Business Systems Rule Continues to Shock and Awe
The final DFARS business system rule (henceforth: “BizSys Rule”) hadn’t been out for 24 hours before Apogee Consulting, Inc. began to hear from our small (yet clearly fanatical) group of readers asking for our take on the matter. Or—as could be fairly said—we were being asked for yet another of one our opinions on the final set of regulatory requirements. The last OpEd piece was right here.
The final BizSys Rule’s language didn’t have much in the way of substantive changes from the interim rule, which was issued May 18, 2011. We found the DAR Council’s promulgating comments to be of more interest. Here are some quotes we’d like to share with our readers—
Comment: A number of respondents stated that DCAA and DCMA are not properly staffed to address the new DFARS rule. Further, with regard to EVMS, the rule provides extensive authority to contracting officers and DCAA and DCMA auditors in evaluating implementation of the ANSI/EIA 748 standard, which was intentionally designed to be flexible. According to the respondents, the magnitude of programs and contractors requiring EVMS surveillance and assessment inherently results in less experienced personnel in positions with this authority. The respondents suggested that Government resources are not adequate in numbers or depth of skills to provide the required oversight.
Response: This rule does not add additional oversight responsibilities to DCAA and DCMA, but instead mitigates the Government's risk when contractors fail to maintain business systems, as is required by the terms and conditions of their contracts. Contracting personnel will continue to make appropriate determinations in accordance with this rule. DoD has been taking measures to align resources and ensure work is complementary. The increased cooperation and coordination between DCAA and DCMA will enable DoD to employ audit resources where they are needed.
Comment: A respondent expressed concern that DCAA has not updated its guidance to reflect the definition of significant deficiency. According to the respondent, DCAA has not issued audit guidance to align its definition of significant deficiency to that in the NDAA and interim rule. DCAA's latest guidance in its MRD 08-PAS-011(R) dated March 2, 2008, starts out defining a significant deficiency as a ``potential unallowable cost that is not clearly immaterial.'' However, in MRD 08-PAS-043(R) dated December 19, 2008, DCAA clarified its guidance that ``DCAA only performs audits of contractor systems that are material to Government contract costs'' and that a contractor's ``failure to accomplish any applicable control objective should be reported as a significant deficiency/material weakness.'' The respondent stated that DCAA's clarification changes the criteria from a ``potential unallowable cost that is not clearly immaterial'' to if any deficiency is found during an audit, it is reported and the system is rated as inadequate. The respondent expressed concern that DCAA's guidance is constantly changing with no oversight body to regulate its audit policies.
Response: DCAA is in the process of updating its guidance and will report significant deficiencies in accordance with the definition of significant deficiency in this rule, as set forth in section 893 of the NDAA for FY 2011. Additionally, contracting officers will administer this rule according to the requirements in section 893 of the NDAA for FY 2011, as implemented in this rule.
Comment: With respect to the language relating to the finding of a significant deficiency by the contracting officer, the interim rule states: ``The initial determination by the Government will describe the deficiency in sufficient detail to allow the contractor to understand the deficiency.'' A respondent suggested that this language be expanded to include a specific explanation as to how the deficiency identified was determined to be a significant deficiency and further, why information produced by the business system under review is considered not to be reliable in accordance with the requirements of the enabling legislation, the NDAA for FY 2011, which defines a significant deficiency as ``A shortcoming in the system that materially affects the ability of DoD to rely upon information produced.''
Response: ``Significant deficiency'' means a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes. The contracting officer's significant deficiency determination will describe the significant deficiency in sufficient detail to allow the contractor to understand the deficiency. This rule incorporates criteria for each business system, which define the aspects of the system that materially affect the ability of DoD to rely on information produced. Determinations of significant deficiencies will be based on the contractor's failure to comply with the business system criteria.
Comment: A respondent expressed serious reservations as to the need for the rule, and identified potential harms to contractors if the rule is administered in an inconsistent or arbitrary fashion. According to the respondent, because the determination of a system deficiency is dependent upon the subjective interpretation of critical system criteria, application of the rule could well lead to inconsistent treatment by individual contracting officers and their DCAA advisers.
