could even order a hardcopy of the Preambles from the Government, if you had the inclination to send a letter to the Publications Office, Office of Administration, Executive Office of the President. But not any longer.
This final rule puts the final nail in the coffin by deleting any references to the Preambles from FAR Part 30.
Before the regulatory revision, FAR 30.101 stated—
(c) The Appendix to the FAR loose-leaf edition contains-
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Cost Accounting Standards and Cost Accounting Standards Board Rules and Regulations Recodified by the Cost Accounting Standards Board at 48 CFR Chapter 99; and
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The following preambles:
(i) Part I-Preambles to the Cost Accounting Standards Published by the Cost Accounting Standards Board.
(ii) Part II-Preambles to the Related Rules and Regulations Published by the Cost Accounting Standards Board.
(iii) Part III-Preambles Published under the FAR System.
(d) The preambles are not regulatory but are intended to explain why the Standards and related Rules and Regulations were written, and to provide rationale for positions taken relative to issues raised in the public comments. The preambles are printed in chronological order to provide an administrative history.
Those paragraphs were stricken by the final rule, and you won’t find them in the FAR again. Unless you already know about the Preambles, you won’t know they exist.
Over the years, the Preambles have become harder and harder to locate. Certainly, they do not exist in either the 48 CFR Chapter 99 found on www.acquisition.gov. Nor do they exist in the 48 CFR Chapter 99 found on the Electronic Code of Federal Regulations. You can’t get where you want to go from those sites.
What you will get is the same statement found in the CAS Board’s Regulations (at 48 CFR 9903.307). To wit—
Preambles to the Cost Accounting Standards published by the original Cost Accounting Standards Board, as well as those preambles published by the signatories to the Federal Acquisition Regulation respecting changes made under their regulatory authorities, are available by writing to the: Publications Office, Office of Administration, Executive Office of the President, 725 17th Street NW., room 2200, Washington, DC 20500, or by calling (202) 395-7332.
Go ahead and write them. I did. When I did, I was told that no copies were available. Maybe you’ll have better luck than I did.
As noted in the soon-to-be-deleted FAR paragraphs quoted above, the Preambles have three parts. Finding Part III used to be relatively easy, but finding Parts I and II was damn near impossible. Now, the Preambles—all three parts—will be assumed to just not exist.
Which is tragic in many respects. As I stated in the beginning, I don’t think you can really understand the Board’s intentions with respect to the CAS Rules, Regulations, and Standards unless you study the Preambles. Consequently, locating them so that you can study becomes rather critical.
Where can you find them?
Well, we noted that the CPA firm Cohn Reznick has kept a copy of Preambles Parts I and II, and made that copy available on its website.
If you want just Part III, you can find it on www.acquisition.gov, even though you can’t find it under the FAR Chapter 99 heading. (Link: HERE.)
You can also buy Lou Rosen’s 2013 book, Cost Accounting Standards Board Regulations, Standards and Rules. That has the Preambles in it; however, be advised that the Preambles are organized chronologically, and not grouped by the Standard (or Regulation) to which they pertain.
The situation, then, is problematic. At least, it’s problematic for students (or want-to-be students) of the Federal Cost Accounting Standards. The FAR Councils’ decision to delete any FAR reference to the Preambles just makes it that much harder for the next generation of contracting officers, auditors, and contractor compliance folks who have to interpret and administer them, without access to the CAS Board's thoughts.
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The Contractor Submission Portal
You can’t find the MRD on the DCAA website, but it’s making the rounds via industry associations, so we thought we’d talk about it. Give it a week or two, and then MRD 20-OTS-005 will be available to the general public.
What is MRD 20-OTS-005?
It’s called “Introduction of The Contractor Submission Portal,” and—as the name foretells—it discusses a new means for contractors to submit the annual proposals to establish final billing rates. (Which are popularly but incorrectly called “incurred cost submissions,” but that’s not the point of this article.)
The Contractor Submission Portal (“CSP”) is “a formal electronic method for contractors to submit their certified incurred cost submissions.” According to the MRD, “The goal of this portal is to provide a single place for contractors to submit their incurred cost proposal.”
Wait, what?
Historically, contractors already have had a single place to submit the final billing rate proposals. It was called email. You emailed the proposal to the cognizant Federal agency official (ACO, DACO, CACO, whatever) and you sent a copy to DCAA. We always sent it to the FAO Manager, but your mileage may vary. Anyway, it’s worked just fine for dozens of years; but now apparently we have a CSP to replace it.
