Apogee Consulting Inc

PBPs? Stick a Fork in 'Em: They're Done

Nick Sanders

Stick_a_Fork
It was nearly three years ago when the Hon. Shay Assad left his role as the Director of Defense Procurement and Acquisition Policy (DPAP) to assume a new job as Director, Defense Pricing. As we told our readers at the time, "Mr. Assad's lateral move to his new position-a position apparently created for him-portends something new in the Pentagon's approach to establishing contract prices." In that article, we speculated wildly about where that move might lead to in terms of DCMA's relationship with DCAA.

Three years later, we're confident in telling you that we nailed it. As the new DPAP Director (Mr. Richard Ginman) recently noted in official correspondence that Mr. Assad's mission was to be "responsible for overseeing the complete renovation of DoD's pricing capability." In other words, we hit the mark when we speculated that the new DOD Pricing Center of Excellence was a key move to upgrade the Pentagon's ability to evaluate and negotiate contractor prices without reliance on a DCAA audit report.

Self-congratulatory pats on the back aside, most reasonable observers would agree that Mr. Assad's effort to renovate DOD's cost monitoring and price analysis capabilities was sorely needed. We are thinking about the November, 2011, GAO report that asserted DCMA had been mismanaged for more than a decade and, as a result, the agency "had experienced an atrophying of some key skill sets." One of the specific functions identified by GAO was DCMA's cost/price analysis function, the degradation of which increased cost risk on DOD programs. GAO said "Loss of this skill set … meant that many of [DCMA's] pricing-related contract administration responsibilities, such as negotiating forward pricing rate agreements and establishing final indirect cost rates and billing rates, were no longer performed to the same level of discipline and consistency as in prior years."

Accordingly, Mr. Assad is on a mission to address the shortfall in DOD's ability to perform cost and price analysis, and we think that mission should be supported by both government civil servant and government contractor.

But we have not always agreed with Mr. Assad's approach to that mission. When he spearheaded the initiative to make contractor's health care costs associated with ineligible dependents expressly unallowable, we believed (and still believe) that was a distraction from what Pentagon leaders told the public he was supposed to be doing. Frankly, it appeared to have been more of a personal crusade than anything else.

And when Mr. Assad spearheaded the initiative to make Performance-Based Payments (PBPs) harder and more costly to contractors to obtain, we disagreed that his initiative was commensurate to the risk he had publicly identified. Indeed, we opined (rather stridently) that the policy change he drove, where the Pentagon's acquisition force stopped treating PBPs as if they were the "preferred" form of contract financing (which they were, and still are, according to the FAR) and, instead, returned to a preference for cost-based "customary" progress payments, was going to lead to future fiascos such as had been experienced in the A-12 "train wreck".

Despite our opinion of the matter, in point of fact the Defense Department has just issued a final DFARS rule that ends PBPs as we know them. We here at Apogee Consulting, Inc., were approached by the press for a comment/quote regarding the final rule, no doubt because our previous blog articles on the topic have been so strident and quote-worthy. We declined the request, because we hadn't yet had a chance to read through the final rule and digest the responses to public comment. Now we have and we want to share our thoughts with the readership of this blog.

The official reason for issuing the rule is "to provide detailed guidance and instructions on the use of the performance-based payments analysis tool." That's not, in fact, the reason for issuing the rule. If that were the reason for issuing the rule then the DOD already had its Procedures, Guidance, and Instruction (PGI) companion to the DFARS to make that happen. If that were the reason for the rule, the Pentagon would not need a DFARS Case or the need to solicit public input. So right off the bat, we are presented with a rationale that simply does not make sense.

Instead, we assert the final rule redefines PBPs into a new contract financing tool not originally contemplated by Congress when it passed the Federal Acquisition Streamlining Act of 1994 (FASA) and created PBPs. Now it is neither fish nor fowl: It is neither cost-based progress payment nor is it the performance-based payment contemplated by FAR subpart 32.10. We don't know what it is, but we do know some of the attributes of the new contract financing tool.

First, use of the new "PBP" requires that a contractor has an adequate accounting system in the eyes of the awarding Contracting Officer. A new DFARS rule at 232.1003-70 states "The contracting officer will consider the adequacy of an offeror's or contractor's accounting system prior to agreeing to use performance-based payments." The adequacy of a contractor's accounting system is defined at DFARS 252.242-7006. While it is possible that a Contracting Officer might use other, less rigorous, criteria with respect to firm, fixed-price contracts that use PBPs, it's rather doubtful.

This is a dramatic shift from historical PBPs, where the adequacy of a contractor's accounting system was irrelevant, since PBP event values were never linked to incurred costs. Back in the late 1990's, the reason for decoupling cost accounting information from PBP events was to encourage non-traditional defense contractors to submit proposals to DOD, and to eliminate "non value-added" oversight such as lengthy and expensive audits.

The reason for the shift is that now contractors that use PBPs will have to report the cumulative incurred costs on the contracts for which they are submitting PBPs. The DOD has to be sure that contractors have the capability to report that information accurately before they consent to provide PBP contract financing. The reason contractors will now have to report cumulative incurred costs is that a new PBP contract clause will prohibit payment of accomplished PBP events, if by doing so the cumulative amount of contract financing provided would exceed cumulative incurred costs. Even if a contract makes technical progress ahead of plan, it cannot submit PBP requests for that progress; it must delay submission until it spends more money.

Of course, now that contractors will be reporting incurred costs, it only makes sense that the auditors have the ability to verify that the incurred costs were reported accurately. Accordingly, "the final rule includes the requirement for the contractor to provide access, upon request of the contracting officer, to the contractor's books and records, as necessary, for the administration of the clause."