Response: This rule incorporates criteria for each business system, which define the aspects of the system that materially affect the ability of DoD to rely on information produced. Determinations of significant deficiencies will be based on the contractor's failure to comply with the business system criteria. Each significant deficiency must be determined on its own set of facts and ultimately decided by the contracting officer.
Comment: A respondent stated that the term ``material'' requires better amplification in the final rule to reduce variability in interpretation. The respondent suggested that the final rule should specify that when determining materiality, a contracting officer or auditor should rely on established Government standards such as CAS and Federal Accounting Standards Advisory Board statements.
Response: The rule requires that an acceptable business system comply with the system criteria set forth under each of the six business system clauses. The criteria for each business system defines the aspects of the system that materially affect the ability of DoD to rely on information produced. Determinations of significant deficiencies will be based on the contractor's failure to comply with the business system criteria. For example, the system criteria under the clause at DFARS 252.242-7006, Accounting System Administration, requires that the contractor's accounting system ``shall provide for *** Accounting practices in accordance with standards promulgated by the Cost Accounting Standards Board, if applicable, otherwise, Generally Accepted Accounting Principles.'' Each significant deficiency must be determined on its own set of facts regarding compliance with the system criteria.
Comment: A respondent suggested standardization of two contractor requirements across all business systems to (1) monitor and periodically review the business system to ensure compliance with established policies and procedures and (2) upon request, present results of those internal reviews to the administrative contracting officer (along the lines of DFARS 252.242-7004(c)(2) and (d)(10)). Currently, both requirements are included in the interim rule, but not for all business systems.
Response: While the system criteria language is not standardized across all business systems clauses, each business system clause contains system-specific requirements for contractor monitoring and disclosure. For example, under the property system criteria, the contractor is required to ``establish and maintain procedures necessary to assess its property management system effectiveness, and shall perform periodic internal reviews and audits. Significant findings and/or results of such reviews and audits pertaining to Government property shall be made available to the Property Administrator.'' Furthermore, the contractor ``shall periodically perform, record, and disclose physical inventory results.''
Let’s be clear here: we are sharing with you only a small snippet of the promulgating comments. There are 51 comment categories in the final rule, with multiple comments appearing in each category. The above quotes are the ones we think need some management focus; but, of course, you should read them all.
In a previous blog article, we shared the travails of Huntington Ingalls Industries, who became the first contractor reported to have payment withholds imposed under the new BizSys Rule. Reports have recently emerged about the second contractor to see payment withholds—Lockheed Martin’s Fort Worth-based Aeronautics Division—prime contractor for the F-35 Lightning II JSF program. The news was first reported by Bloomberg here.
The payment withholds were imposed because of significant deficiencies in the operating unit’s Earned Value Management System (EVMS). According to the article, “the withholding will start in March with billings made under a new production contract of about $4 billion for as many as 30 F-35 fighters.” Because LockMart had submitted a Corrective Action Plan, the payment withholds will be set at two percent instead of five percent.
Fort Worth’s EVMS has been “decertified” since 2010, when the DCMA identified noncompliances with “about half” of the 32 system criteria and also found a failure to make progress on corrective actions, according to this October 2010 story at AW&ST. Our “friends” at POGO obtained, and publicly posted, the 2010 DCMA report here. But it was not until LockMart was awarded the latest F-35 production contract, which contained the complete set of May 2011 BizSys Rule clauses that the payment withholds could be implemented.
Huntington Ingalls. Lockheed Martin. We wonder who will be next in the DOD payment withhold sweepstakes?
Pensions and Post-Retirement Benefits Scare Everybody
One of the most important lessons that can be learned from marriage is to never say, “I told you so.” Being right is rarely a goal worth reaching; most times the long-term cost to the relationship isn’t worth the momentary warm glow that accompanies the phrase “Neener, neener. I was right and you were wrong.”
But this is a blog, baby. Different situation; different rules. So here it is:
We told you so.
We told you that the recent revisions to CAS 412 and 413 necessitated by the Pension Protection Act were going to be an unpleasant surprise to many. But not to you—right? As a reader of the Apogee Consulting, Inc. blog, you not only knew that this issue was going to surface like a bubble of smelly methane gas in the swamp of arcane government contract cost accounting rules, but you also knew that DOD was well aware of the coming scheiß sturm for a least the past six years—and did nothing.
