"Fatally Flawed" Compensation Audit - Part 2

Yesterday, we reported on a recent ASBCA decision that calls into question the methodology used by the Government to assess the reasonableness of contractor compensation levels. The Government of course could appeal that decision. But in the meantime, we have a new methodology, accepted by the ASBCA, for determining "reasonable" compensation levels. The Board's methodology generally results in higher benchmark compensation level when compared to the Government's methodology, We recommend you use it. The methodology is somewhat technical and beyond the scope of this blog but if you are in a situation where your compensation levels are being reviewed and/or questioned, we recommend you seek out expert help in that field.

Compensation for each employee or job class of employees must be reasonable for the work performed. Compensation is reasonable if the aggregate of each measurable and allowable element sums to a reasonable total. In determining the reasonableness of total compensation, contractors must consider factors determined by the contracting officer (who has the ultimate responsibility for deciding whether compensation is reasonable) to be relevant. According to FAR 31.206.b.(2), this would usually entail a comparison with compensation practices of other firms of the same size, in the same industry, in the same geographic area, and engaged in similar non-Government work under comparable circumstances. Making such comparisons, indeed finding the raw data with which to make such comparisons is very difficult. Such work has often been called an "art" rather than science or analysis.

There are a few, benchmarking surveys on the market. Their cost however is often prohibitive for small contractors. Even though the Government relies on them to perform benchmarking studies, these surveys have limitations because its often difficult to find enough companies of the same size, industry, geographical area, doing commercial work under comparable circumstances to make meaningful comparisons. Also keep in mind that there is no FAR requirement for contractors to purchase these surveys, even though the Government often tries to push them into doing so.

"Fatally Flawed" Compensation Audit

In a decision likely to affect the methodology by which the Government assesses the reasonableness of contractor compensation levels in the future, the ASBCA (Armed Services Board of Contract Appeals) issued a decision last week stating that the methodology used by DCAA (Defense Contract Audit Agency) to assess the reasonableness of compensation was "fatally flawed statistically and therefore unreasonable". The methodology that DCAA used in this case followed the guidance in its Contract Audit Manual (Chapter 5) and the same one used in thousands of compensation reviews over the years. If you have ever had employee compensation questioned by the Government, you will want to read this decision.

In the present case, the contractor challenged DCAA's methodology for determining reasonable executive compensation based on four discrete arguments. The first argument contended that the Government's methodology was fatally flawed as a matter of basic statistical analysis. The Board found that the contractor's first argument was sufficient to prove its case so it did not need to address the contractor's other arguments.

The Government didn't help itself in this case either. In its decision, the Board wrote:

The government made no effort at the hearing or in its brief, to respond to the statistical arguments made by appellant and thus we are left with unrebutted evidence that the methodology used by DCAA was fatally flawed statistically and therefore unreasonable. Moreover, the government effort to support its own methodology was supplanted by an expert witness of questionable judgment. Consequently, we conclude that there are statistical flaws in the government methodology for determining reasonable compensation and that the computations performed by (the contractor's expert) to overcome those flaws are reasonable.

Order of Precedence - Contract Modifications

The Department of Defense is proposing to amend its FAR supplement (the DFARS) to establish an order for application of contract modifications to resolve any potential conflicts that may arise from multiple modifications with the same effective date. Although it does not happen frequently, there are enough cases involving contract modifications with conflicting contract provisions that have the same effective date, to make such a regulation desirable.

Currently there are no rules to describe in what order to apply modifications to determine the actual content of a resulting modified contract. In order to determine the sequence of modifications to a contract or order, a method for determining the order or application for modifications will resolve any conflict arising from multiple modifications with the same effective date.

Under the new regulations, modifications will be applied in the following order:

1. Modifications will be applied in order of the effective date on the modification.
2. In the event of two or more modifications with the same effective date, modifications will be applied in signature date order.
3. In the event or two or more modifications with the same effective date and the same signature date, procuring contracting office modifications (contract modifications beginning with the letter "P") will be applied in numeric order, followed by contract administration office modifications (contract modifications beginning the the letter "A") in numeric order.

Proposed Change to Definition of Cost or Pricing Data

DoD is moving to replace all references to "Cost or Pricing Data" to "Certified Cost or Pricing Data in its FAR Supplement (DFARS).  This is not a significant change to the procurement regulations but it should clear up some confusion by making it clear when cost or pricing data submitted in response to a Government solicitation must be certified. The change should also improve consistency between DFARS and FAR. FAR was amended several months ago to add the word "certified" to the definitions of Cost or Pricing Data.

Under existing regulations, contracting based on the submission of certified cost or pricing data is considered a last resort. If there is adequate price competition, if prices are set by law or regulations, or if acquiring commercial items, etc, contracting officers are precluded from requiring certified cost or pricing data. The contracting officer can however request "information other than cost or pricing data" necessary to make a determination that proposed prices are reasonable. Sometimes this "information other than cost or pricing data" is required to be submitted in a format and detail that looks just like regular cost or pricing data. And that's where the confusion set in. There was anecdotal evidence that contracting officers were requiring prospective contractors to certify the "information other than cost or pricing data.

By the way, the threshold for requiring certified cost or pricing data (FAR 15.403-4) remains at $700 thousand.

Proposal to Streamline Submission of Interim Vouchers

The Department of Defense is proposing to make a significant revision to its procedures for processing interim vouchers by taking away the Defense Contract Audit Agency's (DCAA's) authority to approve contractors for direct billing. Under current regulations (DoD FAR Supplement 242.803), DCAA can authorize contractors to directly submit their vouchers for provisional payment to the disbursing office when DCAA is satisfied that the contractor's billing system is adequate. For contractors without approved billing systems, interim vouchers must first go through DCAA for review and approval. Contractors that are able to submit interim vouchers directly Government paying offices, can often significantly reduce the cycle time between voucher submission and payment and that means faster cash flows.

Under the proposal published January 19, 2012, every contractor is automatically approved for direct billing. DCAA has no say in the matter. The only interim vouchers that DCAA can review prior to payment are those "selected using sampling methodologies". This proposal represents a significant diminution of DCAA's authority and responsibility and is yet another example of how DoD is systematically dismantling its auditing arm or, as some have called "its first line of defense" against contract irregularities.

You can read the entire proposal here.

Any comments received by March 19, 2012 will be consider in the formation of the final rule.