Subcontract Administration - Part 3 - Monitoring Subcontracts

Continuing on in our discussion of subcontract administration, we look today at the contractor's responsibilities for administering subcontracts. The fundamental requirement is found in FAR 42.202(e)(2) as follows:

The Prime contractor is responsible for managing its subcontracts. The CAO's (contract administration official) review of subcontracts is normally limited to evaluating the prime contractor's management of the subcontracts. Therefore, supporting contract administration shall not be used for subcontracts unless

• The Government otherwise would incur undue cost,
• Successful completion of the prime contract is threatened, or
• It is authorized by some other regulation.

The term "managing subcontracts" encompasses not only what contractors might consider necessary but also activities that the Government considers necessary. For example,

1. Subcontract award
2. Technical performance
3. Financial performance
4. Monitoring (including QA and QC)
5. Payment

A contractor's internal control system over subcontracts (and intercompany orders as well) should provide for appropriate flow-down clauses into the subcontract. There are a lot of prime contract clauses that must flow-down to subcontracts. Depending upon the type of subcontract, clauses (i) giving the prime contract access to a subcontractor's books and records, (ii) limiting billings to only allowable costs, and (iii) requiring subcontractors to submit annual incurred cost proposals must be flowed down to the subcontracts.

Essentially, anything that the contracting officer does when awarding contracts (establishing requirements, selecting the contracting vehicle, selecting source, and negotiating prices), is expected of contractors when awarding subcontracts. After award, anything that DCMA (Defense Contract Management Agency) or DCAA (Defense Contract Audit Agency) does in administering and providing oversight of contracts is expected of prime contractors with respect to their subcontracts.

DCMA conducts periodic purchasing system reviews of the most significant Government contractors to ensure that their subcontracting policies, procedures, and practices are adequate for protecting the Government's interests. It is to the contractor's benefit to have their system considered adequate to avoid the need to secure the contracting officer's consent to subcontract and also to avoid billing withholds.

Subcontract Administration - Part 2 - Consent to Subcontract

The level of Government oversight on contractors' subcontracting practices is highly dependent upon the adequacy of contractors' purchasing systems. Most Government contracts include FAR Clause 52.244-2, Subcontracts. The requirements under this clause depends upon (i) whether the contractor has an approved purchasing system and (ii) the type of contract involved. An approved purchasing system is one that has been reviewed and approved in accordance with FAR Part 44 (FAR Part 44 is a subject for another day but to see what is required to have an approved purchasing system, go here). Consent to subcontract means the Contracting Officer's written consent for the Contractor to enter into a particular subcontract.

If a contractor does not have an approved purchasing system, the contractor must obtain a consent to subcontract from the contracting officer prior to awarding a subcontract under a contract that is cost-reimbursable, time-and-materials, or labor-hour. Additionally, consent to subcontract is required for fixed-price contracts that are greater than the simplified acquisition threshold (currently $150 thousand) or five percent of the estimated contract cost.

If a contractor has an approved purchasing system, the Government reserves the right to require a "consent to subcontract". These are usually and specifically spelled out in the contract, and, in our experience, a somewhat rare occurrence.

Contractors must provide a minimum level of information when applying for a consent to subcontract. Among the data required are the following:

• A description of the supplies or services to be subcontracted
• Identification of the type of subcontract to be used
• Identification of the proposed subcontractor
• The proposed subcontract price
• The subcontractor's current, complete, and accurate cost or pricing data and certificate of current cost or pricing data (when required).
• The subcontractor's Disclosure Statement or Certificate relating to Cost Accounting Standards (when required)
• A negotiation memorandum reflecting
• The principal elements of the subcontract price negotiations
• The most significant considerations controlling establishment of initial or revised prices
• The reason cost or pricing data were or were not required
• The extent, if any, to which the contractor did not rely on the subcontractor's cost or pricing data in determining the price objective and in negotiating the final price
• The extent to which it was recognized in the negotiation that the subcontractor's cost or pricing data were not accurate, complete, or current, the action taken by the contractor
• The reasons for any significant difference between the contractor's price objective and the price negotiated; and
• A complete explanation of the incentive fee or profit plan when incentives are used.

It is important to note that consent does not mean constitute a determination that subcontract costs are allowable, that all the subcontract terms and conditions are acceptable nor that the contractor is relieved from any responsibilities under the contract.

Finally, contractors should build into their processes, sufficient time for the Government to review the "consent" file. The time required by the Government varies considerably and is somewhat dependent upon the complexity and value of the subcontract. At a minimum, allow 30 days but to be safe, allow 60 days.

Subcontract Administration - Part 1

Its been a long time since we discussed a contractor's responsibility for monitoring subcontracts (see this post from 2009 which focused on surveillance responsibilities). Over the next few days, we are going to dig a little deeper into exactly what FAR requires when it comes to the prime contractor/subcontractor relationship.

