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GFY 2011 Was a Great Year for DCAA, According to DCAA

Nick Sanders

Two documents were brought to our attention by one of our ever-attentive minions. Both of these documents appeared on the DCAA website very recently, with no public announcement or fanfare. The thing of it is: there really should have been some fanfare—because the audit agency deserves some serious applause for its efforts at spinning its problems into self-congratulatory praise.

The first document is entitled 2011 Year in Review. (Readers need to keep in mind that the Government Fiscal Year runs from October 1 through September 30 so, for DCAA, its Fiscal Year 2011 ended September 30, 2011. That’s the period being discussed.) It’s fairly innocuous but still worthy of somebody pointing out the spin.

And that somebody is us!

We grant that this document is likely produced for DCAA’s workforce and, as such, is designed to accentuate the positive and improve morale. But even granting that worthy objective, in a couple of statements the spinning is more obvious than usual—to the point of being misleading.

Everything you need to know about the spin, you can find on the cover of the document, with the following summary of DCAA activity in GFY 2011—

In 2011, DCAA examined over $125B in defense contractor costs and issued over 7,000 audit reports. These reports recommended $11.9B in cost reductions. Overall, DCAA’s efforts resulted in $3.5B in net savings to the Government. Based on these net savings, the return on taxpayers’ investment in DCAA was approximately $5.80 for each dollar invested. This $5.80 return represents actual savings that DoD can reinvest in other ways to help the warfighter.

What DCAA didn’t say was that issuance of 7,390 audit reports in FY 2011 represented a decrease of 37 percent from the number of audit reports issued in FY 2010. And DCAA didn’t say that the FY 2010 volume represented a decrease of 45 percent from the number of audit reports issued in FY 2009.

Issuance of 7,390 reports during GFY 2011 means that less than two audit reports were issued by each of DCAA’s 4,225 auditors over the course of a year.

We don’t want to seem overly harsh. But really? That’s pathetic.

But there’s more spin to be discussed.

As we’ve reported before, DCAA has a history of inflating its reported cost savings to the taxpayer, apparently so as to seem like a good investment when Congress discusses budgetary appropriations. So we view the figure of $11.9 Billion in “recommended cost reductions” with a great deal of skepticism. For instance, when DCAA reported that $9.6 of the $11.9 Billion was related to audits of “forward pricing,” then we expect that most of that reported amount related to proposals that were never awarded—saving taxpayers nothing.

Most of the document is a litany of anecdotes and case studies, much like one would find in a public company’s annual report. There’s absolutely nothing wrong with publishing this kind of stuff if it helps auditor morale. Before we move on to the other document (which is perhaps the more interesting of the two) we want to note (and quote) Director Fitzgerald’s plans for the agency in FY 2012—

Attaining a balance between quality and schedule: As we continue to address the quality of DCAA audits, we cannot forget that timeliness is an important part of a quality audit. Attaining this balance will include continuing to revamp our audit process to build in quality early on and to increase communications with acquisition and industry stakeholders throughout the entire process. Additionally, DCAA will use the new Agreed-To-Date performance measure to track the Agency’s progress in meeting its audit commitments and attaining the balance between quality and schedule.

Harnessing the Agency’s Strategic Plan to focus on audit quality and workforce issues: DCAA has established 16 strategic plan ad hoc groups to focus on improving audit quality and address workforce issues. During 2012, the Agency will institute many of the recommendations of the ad hoc groups. This will include changes to how new employees are brought on-board, mentored and trained, development of new audit guidance related to business system reviews at major contractors, and development of a revised Agency-wide telework policy.

Assessing the Agency’s formal training program at the Defense Contract Audit Institute: During 2012 DCAA will arrange for an independent review and evaluation of it training operations. This will be first big step in developing a state of the art training concept and methodology for the entire audit workforce.

Enhancing audit quality in preparation for a Government peer review: As the Agency prepares for an external peer review, 2012 will be a critical year for DCAA. Everyone in the Agency will need to display a sense of dedication and urgency in continuing to improve our audit quality to ensure we successfully pass our peer review

We think those are excellent goals and we are in favor of anything that increases audit quality and timeliness of audit reports. So we hope that DCAA moves toward attaining those goals in the next five months (which is all that is left of GFY 2012).

The second document is the first annual DCAA Report to Congress, dated March 30, 2012. We told our readers that it was coming.

As we told our readers, the 2012 National Defense Authorization Act (NDAA) required (for the first time) that DCAA submit its own report to Congress, rather than simply including its audit metrics within the DOD Inspector General’s Semi-Annual Report. The Report was addressed to “Congressional Defense Committees,” so our readers should keep in mind that, unlike the previous report, this Report was written for external readers; indeed, it was written for the elected Representatives (and their staffs) who make policy and determine budgets.