In addition, the new rule will tells Contracting Officers contemplating usage to go visit a special website in order to learn about the new PBPs, and to download a DOD Tool to be used to determine how much consideration a contractor must provide to the government in order to use PBPs instead of cost-based progress payments. Much public input was received regarding the DOD Cash Flow tool, especially regarding the interest rate assumptions it used. In response to some comments, the rule-makers responded as follows-

The cost of raising money is not the same for industry and the Government and therefore the time-value of money is not the same for each. The model will be revised as follows: The discount rate for contractor cash flows will be reflective of the short term borrowing rate as represented by the published Prime Rate adjusted for the corporate income tax rate of 35%. At the current Prime Rate of 3.25%, the discount rate for contractor cash flows would be 2.11% [3.25% × (1 −.35)].

Other commenters pointed out that rules associated with the new PBPs conflicted with the DOD's "Users' Guide to Performance-Based Payments." That comment was disposed of quickly, by announcing publication of a new Users' Guide that covered all the new guidance and procedures. However, despite the new Users' Guide, at least one commenter expressed concern that the Cash Flow Tool, in particular was counter-intuitive and would lead to potential errors in calculation of consideration. Another commenter asked why all the new guidance and procedures was expected to address long-standing concerns about the ability to DOD Contracting Officers to effectively administrate PBPs. The rule-makers replied to those concerns by stating "The cash flow model will be used by trained contracting officers who will be able to walk the contractor through the process …."

To other commenters who stated that the new PBP guidance conflicts with the regulatory preference for use of PBPs, the rule-makers stated "This rule does not change the FAR stated preference for PBPs when Government financing is determined to be appropriate." In our view, that statement was true only because what the Pentagon now calls Performance-Based Payments is no longer the same PBPs as was contemplated by the FAR. The new PBPs are now a bastardized hybrid, a Frankenstein's Monster cobbled together from pieces of cost-based progress payments and milestone billings.

Whatever you want to call it, we don't think it should be called Performance-Based Payments. The PBP events are no longer solely tied to program execution, to technical milestones that are "Yes/No" achievements that lay outside the province of cost accountants and auditors. Now contractors wishing to use PBP financing will need much the same accounting system as those who use cost-based progress payments. Now the PBP requests will be subject to auditor scrutiny, much the same as would be the case for cost-based progress payments.

Much of the rationale for the "win/win" associated with the use of PBPs has gone by the wayside. We don't expect many contractors will be eager to enter into the burdensome business of PBPs when there are now so many disincentives for their use. Instead, we expect most if not all contractors will go back to the tried-and-true contract financing method of cost-based progress payments.

You know, the kind of financing that doesn't care about technical progress, and reimburses contractors for how much they spend and not what they actually accomplish for the money.

So stick a fork in the old PBPs. They lasted from 1996 until 2014. It was a good run, but now it's over.

And when DCAA shows up to audit your accounting system for adequacy, or when the auditors show up to audit your cost-based progress payments, then raise a glass in memory of the quaint notion that contractors and their government customers had more to worry about than contract financing payments on firm, fixed-priced contracts.

Delinquent Final Billing Rate Proposals

Nick Sanders

Whether you call them “Incurred Cost Submissions” or “Incurred Cost Proposals” or “Proposals to Establish Final Billing Rates” they have become the eye of a hurricane around which many dangerous winds swirl, winds that have the potential to damage a government contractor’s competitive position as well as its financial health. You might say that the Final Billing Rate Proposals have risen to Level 4 or 5 on the Saffir-Simpson Scale of hurricane winds. That is to say, catastrophic damage will occur unless you prepare for the storm.

Hurricanes don’t care about the cost, in terms of either things or people. Like nature herself, the storm winds are indifferent as to who gets harmed. To wrap up the extended metaphor, the same storm winds that blow the contractor around can also damage government customers. We’ve discussed some of the damage suffered by the government on this blog. For instance, DCAA has suffered (at least reputationally) because it cannot seem to whittle down its astounding backlog of unaudited contractor submissions; and the audit agency has had to admit to Congress that it now takes far too long to audit a single submission—such that it seems the only way to reduce the backlog of contractor submissions awaiting audit is to resort to bureaucratic reporting tricks.

The sad fact of the matter is, as DCAA itself has admitted, the audit agency dug its hole intentionally. According to the latest DCAA Annual Report to Congress (link above), the agency made a conscious policy decision to “defer” audits of contractor Final Billing Rate Proposals because “incurred cost audits were one of the few areas that could be deferred.”

Unfortunately, DCAA does not appear to have thought its cunning plan all the way through.

The problem with DCAA’s brilliant strategy, as most of us have come to learn, is the Contract Disputes Act (DCA) and its pesky Statute of Limitations (SoL). We’ve blogged rather extensively about the CDA SoL on this site, because it has emerged as perhaps the single most important issue in government contracting today. And because we’ve written so much about the topic we’re not going to belabor it again in this article. (You can just type “CDA” into the site’s keyword search feature and get a surfeit of articles if you need to catch up.) Suffice to say that, while the rules are still evolving, it’s fairly clear at this point that the government has six years from the time a contractor submits its Final Billing Rate Proposal to assert any findings with respect to alleged unallowable costs that were included in the rate calculations in violation of FAR requirements. If the government doesn’t issue a Contracting Officer Final Decision (COFD) within six years, it’s (generally) going to be out of luck.

Consequently, DCAA’s inability to get audits of contractor Final Billing Rate Proposals out to DCMA Contracting Officers for action has left the Defense Contract Management Agency with a not-so-small mess on its hands. Not only are contractor billing rates not getting finalized (which potentially lets millions if not billions worth of unallowable costs slip through the government customers’ fingers and into contractors’ coffers), but without final billing rates physically complete contracts cannot be closed. Physically complete contracts that cannot be closed simply languish in an administrative purgatory. Funds expire. Paperwork is lost. Property vanishes. Nobody remembers who had administrative cognizance over what. The large number of unclosed contracts has affected the Defense Department’s ability to get a clean opinion on audits of its financial statements.

