Booz Allen Hamilton Back in the News “for the Wrong Reasons”
We had intended to publish an update on the continuing saga of Booz Allen Hamilton’s (BAH) continuing demonstration of its corporate ignorance of fundamental procurement rules even before we saw this snarky story from Scott Amey at POGO. You remember our original article on BAH’s problems with its San Antonio office, don’t you? It’s received more than one thousand hits as this article is being written.
Poor BAH. In our previous article, we provided a reported quote by the “debarring official” of the U.S. Air Force. That individual reportedly said—
The conduct … raises serious concerns regarding [BAH’s] business integrity, business honesty, and compliance with government contracting requirements, and the adequacy of BAH San Antonio’s ethics and compliance program, including the training provided to its employees.
We agreed with those sentiments. But we were careful to distinguish the conduct of a few, clearly ill-informed and poorly trained, BAH employees in the organization’s San Antonio office from the conduct of the thousands of well-informed and well-trained BAH employees housed in offices around the world. The improper actions of a few should not taint the actions of the vast majority. And in a similar vein, the USAF was careful to suspend, and move for debarment, of just the single BAH office in San Antonio, and not the entire BAH organization that reports more than $5 Billion in annual sales. We’ve all learned from the inequitable treatment of Arthur Andersen’s personnel, almost all of whom had nothing to do with the Enron account—and so now we aim for a proportionate response to a limited problem (or so we’d like to believe).
But now we aren’t so sure that the problems at BAH are limited to a single Texas office.
The POGO story linked-to at the beginning of this article focused on the hiring of BAH by the Securities and Exchange Commission (SEC) for “management support services,” asserting that the SEC incurs a premium of more than 50% from the substitution of BAH personnel for its own employees. The cost of outsourcing government jobs has been a POGO concern for a while, as we reported here. But that’s not the part of the story that caught our eye. No.
What caught our eye was the part of the story where POGO reported that a retired Navy employee by the name of Gregory R. Penk, had pleaded guilty to unlawfully disclosing “procurement contractor bid and source selection information” … to Booz Allen Hamilton.
Here’s a link to the official Department of Justice press release. And here’s a link to a local newspaper story on the same topic (which, quite frankly, adds very little if anything to the DOJ release).
According to the DOJ—
On June 30, 2010, the Navy solicited bids for a new Naval Air Warfare Center - Aircraft Division (NAWCAD) contract as part of a competitive procurement process. The services had previously been provided by Booz Allen Hamilton (BAH), one of the companies submitting bids on the new contract. Penk was responsible for assisting the contracting officer with funding, performance and technical issues related to the program.
Penk admitted that on three separate occasions, he disclosed contractor bid and source selection information about the NAWCAD contract to BAH. Specifically, on February 14, March 2 and March 4, 2011, Penk called a BAH employee and provided specific information about the contract, including the fact that BAH might not win the project and that BAH’s bid was $7.5 million higher than a competitor’s bid. Penk also informed the employee that the Navy would be issuing a best and final offer request and that BAH should prepare for that request. Penk disclosed the information to give BAH a competitive advantage in the award of the contract.
The Navy learned about Penk’s illegal disclosures and had to rebid the contract.
The BAH office in San Antonio was focused on proposing for work at an Air Force facility. Presumably, this is a BAH office in Maryland or Washington, D.C., proposing for work at a Naval facility. Yet despite differences in military services, geographic location, and in the type of work being solicited, there are some noticeable commonalities. Do you see them?
Yeah, it’s not hard to see that both of these groups of BAH employees shared a common ignorance of expected standards of legal conduct in the government procurement environment, a common ignorance of expected standards of ethical conduct within BAH, and/or a willful and intentional disregard of those standards of conduct.
Remember at the beginning of this article when we said “The improper actions of a few should not taint the actions of the vast majority?” Remember that sanctimonious equine fecal matter? Yeah; now we’re rethinking that.