Nonetheless, we think the spin is reminiscent of the internal employee morale-booster we discussed above. For example, the letter of transmittal to Congress stated—

FY 2011 was a very successful year for DCAA. We examined over $128 billion in defense contractor costs and issued over 7,000 audit reports. These reports recommended $11.9 billion in cost reductions. Overall, our efforts assisted contracting officials achieve $3.5 billion in documented savings to the Government. Based on these savings, the return on taxpayers’ investment in DCAA was approximately $5.80 for each dollar invested. This $5.80 return represents actual savings that DoD can reinvest in other ways to help the warfighter.

Our success in FY 2011 was a result of our commitment to the workforce and audit process. The main focus of our Agency-wide efforts was twofold: improving the quality of our audits, and supporting and enhancing our workforce. …

Yeah, no. While whether audit quality improved measurably might be a matter of some debate, there should be no debate whatsoever that GFY 2011 was not a successful year for DCAA. (See our comments above regarding DCAA’s definition of “successful”.)

But we’re just getting started ….

On Page 3 of the Report the statement was made that, “A key indicator of DCAA’s effectiveness is the increasing ratio of DCAA questioned cost to dollars examined as depicted in Figure 1.” Figure 1 showed that the percentage of questioned costs to dollars examined reached an amazing figure of 9.25 percent in 2011—literally more than four times the 2001 percentage of 2.2 percent. DCAA auditors are questioning nearly one dollar out of every ten dollars proposed and/or incurred by contractors. And that is supposed to be a good thing.

The problem with that logic is that DCAA auditors can question costs for any number of legitimate and illegitimate reasons, including costs that are deemed to be unsupported because documentation is allegedly lacking. Every DCAA auditor knows that the only way to avoid being “gigged by CIGIE” is to not have a clean audit report. Questioned costs are a good thing in the new audit environment because it means the auditor did a thorough job; whereas a clean audit report subjects the auditor to criticism for failing to do a rigorous audit “in accordance with GAGAS.” Consequently (as our readers know all too well), DCAA’s current audit approach to assuring quality calls for auditors to dig and dig and keep requesting documentation until something is found to be lacking—at which point the costs are questioned and the auditors breathe a sigh of relief. (So much for auditor independence….)

Thus we are completely unsurprised that DCAA leadership believes that the percentage of questioned costs to dollars examined is “a key indicator of DCAA’s effectiveness.” Given the audit environment they have created, how could they not think so?

We think a more important indicator would be percentage of questioned costs that are actually sustained by a Contracting Officer. Or we would think so, if we thought a DCMA Contracting Officer had the courage to stand up and (as the FAR requires of them) use independent business judgment to make a Final Decision regarding DCAA’s audit findings. Unfortunately for everybody, that is not the current business environment in which defense contractors operate. Contracting Officers live in fear and they know that if they don’t sustain DCAA’s findings—regardless of the merit of those findings—then they will be visiting at least one Review Board.

On Page 5 of the Report, DCAA tells Congress that it issued 349 incurred cost reports during GFY 2011. There is no comparison of that figure with prior years’ output. But we all know that the backlog of uncompleted (and, indeed, unstarted) incurred cost audits is growing and growing. Indeed, DCAA reported that—

At the end of FY 2011, DCAA had about 15,000 adequate annual contractor incurred cost submissions on hand with a total value of about $254 billion. Additionally, DCAA was either awaiting receipt of, or had not made an adequacy determination for approximately 9,000 incurred cost submissions with a total value of about $320 billion.

Pardon us if we assert, based on the foregoing, that 349 completed incurred cost audits in one year means that we will all be long dead before DCAA gets around to auditing FY 2012 or 2013 costs. To make things worse, DCAA reported that, under its current audit procedures, it now takes about three times as long to perform an incurred cost audit as it used to take. On Page 7 of the Report, DCAA tells readers that it now takes an average of 965 days to perform an incurred cost audit.

Yes, you read that correctly. DCAA is now taking an average of three years to audit one year of a contractor’s incurred costs. We very much hope that the alarm bells are ringing somewhere inside the Beltway.

We also noted that DCAA reported it takes 120 days (4 months) to complete and issue an “forward pricing” audit report—i.e., an audit of a contractor’s cost proposal or Forward Pricing Rates to be used for cost proposals. Four months. That’s (also) pathetic.

