He Said, She Said, and Other Relationship Problems
You know, because you are a regular reader, that we’ve had our finger on the pulse of the DOD/contractor relationship for quite some time. We’ve told our readers that the number of DOD suppliers has fallen by 14 percent even as the Obama Administration has tried to increase competition. We’ve told our readers that the DOD Leadership has stated publicly that it does not consider itself to be in a partnership with its suppliers—a 180 degree turn from the DOD’s expressed position in the mid-1990’s.
In this article, we reported that the Armed Services Committee of the U.S. House of Representatives made several recommendations to their fellow Legislators, with the goal of improving oversight and improve the oversight agencies’ “relationship with the industrial base.” In another article, we opined (with tongue only somewhat in cheek)—
If the DOD and its industrial base were in a marriage, we think it would be fair to say that we are long past the honeymoon phase. We think the current relationship might be fairly characterized as a ‘separation.’
The funny thing is, as DOD shops around for a new partner with whom to commit, calling it a renewed emphasis on competition, it is seemingly learning that it has built up quite a bit of baggage over the past decade or so—baggage, in the form of onerous rules and regulations, that make it hard to attract a new mate.
Maybe the Pentagon’s current relationship is not as bad as it thinks? Maybe DOD needs to recommit to its existing contractor/partners?
If only there was a therapist with the power to get the parties together in one room, for some heart-to-heart sharing….
So yes, as the relationship between the Pentagon and its contractors grows more adversarial by the day, we have been watching and reading the “He said, She said” back-and-forth fingerpointing with mixed feelings. After all, this is our primary industry here at Apogee Consulting, Inc. No defense dollars, no funding for consultants—no matter how much value they might add. And yet all the chaos does drive the need for some level-headed, dispassionate, knowledgeable mediators, who can assist the parties in negotiating win/win solutions. (This last plug brought to you by our sponsors, Apogee Consulting, Inc.)
But we are not the only ones watching the military-industrial base unravel at its seams.
For example, let’s look at this editorial by Daniel Green at The Lexington Institute, entitled, “Who is Really Responsible for the Deteriorating Relationship Between The Pentagon and Industry?” (Hat tip to Defense Industrial Daily for bringing the article to our attention.) In his piece, Mr. Green called the current relationship “something akin to a Cold War,” and asserted, "What began as an effort by the Obama Administration to rationalize DoD’s modernization program, rein in the costs of major weapons systems and reform the acquisition system so as to achieve better buying power for each defense dollar has morphed into something quite different, sometimes ugly and certainly not good for national security."
He described recent examples of the parties lashing-out at each other as follows—
So bad has the relationship become that neither side tries any longer to pretend that the breach doesn’t exist. … In a speech at last year’s Air Force Association’s annual conference, then-Air Force Chief of Staff, General Norton Schwartz described the deteriorating government-industry relationship thusly: ‘The gravity of this situation reminds me of the old allegory of the scorpion and the frog that meet on the bank of a stream.’ At this year’s AFA conference, Air Force Major General Christopher Bogdan, nominated to be the head of the F-35 Joint Strike Fighter Program Office, declared the relationship between his organization and Lockheed Martin, the company leading the effort to build the three-in-one airplane to be ‘the worst he has ever seen.’ Late last year, Major General Wendy M. Masiello, Air Force Deputy Assistant Secretary for Contracting, spoke to an industry group about a ‘culture of excess’ in which some companies were earning excessive profits and spending money on plush carpeting and leather sofas.
Mr. Green recites a litany of Pentagon misdeeds that, in his view, have contributed to the deteriorating relationship. The problematic Pentagon policies include—
… changes to acquisition laws, regulations and policies that, inter alia: 1) increased the role of the government-owned defense facilities in weapons systems maintenance; 2) asserted the Pentagon’s right to cost and pricing data for and the intellectual property associated with commercial items used in or modified for military systems; 3) demanded that private companies assume an unprecedented level of financial risk for major weapons systems development programs, and most recently; 4) directed acquisition officials to negotiate labor and overhead rates for future contracts based on the levels that existed in 2010. Finally, DoD has imposed on industry additional layers of oversight, new reporting requirements and legal constraints that slow the rate of progress and increase the costs of programs.