In late 2012, the Under Secretary of Defense (Acquisition, Technology and Logistics) publicly commented that “the contract audit administration -- agency has a long backlog of both closeout audits at the end of contracts, which our industry doesn’t get paid fully until they close out the contract ….” Thus, it’s fairly clear (behind the word salad quoted in the previous sentence) that even DOD’s top leadership echelon is feeling the pain of the lack of contractor final billing rates. Since then, the government stakeholders have been focusing on getting those rates finalized, even if it means doing so without the benefit of a full GAGAS-compliant DCAA audit.

Recently, DCAA issued new audit guidance that seems designed to streamline the process for establishing final contractor billing rates. Given the foregoing, that would seem to be a good thing, a “win/win” for all parties. But as with so much of the agency’s guidance, it signals more trouble for contractors and we suspect it portends yet another increase in litigation between the Pentagon and its contractors.

The audit guidance addresses “delinquent” final billing rate proposals. It tells auditors what to do in the case where a contractor has failed to submit its annual proposal when required (generally, six months after the close of the fiscal year). It tells the auditors not to bother with sending a bunch of follow-up letters to a contractor, and to work directly with the cognizant Contracting Officer to obtain delinquent proposals. Seems kind of harmless, right? Most contractors know to submit their proposals on time and most contractors get a letter from the government reminding them about their obligation to do so if, somehow, the requirement slipped their minds. Not a big deal.

But the first question we need to ask is, why does DCAA care? It already has a pile of some 25,000 or so proposals that are not delinquent and which await audit. Why would the agency focus on what it doesn’t have, when what it does have has become such an overwhelming problem for it? What’s really going on here?

Well, what’s really going on here is that it seems that DCAA is now classifying “inadequate” proposals along with non-existent proposals in its definition of “delinquent” proposals. So it appears to be the case that a contractor can have a “delinquent” final billing rate proposal even though the proposal was submitted on time. If we are correctly interpreting the guidance, then that means the contractor’s submission also has to meet DCAA’s definition of adequacy in addition to being timely. And that, gentle readers, is a big deal indeed.

The FAR does not give DCAA the power to determine whether or not a contractor’s final billing rate proposal is adequate. That authority is reserved for the cognizant Contracting Officer. See FAR 42.705-1(b)(1), which states—

The required content of the proposal and supporting data will vary depending on such factors as business type, size, and accounting system capabilities. The contractor, contracting officer, and auditor must work together to make the proposal, audit, and negotiation process as efficient as possible. … If the auditor and contractor are unable to resolve the proposal’s inadequacies identified by the auditor, the auditor will elevate the issue to the contracting office to resolve the inadequacies.

As has become the new norm for DCAA, the audit guidance blithely ignores the FAR and simply assumes DCAA auditors, and nobody else, can determine whether or not a contractor’s final billing rate proposal is adequate. That position is flat-out wrong and even though that’s just our opinion, we predict that someday soon a judge is going to make our opinion an official point of law in a judicial decision that goes against the government. In the meantime DCAA continues to think its proposal adequacy checklist defines the adequacy of a contractor’s proposal. And the new audit guidance tells auditors what to do about such inadequate/delinquent proposals.

It isn’t pretty.

DCAA plans to give DCMA a list of all contractor proposals related to Fiscal Year 2011 (or earlier), and we are told that “DCMA plans to either obtain an adequate proposal (e.g., within 30 days), or unilaterally establish contract costs as authorized by FAR 42.703-2(c)(1) and FAR 42.705(c)(1).” As we interpret the guidance, it’s telling contractors that they have 30 days to conform to DCAA’s notion of proposal adequacy or else DCMA will “unilaterally” determine contract costs for them.

It is critical to note that the audit guidance clearly says that the Contracting Officer will unilaterally establish “contract costs” and not just final billing rates. That means that both direct costs and indirect cost rates—i.e., claimed incurred total costs as submitted in the proposal—will be subject to unilateral determination.

With respect to newer final billing rate proposals generated for FYs 2012 and later, the audit guidance tells auditors that DCAA will issue a list to DCMA annually that identifies proposals which are “more than six months overdue without a valid extension or considered inadequate for audit.” At that point, DCAA will close its audit assignment in DMIS and will no longer track the proposals in its backlog of overdue audits.

Well, that’s yet another way to reduce the backlog, right? Anything over six months in arrears will simply not be counted as backlog. It’s no longer the audit agency’s problem; now it’s DCMA’s problem. That ought to improve the audit backlog statistics reported annually to Congress!

The audit guidance provides details regarding how unilateral contract costs are to be determined. It states—

Whether to apply a unilateral cost decrement, and how much to apply, are judgments at the discretion of the contracting officer. Upon request, audit teams should provide support to assist the contracting officer with applying a unilateral contract cost decrement. … Audit teams should provide the contracting officer with all information that is relevant to the contractor’s delinquent CFY, including billing deficiencies and incurred cost audit experience, etc. Upon request, audit teams may offer for the ACO’s consideration a calculated unilateral contract cost decrement based on relevant historical questioned costs.

But in those circumstances where “relevant history does not exist,” then “as a last resort” DCMA may simply reduce proposed contract costs by 16.2%, which is a factor “based on Agency-wide analysis.”

We have a couple of problems with the foregoing.