Predictably, DCAA blamed its lack of productivity on “resource constraints”—ignoring poorly thought-out audit procedures, multiple levels of management review, and mismanagement of the existing audit resources as contributing factors. Also predictably, DCAA blamed the contractors for its failings—as it has done since 2009. DCAA told Congress—

Inadequate contractor proposals are a significant barrier that DCAA faces in performing a timely and quality Forward Pricing audit. … FAR Part 15, Contracting by Negotiation, provides general instructions and guidelines for contractors to submit proposals. Prior to beginning a forward pricing audit, DCAA reviews the contractor’s proposal for compliance with FAR Part 15.408 Table 15-2. If the proposal is not prepared in accordance with Table 15-2, it is returned to the contracting officer so that the contractor can correct the deficiencies. However, the contracting officer often requests DCAA to audit inadequate proposals due to acquisition timeline requirements–further contributing to extended audit cycle times and less efficient use of audit resources.

Yeah, that’s bullshit.

As our readers know (because we’ve told you), the requirements of FAR Table 15-2 only apply when the contractor is submitting certified cost or pricing data and needs to comply with the Truth-in-Negotiation Act. For all the many other proposals being submitted, those requirements are simply Not Applicable. But current DCAA audit guidance tells its auditors to use the Table 15-2 requirements as the basis for determining adequacy of all proposals. DCAA auditors are making up deficiencies and are returning perfectly cromulent cost proposals because they don’t understand the difference between a TINA-compliant proposal and one that doesn’t need to comply with TINA. The audit guidance (and, apparently, the auditor training) is leading auditors down a path of poor performance. And somehow that’s the contractors’ fault.

But that’s not all. DCAA also told Congress that it needs enhanced statutory authority for access to contractors’ records in order to do a better job. (What’s better than “successful”? But we digress…)

On Page 10 and 11 of the Report, DCAA stated—

DCAA is required to perform audits in accordance with GAGAS. To perform GAGAS-compliant audits, DCAA must obtain sufficient evidence to provide a reasonable basis for the conclusions expressed in its audit reports. To address limitations of DCAA’s access to contractor records under existing law, DCAA believes it needs statutory authority to access: other than cost and pricing data, management reviews and internal audits related to Government contracts, contract costs, and the contractor’s internal control documentation related to compliance with applicable Government regulations.

Currently, under Public Law 99-145, 10 U.S.C. §2313(b), the Director of DCAA has the authority to issue subpoenas when a contractor refuses to grant DCAA access to the records covered by the statute. However, in 1988 the United States Court of Appeals, Fourth Circuit denied enforcement of a DCAA subpoena related to internal audit material from Newport News Shipbuilding. The Court ruled that DCAA’s subpoena power provided by 10 U.S.C. §2313(b) is limited to negotiations, pricing, or performance of a particular contract. This ruling denied DCAA access to records of management reviews and internal audits which the Court determined to be beyond the statutory provisions of DCAA’s subpoena power. Consequently, government contractors frequently use the Newport News court case as a basis for denying DCAA access to specific records.

Amendments to 10 U.S.C. §2313 would give DCAA access to the types of records needed to accomplish the Agency’s mission. The Newport News decisions bring into question the DCAA statutory authority to require contractors to provide other than certified cost and pricing data supporting the reliability of the related internal control systems. It is essential for DCAA to have access to contractor reviews, inquiries, investigations, and internal audits in order to evaluate contractor business systems. …
Greater access to contractor records means that DCAA would have a more accurate picture of cost and price data. DCAA needs access to contractors’ internal documents to determine if contractors are taking appropriate corrective action when irregularities or misappropriations are identified, that the Government is not overcharged, and that appropriate contractor disclosure has been provided to Government officials in compliance with the FAR. Therefore, it is also essential for DCAA to have access to contractor reviews, inquiries, investigations, and internal audits in order to evaluate contractor internal control systems and determine compliance with any applicable contract clauses or Federal or agency acquisition regulations. Greater access by DCAA would lessen the burden on the contractor to identify and isolate specific records that have already been analyzed internally. This increased access would allow DCAA to take a comprehensive look at contractors’ internal audits that have already been completed, thus reducing duplication of effort and increasing the cost effectiveness of audit analysis.

Well, that’s just more bullshit, isn’t it?

Those damn activist judges, interfering with DCAA’s access to records. Something needs to be done about that! But of course, let’s all ignore the fact that DCAA doesn’t actually use the subpoena power it already has. And let’s ignore the fact that most DCAA auditors don’t think contractor internal audit reports are even relevant to their audits. That’s not our opinion: it was the official finding of a GAO audit report (link in the previous sentence). GAO reported—

Auditors from three DCAA audit teams stated that they did not believe that access to contractor internal audit information is critical to their own audit work and that the internal audit reports do not have enough detail to be helpful. They also stated that they are restricted by auditing standards in relying on the work of others.

The DCAA Report used the foregoing as support for a request to Congress for more resources. And you know what? The agency probably does need more auditors. But before Congress gives DCAA more budget, we hope DCAA is first required to (a) better manage its current workforce and (b) better train its current workforce.