Mr. Green quoted one “senior defense industry executive” as saying—
‘We're encountering a slew of new regulations, rulings and procedures government-wide that were intended to save costs but are, in fact, increasing complexity, increasing reporting requirements, increasing costs for contractors and the department, and that appear, taken as a whole, to reflect a deliberate effort to shift risk to and reduce profits for contractors.’
So how is industry reacting to the alleged problems caused by the new Pentagon policies? Well, for one thing, we believe that a tsunami of litigation is in the works. We based that impression not on any inside information, but simply on what we’ve heard around the watercooler. We think the Top 10 defense contractors are girding their loins for some slingshot work, aimed at the giant Federal government—and we expect to have a lot to write about when the stones start flying.
As we have publicly predicted, we continue to believe that the Pentagon’s ill-conceived and poorly handled “Contractor Recovery Initiative” is going to be at the forefront of the litigation. And as we’ve explored in depth, the Contracts Disputes Act’s Statute of Limitations, coupled with the ginormous backlog of uncompleted audits at DCAA, is going to follow. Boeing’s EELV suit is the tip of the iceberg, we think.
We are not necessarily thinking too hard about the DFARS Business System administration regime at this point, because DCMA is (seemingly) taking care to make sure its Contracting Officer Decisions are supported with lots of facts. But that may change and, if it does, we expect contractors to dial-up their lawyers and get busy with court briefs.
Here’s the bottom-line, in our view. If you threaten a contractor with negative impacts to its current programs, you have leverage and it will likely try very hard to resolve the issue. If you threaten a contractor with nickel-and-dime cost disallowances, it will likely settle—because doing so is cheaper than litigating. But if you threaten a contractor with multi-million dollar cost disallowances related to ancient issues that have lain unresolved for years (or perhaps even decades)—issues that have nothing to do with its current operations—then it will likely lawyer-up and drag your government ass into court. Because you have left it no other alternative.
So, yes. The marriage between DOD and its contractors is, seemingly, headed for a divorce. And like every divorce we’ve ever heard about, at the end of the day, the only winners are going to be the lawyers.
Another Successful Plea Bargain
It’s been a minor theme throughout the nearly 600 blog articles on this site that we are, occasionally, puzzled by the workings of our justice system. Take, for instance, this recent press release issued by the U.S. Attorney’s Office in the Northern District of Texas. It announced that Assistant U.S. Attorney (AUSA) David Jarvis had successfully negotiated a plea agreement deal with John Torrance Gilmore III, Larry Thomas Ballard, John Carmon Freeman, and Miguel Angel Hughes. Gilmore and Ballard were former employees of Sheppard Air Force Base (SAFB), while Freeman and Hughes were contractors at SAFB.
Gilmore was employed as the Lead Civil Engineer in the SAFB Civil Engineering Squadron engineering department, where he “supervised several engineers, including Ballard.” Hughes owned Hughes and Guzman Construction Services and Hughes Building Services, while Freeman owned Freeman Construction.
According to the press release, the four conspired together, along with others, to do various perfidies and suchlike. The press release said—
The purpose of the conspiracy … was for Gilmore and Ballard to unlawfully provide sensitive source information to their friends, Freeman and Hughes, to provide Freeman and Hughes with a competitive advantage or financial benefit in connection with several government contracts. Over several years, Freeman and Hughes gave Gilmore and Ballard personal gifts and benefits in return for their preferential treatment in connection with several government contracts. In fact, sometime in the mid to late 1990's Freeman paid large sums of cash to Gilmore, and on at least one occasion, Freeman gave $10,000 in cash to Gilmore. Freeman’s plea documents indicated that Freeman paid Gilmore in appreciation for Gilmore approving and accepting Freeman’s work on government contracts. Hughes’ plea documents stated that during the period from 2004 through 2008, Hughes paid travel expenses and took Gilmore to several gun shows in order to curry favor with Gilmore. … [and] when Gilmore became aware of this criminal investigation, he told Freeman to lie about his cash payments to him. After initially lying about them to investigators, Freeman later admitted that he had paid cash bribes to Gilmore.
So this would seem to be another tawdry story of government employees who provided bid information to contractors in return for cash and gifts. It’s not the first such story, and undoubtedly it will not be the last.