First, it’s not at all clear that the government has the authority to unilaterally establish contractor costs. The FAR language cited by DCAA is meant for circumstances where a contractor refuses to certify that its rates are free of unallowable costs or when a contractor fails to submit a final voucher within 120 days after finalization of indirect cost rates. The FAR language simply does not apply to the situation where DCAA decides there are problems with the format of the contractor’s proposal and, as a result, refuses to audit it. The FAR language does not authorize the government to take the actions outlined in the audit guidance.

Second, it’s not at all convincing that both direct and indirect costs need to be reduced by the same decrement factor, given that direct and indirect costs tend to generate unallowable costs at vastly different rates. Any reasonable person who thinks that unallowable costs are uniformly distributed between direct and indirect cost objectives simply hasn’t read any recent DCAA audit reports. Or any older ones either. Arbitrarily reducing direct costs—costs incurred for which the government inarguably received benefit—will generate a windfall for the government at the expense of the contractor. We suspect this is going to be a problem for the government, especially when quantum meruit arguments are made in court.

Third: about that unilateral decrement factor. For the past 12 years DCAA has used a 20% decrement factor and only now is a new, lower, factor being recommended to DCMA. What’s changed? Are we to understand that DCAA has knowingly used an inflated decrement factor for more than a decade? Has the government obtained a windfall from use of that inflated decrement factor? If the 20% factor was overstated for 12 years and DCAA was silent about the overstatement, then how much confidence should Contracting Officers (and taxpayers) (and judges) have in the new, 16.2% unilateral decrement factor?

And to make matters worse, the audit guidance notes that the unilateral decrement factor will be updated annually. So today’s 16.2% factor may be tomorrow’s 15.0% factor, and so on. That’s confidence-inspiring, we’re sure.

The audit guidance reminds auditors that “whether to apply a unilateral cost decrement, and how much to apply, are judgments at the discretion of the contracting officer.” That part is absolutely true. But DCAA’s offer to provide those Contracting Officers with “relevant history” such as “billing deficiencies and incurred cost audit experience, etc.” raises issues with how credible such history will be. As we’ve noted before, DCAA’s “questioned cost” metrics are more than a little suspect. We quoted one source that indicated more than half of DCAA’s questioned costs fail to be sustained by a warranted Contracting Officer. We hope those Contracting Officers keep that little info-nugget in mind as they exercise their judgment and discretion.

Based on the audit guidance, it looks like DCAA is going to punt the workload over to DCMA (and the Contracting Officers of other agencies of the Executive Branch) and simply act as advisors. The Contracting Officers will get the dirty end of the stick, as they try to figure out how to deal with DCAA “recommendations” without litigation, while the CDA SoL clock continues to tick-tick-tick away.

Based on the audit guidance, this is not going to go well for contractors whose Final Billing Rate Proposals have been deemed to be inadequate by DCAA. We predict litigation will ensue.

The good news (for contractors) is that it is very likely that any unilateral action by a Contracting Officer is going to be made via COFD, which offers appeal rights under the CDA. We trust we’ve outlined in this article why such contractor appeals are likely to be meritorious and why the government’s position is not likely to prevail when an appeal is made.

This was a fairly easy article to write, because we’ve written it before.

Twelve years ago, when DCAA issued its original audit guidance regarding unilateral decrement factors, we didn’t think much of it. It inspired us to write our very first article for publication (in the BNA Federal Contracts Report, if it matters at this late date). Twelve years have passed since DCAA first assayed the position that unilateral decrement factors were authorized by the FAR. Not much has changed in those intervening years, except the ice under DCAA’s position has grown even more thin and untenable.

Whistle-Blower Protections

Nick Sanders

It should not need to be said that you do not retaliate against whistle-blowers.

You do not retaliate against whistle-blowers.

You do not take any action against an employee who calls the company hotline, or who calls the Inspector General, or who files a qui tam suit under the False Claims Act against your company.

You just don't.

And now the DOD has made it official, adopting as a final rule DFARS Case 2013-D010 on February 28, 2014. The final rule adopted, with minor changes, the interim rule adopted at the direction of the 2013 National Defense Authorization Act (Public Law 112-239). The final rule modified DFARS 203.903 to state the following policy of the Department of Defense-

(1) Prohibition. 10 U.S.C. 2409 prohibits contractors and subcontractors from discharging, demoting, or otherwise discriminating against an employee as a reprisal for disclosing, to any of the entities listed at paragraph (2) of this section, information that the employee reasonably believes is evidence of gross mismanagement of a DoD contract, a gross waste of DoD funds, an abuse of authority relating to a DoD contract, a violation of law, rule, or regulation related to a DoD contract (including the competition for or negotiation of a contract), or a substantial and specific danger to public health or safety. Such reprisal is prohibited even if it is undertaken at the request of an executive branch official, unless the request takes the form of a non-discretionary directive and is within the authority of the executive branch official making the request.

(2) Classified information. As provided in section 827(h) of the National Defense Authorization Act for Fiscal Year 2013, nothing in this subpart provides any rights to disclose classified information not otherwise provided by law.

So now it's official.

But that's not all. Did you know that if you are a DOD contractor, you must educate your employees regarding their whistle-blower rights? Did you know you must provide them with their rights-in writing? Did you know that requirement is a "mandatory flow-down" to all your subcontractors?

Yeah, you might want to check out DFARS contract clause 252.203-7002 ("Requirement to Inform Employees of Whistleblower Rights," Sept. 2013). That clause states-

(a) The Contractor shall inform its employees in writing, in the predominant native language of the workforce, of contractor employee whistleblower rights and protections under 10 U.S.C. 2409, as described in subpart 203.9 of the Defense Federal Acquisition Regulation Supplement.

(b) The Contractor shall include the substance of this clause, including this paragraph (b), in all subcontracts.

So now you know.