And now the scheiße has hit the fan, so to speak, as recently published polemics demonstrate. To wit—
The Citizens Against Government Waste (CAGW) is (according to Wikipedia) “functions as a think tank, ‘government watchdog’ and advocacy group for conservative fiscally causes.” (Here’s a link to their website.) If you want a hint as to their approach to campaigning against government waste, note that the organization’s phone number is 1-800-BE-ANGRY.
CAGW recently issued a report on contractor pensions and post-retirement benefits (PRBs) that seemed intended to incite Congress to DO SOMETHING about the price being paid by taxpayers for those particular items of cost. Here’s a link to the CAGW report in question.
The Federal Times ran a story about the CAGW report. Here’s a link to the Federal Times article. The article reported that—
Taxpayers contributed more than $3.3 billion to the pension programs of 18 of the biggest federal contractors in 2010, according to estimates by the Citizens Against Government Waste (CAGW) watchdog group. …
The CAGW estimates the government reimbursed Lockheed Martin Corp., the largest federal contractor, $988 million in 2010 for its pension payments. The figure for Raytheon was $667 million, and for Northrop Grumman Corp., $529 million.
CAGW’s methodology consists of extrapolating from two GAO reports concerning estimates of pension and PRB liabilities associated with Department of Energy (DOE) contractors. Note that the operative word in the Federal Times quote is “estimate”. One might also reasonably wonder whether DOE’s pension/PRB liabilities—which include personnel costs associated with several National Laboratories such as Los Alamos, Sandia, and Lawrence Livermore (whose Operation & Management contracts have only recently been subject to competition)—would be a good representation of the liabilities of other Departments such as Defense. But that’s not the issue that we think readers should take with the CAGW report. No, the disputable issue is that CAGW has taken a position against reimbursement of defense contractor pension and PRB costs.
The Federal Times article quoted the CAGW report as follows—
This [reimbursement of contractor pension/PRB costs] can lead to moral hazard and higher federal spending, making it a challenge for all government agencies to meet their core mission and responsibilities, while at the same time using taxpayer money to subsidize investment decisions made by some of the most profitable corporations in the United States.
The Federal Times article reported that the CAGW report recommended several changes to the current government contract accounting policies affecting how contractors measure, propose, and bill for such costs. The article reported that CAGW “urged” the Federal government to—
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Require that its reimbursements to contractors' pension plans be based on actuarial assumptions required under federal law, not the contractors' own assumptions.
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Require that market losses in invested pension funds be recouped from the contracting companies that make the investment decisions, instead of taxpayers.
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Stop reimbursing contractors for defined-benefit pension plans for new employees and instead reimburse them only for defined contribution plans, such as a 401(k) plan.
This article in Washington Technology took a different approach to the CAGW report. It told its readers—
The federal government is on the hook for billions of dollars in federal contractor private pension costs that possibly could have been avoided … Citizens Against Government Waste (CAGW) said … it has begun investigating situations in which the federal government has assumed ongoing responsibility for the cost of contractor pension plans. These situations have occurred primarily because of terms approved under cost-plus federal contracts, in which the government contributes to ongoing costs of contractor retirement benefits. …
‘Many of these companies sponsor defined benefit pension plans for their employees (in which) company officials control not only the level of benefits offered, but also the strategies used for investing plan assets,’ CAGW said …. ‘Since many cost-plus federal contracts include clauses that ensure these pension plans are fully funded even if the plans' investment benchmarks are not met, taxpayers ultimately bear the investment risks associated with pension fund investment decisions made by some of the most profitable corporations in the United States.’
The article reported that CAGW stated that, “the structure of those contracts has encouraged several major federal contractors to maintain more expensive defined-benefits plans, even as most of government and private industry have moved away from those types of plans.”