Now we’re wondering at the actual proportion of ethical employees at BAH versus the unethical few. Now we’re wondering who’s in the majority, and who’s in the minority within that organization.
And we wonder if the folks within the Naval law enforcement community are wondering the same thing.
Can the F-35 JSF Prevail Over Program Pressures?
At $323 Billion, it was already the most expensive defense program ever, even before cost growth took the program value to $382 Billion. As costs have risen, the planned production volumes have decreased—from 3,000 to approximately 2,450 (not counting international sales). And the Pentagon just decided to delay 179 of those 2,450 aircraft. Frequent news stories and editorials critical of the program’s cost-growth, schedule delays and performance issues have led a National Defense Industrial Association blog to call it “a symbol of dysfunctional, overpriced Pentagon programs.” And that’s from a bona fide defense industry cheerleader.
When a test flight had to be cut short because of a fuel leak that resulted in an “in-flight emergency,” another erstwhile defense cheerleader, the Defense Industry Daily, opined that perhaps the Air Force’s “lofty rhetoric” should “be taken down a couple of notches”—because (in DID’s words) “Updating [USAF] doctrine to ‘maintain air dominance, 15 minutes at a time’ does not sound very convincing ….”
The Honorable Frank Kendall (Acting Under Secretary for Defense, Acquisition, Technology & Logistics) called the Pentagon’s decision to have the F-35 program enter production before flight testing was complete “acquisition malpractice” and said, “it should not have been done.” According to this Defense News story—
Kendall said that the Pentagon had made ‘optimistic’ predictions about the capabilities of design tools, simulations and modeling to build a fighter that would breeze through test flights without problems. ‘Now we’re paying the price for being wrong,’ Kendall said.
Problems are cropping up on all three variants of the F-35 that would typically be expected in any highly ambitious next-generation fighter program, he said. ‘We didn’t model everything as precisely as we thought,’ Kendall said. …
Kendall said there is a tendency to start production too early, adding that the F-35 is an ‘extreme example.’ Barry Watts, an analyst at the Center for Strategic and Budgetary Assessments in Washington, D.C., agreed with Kendall’s assessment. ‘My understanding is the amount of concurrency on this program is as great as or greater than any past program,’ he said.
Watts, who has been to Lockheed’s Fort Worth, Texas, plant, described long lines of F-35s already being built. ‘Most of those, if they’re going to be operational airplanes eventually, are going to have to go back and have a bunch of changes made to them,’ he said. ‘That drives up cost and delays things.’
It’s not just operational issues that plague the program. The Defense Department has implemented “payment withholds” on the Lockheed Martin Fort Worth F-35 Prime Contractor facility. (And that’s after not paying out $614 Million in budgeted award fees for the development phase of the program.) Since the facility’s Earned Value Management System was “decertified” two years ago, the DOD felt it could no longer rely on Lockheed Martin to provide accurate cost and schedule performance information, and thus started decrementing program payments by two percent until LockMart’s EVM System can pass an audit.
If the foregoing wasn’t enough to cause migraines, POGO has reported a “slew of problems” with the aircraft, and ex-POGO Investigator Nick Schwellenbach has reported (on his new blog at Time.com) that the DOD Inspector General is performing a review of the program’s quality management system. Schwellenbach’s blog quotes the DOD IG as saying that, “the assessment will focus on conformity to specified quality management system(s), contractual quality clauses, and internal quality processes and procedures.”
Over at Federal Times, author Lawrence Korb (of the Center for American Progress) asked who will be held accountable for “F-35 program mismanagement”? Korb wrote—
In any profession when there is malpractice, the person or persons who commit the offense are held accountable. They lose their jobs or their licenses, or resign from sheer embarrassment.
But this is apparently not the case in the military-industrial complex when it comes to the F-35 Joint Strike Fighter, the most expensive program in the history of the Pentagon, whose unit costs have risen from $69 million to $159 million and whose initial operational capability has been set back at least five years. …
Lockheed's most recent contract for building 32 F-35 jets overran its target cost of $3.46 billion by $245 million, or 7 percent.