Contract Financing Failure

Nick Sanders

The_Silent_Auditor
The mission of the Department of Defense Office of the Inspector General (DOD IG) is "to provide independent, relevant, and timely oversight of the Department of Defense that supports the warfighter, promotes accountability, integrity and efficiency, advises the secretary of defense and Congress, and informs the public." Audit reports and testimony issued from the DOD IG generally fall in line with its mission. However, every once in a while we scratch our head(s) in puzzlement and wonder what in the name of accountability the DOD IG was thinking.

This is one of those times.

Recently the DOD IG issued an audit report criticizing financial management of the Army's Ground Combat Vehicle (GCV) program. We think it missed the mark and failed to promote accountability, integrity and efficiency. We think it failed to advise the Secretary of Defense and Congress regarding significant issues. We think it failed to inform the public regarding significant procurement policy shortfalls.

As you may be able to ascertain, we don't think very highly of that particular DOD IG audit report.

First, let's remind readers that we have expressed concerns with the management of the GCV program before. We've gone on record as expressing skepticism that any contractor could meet the Army's expressed requirements in the timeframe it wanted them met, for the budget it said it had to spend. Despite our concerns, in August, 2011, the Army awarded two early GCV technology development contracts. BAE Systems Land & Armaments division received $450 Million and General Dynamics Land Systems received $440 Million. The contracts called for each contractor to deliver a design for consideration by August, 2013. A prototype development contract was expected to follow. The GCV prototype was to be delivered by 2014.

In January, 2013, the technology development contract performance period was extended by six months. The Army decided it would award an Engineering & Manufacturing Development (EMD) contract to only one of the two competing contractor teams, though it is not clear if the downselect decision would be made solely on the design or whether the two teams would each produce a prototype to give the Army something tangible to evaluate.

Now, nearly three years after initial contract award, the program is essentially dead. The Secretary of Defense publicly announced termination of the program in February, 2014; but the truth is that the program continues today, though it has been "downgraded to a study project."

What happened? The Defense News reported-

BAE Systems and General Dynamics have been given hundreds of millions of dollars by the Army since 2011 to develop technologies for the GCV program, even though the Congressional Budget Office has argued against building the platform due to its ballooning weight, armor and projected sustainment requirements. In an April report, the agency estimated that the Army would have to spend $29 billion between 2014 and 2030 to purchase 1,748 GCVs.

Obviously, sequestration and other budget constraints were going to negatively impact the Army's ability to fork over a couple of billion dollars per fiscal year. (Actually, it would be more than that if you make a reasonable estimate of probable cost growth.) Plus, if you do the math you get a fairly high cost per vehicle (something in the neighborhood of $16.6 million per). That's seems rather pricey when you consider that the world's most effective anti-armor missile (the Javelin) can be had for a $125,000 command and control unit plus $40,000 per missile. All other factors being ignored, putting $16 Million at risk from a $165K missile would not seem to be on the right side of the economic equation.

Thus, the GCV program was essentially doomed before it got started.

With the foregoing as background we can put the DOD IG audit report in its proper context. In the proper context, the audit report becomes a stellar example of the maxim that an auditor is one who enters the battlefield after the battle has already been fought and proceeds to efficiently bayonet the wounded.

The DOD IG showed up at end of the program's life to audit the Army's financial management of the program. If the IG's input was really going to affect the program's financial management of the program, wouldn't we (as taxpayers) have wanted the IG auditors to show up at the program's inception? At this point, the audit report is essentially moot and simply criticizes those who are probably searching for new jobs at this point in time.

But the timing of the report is not our real concern. It's not like government audit reports spit out from an assembly line in a week or two. The timing of this report is nothing more than a cavil. No. Our real concerns (and criticisms) of this particular IG audit report lie elsewhere.

Let's start here. Readers should be clear that when the DOD IG says it audited the Army's financial management of the program, it did not, in fact, audit the Army's financial management of the program. The DOD IG did not audit whether the Army's program requirements were reasonably achievable, or whether the required technology was sufficiently mature, or whether the program schedule was achievable for the appropriated budgets. Nope. The DOD IG didn't look at any of those attributes, though we believe most people would agree with us that those aspects might reasonably be considered to be important signposts of the financial health (or lack thereof) of a Major Defense Acquisition Program.

When the DOD IG says it audited the Army's financial management of the GCV program, what it means is that it audited the administration of progress payments by DOD officials, so as to determine whether those officials "authorized and administered progress payments in accordance with selected Federal Acquisition Regulation (FAR) [requirements] and [the requirements of] DOD policies."

Yep, that's it. That was the entire audit objective.

You've got a billion taxpayer dollars being spent, and your entire audit focus is on whether or not the program's progress payments were being "appropriately authorized and administered"? Seriously?

No, this was not a joke. The DOD IG was completely serious.

In fairness, we have to report that the DOD IG audit objective actually grew during performance (much like we suspect the GCV program requirements grew during design and development). As the DOD IG audit report stated-

Our initial announced objective was to determine whether DoD officials authorized and administered progress payments in DoD contracts in accordance with selected Federal Acquisition Regulation (FAR) and DoD policies. During the course of the audit, we found significant issues related to the authorization of contract financing for the Ground Combat Vehicle (GCV) development contracts. As a result, we modified the audit objective to determine whether DoD officials complied with selected FAR and Defense Federal Acquisition Regulation Supplement Subpart (DFARS) clauses for progress payments awarded for the GCV Technology Development Phase.

So the DOD IG added compliance with DFARS clauses to the audit scope, based on findings during audit procedures.

Now readers can see the vastness and pertinence of the DOD IG audit scope. It not only encompassed compliance with FAR requirements and DOD policy requirements, but it also included compliance with DFARS requirements as well! (Note: You must read the foregoing sentence in a biting, sarcastic, tone of voice.)