To be "responsible", a contractor (or subcontractor) must have adequate financial resources to perform the contract, or the ability to obtain them, (ii) be able to comply with the required or proposed delivery or performance schedule, taking into consideration all existing commercial and governmental business commitments, (iii) have a satisfactory performance record, (iv) have a satisfactory record of integrity and business ethics, (v) have the necessary organization, experience, accounting and operational controls and technical skills (or the ability to obtain them), (vi) have the necessary production, construction, and technical equipment and facilities or the ability to obtain them, and (vii) be otherwise qualified and eligible to receive an award under applicable laws and regulations (see FAR 9.104-1).

In the case of a prime contract, the Government must determine "responsibility" before awarding a contract (see our recent seven-part series on preaward surveys). When it comes to subcontracting however, it is the prime contractors' responsibility, not the Government's, to determine subcontractor "responsibility". In essence, everything the Government does to ensure prime contractor responsibility, the prime contractor should replicate to determine subcontractor responsibility. This is a tall order but is absolutely required by FAR 9.104-4 (unless, in rare circumstances, the Government decides to take on that responsibility itself).

The approval to subcontract out part of a Government contract is not automatic. On Monday, we will look at the "Consent to Subcontract" clause.

Contract Options

Contract options allow the Government, for a specified time and at a specified price, to purchase additional supplies and services called for in a contract. Options seem like a pretty good deal - contractors increase their sales when the Government exercises options - but they are not without some risk. Sometimes its very difficult to predict prices three to five years in the future. A lot of contractors got hit hard when fuel price increased substantially in the late 90s. Its sometimes difficult to predict the availability of the type of labor needed for a particular project. If there's a local building boom going on, the wage scales and availability of construction workers is impacted. 

Generally, the contract period including all options may not exceed five years. This is not to be confused with delivery period which may exceed the five year limitation. 

Options are not automatic. The Government has a little homework to do before exercising options. The contracting officer must

• ensure that funds are available
• the requirement fills an existing need
• the exercise of the option is the most advantageous method of fulfilling the Government's need, price and other factors considered. This includes determinations that
• a new solicitation fails to produce a better price or more advantageous offer or 
• an informal analysis of the market indicates the option is more advantageous
• the time between contract award and exercise of the option is so short that the option is most advantageous

The decision to exercise options is the sole discretion of the Government. Decisions not to exercise are not typically protestable. So, contractors cannot count on the Government's exercising options to support plant expansions or long term labor contracts. There's no guarantees when it comes to options.

When proposing and negotiating option prices, contractor's need to ensure that there is sufficient provisions in the option prices to cover known and unknown market conditions. If the Government sees a bargain price, its going to take it as opposed to opening up the bidding process again. And, a bargain price for the Government is likely to hurt the contractor.

The Truman Committee

Back in 1940, a relatively unknown Harry S. Truman was elected Senator from the State of Missouri. While campaigning in Missouri, Truman heard about wasteful spending and profiteering in the construction of Ft. Leonard Wood. After being elected and determined to see for himself whether the stories were true, he jumped into his Plymouth (some accounts say it was a Dodge) and drove not only to Ft. Leonard Wood but to many other military installations across the mid-west and down to Florida. In fact, he traveled more than 10,000 miles on these visits. Everywhere he traveled, he witnessed poverty among the workers and contractors reaping excess profits off of their cost reimbursable contracts. He found no accountability for poor quality and he also found that most of the contracts were held by a small number of contractors based on the East Coast rather than spread out among companies in the various states.

He returned to DC and reported his findings. A year later, in 1941, the Senate formed the "Senate Special Committee to Investigate Contracts Under the National Defense Program" (later known as the Truman Committee) and appointed Truman to head it up. From 1941 until he stepped down to concentrate on running for Vice President, the Truman Committee held 432 public hearings, listened to 1,798 witnesses and published 2,000 pages of reports. It is said that his efforts saved billions of dollars in wasteful military spending and saved countless lives. The bi-partisan Truman Committee had a reputation for honesty and courage, was viewed as successful and the headlines it generated became popular among the American people. Truman's dogged pursuit of unscrupulous contractors propelled him into the Vice Presidency.

Some historians believe that Truman was the precursor to the contract management we have today; the Defense Contract Management Agency, the Defense Contract Audit Agency, the various Inspector General organizations, the Office of Federal Procurement Policy, the Government Accountability Office and many others. Certainly, none of these Agencies existed before the Truman Committee nor was there any other form of organized contract oversight. In fact, the Committee was extremely critical over the lack of Government oversight of Government contracts and many of its recommendations centered upon the need for increased contract oversight.

The next time someone shows up to conduct a review of one of your business systems, a proposal you've submitted, a payment request you've turned in, or to see whether you've engaged in any defective pricing, you can thank the man where the "buck stopped".

From all of us at Pacific Northwest Consultants, have a Merry Christmas. We'll be back on Thursday.

What are "Letter Contracts"?

A "Letter Contract" (also known as an Undefinitized Contract Action or UCA) is a type of contract. Its a temporary contract that allows contractors to get started on a project before a "real" contract can be negotiated. Letter contracts are used rarely and only when the Government's interests require that work start immediately because there is insufficient time to negotiate a definitive contract. We see these used in contingency operations (e.g. Iraq & Afghanistan) or in natural disasters (Katrina) to get supplies or relief rolling. Letter Contracts are also used to allow contractors to procure "long lead" items that need to be ordered immediately in order to complete production by a specified due date.