Back to the MRD.
When a contractor submits its proposal into the CSP, an email will be generated from the CSP “to the cognizant FAO mailbox.”
So, basically, the CSP is simply a middleman. Instead of emailing your proposal to the FAO Manager, you submit to CSP and then CSP generates an email to the FAO Manager. That’s some brilliant process improvement and streamlining, right there.
Back to the MRD.
What the CSP is, according to the MRD, is a Sharepoint site that “is designed to allow access to all employees within the FAO.” What’s the value-added by the CSP Sharepoint site? “This allows any employee within the FAO to download a copy of the proposal submission from the SharePoint site to the contractor perm file and perform the adequacy review and subsequent audit of the submission.”
As opposed to forwarding it via email, we guess.
Another benefit (to DCAA) is that the CSP can generate status reports by contractor, showing which proposals are pending an adequacy determination and/or which proposals have been determined to be adequate and need to be audited. This is a cool feature, because (as you probably know) DCAA has two months after receipt to determine proposal adequacy and 10 more months after than to start and complete the proposal audit. We get that it would be important to be statusing contractor proposals, by contractor and by FAO, to make sure the statutory deadlines are being met.
Therefore, as near as we can tell, there is zero benefit to the contractor from the new CSP and next to zero benefit to the FAO auditors, but perhaps some moderate benefit to DCAA Headquarters from improved reporting.
Meh.
Contractors are not required to use the new CSP, as the MRD makes very clear. However, FAOs are required to engage with their contractors and “encourage” support of the new initiative. It would be weird if nobody used this fancy Sharepoint site, right? Kind of makes you wonder what Fort Belvoir would do when some of the data is coming out of the CSP Sharepoint site and the rest is being manually aggregated by each FAO.
And there it is. Once touted as a “TurboTax of Incurred Cost Submissions,” the CSP is revealed to be a ho-hum Sharepoint site with some basic reporting functions.
Use it if you wish.
But before you decide, there is one thing we will mention that you may want to consider—and it’s something we’ve mentioned here before. Courts have held that the Contract Disputes Act’s Statute of Limitations does not start to run until the government knew or should have known about the costs the contractor was claiming. Courts have held that the government should not be expected to know about potentially disputable indirect costs until they have access to details about those costs; commonly, that’s not until the audit actually starts. We think that one way to start the clock earlier is to submit the entire expense ledger along with the final billing rate proposal.
It’s not clear to us that the CSP will accept such a potentially massive document. If the CSP will not accept it and you want to get that clock started, then that would be a reason not to use it and stick with tried-and-true email. Of course, given the current deadlines, it’s fairly rare that DCAA will wait to get that audit started. But you never know….
Something to consider.
Is Severance Pay Subject to the FAR Compensation Ceiling?
The FAR cost principle at 31.206 establishes the allowability of various aspects of employee compensation. It’s the longest cost principle, running from 31.205-6(a) through 32.205-6(q), and covers such diverse items as income tax differential pay, bonuses and other incentive compensation, and backpay. Among the items addressed in the cost principle is severance pay.
Severance pay is defined at 31.205-6(g) as “a payment in addition to regular salaries and wages by contractors to workers whose employment is being involuntarily terminated.” (We’re guessing most of our readers already knew that part.) According to the cost principle, severance pay is allowable only to the extent that it is required by law, required by an employer-employee agreement, an established policy that constitutes (in effect) an implied agreement, or “circumstances of the particular employment.” Except for that last part—which seems rather vague—the cost principle is fairly straight-forward. If you meet one of the four tests, the severance pay is allowable.
The 31.205-6 compensation cost principle also establishes allowability limits for certain employees. If you check out 31.205-6(p), you’ll find a fairly complex set of rules that establishes, based on the agency and timing, maximum ceilings on the compensation of certain contractor “senior executives”—and then later “all employees” regardless of their title. The rules are so complex that DOD, DCAA, and contractors all agreed that a “blended rate” formula could be used to establish compensation allowability in the aggregate, rather than by individual employee. (For some discussion on blended rates, please see this article.)