Seriously. That was the scope of the DOD IG audit.

Now before we get into the "meat" of the audit report, we should remind readers that administration of contracting financing payments is not the DOD's strong suit. Those pesky Performance Based Payments (PBPs) always seem to trip up Contracting Officers. As we told our readers during the last go-round (in April, 2013)-

DOD has been using PBPs for contractor financing since 2000. DOD IG has been criticizing DOD's administration of PBPs for just about that same length of time. While some of the details have changed, in a larger sense none of the 2013 criticisms are new; they are essentially the same criticisms asserted in 2001 and 2003. Pentagon policy-makers continue to largely concur with the IG's audit findings, and continue to commit to enhanced/revised policy guidance and enhanced/revised detailed user's guidance, and to enhanced/revised training for DCMA personnel involved in the administration of PBPs. Not too much has changed over the past decade.

So let us offer this prediction.

Sometime in the next decade, the DOD IG will conduct an 'audit' of DOD's administration of PBPs on its fixed-priced contracts. That audit will find many failures. It will recommend enhanced policy guidance. It will recommend more detailed direction. It will recommend enhanced training. And the Pentagon policy-makers will concur, and agree to implement the recommendations.

And that cycle will continue. Forever.

Well, it took less than a year for the DOD IG to issue another report finding fault with DOD's administration of contract financing payments on fixed-priced contracts. You may be as unsurprised as we were to see that additional internal guidance and additional training were found among the IG's recommended corrective actions. You may be as unsurprised as we were to see that DOD policy makers concurred with the findings and agreed to implement the recommended corrective actions.

But if that was all to tell you, we wouldn't have bothered.

What makes this audit report more interesting than the usual run-of-the-mill criticisms of those who do by those who do not, was (1) the IG was auditing the use of "customary" progress payments based on contractor costs incurred, and (2) the IG found that US Army Procurement Contracting Officers (PCOs) were inappropriately mixed "customary" and "unusual" contract financing methods on the GCV contracts.

That's kind of new.

By way of background, contract financing payments are permitted in certain circumstances and are intended to assist contractors with cash flow needs when their contract delivery dates are far in the future. Customary progress payments mean that a contractor can submit payment requests equal to a percentage of costs it incurs-generally, large contractors can receive reimbursement equal to 80 percent of their costs. On the other hand, PBPs are not tied to incurred costs; instead, they are tied to significant program events that measure technical progress. If a contract uses PBPs, the contractor can (in theory) receive financing of up to 90 percent of contract price (assuming program milestones are achieved).

So which is better?

Well, to those who remember the A-12 fiasco, PBPs are significantly better than cost-based progress payments. The A-12 nightmare taught us that progress payments do not pay contractors for making progress; instead, they pay contractors for spending (taxpayer) money. A contractor can be dead in the water (in terms of program execution) and still get 80% or so of the cost it incurs on the program. In contrast, a contractor needs to complete its program event milestones in order to be able to submit PBP requests. So if you want to tie payments to execution, you go with PBPs every single time.

But if you are a government bureaucrat you don't really care for PBPs. Use of PBPs does not require an "approved" accounting system. PBPs are not subject to the kind of GAGAS-compliant audit that certain government auditors like to perform. Use of PBPs is not well understood by the government contracting officers who have to administer them. Proper use of PBPs requires an investment of time and effort by those who have little of either, in return for downstream cost savings by other functions. PBP event milestones are "yes/no" questions that can only be answered by technical folks, which leaves certain government auditors with idle time on their hands. Plus, it's undeniable that contractors have used the government's wide-spread ignorance of PBPs to their advantage by "gaming" event milestone values so as to accelerate their cash flow.

Consequently (and despite the official FAR policy that PBPs are the "preferred" contract financing method), the DOD announced in 2011 that it was going to go back to the tried-and-true customary contract financing method of cost-based progress payments. As we reported at the time, the Honorable Shay Assad, who was at that time Director of Defense Procurement and Acquisition Policy (DPAP) wrote a memo that reinstituted the old policy, based primarily on the assertion that contractors had accelerated their cash flow by use of PBPs without providing the Pentagon with adequate consideration for having done so. (We have to admit he was probably correct in his assertion, even though we thought (and still think) he was engaging in a bit of overreaction.)

We wrote at the time-

So nice job, Mr. Assad. You managed to reverse one of the more important innovations of Clinton-era acquisition reform. You've opened the door for contractors to increase their offer prices at a time when the DOD (and indeed the entire Federal government) is focused on lowering those very prices. And you've managed to recreate the environment that led to one of the worst DOD weapon system 'train wrecks' in history.

(Reading that quote two years later, we suspect we were engaging in a fair bit of overreaction ourselves.)

Which brings us back to the GCV program and the DOD IG audit of its use of cost-based "customary" progress payments.

According to the IG audit report, the two contractors quickly found that submitting progress payment requests based on 80 percent of costs incurred (as adjusted in accordance with the progress payments contract clause) led to a negative cash-flow situation. Which is exactly what one should expect, right? If you are only getting reimbursed for about 80 percent of the costs you're incurring, that obviously means you have a negative cash flow of at least 20 cents on the dollar. Nobody should have been surprised about that situation, especially the two GCV contractors. That didn't stop the contractors from complaining to the PCO, however. The IG noted with approval that the assigned PCOs rejected the contractors' requests to modify their contract financing arrangements so as to augment their cash flows.