Oh, and (c) quit misleading Congress. Man up and admit your shortcomings. Admit that GFY 2011 was not a successful year under any reasonable definition of “successful.” When you have admitted you’ve hit bottom, anything else will be an improvement.

OFPP Issues FY 2011 Executive Compensation Benchmark/Ceiling a Year Late

Nick Sanders

Dollar Section 39 of the Office of Federal Procurement Policy (OFPP) Act requires the OFPP to issue, annually, an executive compensation “benchmark” amount that establishes an allowability ceiling on compensation of contractor executives. The benchmark amount is set at the median (50th percentile) amount of compensation over a recent 12-month period for the five most highly compensated employees in management positions at each home office and each segment of all publicly-owned companies with annual sales over $50 million, and the determination is based on analysis of data made available by the Securities and Exchange Commission (SEC). As defined by the Cost Principles at FAR 31.205-6(p), executive compensation means the total amount of wages, salaries, bonuses, restricted stock, deferred and performance incentive compensation, and other compensation for the year, whether paid, earned, or otherwise accruing, as recorded in the contractor's cost accounting records for the year. For government contractors, executive compensation in excess of the annual OFPP benchmark/ceiling amount is unallowable. Period.

The last time the OFPP established the executive compensation benchmark was two years ago, in April, 2010. We reported it here. So why was there such a delay?

One of the reasons given by OFPP for the delay was the uncertainty surrounding the allowability of executive compensation. Congress has been tinkering with the rules. As we reported in this article, Section 803 of the FY 2012 National Defense Authorization Act (NDAA) extended the compensation cap beyond the “top 5” most highly compensated executives in each segment, to encompass all contractor employees. So (ostensibly) OFPP delayed issuing the FY 2011 benchmark amount because it was concerned that Congress would change the rules in such a fashion as to make its efforts worthless. Well, that didn’t happen and so OFPP finally—and, quite clearly, reluctantly—issued the 2011 benchmark amount.

The FY 2011 ceiling amount of executive compensation is $763,029.

The Federal Register notice provided ample evidence that the OFPP decided to comply with statutory direction only reluctantly. For instance, the ceiling amount was agreed-upon only “after consultation with the Director of the Defense Contract Audit Agency.” Further, the majority of the FR notice (at least four paragraphs’ worth of verbiage) consisted of an attack on the existing statutory formula. Included therein was an endorsement of a new formula that would tie executive compensation to Senior Executive Service compensation levels. Quite clearly, the OFPP was telling readers: “Don’t blame us. We just follow statute.”

Which is kind of ironic, given how OFPP has spent the past twelve months not following statutory requirements.

At this point, the majority of government contractors have already incurred FY 2011 executive compensation costs and are within about 60 days of submitting their FY 2011 Final Incurred Cost Proposals (FICPs). It’s manifestly unfair, and very nearly a retroactive application of an allowability rule, to tell them in April 2012 what their allowable 2011 costs should be. But of course, the counter argument will be: “Fine. Feel free to use the (lower) FY 2010 executive compensation benchmark if you’d like.”

Interestingly, the delay in issuance, coupled with the NDAA language changes, worked to create a two-tier cost allowability structure for defense contractors. As the OFPP reports in its FR notice—

… this broader application of the Section 39 cap does not apply to FY 2011. That is because Section 803 of the NDAA provides that its amendments ‘shall apply with respect to costs of compensation incurred after January 1, 2012.’ Accordingly, the benchmark compensation amount in this notice, for FY 2011, applies only to the same limited number of contractor executives as did the Section 39 caps for FY 2010 and prior years. The broader application called for in Section 803 of the NDAA will be implemented through regulation and addressed in future notices.

What that means is that the OFPP benchmark amount applies to all contractors’ executive compensation costs incurred effective January 1, 2011. For non-defense contractors, the ceiling applies only to the top five most highly compensated executives in the company (and in each segment). However, for defense contractors, the ceiling applies to the “Top 5” for FY 2011 only; in FY 2012 it applies to all employees. That bifurcated approach will take some work to figure out.

With rules like this one, is it any wonder why defense contractors’ overhead rates continue to increase?

Procurement Problems at Savannah River

Nick Sanders

In 2008, a Limited Liability Company called “Savannah River Nuclear Solutions” (SRNS) became the management and operating (M&O) contractor for the Department of Energy (DOE) at the Savannah River site. Fluor Federal Services, Newport News Nuclear, and Honeywell International are the three parent companies of SRNS, “who is responsible for environmental cleanup, national security activities and operation of the Savannah River National Laboratory.”