Of particular note, 31.205-6(p) has a unique definition of compensation that applies only to that paragraph of the cost principle. According to 31.205-6(p)—
‘Compensation’ means the total amount of wages, salary, bonuses, deferred compensation (see paragraph (k) of this subsection), and employer contributions to defined contribution pension plans (see paragraphs (j)(4) and (q) of this subsection), for the fiscal year, whether paid, earned, or otherwise accruing, as recorded in the contractor's cost accounting records for the fiscal year.
Presumably, if an element of compensation is not included in the above list, then it may properly be excluded from calculating an individual’s compensation that is subject to the 31.206-6(p) ceilings. At least, that’s what we thought, until a recent opinion by Judge Clarke at the ASBCA called that presumption into question.
The situation was fairly simple. In 2014, and as required by the 2014 Separation Agreement, DynCorp International (DI) made a severance payment to its CEO on the way out. The severance payment was also made pursuant to the 2010 Employee Agreement between the CEO and the company. The severance payments were made over a three-year period, in 2014, 2015, and 2016. DCAA questioned the costs because the auditors believed the severance payments were not reasonable.
Interestingly, the DCAA audit report stated that the amount of the severance payments was not significantly more than other defense contractors of similar size had made, and that DI’s severance payments “were reasonable in comparison.” Nonetheless, the auditors questioned the severance payments because—and we’re going to quote the audit report note in full—
In our opinion, the annual compensation used in the calculation should be subject to the limit discussed in FAR 31.205-6, Compensation. FAR 31.205-6(p)(1)(i) defines compensation as, in part: “...the total amount of wages, salary, bonuses ....” Although the severance payments do not meet the definition of compensation, the salary and bonus components of the severance calculations do meet this definition. Therefore, in our opinion, the FAR 31.205-6(p) limitation on allowability of compensation is an appropriate benchmark to determine reasonableness of the salary and bonus components. Consequently, in our opinion, the salary and bonus portion of the severance payment calculation in excess of the limit in FAR 31.205-6(p)(1)(i) is unreasonable.
(Emphasis in original quote found in the ASBCA opinion.)
To determine the allowable amount of compensation, the auditors went back to the 2010 executive compensation limit and then applied that amount to the severance pay (doubling it as required by the terms of the agreement). Thus, $7,812,098 out of $8,050,000 was questioned as compensation in excess of the ceiling in effect at the time the CEO was hired.
DynCorp disagreed but the CACO agreed with the auditors and issued a Contracting Officer’s Final Decision in which he unilaterally establish DI’s final rates based, in part, on the questioned severance payments.
Judge Clarke started by agreeing with DI that severance pay is not compensation as defined by 31.205-6(g). But then he took issue with DI’s argument that DCAA had found the amount of compensation to have been reasonable. He wrote—
DI interprets this [the DCAA audit note we quoted above] to mean that the severance payment ‘amounts’ are reasonable. We do not agree. DCAA simply found that ‘severance terms of twice a CEO’s salary plus bonus to be reasonable.’ The word ‘terms’ cannot reasonably be interpreted to refer to the dollar amount of the severance paid to former CEO Gaffney. We interpret the language as DCAA finding the mechanism of calculating the severance pay reasonable.
As non-lawyers, this reasoning seems confusing. To us, if the mechanism of calculating the amount is reasonable and in alignment with what other contractors of similar size do, then the result of that mechanism must also be reasonable. But as we said, we’re not lawyers. So what do we know?
Even though Judge Clarke agreed that the severance payments were not subject to the exact ceilings found in 31.205-6(p), he decided that they were unreasonable in amount, because DynCorp had a responsibility to “the Government … and the public at large” under the definition of “reasonableness” found at 31.201-3(b)(3). He concluded as follows—
DI’s severance payments were calculated in part using salary and bonus amounts that exceeded the statutory caps. We find that the portion of the severance payments derived from unallowable salary and bonus amounts above the statutory caps are likewise unallowable. This conclusion is just common sense, there is nothing magic about a severance pay calculation that converts unallowable salary into allowable severance payments. … Bottom line: unallowable salary cost used in a severance pay calculation results in unallowable severance costs – unallowable in, unallowable out.
So, common sense apparently trumps the plain language of the cost principles.
Nice.
As non-lawyers who nonetheless have been dealing with FAR cost principles for several decades, we must express vehement disagreement with this opinion. How Judge Clarke persuaded two other Judges of the Board to agree with him is a mystery to us.
But as we said, we’re not lawyers. So what do we know?
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