But just a few months later, one PCO executed a bilateral modification to one of the contractors (GDLS)

… that authorized the current customary progress payments be supplemented with additional financing payments for the successful completion of the Systems Functional Review, the Preliminary Design Review, and the end of the period of performance. The Systems Functional Review and Preliminary Design Review were included in the original GDLS contract under the Contract Data Requirements List, which was a 'not separately priced' contract line item. The modification stated that its purpose was to establish 'a change to the current contract financing arrangement' and also included a payment plan for event completion to incorporate the terms and conditions of the additional financing payments.

Thus, by mixing use of cost-based progress payments with use of PBPs on the same contract, the PCO was in violation of FAR requirements. Just as importantly (as the IG pointed out), the modification was "not in line with … the April 5, 2012, memorandum [from the PCO] that stated [those particular] performance events did not represent value or benefit to the Government." Finally, the IG noted that the PCO failed to obtain "adequate consideration" from the implementation of PBPs, as directed by the 2011 Shay Assad Memo we discussed above.

The DOD IG audit report devotes some verbiage to the discussion of the PCO's failure to document why GDLS needed the contract financing and how consideration should have been calculated. We were interested to note that the IG stated that DPAP guidance required the PCO to calculate consideration "at no less than a 2 percent interest rate," and criticized the PCO for using the current Treasury Rate instead. The PCO's argument that "the Government received additional work concurrent with the change in financing, and the additional work approximated the value of the consideration that he calculated," was received with some skepticism by the IG auditors.

A similar situation was reported with respect to the BAE contract. The second GCV program PCO followed the GDLS PCO in issuing contract modifications that enabled use of PBPs while concurrently continuing use of cost-based progress payments.

Had the "proper" interest rate been used by the two PCOs, then (according to the IG) the government would have received $1.3 million in consideration from the two contractors.

The DOD IG audit report described the ignorance of the DOD personnel involved in the foregoing decisions in some detail. Let's quote a bit-

The PCOs either did not understand the proper use and approval of contract financing, or disregarded key FAR contract financing guidance. Specifically, both PCOs stated they did not consider the additional financing payments to be unusual contract financing payments. Instead, all internal ACC-Warren documents called the extra events PBPs and the modifications referred to the revisions as additional financing, the PCOs stated that they never intended the events to be additional financing. The PCOs stated the events were actually contract deliverables with a discrete price. The PCOs believed they only erred by using the financing and PBP wording choices. Therefore, the PCOs stated they did not obtain the approval for unusual financing required by FAR 32.114 and DFARS PGI 232.501-2 because they did not believe they were providing unusual financing. They could not explain why they used the financing and PBP wording originally, and then later determined it was in error. However, based on the evidence the ACC-Warren PCOs provided, including comparison of the original contract terms to the modification, the modifications on the two contracts most closely exhibited payments for specific performance events, as opposed to distinct deliverables; and therefore, the payments represented PBPs.

The DOD IG audit report contained several recommendations for fixing the various problems it noted. However, the current Director of DPAP pointed the finger for implementing some of those recommendations at Mr. Assad (currently Director of DOD Pricing), because it is Mr. Assad (and not Mr. Ginman) who "is responsible for overseeing the complete renovation of DoD's pricing capability." In other words, the office of Defense Procurement and Acquisition Policy declines to take responsibility for at least some aspects of defense procurement and acquisition policy.

We are reminded of that bit in the classic movie, "Office Space," where the two external efficiency consultants ask that one poor employee "so what would you say you do here?" That being said, we have no doubts whatsoever that the assignments and workload are clearly delineated between Mr. Ginman's and Mr. Assad's organizations.

But if the DOD IG audit report in question is simply a bit more of the same-albeit with a twist involving cost-based progress payments instead of the traditional PBP target-then why did we devote so much typing time to this particular article? Why do we criticize the DOD OIG so harshly for taking time and attention to a mooted matter than really did little more than point to widespread training problems within the DOD acquisition team?

Well, here's the thing.

We think the DOD IG audit report was so focused on slapping these two PCOs (and their management) on the wrists for helping the contractor that they missed the root cause of the problem. What's the root cause?

Fixed-priced development contracting.

Four-and-a-half years ago, we warned our readers about the perils of fixed-priced development contracting. We had lots to say, including quoting from FAR Part 35 regarding the official regulatory preference for cost-reimbursement development contracting.

In that same article we discussed the four elements that one policy wonk asserted would need to be aligned in order for fixed-priced development contracting to work. Those four elements were:

Stable, detailed, and technically sophisticated customer requirements definition
Clear understanding of those requirements by the contractor(s)
Savvy and skilled contract negotiating by the Government
A willingness to adjust requirements to meet the fixed price, if necessary

We wonder how the GCV technology program addressed those four elements. We wonder whether the decision to give the two contractors additional cash flow was driven by a tacit acknowledgement that the contracting parties never should have been involved in fixed-priced development contracting in the first place.

We wonder, but we'll never know the answers. We'll never know the answers to those questions because the DOD IG chose to focus on minutiae instead of things that would actually lead to better outcomes for future DOD programs. The DOD OIG missed its opportunity to create an audit report that tackled fundamental issues, and to make value-added recommendations. Instead the DOD OIG settled for more of the same: more contract financing violations, more recommendations about policy guidance and training. And so the DOD leadership that decided a fixed-priced was the right way to go for the GCV development program was let off the hook, and no doubt they were happy to agree to the same type of recommendations the DOD OIG has been making for more than a decade (without a noticeable improvement in results).

And speaking of DOD leadership, it seems funny how the same bureaucrats who ignored FAR Part 32's official regulatory preference for the use of PBPs instead of cost-based progress payments are seemingly the same ones who also ignored FAR Part 35's official regulatory preference for cost-reimbursement development contracting. Are they in fact the same individuals? We don't know because, once again, the DOD IG auditors chose to ignore (or at least not pursue) that particular issue.