The use of a letter contract must be approved, in writing, by the head of the contracting activity (HCA). This approval must include a finding that no other contract is suitable (see FAR 16.603-3). The letter contract must also include a NTE (not-to-exceed) price. Herein lies the risk for both the Government and contractor. If the Government does not have time to negotiate a contract, the contractor probably doesn't have sufficient time to prepare an adequate estimate of costs. Significant oversights could lead to unanticipated financial burden. On the other hand, since the contractor does not have sufficient time to prepare an adequate estimate, the tendency is to throw everything including the kitchen sink into the NTE price (defective pricing does not apply at this point in the contracting process). If any of those costs have been incurred at the time of contract definitization, the Government is hard -pressed to question them.

The Government and the contractor are required to definitize  a letter contract (agree upon contractual terms, specifications, and price) by the earlier of

• 180 day period after the date of the letter contract, or 
• The date on which the amount of funds obligated under the contract action is equal to more than 50 percent of the negotiated overall ceiling price for the contractual action.

Letter contracts do not obligate the Government to pay up to the amount of the NTE price. The maximum liability of the Government is the estimated amount necessary to cover the contractor's requirements for funds before definitization, but shall not exceed 50 percent of the estimated cost of the definitive contract unless approved in advance by the official who authorized the letter contract.

There are a few restrictions on the use of letter contracts. They cannot be used to

• Commit the Government to a definitive contract in excess of funds available at the time of contract.
• Be entered into without competition when required.
• Be amended to satisfy a new requirement unless that requirement is inseparable3 from the existing letter contract.

Government Contractor Disclosure Program

By now, most contractors know that if they have a $5 million contract, they need a code of business ethics and conduct. If you're unsure, check your contract(s) to look for FAR Clause 52.203-13, Contractor Code of Business Ethics and Conduct.

There are a number of facets to the code of ethics and conduct clause but today we want to focus on just one of those; the requirement for contractors to disclose to the Government, credible evidence of criminal violations involving fraud, conflict of interest, bribery, gratuity violations, or violations of the civil False Claims Act. The exact wording reads as follows:

(3)(i) The Contractor shall timely disclose, in writing, to the agency Office of the Inspector General (OIG), with a copy to the Contracting Officer, whenever, in connection with the award, performance, or closeout of this contract or any subcontract thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed—
     (A) A violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code; or
     (B) A violation of the civil False Claims Act (31 U.S.C. 3729-3733).

This is a significant clause and more than a few contractors are getting tangled up in failing to comply with the requirements. Some contractors have plead ignorance to a particular situation maintaining that they didn't know about the impropriety. Some have maintained that the impropriety had no impact on Government contracts. Others have tried to wiggle around the word "credible", asserting that a hint or inkling doesn't make it "credible". Still others have maintained that they didn't know the "impropriety" rose to the level of criminal law or violations of the False Claims Act. 

The DoD-IG (Inspector General) has made it rather easy to file a written notice of violations. They've set up a special website called the Contractor Disclosure Program where contractors can complete an on-line form and wait for a knock on their door from their investigators. Other Agency's have similar programs. The purpose of this website is to 

• Afford contractors a means of reporting certain violations of criminal law and violations of the civil False Claims Act discovered during self-policing activities
• Provide a framework for government verification of the matters disclosed; and
• Provide an additional means for a coordinated evaluation of administrative, civil, and criminal actions appropriate to the situation.

This particular website has additional information that will be useful to contractors preparing to self-disclose some form of contract irregularity.

"Reporting" is not a matter to be taken lightly and we always recommend that contractors contact legal counsel before doing so. 

If you need assistance in setting up an ethics program for your firm, give us a call.

Protecting Proprietary Information

Government contractors have always been reluctant to provide the Government with data and information that it considers proprietary. Its a natural reaction. After all, who really knows what happens to information once it gets sucked into the bowels of the Government bureaucracy. Is it passed around? Is it carelessly left unprotected for anyone to view/copy/steal? Is it given to competitors?

In our experience, Government contractors do not have too much to be concerned about. Government employees are trained and instructed to protect all contractor data - regardless of whether the data contains protective markings. Data provided to auditors for example, get bound into folders and stuffed into filing cabinets for a few years, then boxed and sent to a Federal Records Center for a few more years, then destroyed. There is very little risk that contractor proprietary data will get into the wrong hands. There is less risk that if the information should leak out, it would irreparably harm the contractor.

There was one case many years ago where Congress requested contractor proprietary information from Defense Contract Management Agency (DCMA) that was subsequently publicized in a Congressional hearing. The contractor protested loudly and for a long time afterward, there was a lot of mistrust whenever DCAA or DCMA requested proprietary information necessary to perform its work.