The DOE Inspector General recently reviewed SRNS’s procurement activities related to acquisitions of services from its three parents. As the DOE IG reported—

To help ensure that procurements from affiliates are free from conflicts of interest, adequately competed and reasonable in cost, the Department's contractors are required to obtain approval of related party procurements from Federal officials. For the SRNS contract, the Department established a requirement that procurements from the parent or an affiliate, regardless of type or amount, be submitted for approval prior to award.

The DOE IG reported that, in 2009, SRNS had entered into non-competitive contracts for personnel services from both Fluor and Newport News. In the first fourteen months of activity, “126 purchase orders … valued at approximately $26 million” had been issued to the two parent companies. The DOE IG had a problem with this. Specifically, the DOE IG found—

Although specifically required under the terms of its contract, SRNS also did not obtain approval for subsequent modifications that increased the budget ceilings for those contracts from $5 million to $40 million in one case, and, from $500,000 to $15 million in the other; [failed to demonstrate] that the affiliates were the only sources capable of providing the expertise necessary to perform the needed services, a pre-requisite for noncompetitive awards to affiliate companies; and [failed to perform] cost analyses to ensure the reasonableness of the cost of affiliate personnel services, as required.

The DOE IG provided details regarding its findings. Here’s one snippet from the report—

For example, SRNS issued noncompetitive purchase orders to obtain the services of an internal auditor and a project controls scheduler from a parent company, Fluor. In the first order, the period of performance was approximately 21 months, at an estimated cost of $400,412, which included $310,013 in labor and $90,399 in estimated travel related to temporary living expenses and periodic trips home. In the second order, the period of performance was approximately 24 months, at an estimated cost of $408,515, which included $285,406 in labor and $123,109 in estimated travel. In neither case did SRNS demonstrate that the individuals solely possessed special expertise or that the acquisitions were reasonable in cost.

How did this situation happen? The DOE IG had the answer—

The noncompetitive acquisitions occurred and persisted because the Department did not effectively administer the SRNS contract as it pertains to the procurement of affiliate personnel services. For example, Department contracting officials were apparently unaware that they had approved, in June 2010, an exemption from Federal requirements for the acquisition of affiliate personnel services as part of a multiple modification initiative to SRNS' procurement manual.

Furthermore, Department contracting officials stated that they were aware that SRNS had proposed using affiliate personnel services, but they were unaware of how extensively the services were being used. Additionally, the Department was not notified of a potential OCI because SRNS' General Counsel determined that SRNS did not need to submit a representation regarding such a potential conflict to the Department for these two noncompetitive contracts with parent companies. According to senior contractor officials, SRNS had tacit approval to use affiliate personnel services because the intention had been disclosed in the contract proposal prior to award of the management and operating contract. As a result, even though specifically required under the terms of its contract, SRNS never submitted its affiliate personnel service contracts with Fluor and Newport News to the Department for approval.

With respect to whether or not disclosure of use of affiliated services created a “tacit approval” on the part of DOE, the DOE IG had this to say—

SRNS sought to rely on inclusion of its intent to acquire personnel services as tacit approval for the process, yet violated a major condition of its original proposal. Specifically, the SRNS proposal stated that ‘Should the availability of critical skills become an issue … we will fill any short-term gaps by drawing from the qualified personnel of our member companies.’ SRNS defines short-term assignments as work expected to last less than 12 months. However, of the 42 purchase orders in our sample, 22 contain assignments that have lasted 12 months or longer.

Oops!

We have discussed the operation of joint ventures in this blog before. Companies wishing to enter into JVs for performance of government contracts should consider the following words of the DOE IG report—

We also noted that SRNS officials directly involved in the overall management and administration of the two affiliate contracts had what we considered to be an apparent conflict of interest in that they were assigned to SRNS but remained employees of the parent companies. The relationship of these SRNS employees to the affiliates, coupled with their responsibilities associated with administering the two affiliate contracts, calls into question SRNS' ability to provide assurance that it was performing objectively and without bias, and, as a result, preventing the affiliates from receiving an unfair competitive advantage. No instance of personal enrichment came to our attention during the course of our review. In our opinion, however, the appointment of affiliate personnel to key management positions, whose roles include administering the two affiliate contracts, creates a potential conflict of interest that had not been evaluated by SRNS, had not been brought to the attention of the Department, and was contrary to the very explicit terms of the master contract.

DOE’s Environmental Management team did not fully agree with the findings in the DOE IG report. In particular—

… EM concluded that corporate reachback is not a procurement action and is not subject to a determination that the affiliate is the sole-source of needed expertise. Finally, EM stated that corporate reachback costs are subject to the same requirements for reimbursement as any other costs and only reimbursed to the extent that the costs are allowable and reasonable.

The fact of the matter is that many joint ventures and M&O teams are largely unpopulated and use employees badged to their home companies. This DOE IG audit report points out some significant problems with that approach. We still think such an approach is viable; however, we also think that companies need to be explicit in the management approach and provide details in their proposal regarding exactly how they intend to operate after contract award.