Choosing to focus on the administration of contract financing payments instead of whether the parties should have been in a fixed-priced development contract was clearly the easier path, the one with fewer political pitfalls for all involved. But by making the choice it made, we believe the IG auditors missed a significant opportunity to promote accountability, integrity, and efficiency. We believe the IG auditors missed a significant opportunity to inform the Secretary of Defense and Congress, and to inform the public about the perils of fixed-priced development contracting.

Not the DOD OIG's best choice, in our view.

DOD Embraces the "IT Box" Concept to Speed IT-Related Acquisitions

Nick Sanders

We recently wrote an article exploring whether technology has been evolving too quickly for the Department of Defense to keep up. We wrote, "DOD's inability to innovate and match the private industry product development cycle is leaving the logistics, repair and maintenance functions with a big headache, as they struggle to source technologically obsolete parts called for by their 'frozen' designs."

If the problem of parts obsolescence is a "headache" for acquisition of major weapon systems, how much worse must the problem be for acquisition of Information Technology programs?

It's a problem we all feel. By the time we've got our hands on the latest and greatest smart phone or tablet (or phablet), it's already passé. We spend top dollar for the best and the coolest technology, but our friends always seem to have tech that's newer or better-and always cooler. How much worse must it be for the Pentagon, whose acquisition system is notoriously slow, and where workflow flows like molasses at the North Pole?

When you combine DOD acquisition processes with the acquisition of information technology, how can the result be anything other than completely ridiculous?

Recognizing the problem, Assistant Secretary of Defense for Acquisition (the Hon. Katrina McFarland) told Senators at a hearing of the Senate's Armed Services Committee (Subcommittee for Readiness and Management Support) that the DOD "is working to speed up the route to acquiring new [Information Technology] systems by increasing collaboration and improving processes."

ASD(A) McFarland testified that the Pentagon is making several improvements in the way it acquires IT-related systems, in order to speed things up and avoid acquiring obsolete technology. Among them-

Adoption of interim guidance to adopt "modular, open system methodology" with an emphasis on "design for change".

Creation of the Cyber Investment Management Board, to unite "IT policy and operational requirements by identifying gaps in resources and in capabilities."

Development of a cybersecurity guidebook for Pentagon program managers "to assist them in understanding what cybersecurity activities are necessary at each point in the acquisition life cycle."

Using the Defense Acquisition Workforce Development Fund to support "training of IT acquisitions personnel through the Defense Acquisition University."

In addition to the foregoing, the DOD is also adopting the "IT box" concept, which was described as "a significant change" to the IT acquisition process. According to Ms. McFarland's testimony, "The IT box gives organizations the ability to acquire technology that improves on already-approved technology, as long as the changes don't exceed certain parameters." In other words, instead of "freezing" a design based on specified technology, the "IT box" concept allows end-users to upgrade the initial requirements to adopt advances that took place after the requirements were definitized-so long as those upgrades fall within "certain parameters" that were not specified.

It is to be hoped that DOD's adoption of the foregoing improvements will indeed improve acquisition of information technology and IT systems. However, we have our doubts.

In 2010, the National Defense Authorization Act (Section 804) required DOD to "develop and implement a new acquisition process for information technology systems." Further, Section 804 directed the Secretary of Defense to base that "new acquisition process" on "the recommendations in chapter 6 of the March 2009 report of the Defense Science Board Task Force on Department of Defense Policies and Procedures for the Acquisition of Information Technology." Section 804 listed several attributes the new acquisition process was to embrace, including (but not limited to) incorporating "a modular, open-systems approach."

The 2010 NDAA was signed into law on October 28, 2009.

In other words, the Pentagon has had more than four years to take action, action that was directed by Congress and approved by the Commander-in-Chief (when he signed the bill into law). DOD has had more than four years to improve its acquisition of information technology and IT-related systems. It has taken DOD more than four years to develop the acquisition process innovations described earlier in this article.

More than four years.

In contrast, it took the Toyota Motor Company only two years to develop, produce, and start to sell its Prius automobile. Toyota was able to go from a blank sheet of paper to selling production vehicles in less than half the time it took Pentagon acquisition officials to implement recommendations from the Defense Science Board, recommendations that they had statutory authority to implement.

Why did it take the Pentagon so long? Good question. But perhaps a better question is why did the Pentagon need Congress to tell them to go do it?

Remember, the Defense Science Board (DSB) came up with the basic recommendations even before Congress got involved. The DSB recognized the problem, studied it, and made recommendations. Those recommendations didn't go to Congress-they went to the Secretary of Defense.

One is left with the impression that the Pentagon does not think much of DSB recommendations, since it does not seem to want to implement them unless directed to do so by Congress. And even then, it takes half a decade to get around to doing so. What's up with that?

The Defense Science Board has been advising Secretaries of Defense since 1956. Maybe it's time to do away with it, since the people being advised don't think very highly of its recommendations.

Actually, that's probably not the right answer to the problem of bureaucratic inertia. We suggest a better answer might be to hold Pentagon officials accountable for dispositioning recommendations received by the DSB. Make the bureaucrats publicly declare what they think of those recommendations. If they decline to implement a DSB recommendation, make them publicly declare what's wrong with it. If they like a recommendation, then make them publicly commit to an implementation date-and hold them accountable for meeting that commitment date.

Meanwhile, the Pentagon policy-makers will continue to inch along their infinite loop of incremental acquisition process improvements, funded by taxpayers and overseen by gullible members of Congress.

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PBPs? Stick a Fork in 'Em: They're Done

Delinquent Final Billing Rate Proposals

Whistle-Blower Protections

Contract Financing Failure

DOD Embraces the "IT Box" Concept to Speed IT-Related Acquisitions

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