How did AUSA Jarvis characterize the conspiracy? We quote—
The indictment alleges that the four defendants conspired together to impair and obstruct the government’s ability to have a competitive and unbiased selection of contractors — depriving the government of its right to exclusive use and control over sensitive source selection information, to include contractor bid information, government pricing and cost estimates and contractor proposal information. The indictment also alleges that the defendants conspired together to knowingly disclose and obtain sensitive source selection information related to several contracts’ specifications, including those for roof and pothole repairs and the liquid oxygen maintenance facility.
According to plea documents filed in the case, the defendants conspired together and with others during the period from at least the mid 1990's through 2009, to defraud the 82nd Contracting Squadron and the Department of the Air Force by depriving the United States of the lawful right to exclusive use and control over sensitive source selection information, such as contractor bid information, government pricing and cost estimates, and contractor proposal information, on several contracts. They also conspired together and with others to disclose or obtain sensitive source selection information on several contracts.
Wow. It sounds so … trivial … the way AUSA Jarvis describes it. Note the omission of the terms “bribery,” “Procurement Integrity Act,” “gratuity,” and other similar descriptions that might lead a casual reader to think that something illegal had actually taken place.
Gilmore and Ballard each pleaded guilty to “one count of conspiring to defraud the United States and conspiring to unlawfully disclose sensitive source information.” Freeman and Hughes each pleaded guilty to “one count of conspiring to defraud the United States and conspiring to unlawfully obtain sensitive source information.”
The press release stated that “each faces a maximum statutory sentence of five years in prison, a $250,000 fine and restitution.” Which is interesting, because had any of the four been found guilty of bribery, they might have been facing 15 years in prison, and a fine equal to three times the things of value that were given/received.
And this difference, we suspect, was the foundation of the successful plea bargain.
And now we have yet another example of the mysterious machinations of the modern U.S. justice system.
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Auditing by Checklist
Before we had a falling-out, I used to know this guy, Ben. Ben was a very smart guy—as he would be the first to tell you. Ben had a lot of talents and a lot of experience and a lot of knowledge … but he had this way about him that just pissed people off. (Yes, guys in the back. Indeed, I do realize I frequently hear that I have the exact same personality attributes, but this is a story about Ben. So shut up and sit back down.) Like me, Ben got hired into the world of Big 4 Accountancy after many years in industry. Like me, Ben tried to bring the benefit of his experience to the world of auditing, with—shall we say?—mixed results.
Ben’s big innovative idea was to review the work of the auditors he managed by use of a checklist. The checklist formed a cover sheet, an approval sheet, and evidence that the review had been performed. It was a pretty cool idea, actually.
So naturally everybody hated it.
I can’t articulate exactly why everybody hated it. Maybe they thought a checklist was too mechanical. Maybe they thought it was too easy to simply check a box and, as a result, reviewers would fudge their substantive reviews. Maybe they just didn’t like Ben (a distinct probability).
It might have been a reaction to the idea that the Firm’s audit approach could be improved. Certainly, if the Firm had wanted supervisors and managers to use checklists, it could have created them and mandated their use; and that was just not the case. Use of a checklist was not in the approved audit approach—so Ben’s innovation was a subtle implied criticism of the approved audit approach, which was used by thousands of auditors at thousands of clients every single day.
It might have been because Ben was not a Partner. The Firm had a pervasive respect for Partners. If anybody was going to improve the audit approach, it would be one or more Partners, likely supported by at least one field testing team. The change would be tested, reviewed and approved—and it would be done at the Partnership level. And it would be done in New York. A lone Audit Manager in Southern California simply wasn’t going to be the source of innovation.
For whatever reason or reasons, Ben’s management tool immediately ran into strenuous objections.
Ben replied that astronauts used checklists. Pilots used checklists. Use of checklists reduced the chance of omission and ensured that the reviews were thorough. If checklists were good enough for astronauts and pilots, they should be good enough for accountants and auditors. So he was going to keep using his checklist, even if doing so was not the official Firm policy.
Ben was deemed to be “not a good fit” and quickly transferred out of his audit supervisor role … and then it became my privilege to work with him. We both left the Firm a relatively short time thereafter.
Which brings me to DCAA.
DCAA seems to be moving towards an expanded use of checklists in its audit procedures. Some of us can gripe and moan and complain about “auditing by checking the box” but, as Ben asserted, a checklist can form a useful audit tool, providing assurance that important steps are not omitted through human error. So we need to get over it, already.