Anyone who releases proprietary information to an unauthorized party, risks fines and jail time. The law pertaining to unauthorized disclosure of contractor information, and penalties for violation thereof, is contained in 18 USC 1905:

Whoever, being an office or employee of the United States or of any department or agency thereof, any person acting on behalf of the Office of Federal Housing Enterprise Oversight, or agent of the Department of Justice as defined in the Antitrust Civil Process Act, or being an employee of a private sector organization who is  or was assigned to an agency under chapter 37 of title 5, publishes, divulges, discloses, or makes know in any manner or to any extent not authorized by law any information coming to him in the course of his employment or official duties or by reason af any examination or investigation made by, or return, report or record made to or filed with, such department or agency or officer or employee thereof, which information concerns or relates to the trade secrets, processes, operations, style of work, or apparatus, or to the identity, confidential statistical data, amount or source of any income, profits, losses or expenditures of any person, firm, partnership, corporation, or association; or permits any income return or copy thereof or any book containing any abstract or particulars thereof to be seen or examined by any person except as provided by law, shall be fined under this title, or imprisoned not more than one year, or both; and shall be removed from office or employment.

One last thing. Contractors who object to providing routinely requested information will sometimes pique an auditor's curiosity. Auditors might wonder what the contractor is trying to hide and they'll dig a little deeper than they might otherwise have. That's called "risk assessment".

Government Settles for 30 Cents on the Dollar

After 22 years, Boeing and General Dynamics are finally going to pay-off their $1 billion debt to the Navy by providing about $400 million in in-kind products; three aircraft and a ship deckhouse, hanger, missile-launching system. Not a bad deal for the Companies, not so good for the taxpayers. The settlement is conditional upon passage of the 2014 NDAA (National Defense Authorization Act) as its currently constructed.

Back in 1988, the Air Force was flying around in stealth aircraft. The Navy was jealous and wanted its own stealth attack jet. So, it awarded a firm fixed-price contract to a consortium of McDonnell Douglas (a company that has since been bought by Boeing) and General Dynamics to buy eight planes for $4.7 billion. Deliveries were scheduled for January 1991. The contract also had an option for purchasing another 850 or so aircraft.

By June 1990, the program was in serious trouble. The airplane was 30 percent heavier than specifications and there were a host of other technical issues as well. The companies notified the Navy that they could not deliver the aircraft on time and more importantly, the cost of completing the eight plane contract had grown from $2 to $5 billion.

In 1991, then Secretary of Defense Dick Cheney terminated the contract for default (T for D) and the Navy demanded that the contractors return the $1.35 billion already advanced under the contract.  The companies refused so the matter has been in the courts ever since. In 2011, the Supreme Court ruled that the Navy was justified in terminating the contract but the matter went back to lower courts for decisions on other issues where it has remained.

Congress feels justified with the settlement. It felt the settlement was good for the Navy at a time of tight budgets and "incredible fiscal challenges" and good for the taxpayers because there's no guarantee that the government will ultimately prevail in the ongoing litigation. Also, it will end decades of litigation. Think about that for a moment - 22 years of litigation - there's probably attorneys and others that have spent entire careers on this one issue.

Penalties for Unallowable Costs

Let's talk about penalties for unallowable costs. It's pretty well known that if an auditor finds unallowable costs in your annual incurred cost submission, they'll recommend that the Contracting Officer slap you with a penalty. There are provisions to waive the penalty; e.g where the unallowable costs total less than $10 thousand or you can do a bang-up job of convincing the Contracting Officer that you've really got it together now and it'll never happen again. But it seems to us that the Government is less inclined these days to be so forgiving.

There are two kinds of penalties. There are the penalties that apply to unallowable costs defined in FAR Part 31 or the corresponding Agency FAR Supplements. The other penalty applies where the Contracting Officer determines that a cost submitted by the Contractor in its proposal includes a cost previously determined to be unallowable for that Contractor. This latter penalty could get costly as it is double the amount of unallowable costs charged to the contract(s).

A recent settlement (announced this month) between Northrop Grumman and the Government nicely illustrates the application of the second penalty. Northrop Grumman paid $11.4 million to settle a Government claim based on its failure to abide by a 2002 settlement agreement with DCMA (Defense Contract Management Agency). Northrop charged costs related to deferred compensation to key employees to Government contracts even though it had promised not to do so as part of the 2002 settlement.

The Contracting Officer found that Northrop had failed to honor its commitment and assessed a penalty equal to twice the amount of the unallowable costs. Northrop appealed to the U.S. Court of Federal Claims in Washington, D.C. Ultimately, Northrop decided to settle for the $11.4 million.

So, if you've reached agreement with the Contracting Officer over the allowability of certain costs, be careful to exclude the same or similar costs from any billings or incurred cost submissions.

Executive Compensation - December Update

Last month, we discussed the various executive compensation caps that exist within the President's budget and the Senate and House versions of the 2014 NDAA. You can read about it here.

The latest news on this subject has the House and Senate Armed Services Committee reaching an agreement on the cap. This agreement sets the cap at $625 thousand and provides for adjustments based on the BLS's (Bureau of Labor Statistics) Employment Cost Index. That index is currently hovering around the two percent level.