We did, in fact, review the CAGW report. Here are some salient portions of that report—
Many of these [government contractors] sponsor defined benefit plans for their employees and they control not only the level of benefits offered, but also the strategies used for investing plan assets. Since cost-plus contracts include clauses that ensure these pension plans are fully funded even if their investment assumptions are not met, taxpayers ultimately bear the investment risk. …
Federal agencies have increased pension reimbursements to contractors in order to meet the PPA requirement that private company defined benefit pensions be funded to 100 percent of liabilities. … As a result, contractors often decide to contribute more than the minimum to prevent losing favorable tax treatment or to build credit balances that can be used in the out years to try to level the amount it budgets for pension contributions. Combine the PPA standards and internal agency policies with external factors, and the result is record contractor reimbursement costs. …
While the vast majority of corporations and private businesses have transitioned to defined contribution pension plans, defined benefit plans continue to be a mainstay for many of the largest federal government contractors. They are reaping billions of dollars in reimbursements because of contractual obligations, PPA funding, actuarial requirements, and economic and financial factors. …
On December 7, 2011, Senate Armed Services Committee Chairman Carl Levin (D-Mich.) and Ranking Member John McCain (R-Ariz.) sent a letter to the GAO asking the agency to examine the cost of post-retirement benefit reimbursement at the Department of Defense (DOD). Their letter requested ‘an estimate of how much DOD has paid its contractors to backfill their pension plan shortfalls over the past 10 or so years,’ a ‘projection of future liabilities,’ an evaluation of ‘options for limiting DOD’s liability for contractor pensions, including but not limited to the options of eliminating reimbursement for all or some defined plans,’ and the savings that could be achieved from implementing the various options. It is anticipated that GAO will merge the senators’ concerns with an earlier request on the same subject matter from two other members of the Senate Armed Services Committee, and release the final report later this year.
So the CAGW report is getting play and Congress is concerned. We want to share one more article on this topic with you. It’s a Federal Times story from February 27, 2012.
The Federal Times story includes quotes from DOD Comptroller Robert Hale. It reported—
The Defense Department has not yet budgeted for the additional pension costs, but estimates they ‘could be billions of dollars, conceivably,’ Defense Department Comptroller Robert Hale told ‘This Week In Defense News’ on Feb. 23.
‘I'm hoping that our vendors realize in tight fiscal times that they need to work with us to hold down weapons costs,’ Hale said. ‘We think there may be modest added cost, we'll just have to see, but we are going to have to start budgeting for them, and it is a question I'm asking internally as we look into our next budget plan.’
The cost to the Pentagon will depend on how the companies' pension funds fare in the stock market, Hale said. If investments do well and earn money, a greater part of the plans will be funded, he said.
However, if investments do poorly and pension funds become further underfunded, affected contractors would be forced to make greater payments to cover those liabilities, pension experts said. And that will mean more cost to the Pentagon.
The Federal Times story also reported—
With its roots in a 2006 law, the rule's impact should have been anticipated, giving Defense Department officials plenty of time to budget for the expected costs, said David Berteau, director of the Center for Strategic and International Studies Defense-Industrial Initiatives Group.
‘How can this have snuck up on us and caught us unaware?’ he said. ‘I didn't hear any alarm bells.’ …
The impact of the new rule on government contracting costs could be dramatic given the tight budget environment most Defense Department agencies are operating under, Berteau said.
‘This is way more than a bookkeeping question,’ he said.
Because you read this blog, you know that we’ve been ringing the alarm bells for years. More importantly, you also know that DOD Leadership has known about this issue since the passage of the PPA in 2006. They knew, and they did nothing. In fact, DOD Leadership issued direction that prohibited anything from being done. They hid their heads in the sand. They kicked the can down the street and made it somebody else’s problem to deal with. Pick your metaphor.
You knew it, because we told you so.
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Revenge of the Dragon Lady: Another USAF Procurement Puzzler
You remember Darlene Druyun, don’t you?
Ms. Druyun—called by her subordinates “the Dragon Lady” because of the way she ran her fiefdom in the US Air Force’s acquisition realm—was sentenced to nine months in prison and fined $5,000 for her corrupt role in fixing contract awards to The Boeing Company. Boeing’s CFO was fired and its CEO resigned for their roles in the scandal. Boeing ultimately settled with the U.S. Department of Justice for $615 million. Almost two years ago, Aviation Week & Space Technology ran a piece on the sixth anniversary of her guilty plea.
And today, we are reminded once again of the Dragon Lady as we ponder the USAF procurement puzzler that is the recent award of the Light Air Support (LAS) contract. We first wrote about the issues associated with the LAS contract award right here. In that article we had some strong words about the “fiasco,” and pointed the finger at both Hawker Beechcraft Defense Company (HBDC) and the Air Force. We wrote—
The Air Force could have resolved this with some open communication as to why HBDC was excluded from the competitive range. … Remember, the Commander-in-Chief has promised taxpayers more transparency, and his folks clearly are not living up to his pledge.