DCAA has a checklist for proposal adequacy, called “Criteria for Adequate Contract Pricing Proposals.” Other folks (including those at DCMA) became enamored of it and tried to get it made an official proposal requirement for defense contractors. We opined that was a bad idea. Despite our concerns, it looks like the proposed DFARS rule is moving forward; the DAR Editor is “currently reviewing” the final language (as of October 5, 2012).
DCAA also has a checklist to use in performing pre-award accounting system adequacy surveys, called “Preaward Survey of Prospective Contractor Accounting System Checklist.” It is a mystery to me as to why DCAA felt the need to have its own checklist for this exercise, given that the government already had a perfectly good Standard Form (SF) 1408—called “Preaward Survey of Prospective Contractor Accounting System.”
DCAA also has a checklist to use to evaluate the adequacy of a contractor’s proposal to establish final billing rates, called “Incurred Cost Adequacy Checklist.” We’ve discussed this checklist before, including right here. Why DCMA continues to permit DCAA to usurp the authority given to the Administrative Contracting Officer by the FAR, i.e., to determine whether or not a contractor’s submission is adequate, continues to baffle me. In any case, this is a very important checklist to understand because, for some contractors, it will form the basis for all review work that is performed by DCAA.
And now DCAA has added a new checklist—called “Adequacy Checklist for Forward Pricing Rate Proposals.” This new checklist addresses the format and content of the proposal to establish a Forward Pricing Rate Agreement (FPRA). We have discussed the process needed to establish FPRAs before, such as in this article.
DCAA’s notion is that an adequate FPRP will facilitate the audit and speed up the process. There are 29 adequacy criteria. We were interested to see that DCAA has put a backdoor into its checklist, stating—
The existence or adequacy of some of the supporting data can be determined only by discussing it with the contractor during the walk-through or during the course of a detailed audit. Therefore, it is possible that an initial finding of adequacy may be changed once the audit has started.
[Emphasis in original.]
From our point of view, the problem with all these checklists is that they are based on certain assumptions that would seem to be questionable. Does every contractor generate its FPRP based on a bottoms-up estimate of every direct and indirect cost element, including secondary pool allocations? Does every contractor need to submit every Incurred Cost Electronically schedule, even those that are clearly not applicable? We don’t think so.
And so the question is, will the DCAA auditors and Quality Assistants and Internal Reference Reviewers feel comfortable in tailoring the checklists to adapt to the individual circumstances of the contractors they are auditing? Or will they simply mark “INADEQUATE” on any submission that doesn’t meet the standards established by the checklist?
If you experience one or the other, why don’t you send me an email?
WARNing Sign Part 2
At the request of our old friend, “Cajun CPA,” we put together some thoughts on the ongoing WARN Act controversy. In Part 1, we brought readers up to speed on the Dept. of Labor opinion that contractors should not issue WARN Act notices to their employees simply based on the speculative notion that sequestration might occur and, if it did occur, that the contractor would be affected by sequestration immediately and, if the contractor was affected immediately, that it immediately would need to lay off employees and, if it did immediately need to lay off employees, then it would know (in early November) which ones it would need to lay off in early January. We also reported on the OMB Memo which offered some comfort to those contractors who were still worried about potential liability under the WARN Act, promising them that they would be covered in the event of legal entanglement.
And then we pointed out how thin that promise of coverage might really be.
Regardless of our opinion, the Dept. of Labor opinion plus the OMB liability coverage promise seemed to successfully signal to contractors that they really didn’t need to issue WARN Act notices to their employees just before the Presidential election.
Which (predictably) upset those politicians who thought it would be beneficial to their election chances to have as voters those people who had just received layoff notices from their employers. Those most upset by the lack of WARN Act notices were Republicans.
Go figure.
For example, the House of Representatives’ Education and the Workforce Committee (John Kline, R-Minnesota, Chair) sent a letter to OMB Acting Director Zients that offered concerns about both the Dept. of Labor opinion and OMB’s promise to contractors. The Committee was “greatly concerned” about the situation and “respectfully” requested lots and lots of information, documents, and internal communication to help understand how OMB reached such problematic conclusions.