The House Armed Services Committee introduced the agreement with these words. The "flawed formula" being discussed is the one that has executive compensation set at $950 thousand for 2012.

Executive Compensation Reform: The NDAA recognizes the White House’s formula for calculating allowable private sector compensation on DOD contracts has become dysfunctional and does little to protect the taxpayer or provide transparency in government contracting. The NDAA rationalizes the cap to $625,000 and does away with the flawed formula. The NDAA allows for the cap to be adjusted based on the Employment Cost Index, which is commonly known and publicly available index computed by the Bureau of Labor Statistics. The NDAA rejected calls by some to cap individual industry compensation at the President or Vice President’s salary level, as such a standard represents an arbitrary comparison between compensation and salary and will only serve to drive critical talent from the nation’s defense industrial base.

The specific wording appearing in the Bill, amending Section 2324(e)(1) of title 10, United States Code, states that the following costs are unallowable:

Costs of compensation of any contractor employee for a fiscal year, regardless of the contract funding source, to the extent that such compensation exceeds $625,000 adjusted annually for the U.S. Bureau of Labor Statistics Employment Cost Index for total compensation for private industry workers, by occupational and industry group not seasonally adjusted, except that the Secretary of Defense may establish exceptions for positions in the science, technology, engineering, mathematics, medical, and cybersecurity fields and other fields requiring unique areas of expertise upon a determination that such exceptions are needed to ensure that the (Government) has continued access to needed skills and capabilities.’’.

The House passed this version of the 2014 NDAA (National Defense Authorization Act) but the Bill has not passed in the Senate yet, where, some 507 amendments have been offered. Reports we've read however, state that the Senate is rushing to pass it before the end of the year.

One Person Company Gets a $15 Million Subcontract

The Department of Justice has just stepped in on a Qui Tam action filed by a scorned small business. Last week, the Department filed a civil complain under the False Claims Act alleging that a DOE (Department of Energy) contractor falsely claimed credit for awarding tens of millions of dollars worth of federal subcontracting business to small businesses including woman-owned small businesses.

The complaint alleges that the contractor claimed these small businesses would perform subcontracted work, but that those companies were really used merely as pass-throughs and the actual work was performed by another subcontractor who is not a small business.

The prime contractor, operating a cost reimbursable contractor for DOE (Energy) is required to award a certain percentage of subcontracts to small businesses and disadvantaged small businesses, including woman owned small businesses. Failure to meet the targets would result in a reduction of fees or profit.

In this case, the complaint alleges that the contractor falsely represented to DOE that it had awarded three different multi-million dollar subcontracts to two different woman-owned subcontractors when in fact, those entities were merely pass-through entities for another subcontractor who wasn't a small business. One of those two companies had only one employee, the owner, and received more than $15 million in subcontracts. The subcontractor farmed all the work out to the non-small business subcontractor.

According to a related article in the local newspaper, the non-small business subcontractor denied any wrongdoing stating that teaming arrangements were very common and encouraged by DOE.

This entire matter was first raised by a different small business who had bid and lost on several subcontracting opportunities. The owners investigation into the matter led to the Qui Tam action and subsequent civil suit by the DOJ. Should the Government prevail, the whistleblower stands to share in the proceeds.

You can read the DOJ's full press release here.

Healthcare Costs for Ineligible Dependents - Cost/Benefit

For the past three days, we've been discussing the new DFARS (DoD FAR Supplement) Cost Principle on Fringe Benefits. The new rule reads:

Fringe benefit costs that are contrary to law, employer-employee agreement, or an established policy of the contractor are unallowable.

Someone asked us about the definition of ineligible dependents. It depends upon the healthcare policy's definition of "dependent". Often, dependent children become ineligible because of age or they lose their full-time student status. Companies can track ages pretty well but its more difficult to determine whether the child remains a full-time student. Divorces can also make ex-spouses ineligible. Ultimately, one needs to review the eligibility requirements of the health insurance policy. Everyone is a bit different - and some are much more generous than others.

Continuing now with the Q&As from the draft rule.

One respondent suggested that the rule will force companies to expend disproportionate sums to ensure no claims for costs include ineligible healthcare costs in order to avoid penalties. DoD replied that ineligible fringe benefit costs are already unallowable under existing regulations. The new rule only make them expressly unallowable so that penalties can be levied.

Another respondent asserted that the costs of internal controls should not exceed the actual costs of the ineligible benefits. Treating the costs as expressly unallowable is likely to force companies to spend more money than they would otherwise, in order to avoid the penalties. The result will be increased allowable costs to the Government in exchange for little or no value. DoD cited research that indicates the cost of ineligible dependent health care claims often far excceds the cost of dependent verification programs. DoD was unable to find any studies or other evidence indicating that the cost to detect ineligible claims is higher than the cost savings. Here again, we're suspicious of these "studies". 