As a result of the continuing problems with the F-35, Leon Panetta, Gates' replacement as Defense secretary, along with Carter and Kendall, have made a ‘management decision’ to slow production of the F-35 over the next two years. Nonetheless, Lockheed will receive $9.2 billion in the fiscal 2013 budget to build 29 planes, more than $300 million per aircraft. If anything, this will increase the cost, drive up profits for Lockheed, and keep Carter and Kendall managing this program and all the other weapons programs.
So much for paying the price for malpractice.
Taking a less incendiary approach to the question, the writers at Aviation Week & Space Technology recently addressed the topic of “Why Major Acquisition Programs Fail”. The authors wrote—
Kendall—a veteran of procurement politics and management—remarked than none of the problems he had seen during the Reagan administration have been solved, and he joked that acquisition has two main problems: ‘planning and execution.’ …
The Pentagon’s director of operational test and evaluation, Michael Gilmore, made … clear at a conference last year {the point that Pentagon planners know about program problems well ahead of time]: ‘Most of the time, when unrealistic requirements are promulgated, there are numerous people who know that they are unrealistic, so it’s not a case of their being not fully understood.’ The problem, Gilmore continued, is that there are ‘incentives to promise to deliver revolutionary capabilities quickly at low cost.’ …
… most military procurement systems reward companies that underestimate the cost of new programs. The first reward is winning the program, and the second is higher revenue as a result of overruns under development contracts that are cost-plus. (Development costs do overrun in the non-defense world—the Boeing 777 and 787 and Airbus A380 being good examples—but they are still small relative to the companies’ production revenue, so that even the 787 debacle has not threatened Boeing’s survival or independence.)
Higher acquisition costs also drive company growth, as do higher-than-predicted operating costs, particularly this century as more maintenance work was outsourced to contractors. The failure of the Global Hawk Block 30, whose operating costs were higher than the aging, manned U-2, is the exception rather than the rule: Most operators accept the overruns and reduce capability in other areas. …
Military planners—and it is overwhelmingly military planners—want to obtain a capability they cannot afford, or which is at the risky end of the spectrum. To avoid scaring those assessing or paying the bills, they either under-estimate how much it will cost, or they fudge the risk of the project, or both.
If a program is ‘on budget,’ it is more difficult to cancel. If the paperwork looks good, then officials have to look elsewhere to find more funding to actually get the program up to the implied status. In turn, other projects are salami-sliced as billpayers, which then starts to imperil those programs. Alternatively, the original, badly estimated, badly specified program is stretched out yet further, a move that always costs more in the longer term.
Getting back to the F-35 program, the Defense Acquisitions Board (DAB) recently “recertified” the program after a Nunn-McCurdy Breach, but continuing cost growth and budget problems (especially related to a new cost estimate of $1 Trillion for program sustainment costs) “might force the Pentagon to slow production down further or trim flight hours for aircrew”—according to this article at Defense News. The article reported—
Because of the way sustainment costs are calculated, affordability is still a problem, and that might mean that the number of aircraft bought in the near term might be further truncated or that flight training hours are curtailed, [a senior defense official] said. The numbers are expected to fluctuate during the next five years.
Additionally, costs associated with military construction still have to be sorted out.
Eight nations other than the USA have contributed funding to the program. The initial program budgeting assumed sales of 3,100 aircraft to international partners. The eight partners included Australia, Canada, Great Britain, Turkey, Denmark, Holland, Norway, and Italy. In addition, both Japan and Israel have committed to the program.
This recent Reuters story reports that “Britain has deferred to 2015 a firm commitment on how many Lockheed Martin Corp F-35 Joint Strike Fighter jets it will buy, adding to uncertainties over the multinational program.”
This recent article reports—
Defense Minister Giampaolo Di Paola said Italy would cut investment in the radar-evading new fighter, although he said the plane was ‘still an important commitment’ for the country's defense system. He gave no details, but Italian media reports forecast Italy would cut 40 warplanes from the 131 originally planned.