HBDC still has to explain (to its Board of Directors and shareholders (if to nobody else) why a critically important piece of correspondence lay unopened for two weeks, letting regulatory deadlines lapse in the meantime. (We would not want to be in that contracts manager’s seat right now….)
Not to mention, of course, why its proposal for such a ‘must-win’ competition was so flawed that the Air Force threw it out as being (essentially) uncorrectable. Did HBDC have the right skill sets? Did they put the company’s varsity team on the proposal? What went wrong?
It is incorrect to posture this story in terms of ‘USA versus Brazil’. That’s not what this is about. What it is about, quite clearly, is having the Air Force act like stewards of taxpayer funds, and explain their decision-making. The Air Force is hunkered-down and lawyered-up, and acting like this is an adversarial relationship. Instead, they need to come clean and make this all go away.
HBDC needs to understand why it screwed-up, so we can get the warfighters the light air support (and reconnaissance) necessary to minimize the loss of life in the war zone.
Soon after we wrote the above, HBDC President Jim Maslowski abruptly announced his retirement. We told our readers, “The HBDC Board of Directors apparently held Admiral Maslowski responsible for the fiasco we described in our article. His departure was abrupt and unplanned-for, as the company has appointed an interim President while they search for a suitable successor.”
What’s new?
Well, on February 29, 2012, the Air Force announced that it was terminating Sierra Nevada Corporation’s LAS award (for “convenience” we assume). And not only was it terminating SNC’s contract, but it was also going to “launch an investigation into the original [source selection] decision.” That didn’t sound very good. The official USAF announcement (as published in the AOL Defense article linked to above) read—
Today, the Air Force advised the Department of Justice that it will take corrective action on the Afghanistan Light Air Support contract and will set aside the contract award to Sierra Nevada effective March 2, 2012. Michael B. Donley, the Secretary of the Air Force, said, ‘While we pursue perfection, we sometimes fall short, and when we do we will take corrective action. Since the acquisition is still in litigation, I can only say that the Air Force Senior Acquisition Executive, David Van Buren, is not satisfied with the quality of the documentation supporting the award decision.’ Additionally, General Donald Hoffman, commander of Air Force Materiel Command, has initiated a Commander Directed Investigation into the matter.
Yeah. No, that really didn’t sound good. At all.
Anytime you’ve got the Secretary of the Air Force commenting on the deficiencies of a contract award, you can be fairly sure there are going to be career-limiting consequences for some body, or bodies.
In a follow-up story at DefenseNews, Air Force General Norton Schwartz called the LAS contract award situation “an embarrassment” and “a profound disappointment.” The story reported—
The move comes as a damaging setback for the Air Force, which has tried to reform its weapons-buying practices after a drawn-out competition for a new aerial refueling tanker that was plagued by scandal and controversy. … The four-star general warned of drastic disciplinary action if the investigation reveals the contract was derailed by wrongdoing.
‘I can assure that if it wasn’t an innocent mistake, there will be hell to pay,’ he said.
He said the ‘stakes are high’ and that the Air Force would work hard to remedy the problem. ‘We will work our asses off,’ he said.
The reference in the DefenseNews story, of course, is to the KC-X aerial tanker competition, which has been the subject of several blog articles on this site. During that completion, the Air Force promised to put its best and brightest acquisition professionals on the procurement, so as to forestall problems such as bid protests. Despite the assurances, the KC-X competition stands out as a poster child for what not to do.
Let us all hope that there is a new generation of Air Force acquisition “best and brightest” who can quickly get to the bottom of this fiasco and correct the situation. Apparently, the old guard ain’t cutting it.
Human Capital Challenges of the A&D Industry
We’ve been mulling this article over for a while, thinking about budgetary pressures facing defense contractors and the never-ending debate about right-sizing the Executive Branch’s workforce of government employees. You might think that, just because we focus on FAR and CAS and DCAA audit issues, we don’t also consider HR issues (aka “human capital” issues). If so, you’d be wrong.
The biggest problems aren’t numbers problems. The biggest problems—the most intractable problems—are people problems.