Perhaps we've beaten this subject to death. In closing, we want to make sure that everyone understands the importance of insuring compliance with this new rule. It's not going away and we don't expect that DCAA will be satisfied with existing internal controls systems no matter how comprehensive they may be. We know of a company that is 93 percent commercial, 7 percent government and has a TPA (third party administrator) performing eligibility verification. That wasn't enough for DCAA because the contractor had no procedures in place to ensure that the TPA was doing the job it was paid to do. As a result, DCAA questioned significant costs assuming that all dependents over 18 were ineligible.

9.Fully or Partially Subject to CAS

Comment: One respondent asserted that the proposed rule has the effect of discriminating against companies that are fully or partially subject to CAS. The respondent asserted that, for those fully subject to CAS and those partially subject to CAS, the potential risk for liability for claiming unallowable costs is significant, while companies that are not subject to CAS have no such liability and do not face the possibility of False Claims Act prosecutions, Civil False Claims Act damages, qui tam lawsuits or debarment/suspension. A rule that allows companies subject to CAS to use a reasonable method for dealing with these costs will reduce the cost to the companies and reasonably protect the government from paying for the costs of ineligible dependent healthcare costs.

Response: The rule and, thus, the potential liability to incur penalties, apply equally to all contractors regardless of whether they are subject to CAS. Therefore, the rule does not discriminate against companies that are fully or partially subject to CAS. Additionally, the assertion that companies not subject to CAS do not face the possibility of False Claims Act prosecutions, Civil False Claims Act damages, qui tam lawsuits or debarment/suspension is inaccurate.

Healthcare Costs for Ineligible Dependents - Wasn't Clear - Now It's Clear

For the past two days, we've been discussing the new DFARS (DoD FAR Supplement) Cost Principle on Fringe Benefits. The new rule reads:

Fringe benefit costs that are contrary to law, employer-employee agreement, or an established policy of the contractor are unallowable.

Today and tomorrow we want to highlight a few of the comments made by interested parties to the proposed rule.

One respondent to the draft rule stated that the treatment of ineligible fringe benefit costs as expressly unallowable does not comport with CAS 405. CAS 405 uses the term "expressly" in the definition of "expressly unallowable costs" as "...that which is in direct and unmistakable terms." The respondent believed that "fringe benefit costs ... contrary to law, employer-employee agreement, or an established policy of the contractor" are not direct and unmistakable costs. DoD had an answer for this concern. DoD stated that "The Director of Defense Pricing Policy determined these conditions are direct and unmistakable." So there, take that.

Another respondent thought that the FAR coverage was already adequate - that contractors are currently required to exclude fringe benefit costs that do not meet the requirements for reasonableness. DoD had an answer for this concern as well. DoD stated that "The results of the DCAA audits have made it clear that coverage is not sufficiently clear". How's that again? Clear that its not clear?

Now that the auditors are emboldened with this new DFARS rule, we can expect to see increased emphasis on ascertaining whether contractors have effective policies for excluding healthcare payments for ineligible dependents.

Healthcare Costs for Ineligible Dependents - Broadening the Fringe Benefit Category

Yesterday, we discussed the new DFARS Cost Principle on Fringe Benefits and the reasons why DoD felt the need to amend its FAR Supplement. The new revision is very concise and reads "Fringe benefit costs that are contrary to law, employer-employee agreement, or an established policy of the contractor are unallowable."

A few years ago, DCAA tapped into what it thought was the Mother Lode of questioned costs. It found a contractor that had not done a very good job of screening employee dependents for eligibility under the terms of its health insurance policy before paying for or reimbursing the employee for medical expenses.
So, the Agency questioned those costs related to ineligible dependents. News of that spread like wildfire among contract auditors and pretty soon, everyone joined in and began asking contractors to prove there were no payments made to ineligible dependents. Of course, it didn't matter that the auditors didn't find any evidence of improper payment. They could just look at the contractors policies and procedures and if the contractors didn't have policies and procedures to ensure that ineligible dependents were identified and excluded from any reimbursement, the auditors would derive a figure out of whole cloth.

One positive aspect of DoD's implementing language is this:

DoD (believes) that contractors should have adequate internal controls to ensure improper healthcare charges are excluded from fringe benefit costs. The rule encourages contractors to adopt reasonable internal controls to eliminate costs that are already unallowable.

The focus here is on the implementation of an internal control system. Internal controls are not designed to ensure absolute accuracy but are designed to provide "reasonable" assurance that unallowable costs are not charged to the Government. Contractors cannot be expected to review every healthcare claim submitted for payment or reimbursement. That would never be cost effective. But, one suggestion is for contractors to require that employees periodically update their dependent eligibility statements.

Broadening the Category

One thing that puzzled us was why, if the issue was healthcare payments to ineligible dependents, does the rule address the borad category of "finge benefits". DoD answered that question. DoD stated that the same logic that applies to healthcare (e.g. good internal controls), applies to all fringe benefits. So, there you go.

Materiality

DoD stated that "Research indicates the rate of ineligible dependent claims can represent as much as three percent or more of total healthcare costs. The overall cost for ineligible dependent claims, which are often fraudulent, can be significant for large contractors that spend millions of dollars for dependent healthcare". Really? Three percent? We would really like to see that research.