More Failed IT System Implementations

Nick Sanders

We recently blogged about the problematic ERP system implementation undertaken by the State University of New York’s Downtown Medical Center (SUNY DMC, or “the Center”). We reported that the Center spent $2 million over four years, and at this point about five percent of the Center’s departments were using the system. The New York State Comptroller’s Office concluded—

It has been more than four years since the initial implementation began, however, and a majority of the Center’s units are not currently using the software as was intended. Thus, we find that management did not effectively implement or use the product it purchased, thereby diminishing its value.

But we don’t want SUNY DMC to feel that it is alone in having a problematic IT system implementation. No. SUNY DMC has lots of company in that regard.

For example, Federal Times reported that the U.S. Air Force has experienced similar problems. Reporting on USAF testimony before the Senate Armed Services Committee’s Subcommittee on Readiness and Management Support, Federal Times stated—

A seven-year, billion dollar investment by the Air Force in a new logistics management system has turned out to be a bust, officials say. ‘I am personally appalled at the limited capability the program has produced relative to that amount of investment,’ Air Force Comptroller Jamie Morin told the Senate Armed Services readiness and management support subcommittee on Wednesday.

The Air Force is now trying to sort out what can be salvaged from its investment on the Expeditionary Combat Support System and map out a way forward in a new report likely to be delivered to Congress next month.

So SUNY DMC should not feel too sad at having wasted only $2 million over four years. That amount pales in comparison to the USAF’s $1 billion waste over seven years. We wonder if CSC (the Air Force’s prime contractor) will be held accountable in some fashion.

In related news, this story at The Southeast Texas Record concerned a lawsuit against an accounting firm that installed software at a medical practice. The owners of the medical practice filed suit because they allege that the accounting firm botched the installation, which permitted an employee to embezzle $1 million over a five year period. The story reported—

The [accounting] firm … installed an accounting software system used by the medical practice's employees … However, when installing the software, the accounting firm failed to install a security function that would prevent manipulation of the system, the suit states.

In turn, an employee at the medical office allegedly embezzled nearly $1 million … from 2005 until September 2010, the complaint says.

‘Defendants, despite obvious indications of embezzlement in the records that were sent to them monthly and which they were responsible for reviewing and reconciling, failed to notice the irregularities, advise Plaintiffs of ways to identify or check for the same, and/or expose the embezzlement,’ the suit states. ‘Defendant … Begnaud in fact, would ridicule Plaintiffs when they would express to him they were not receiving the monies as indicated in the quarterly statements prepared by Defendants and provided to them.’ It was not until Sept. 23, 2010, that the [owners] discovered the embezzlement, the suit states.

The [owners] allege negligence against the defendants, saying they negligently failed to properly train the plaintiffs on the software and failed to properly install the software, among other negligent acts. They also allege negligent misrepresentation and breach of fiduciary duty against the defendants.

We should note (in a subtly self-serving way) that government contractors seeking to implement a new accounting system—or, indeed, any significant management system—need to navigate far more than simply the software. Policies, procedures, and practices all need to be updated and enhanced. Disclosure Statements may need to be revised. The last thing a company needs is to have a Business System declared to be inadequate because a system implementation was blown.

We also want to point out that the funds spent on a system implementation that went wrong are subject to being questioned by government auditors as being unreasonable. If upheld by a Contracting Officer, those questioned costs would then be unallowable. So not only would you have wasted time and money, such funds would not be recoverable in billings to the U.S. government.

Which would really be adding insult to injury.

The GSA Spending Spree

Nick Sanders

NOTE: This article contains a big, fat, factual error. Please see the UPDATE AND CORRECTION link at the bottom for a correction and an apology.

Readers of this blog might be wondering why we have not been all over the stories of the General Services Administration “conferences” like white on rice. After all, the story is relevant to many themes which form the basis for article after article on this site—themes such as lax oversight, the importance of instilling a culture of compliance, and holding management accountable for investing in adequate internal controls. More fundamentally, the stories of waste and abuse at the GSA are further evidence (if further evidence was even needed) that a monocular focus on fraud, waste and abuse by government contractors is misplaced and ignores the similar levels of fraud, waste and abuse within the Federal government itself. So why have we not been gloatingly reporting these stories, diving into slice after slice of Schadenfreude pie?

Well, let’s answer that oh-so-reasonable question. We’ve been holding-off on this one for two reasons. The first reason is that the story is still developing. We’re pretty sure we have the waste and abuse parts of the picture, but we’re still missing the third part of the triumvirate: we need the fraud/corruption part. And while there have been tantalizing hints of bribery and kick-backs, we haven’t yet seen anything solid. So there’s that.