The biggest mistakes companies make aren’t about numbers. They aren’t about defective pricing or false claims, or even about screwing-up the financial reporting. No. The biggest mistakes you’ll ever make are the ones involving human interaction. Almost certainly, your biggest mistakes will involve failing to listen to your workforce, or failing to ensure that knowledge is successfully transferred out of the heads of your senior, experienced, team and into the heads of the next generation.
Companies are going through the “rack and stack” process right now, deciding how to reduce costs while preserving abilities and skills. The Federal government is going through a similar process, albeit tailored to meet the unique protocols of the civil service rules. The same thing can be said for the military service.
The point is, the knee-jerk response to budgetary pressures is to slash headcount. And that’s not an incorrect response, if thought-through and strategically executed. Back in 2009, Aviation Week & Space Technology predicted as much as a 10% headcount reduction across the A&D industry, but also reported (perhaps with fingers crossed for luck) that A&D executives had learned from the mistakes that had been made in the 1990’s, when indiscriminate headcount reductions had significant down-stream ramifications, and thus would be smarter this time around. We remain similarly hopeful, but perhaps a bit more cynical that “one-size-fits-all-functions” mandatory headcount reduction percentages will remain the favorite tool of so-called “leaders” who seek to be perceived to be tackling the tough challenges while in reality they aren’t willing to do the necessary work that would lead to the right solution(s).
A recent white paper report issued by the mega-consulting firm, Accenture, discusses some of the challenges facing the A&D industry—and notes that A&D companies “are not yet taking the kind of comprehensive, value-driven approach needed to respond to the business, workforce, leadership and culture challenges ahead.” In other words, Accenture apparently thinks that your corporate leadership is failing at the job of preparing for the future. And Accenture may well be correct in its assessment.
Before we get too far into the Accenture report (called “High Fliers”), we want to give you a link to it, so you can read it yourself. Here’s the link.
The report discusses the challenges facing the A&D industry, including both the commercial airplane and defense sectors. We’re going to focus on the comments, findings, and recommendations relevant to the defense sector. The report sets up the situation thusly—
The defense industry will need to cope with falling budgets and lower government spending levels. For many companies that will mean looking abroad and competing in the international marketplace. These companies will need to put an increased emphasis on operating efficiency and on new kinds of partnerships and alliances. Deeply rooted in a military-oriented culture, defense companies will need to become more entrepreneurial and collaborative—not necessarily a traditional strength.
If one looks closely at these challenges, almost every one of them relies to a large extent on superior human capital—on the A&D workforce, its leadership and its culture. Yet the capabilities and performance of the workforce … are now being severely tested—in some cases straining the ability of organizations to respond. … Based on our research, we contend that companies must be taking action across a range of integrated areas [including] Talent, Leadership, Culture, and Organization. … An effective human capital strategy informs a company’s most important decisions about where and who to compete, and supports the enterprise as it balances short-term decisions with longer-term imperatives.
We have no problem with Accenture’s conclusions. More importantly, we think companies need to take the kind of actions that Accenture recommends, including—
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Initiate broader workforce planning based on advanced, detailed capability models.
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Re-focus on retention and development of top talent—the “high potential” employees.
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Ensure that the current leadership team embraces “diverse thinking” and also fosters that attribute in the next generation of leadership.
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Look to broaden the traditional engineering and/or military backgrounds and skill sets of corporate leaders.
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Evaluate current cultural issues and challenges, and address them.
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Decentralize decision-making as far out and down in the organization as possible.
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Develop a continuous change management capability, so as to move toward a more agile company and workforce.
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Reexamine the current governance and incentive structures so as to enable the foregoing.
There’s a lot more that can and should be said about the Accenture study. Time constraints (and fear of an allegation of copyright infringement) act to limit what we can write. In addition, Accenture has not paid us anything and we are not going to shill for free.
So go read the Accenture report. We think it’s worth your time.
The problem, of course, is that the people who most need to read it probably won’t. They won’t want to read about the approach they should be taking, because then they will have to acknowledge their own leadership failures. Consequently, you need to be smart about how you get the report into their hands and how you spin the need for a strategic approach instead of a knee-jerk reaction. You can do it. We have confidence in you.
More importantly, your co-workers are depending on you.
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