That same article added—
Canadian Defense Minister Peter MacKay repeatedly dodged a question on Tuesday on whether the government was rethinking its planned F-35 purchases, saying only that Canada was committed to buying aircraft that would aid its troops. … Turkey has halved its initial order for four planes, part of a larger order that it has not yet reduced, and Australia is thinking about changing the pace of 12 initial orders.
The issue yet to be faced is what happens if unit costs increase to the point that the aircraft become unaffordable—either for budgetary or for political reasons—by the international partners who have made commitments to acquire a certain number of aircraft? We alluded to this problem in a previous F-35 article, where we wondered whether LockMart might “find itself the builder of a white elephant fighter whose lack of economies of scale make the plane unaffordable for its international partners.”
So to sum it all up, these are clearly tough times for the Lightning II Joint Strike Fighter program. Navy Seals have a saying: “It pays to be a winner.” The Lockheed Martin program management team and its executives are learning what happens to the guy that finishes near the end of the pack. It’s not that the guy is a loser—not at all. After all, he finished and didn’t quit. It’s just that the guy isn’t a winner. Winners get to rest and recuperate, while non-winners have to work harder.
The F-35 program team needs to work a lot harder in order to make the cut.
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What You Need to Know About the FY12 National Defense Authorization Act
Each year, Bob Antonio publishes a world-class analysis of key public laws that impact government contracting, and this year was no exception. WIFCON’s breakdown of the FY2012 National Defense Authorization Act (NDAA) is a must-read for informed compliance and contracting professionals. The reason that the annual NDAA (and other similar legislation) is so important to read is that the contents include Congress’ direction to the DOD. In other words, the contents of the NDAA (and other legislation) drive new FAR and DFARS Cases, which drive revisions to existing regulatory requirements. So to read the NDAA is to glimpse the DAR Council’s future rule-making.
As we scanned the 50 or so separate sections, these are the ones that struck us as being of most importance to our readership and clientele.
Section 803 extended the ceiling on contractor executive compensation, and applies it to all contractor personnel, not just the top 5 highest paid executives at every segment—“except that the Secretary of Defense may establish one or more narrowly targeted exceptions for scientists and engineers upon a determination that such exceptions are needed to ensure that the Department of Defense has continued access to needed skills and capabilities”.
Section 805 required the Director of DCAA to submit an annual report to Congress (separate from the Semi-Annual DOD IG Report) that contains—
- (1) a description of significant problems, abuses, and deficiencies encountered during the conduct of contractor audits; (2) statistical tables showing--
- (A) the total number of audit reports completed and pending;
- (B) the priority given to each type of audit;
- (C) the length of time taken for each type of audit;
- (D) the total dollar value of questioned costs (including a separate category for the dollar value of unsupported costs); and
- (E) an assessment of the number and types of audits pending for a period longer than allowed pursuant to guidance of the Defense Contract Audit Agency;
- (3) a summary of any recommendations of actions or resources needed to improve the audit process; and (4) any other matters the Director considers appropriate.
Section 816 redefined the definition of the term “covered contract” for purposes of complying with the DFARS Business System clauses. The new definition is, “a contract that is subject to the cost accounting standards promulgated pursuant to section 1502 of title 41, United States Code, that could be affected if the data produced by a contractor business system has a significant deficiency.”
Section 818 has been extensively discussed by many industry and technical associations. It required the DOD to assess current processes for detecting and avoiding counterfeit electronic parts, and to enhance them (as well as related acquisition regulations) so as to ensure that weapons systems are free of counterfeit parts. (Longtime readers will recall, perhaps with nostalgia, our many pleas and rants on the topic of secure supply chains.)
Section 853 required an assessment of “the feasibility and advisability of establishing an inventory of rare earth materials….” Again, longtime readers may recall our two articles on the strategic importance of rare earth materials. New readers are advised to use the site’s key word search feature.