The second reason we’ve been holding-off is that we’ve been listening to Vern Edwards. Vern Edwards, for those who may not know, is a demi-god in the pantheon of government contracting experts. We don’t always agree 100% with Mr. Edwards—but when he speaks, we listen. And this is what he said about the GSA spending spree—

Before you start trashing GSA with comments about how you are shocked, shocked by their behavior, keep in mind that what happened was a direct result of the rise of entrepreneurship in government that has been going on at all levels, federal, state, and local. … GSA's mistake in this case was in operating like a firm in the private sector trying to reward and motivate its people to get more business. This is what they had been led to believe that they ought to do. It is a natural outcome of the acquisition reform movement that sprung up during the 1990s during the Clinton Administration's "Reinventing Government" phase and the growing use of clueless political appointees to run agencies. Their mistake was in failing to recognize what is going on in America and realize that they were still functioning within the public sector. … GSA is a good outfit. They'll bounce back. The question now is whether entrepreneurial government was a mistake.

So we’ve been holding-off and watching and reading. Now we’re ready to offer some comments, keeping in mind that the story is still developing and we’ll likely have more to say about it in the near future.

Let’s start with this USA Today story, written by Andy Medici of the Federal Times and published on April 17, 2012. Mr. Medici (he of that noble Firenze ruling family) wrote that the Las Vegas conference debacle was part of a pattern, part of a culture of waste and abuse that was endemic to GSA Region 9. He reported that the Region 9 executive in charge of organizing that $822,000 “conference” in Vegas, Mr. Jeff Neely, “also spent thousands of taxpayer dollars on a variety of wasteful trips and events, according to lawmakers and GSA's top investigator.” Mr. Medici wrote—

In October, Neely took a nine-day trip to Hawaii to attend a one-hour ribbon cutting. He went on another five-day trip to Atlanta in November to attend a conference of questionable value. He also organized a four-day trip to Napa Valley in Northern California that cost more than $40,000 and a $150,000 intern conference in Palm Springs, Calif. [Brian Miller, GSA’s Inspector General, reported that] ‘Spending was part of the culture of Region 9.’ In addition, Miller's office found that thousands of dollars of equipment — iPods, gift cards and other items — Neely's Region 9 office bought for an employee awards program went missing or was stolen. Miller said his office tracked one of the missing iPods to Neely's daughter.
Among the investigations still in the pipeline: possible waste and mismanagement concerning the intern conference in California and another conference that Miller declined to discuss. Neely's office organized both.

In an email Neely wrote in preparation for the 2010 Las Vegas conference, he said, ‘Why not enjoy it while we have it?’ …
Even after top GSA officials became aware in May 2011 of the inspector general's concerns about Neely's spending, they awarded him a $9,000 bonus.

Just to add some fuel to the Neely funeral pyre, this article reported that his wife accompanied him on several official trips he took on behalf of the GSA. That fact would be meaningless, except (according to the report), “The government picked up her tab and she directed event planners to spend government money and arrange lodging for relatives during a trip to Las Vegas in 2010.”

Having been now duly sensitized to the management decisions of Mr. Neely, let us also note that he did not act alone or in a vacuum. Here’s a link to a Fox News report that discusses how GSA officials were “grilled” by members of the House Oversight and Government Reform Committee. Fox News reported that—

Members of the House Oversight and Government Reform Committee at times yelled at the representatives from the General Services Administration called to testify Monday, demanding strict punishment. The acting chief of the agency later assured lawmakers that he's ordered a few GSA officials to repay the government for their personal expenses and will refer any ‘criminal activity’ that is uncovered to law enforcement. …
Rep. Elijah Cummings, D-Md., top Democrat on the panel, said the allegations against Neely document an ‘indefensible and intolerable pattern of misconduct.’

Cummings, referring to internal documents allegedly showing Neely gloating about the money he was spending, accused Neely and his wife of blowing through federal dollars, as if they believed they were ‘some kind of agency royalty who used taxpayer funds to bankroll their lavish lifestyle.’

‘They violated one of the most basic tenets of government service. It's not your money,’ Cummings said.

Other agency officials, both current and former, apologized for the 2010 Western Regions Conference and condemned the over-the-top spending documented in the inspector general's report.

Martha Johnson, the administrator who resigned after the report was made public, called the Western Regions Conference -- which had been escalating in cost for years -- a ‘raucous, extravagant, arrogant, self-congratulatory event that ultimately belittled federal workers.’

She personally apologized, while defending the work of the GSA as a whole. ‘I am extremely aggrieved by the gall of a handful of people to misuse federal tax dollars, twist contracting rules and defile the great name of the General Services Administration,’ she said.