Senators Chuck Grassley (R-Iowa) and Ayotte (R-New Hampshire) were also concerned, writing—
We are concerned about the authority of the executive branch to instruct private employers not to comply with federal law and to promise to pay the monetary judgments and litigation costs that arise out of the lawsuits that may follow … The administration’s new guidance tells employers to willfully ignore the law and stay silent about looming layoffs until after the election — and promises them a taxpayer-funded bailout for their legal expenses if they do so … The administration must explain its legal basis for this interpretation of the Warn Act that leaves taxpayers on the hook, American workers in the dark, and our national security in jeopardy.
Not being able to do much to the President or his employees, several members of Congress decided to “grill” contractor executives instead. Congressman Darrell Issa (R-California) seemed to be at the forefront of the inquisition, according to what we read, telling companies that “The guidance seems intended to invite federal contractors to flout the law, and in doing so places a large contingent financial liability on the shoulders of American taxpayers in order to indemnify those contractors who follow the administration’s direction.” As Chair of the House’s Committee on Oversight and Government Reform, Issa signed a letter to OMB that was very similar to the one signed by Kline.
One key difference between the Kline and Issa letters was that Issa’s Committee requested that—
… the Defense Contract Audit Agency—the agency charged with administering cost accounting standards and guidelines—intervene to examine OMB’s guidelines to ascertain whether those costs incurred by contractors who have been found to violate layoff law should be deemed to be ‘allowable costs’ for purposes of the Cost Accounting Standards.
Now that’s comedy gold, right there.
Readers, how many errors can you find in that single sentence? We found three right off the bat. But the true humor is to be found in the irony of asking DCAA to audit OMB on its compliance with Cost Accounting Standards … when OMB is the organizational home of the Cost Accounting Standards Board—the only entity authorized by law to issue Standards and interpretations thereof.
Readers, we just cannot make this stuff up.
So where are we on this?
First, we don’t think sequestration will be as devastating as many—including us!—have previously predicted. We’ve done some math and it looks like the defense budgets may take a $70 - $80 Billion hit. Yes, that’s a huge immediate reduction, but it’s not unsurvivable, either. It will mean program stretch-outs and some terminations, but it’s not like every defense worker in the United States is going to be laid-off. And the reality is that many were going to be retiring in the next couple of years, in any case. We don’t mean to trivialize this issue by any means, but we’re starting to believe that it will be ultimately manageable, if painful in the short term.
We think the real impact is going to be felt on the government side. It is likely that as many as 200,000 Executive Branch employees could be furloughed or laid-off in some sequestration scenarios—though President Obama has promised to protect military service personnel from cuts. If programs are going to be terminated, who’s going to be left to administrate the termination or to process the Termination Settlement Proposals? Who’s going to be left to audit contractors’ claimed costs? Who’s going to be exercising oversight on the remaining contract obligations?
We are mindful of this article at Federal Times, which reported that Federal employee retirements are surging just as the hiring of new employees “plummets”—and that’s the situation before sequestration is implemented. The article reported—
The long-delayed retirement wave is here. For years, experts have predicted large numbers of baby boomers would retire and take years of experience and institutional knowledge with them. … Retirements for all of 2011 were up 24 percent over 2010 levels, according to OPM statistics. And in the first nine months of 2012, OPM recorded another nearly 8 percent increase. Meanwhile, new hires in the first quarter of 2012 plunged 32 percent over the same period in 2010.
Now, there are many who consider the foregoing bit of news to be happy tidings. They argue that the Federal government is already too large and it’s past time to downsize it. But if we’ve learned anything over the past couple of decades, it’s that workforce cuts need to be handled with a scalpel and not with a meat-axe. If you cut heads to the point where services can no longer be provided, then you’ve gone too far. Government contractors are very much reliant on their government contracting officers and quality assurance inspectors. If the Government can’t inspect, then it can’t accept. And if it can’t accept, you can’t get paid. If there is no Contracting Officer to obligate funds in MOCAS (or whatever system they’re using these days), then DFAS isn’t going to issue any payments. And if there are no DFAS payment clerks, there will be nobody to process contractor invoices and issue payments. So you may have a contractor with authorized funding, even after sequestration—but you still may not get paid.
How do you like those Federal cutbacks now?
Contractor executives and politicians are (perhaps rightly) concerned with the effects of sequestration on contractor workforces. But perhaps we all ought to be thinking about trying to be a government contractor when there’s not enough Federal employees to keep up the Government’s side of the contracting bargain.
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