Section 862 encouraged contractors to support Science, Technology, Engineering and Mathematics (STEM) programs. This may turn out to be an important Section, since DCAA has historically tended to treat such contractor efforts as unallowable contributions.
Section 2801 prohibited the use of “any form of cost-plus contracting” in relation to any military construction project or military family housing project. It will be interesting to see how the term “cost-plus” is used: whether it will be limited to forms of cost-reimbursement contracting, or whether it will be applied to all forms of “flexibly priced” contracts (which would include T&M contract types).
To sum it all up, there are a number of interesting provisions in the FY12 NDAA. Some will affect cost allowability and others will affect contracting with the Federal government. Stay tuned for the FAR and DFARS rule-making, which will be coming our way shortly.
New Law Imposes Taxes Then Makes Them Unallowable
We quote from the February 22, 2012 Federal Register notice of a proposed FAR revision to implement FAR Case 2011-011—
The James Zadroga 9/11 Health and Compensation Act of 2010 (Pub. L. 111–347) was signed into law and effective on January 2, 2011. Section 301 of the law amends the Internal Revenue Code of 1986 by adding a new Section 5000C, Imposition of tax on certain foreign procurements (26 U.S.C. 5000C). This new section imposes on any foreign person that receives a specified Federal procurement payment a tax equal to 2 percent of the amount of such specified Federal procurement payment. Additionally, the law stipulates that no funds are to be disbursed to any foreign contractor in order to reimburse the tax imposed.
According to the proposed rule, the 2 percent tax on payments to foreign “persons” will not only be unallowable, it also cannot be proposed in estimates for fixed-price proposals (even if the FAR Cost Principles do not apply to the procurement). The proposed rule specifies that “the costs for the 2 percent tax [cannot be] included in foreign fixed-price contracts and foreign fixed-price contracts with foreign governments.”
The foregoing summary is perhaps superficial, and likely omits nuances and complexities that matter to compliance professionals. So with your kind permission, we’ll take some time and dig into this a little bit.
Importantly, the excise tax does not apply to every contract with a foreign entity. Instead, it is imposed on contracts for (a) goods that are manufactured by foreign entities outside the United States, or (b) services performed by foreign entities outside the United States, when the country in which the goods are produced (or services provided) is not “party to an international procurement agreement” with the United States.
Unfortunately for us all, the statute fails to define what is meant by the term “international procurement agreement,” so we are left in the wilderness of ignorance, searching for direction. Fortunately for us all, the “Big 4” accounting and professional services firm, Deloitte, thinks it has some good direction to give us, which you can find right here. The folks at Deloitte assert—
Although a payment can be received tax free if a relevant ‘international procurement agreement with the United States’ applies, the Act does not provide any definition of that term. We understand, however, that it was intended to include the World Trade Organization’s (WTO) Agreement on Government Procurement (GPA), as well as free trade agreements (FTAs) between the U.S. and other countries that contain government procurement-related obligations.
- The GPA is a ‘plurilateral agreement’ of the WTO in which a signatory country agrees not to discriminate against suppliers of goods and services in other signatory countries in the area of government procurement. As a plurilateral agreement, some, but not all, of the WTO members have agreed to be bound by its provisions. To date, 40 WTO members have signed the GPA, including Canada, Israel, Japan, Korea, the 27 EU Member States and the U.S. However, many major trading partners of the U.S. have not signed the GPA, including China, Brazil, India and countries in the Middle East (although a number of these countries are currently negotiating accession).
- FTAs that contain government procurement obligations include the North American Free Trade Agreement (NAFTA), the Dominican Republic-Central America-U.S. Free Trade Agreement (CAFTA-DR), and bilateral FTAs between the U.S. and Australia, Bahrain, Chile, Israel, Morocco, Oman, Peru and Singapore.