Healthcare Costs for Ineligible Dependents Now Subject to Penalty

DoD published a final rule last Friday, adding Part 232.205-6(m)(1) to the DoD FAR Supplement (DFARS) as follows:

Fringe benefit costs that are contrary to law, employer-employee agreement, or an established policy of the contractor are unallowable.

Now that might not seem like such a big deal. Its almost common sense. But what we have here is the health care for ineligible dependents issue that's been causing a lot of grief for the contractor community. The amendment doesn't mention health care for ineligible dependents but when one reads the promulgation comments, its pretty clear that this is what its about.

We've discussed this issue several times on this blog (e.g. here and here and here). DCAA (Defense Contract Audit Agency) has been pretty aggressive on this issue and not only where they questioning the costs but were also classifying them as expressly unallowable subject to penalty. In February 2012, DoD told the Agency to knock off the expressly unallowable business until such time as it could modify the DFARS. Well, the DFARS has not been modified and any medical benefits paid to or for ineligible dependents are not only unallowable but are expressly unallowable and subject to penalties.

What's more, the generalized nature of the new DFARS provision will make it more likely that DCAA and contracting officers are going to use it for all manner of questioned costs - even those that haven't yet been thought of.

Since this is a DFARS matter, it applies to only DoD contracts. That alone is going to require some complex calculations if the auditors find health care payments to ineligible dependents at contractors with a mix of DoD and non-DoD Government contracts. In fact, it might be worth the cost of admission just to watch the auditors fumble around with these calculations.

Tomorrow we are going to look at some of the comments received on the proposed regulation that preceded this final rule and DoD's response to those comments. It seems like DoD was going through a formality by requesting comments because they gave short shrift to everyone's concerns and published anyway.

Compensation Cap Approaching $1 Million Annually

The Office of Management and Budget (OMB) announced Wednesday that the new executive compensation benchmark for 2012 is $952,208. That's a mouth-dropping 25 percent increase over the 2011 benchmark of $763,029. Makes one wonder what the 2013 benchmark will be, or the 2014 for that matter.

This is the cap on total annual compensation amount the Federal Government will reimburse a contractor for the compensation the contractor provides to each of its employees for work performed on Government contracts. This doesn't limit what the contractor can pay, it only limits what the Government will reimburse.

In publishing the new compensation, OMB reiterated the Administration's proposal to replace the current formula for determining reasonable compensation with a cap that is tied to the President salary - currently $400 thousand and apply that cap to all military and civilian agencies.

Not everyone was pleased about the timing of OMB's announcement. The Professional Services Council (PSC), a trade group for service contractors, said in a statement it is an attempt to influence congressional debate over reimbursement for contractor executive compensation. PSC does not like the current proposals under consideration (see our blog post from November 6, 2013), thing they'll jeopardize the ability of agencies to recruit top talent, and would harm small and mid-size businesses.

The American Federation of Government Employees (AFGE) was unhappy with the announcement for a different reason. AFGE's President said "Christmas has come early for federal contractor employees, yet the government's own employees are looking at stockings full of coal." He went on to ask retorically "How can the President have allowed this to happen on the same day he spoke against income inequality in the nation's heartland? Why is the Administration enriching the top 1% of the nation's contractors but calling for cuts in compensation to the working and middle class Americans who make up the federal workforce?

Congress is working on passing the 2014 National Defense Authorization Act (NDAA). When that passes, we'll see who comes out on top, the contractor's or the taxpayers.

High Risk, Low Risk Incurred Cost Proposals

Yesterday we reported that DCAA (Defense Contract Audit Agency) revised its threshold for identifying low-risk incurred cost proposals. If you missed that, click here to read it. This revision only changed the amount of questioned costs that were present in the last year audited. The other factors that the Agency considers in determining whether a contractor or a proposal is high or low risk, have not changed. These include:

1. Known significant fraud referral (Form 2000) applicable to the proposal fiscal year or the period in which the proposal was prepared. The key to this determination is that there needs to be a nexus between the suspected irregularity and the proposal. If a suspected irregularity involved falsification of test results in five years before the year in question, that would not be sufficient nexus.
2. Preaward accounting system performed that resulted in an opinion of "unacceptable", or no previous experience with the contractor such as voucher processing, forward pricing effort, preaward accounting systems, etc. So here's another good reason to ensure that you accounting systems are adequate. If you want to know how the Government defines "adequate", take a look at the SF 1408. There are some buying commands that bypass DCAA for all contract audit activities except for the incurred cost audit. Those are the contractors where DCAA has no knowledge or previous activity and incurred cost proposals from those companies will not be placed in the low-risk pool.
3. Specific risk with the contractor that has material impact to the incurred cost proposal being assessed (i.e. significant CO/Auditor identified risk). Auditors like to prepare lead sheets. Lead sheets identify existing conditions at a contractor that the auditor wants future auditors to be aware of. For example, an auditor finds that a contractor is purchasing components from a related party and those components are not being charged to the contract at cost but at list prices. The auditor performing the incurred cost audit should check into the matter and see whether the transfer is appropriate. 