David Foley, a GSA official who was captured on video joking about the agency's spending at the 2010 conference, also apologized at the hearing. Foley said that he didn't know the ‘over-the-top’ expenses were being paid for with government money. …

Two other GSA officials were fired after the inspector general report found the agency spent more than $820,000 on the 2010 conference.
Miller said Monday that investigations are ongoing, and that his department is looking at possible bribery and kickback schemes.

Here’s an Associated Press video.

Let’s conduct an investigation of our own. Let’s look at how the GSA was able to afford such lavish parties. After all, every other Federal agency is having a budget crisis; cutbacks are everywhere. Although the Vegas “conference” took place in 2010, that was not so long ago. Federal spending has been under scrutiny since 2009. So we wonder: where did GSA get the money?

Astute readers might already know or have guessed the answer. GSA obtained its funds from contractors as a condition of contract award. It’s called the Industrial Funding Fee (IFF). Since 1995, GSA has required contractors with Multiple Award Schedule (MAS) contracts to pay a quarterly fee, based on sales generated by the MAS contract(s), in order to fund the cost of administering the contracts and providing goods and services to the rest of the Executive Branch. The IFF has generated so much money for the GSA that it no longer needed to reply on funds appropriated by Congress. Seems like a great success!

The problem is that the IFF has been too successful for GSA. In 2002, the U.S. General Accounting Office (now called the Government Accountability Office) reported that "from fiscal year 1999 to 2001, the revenue generated by [IFF] fees exceeded [FSS] program costs by 53.8%, or $151.3 million. Program customers are, in effect, being overcharged for the contract services they are buying. Nevertheless, program officials have not adjusted the fee." When Congress learned about this finding, hearings were scheduled. GSA then decided to lower the IFF from 1.0% to 0.75% on its own. Since 2003, the IFF rate has been 0.75%.

In addition, GAO issued a 2011 report that discussed the interagency fees charged by GSA to other agencies to recover its administrative costs on non-MAS acquisitions, which ranged from 1 to 12 percent. (The report looked at many interagency support services but we are focusing here only on GSA.) GAO reported—

According to agency officials, the fee revenue generated from the sales orders of the interagency contract programs is intended to cover costs and contributions to reserves, where permitted; however, the programs are not required to break even on an annual basis. As such they are permitted to have excess revenue or costs that exceed their revenue in a given year. According to officials from the selected programs we reviewed, each program is managed with a goal of having its revenues and costs, including contributions to reserves, break even over a period oup to 5 years. We observed, however, that four of the six programs generated excess revenue over their costs for almost every fiscal year since fiscal year 2007.

While not all GSA interagency programs generated “excess revenue over their costs,” GAO reported that the GSA MAS program generated an average of $62 million in excess revenue over costs each year between 2007 and 2010. Even though the IFF had been lowered in 2003, GSA continued to generate tremendous cash income from its MAS program sales. And GSA retained all of its excess revenue in its “reserves”—and gave nothing back to the U.S. Treasury or to the taxpayers.

In February 2012, the GAO reiterated its 2011 findings about the GSA MAS program and reiterated its recommendation that—

… the Administrator of General Services direct the Federal Acquisition Service Commissioner to develop and implement guidance for evaluation of current fee rates when an individual program consistently transfers excess revenue to the reserve funds. Such an evaluation would allow GSA to determine whether a reduction in the fee rate of any of its programs might be warranted. A reduction of the fee rate for the MAS program alone would provide federal agencies potentially significant cost savings.

In our view, when examined in this context, the now infamous Las Vegas “conference” of 2010 was simply a symptom of an agency culture that took every opportunity to generate income. And then the agency took that income and kept it in its own pockets, even though it was clearly excess to current and future needs. To make things worse, there was an actual incentive to spend lavishly on any activity that could possibly be called “business-related”—since spending lavishly would tend to reduce the “excess revenue” figures being reported by GAO to Congress.

So that’s the deal. If the excess IFF funds weren’t spent on conferences and award programs, then GAO and Congress would want the excess funds given to the Treasury. Worse yet, there would be pressure to reduce the IFF rate in order to move to a break-even state. And then the high-living days would come to an end.

Remember Mr. Edwards’ words. And remember that the MAS program had generated profits since inception, and had lived off the Congressional appropriation grid all the while. Though Congressman Cummings wagged his finger and asserted that it was not GSA’s money, he was actually mistaken. It was the agency’s money, because they generated it without Congressional appropriations. The problem was, GSA was too successful at income generation, and all that “excess revenue” created incentives to spend the money, lest Congress want its piece of the action.

Neely didn’t act alone or in a vacuum. And GAO and Congress knew about the excessive IFF rates for years. So when everybody is acting shocked and appalled at the wasteful spending, remember what you’ve learned in this article. There are very few clean hands in this mess.

UPDATE AND CORRECTION

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