The folks on the FAR Councils were smart enough not to try to define terms that weren’t otherwise defined for them, even if that meant that we compliance practitioners would be left in the wilderness of ignorance. As a result, they have proposed to revise the Cost Principle at 31.205-41 (“Taxes”) to state that “any tax imposed under 26 U.S.C. 5000C” will be unallowable. Similarly, several solicitation provisions and contract clauses were proposed to be revised by making reference that same section of the Internal Revenue Code. (See, e.g., 55.229-3, -4, -6, and -7.)
Consequently, in order to determine whether or not an excise tax should be imposed, and whether or not estimated project margins should be reduced by the value of that 2 percent excise tax, you first need to know (a) the country involved, and (b) whether that country has signed a Trade Agreement with the U.S.A. These decision points will need to be addressed at the time the proposal is being prepared—or, even better, at the time of the bid/no bid decision.
Remembering that this is a proposed rule—and not a final rule—readers may want to offer comments to the FAR Councils regarding FAR Case 2011-011.
Were we to offer our comments, we might focus on addressing the inequities involved in mandating a tax and then making it unallowable—especially when the tax appears to be applied somewhat inequitably only on foreign concerns of certain countries. The obvious result of the imposition of the excise tax would be to hurt the ability of foreign contractors to compete with U.S.-based contractors. But the other, perhaps unintended, result would be to make it harder for U.S. contractors to sell their goods and services in the international marketplace.
“How so?” you well may ask. Let us explain our thinking.
In 2010, the United States of America exported about $170 Billion worth of military goods and services to other nations (according to this article). As U.S. defense budgets decline, U.S. aerospace and defense companies (such as Lockheed Martin, Northrop Grumman and Raytheon—to name just a few of the biggies) must rely more and more on their international sales in order to maintain top-line revenue, their stock prices, and their workforces. It is axiomatic that international sales are key to maintaining, or growing, existing market share.
Frequently, in order to close an international deal, companies must agree to a certain amount (or percentage) of “offset” work. As the Wikipedia article we linked-to explains—
As an example of a defense offset proposal we could describe a hypothetical case of Nation P (Purchaser) buying 300 tanks from defense company S (Seller, of Nation S). The total sale contract is $400 and Nation P (Purchaser) requests 120 % of offset. Defense Company S (Seller) is obliged to fulfill an offset equal to 120% of the sales contract, that is 480 M USD. Nation P agrees on a list of specific offset deals and programs to fulfill the agreed total obligation with Company S (Seller). The offset agreement includes both direct and indirect offsets.
The point is, in the foregoing example, Company S is obligated to provide (among other things) a certain amount of subcontracted work to companies located within Nation P. Under the proposed FAR rule (and pursuant to the requirements of the Public Law), unless Nation P is a signatory to a Trade Agreement with the U.S.A., its offset work will be subject to the 2 percent excise tax, which will come out of the profit of the foreign entities, since it neither can be priced-in to bids nor claimed as a reimbursable expense.
That’s going to make executing offset agreements harder, which is going to make exporting defense goods and services harder. A slow-down in exports is going to put additional pressure on the future revenue of U.S.-based A&D companies, which is going to lead to further cost-cutting measures such as workforce reductions.
So that’s our thinking. As you might guess, we are not big fans of this proposed rule, or of the statutory provision that mandated it.
We could mention that including this particular provision in a statute designed to compensate 9/11 First Responders might create the perception that it is a thinly veiled attempt at retaliation aimed at certain countries. We’ll give the drafters the benefit of the doubt on that one. But it might also reasonably be viewed as one more attempt to protect the U.S.-based A&D industry from international competition. If so, wouldn’t it be ironic that the same provision designed to protect U.S.-based contractors might end up hurting them in the long-run?
The foregoing situation is sometimes called creating “unintended consequences.”
So that’s what we would say, if we were submitting comments on this proposed rule. The thing is, since the rule-making is mandated by Public Law, we don’t believe that the Councils have much latitude in the changes they can make. The time to have commented was when the Bill was being considered by Congress. Now it’s pretty much a done-deal.
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