So there you have it. You can probably do your own risk assessment to determine whether you're going to get audited, or at least determine your chances of being audited. If your own risk assessment comes out clean and the auditor comes and wants to audit your incurred cost proposal, it is entirely appropriate to ask the risk factors that he/she identified that put you in the high-risk pool.

DCAA Writing Off More Incurred Cost Claims

DCAA (Defense Contract Audit Agency) recently revised policies and procedures for low-risk cost proposals less than $250 million ADV. ADV. Annual Dollar Volume represents the total costs incurred on flexibly priced contracts (e.g. CPFF, CPIF, FPI, T&M, etc) during a given year.

As part of ongoing monitoring of low-risk incurred cost proposals as well as feedback from auditors actually conducting incurred cost audits, DCAA determined that to improve efficiency, the Agency needed to expend more of its scarce resources on high dollar proposals and less on the low-dollar proposals.

So, instead of identifying low risk proposals as absolute dollar amounts, DCAA is using percentages.

1. For proposals with ADV under $1 million, if questioned costs were less than 10 percent of the last completed incurred cost audit, its low risk. Previously, this strata was set at $15 thousand. Ten percent is fairly high. On a $1 million proposal, it would total $100,000. Not too many proposals will meet this threshold.

2. For proposals with ADV between $1 million and $5 million, the question cost percentage drops to 5 percent.

3. For proposals  with ADV between $5 million and $250 million, the cost question threshold is $250 thousand. I guess that for $250 thousand, the potential benefits outweigh the cost of an audit.

High risk proposals and anything over $250 million get audited. Low risk proposals get dumped into sampling pools. Low risk proposals under $1 million have zero chance of being audited. Proposals between $1 and $50 million have a 5 percent chance of being audited. That jumps to 10 percent for proposals between $50 and $100 million and 20 percent between $100 and $250 million.

Entitlement vs Quantum

Entitlement and Quantum sound like a couple of prize fighters or characters out of an Avengers movie. But they're not. Entitlement and Quantum relate to claims against the Government (or claims against any party for that matter, but this is a Government contracting blog, after all).

If you ever submit a request for equitable adjustment (REA) or a claim under the Contract Disputes Act, there are two things you have to prove. First you have to convince the Government that you are entitled to compensation or damages and secondly, if you are entitled, you need to come to some meeting of the minds as to how much the damages. These concepts are called "entitlement" and "quantum".

Entitlement relates to whether the contract has been impaired by Government action or inaction and therefore has a right to monetary adjustment. Entitlement is a legal question.

Quantum, on the other hand is the amount of the monetary adjustment, assuming that the contractor's assertion of entitlement is proven valid.

REAs and claims are almost always going to be audited. The contract auditor is responsible for quantum issues and is discouraged from opining about entitlement issues. In reviewing quantum, the auditor will typically evaluate:

• Whether the amount proposed or claimed was incurred or estimated.
• Whether the contractor has source documents that establish that it incurred the costs at issue.
• Whether the costs submitted have been correctly allocated or charged to the contract or claim.
• Whether the costs submitted are allowable, pursuant to FAR 31.205 costs principles and contract terms.

Auditors, while performing the above audit steps, may gain some insight into entitlement issues as they go about their work evaluating quantum. Meaningful observations regarding the question of the contractor's entitlement to recover delay damages will be reported.

Contractors who feel that they have a claim against the Government over some contract issue almost always come out better when they have legal assistance. Legal assistance is expensive but sometimes you get what you pay for. By relying on professional expertise, contractors can get back to doing what they are good at - managing contracts.

Sleeter Group Announces 2014 "Awesome Applications"

Each year since 2006, the Sleeter Group has awarded recognition to accounting products available in the SMB (small to medium business) marketplace. Until last year, the recognition program was call "Awesome Add-Ons" as in addting to the functionality of QuickBooks. But last year, the consulting group opened the competition up a bit and included non QuickBooks applications. They also changed the name from "Awesome Add-Ons" to "Awesome Applications" to reflect the broader field of contestants.


As consultants with many clients using QuickBooks, we are always interested in any improvements to the basic QuickBooks platform as well as improved or added functionality provided by third-party add-ons. With hundreds of add-ons available however, it is difficult to assess which ones are worthwhile and which should be avoided. Having reviews by an independent (and reputable) organization helps in assessing a product's strengths, weaknesses, and value.


Last month, Sleeter Group announced the winners of its 2014 "awesome applications" contest. applications whether QuickBooks add-ons, 


If your company is not on an automated timekeeping system, you should make that one of your highest priorities. Automated systems are easy to use and generally very cost-effective. It will make everyone's life much easier. There are dozens of competing products out there and most have features that are important to DCAA; features like supervisory review and signoff, audit trails, and prompts for timely entries. Look for products that allow entries from mobile devises. There were a couple of products among the winners this year that fit in that category - tSheets and BigTime. Both of these products do more than just timekeeping.


If your bugaboo is expense reporting (e.g. travel expenses), you might take a look at Tallie. If you are trying to manage inventory, check out Easy Purchasing.


You can read more about these and other winning products here. There are also links to previous years' winners.