Employee Interviews - By What Authority?

What gives the Government the right to go in to a contractor's facility and start interviewing employees; whether concerning their timecards or anything else? That's a good question, an age-old question (at least during the age of Government contracting), and one that almost every contractor asks the first time it happens.

There is no explicit authority, either regulatory, statutory, or contractual. The best that the Government can come up with is found in FAR 52.215-2(b).

... the Contractor shall maintain and the Contracting Officer, or an authorized representative of the Contracting Officer, shall have the right to examine and audit all records and other evidence sufficient to reflect properly all costs claimed to have been incurred or anticipated to be incurred directly or indirectly in performance of this contract. This right of examination shall include inspection at all reasonable times of the Contractor's plants, or parts of them, engaged in performing the contract.

The key words in the foregoing are "other evidence sufficient to reflect properly all costs..." and "...inspection ... of the Contractor's plants." The logic falls along the following: to ensue the propriety of labor charges, review timecards. To ensure the propriety of timecards, interview employees.

The practice of interviewing employees at their work stations is so entrenched in Government contracting practices that its rarely questioned. Even the big boys (Lockheed-Martin, General Dynamics, Pratt Whitney, Boeing) with pockets so deep that they can afford plenty of legal counsel, don't challenge the Government's right to interview their employees.

However, the issue does crop up from time to time - usually from companies new to the Government contracting environment. There have been cases where auditors showing up to perform unannounced floorchecks have been rebuffed, at least temporarily. By then, the element of surprise has been voided and the interview results are suspect.

Although not widespread, the situation has caught the attention of at least one senator, Senator McCaskill. She has introduced an amendment that has been added to the Senate version of the Fiscal Year 2014 NDAA (National Defense Authorization Act) that will give auditors from the Defense Contract Audit Agency specific authority to interview contractor employees as part of an audit. We don't know yet whether the provision will make the cut when the House and Senate versions of the NDAA are consolidated. We guess that it will survive the conference committee because it doesn't seem controversial and it doesn't change any current practices.

Contractors Need to Reflect the New Compensation Caps in Forward Pricing

Last December 26th, the President signed into law the Bipartisan Budget Act (BBA). Among its provisions is a $487 thousand limitation on compensation for all employees on all Government contracts awarded after June 24, 2014. Now, some of you might be confused. We sure were. On the same date, the President signed the 2014 NDAA (National Defense Authorization Act) which capped compensation at $625 thousand. So what gives?

Well, the President first signed the 2014 NDAA and then the BBA which means that the BBA limitation takes precedence. So there you have it. Compensation is capped at $487 thousand, which will undoubtedly impact a lot of Government contractors. Incidentally, contractors can still pay whatever they want, they just cannot claim anything in excess of $487 on Government contracts.

Like previous incarnations of the compensation cap, the BBA provides for higher caps in limited situations:

The head of an executive agency may establish one or more narrowly targeted exceptions for scientists, engineers, or other specialists upon a determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities.

Additionally, the law provides for an annual escalation based on the Employment Cost Index for "all workers as calculated by the Bureau of Labor Statistics."

DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) are already on record advising their auditors and cost/pricing analysts to ensure that contractors are adhering to the reduced caps in their proposals for contracts to be awarded after June 24th and in forward pricing indirect rate proposals. Contractors who don't impact their proposals for the lowered cap are in danger of submitting defective pricing.

The FAR (Federal Acquisition Regulations) Councils have not issued final rules but they are working to implement this statutory change. According to DoD however, the absence of a final rule does not let contractors off the hook as the basis for the limit is statutory, not regulatory.

Contractor Disclosure Program - High Number of Reported Cases of Labor Mischarging

We've written from time to time concerning the DoD Contractor Disclosure Program. Any contractor with a $5 million contract must have a code of business ethics (if you're unsure, check your contract for the FAR Clause 52.203-13). The ethics program must contain a requirement that contractors self-report to the DoD-IG (Inspector General) criminal and civil violations of law. Specifically, the clause requires contractors to:

...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 violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the US Code or a violation of the civil False Claims Act.

In a recent DoD-IG report, the Inspector General reported that it had received 86 contractor (or subcontractor) disclosures in a six month reporting period. At the same time, it had 687 active cases on the books. Evidently, the IG has a difficult time closing out reported cases of "credible evidence".

Of those open cases, 548 or 80 percent concern labor mischarging. Is it any wonder that contract auditors spend so much of their time and effort performing labor floorchecks and other labor audits?  Other open cases, all representing less than five percent of the total, include violations of the anti-kickback act, false claims counterfeit parts, false certifications, non-conforming parts, and significant overpayments.

But lets get back to the labor mischarging issue. It is absolutely imperative that contractors develop adequate policies and procedures for ensuring the propriety of labor charges. Its not easy. There are a lot of players involved in the process from employees, to their supervisors, to timekeepers, to management, and even to stockholders. There are incentives and pressures, opportunities, attitudes, and rationalizations at play. Everyone wants to meet budget. Perhaps there are incentives tied to performance; bonuses or promotions. We read of a case where a someone felt justified in mischarging because the contracting officer never returned phone calls. We read of another case where an employee wanted to "... stick it to the Government whenever he could."

There are two conditions we see repeatedly the contribute to labor mischarging. One is the "tone at the top". If management does not buy in, neither will employees. The second is the lack of monitoring. Its a fairly simple task to write up sterling policies and procedures for labor charging. Its really pretty basic. Check out the DCAA Contract Audit Manual - all of the attributes are listed. However, often times, there is no on-going monitoring for compliance. After awhile, employees realize that no one is looking so why do they need to comply. As the old adage goes, what gets monitored, gets done.

Two words of advice here. Management must believe that labor charging is important and must convey that message in word and deed. Secondly, companies need a robust compliance review program to ensure that employees and their supervisors are adhering to policies and procedures.

DoD-IG Removes "Handbook of Fraud Indicators" from its Website

The DoD-IG (Department of Defense, Inspector General) cancelled and removed its "Handbook of Fraud Indicators for Contract Auditors" from its website due to its age and outdated scenarios. After all, it hadn't been updated in more than 20 years. In its place, the DoD-IG has added a website section entitled "Contract Audit Fraud Scenarios and Resources." This new section is a work in process as it contains only four scenarios so far, with promises of more in the future.

The four scenarios containing examples of what contract auditors should be alert for include:

• Review of consultant/professional services
• Subcontractor/vendor kickbacks
• Adjusting journal entities - labor transfers
• Material transfers

Obviously, these type of audits represent only a small fraction of a contract auditor's overall audit activities so now, auditors are kind of on their own for determining what types of fraud risks they should be considering when conducting audits.

One reference source is the GAO Yellow Book (also known as GAGAS or Generally Accepted Government Auditing Standards). Follow this link and go to page 183.

Also, the ACIPA Professional Standards, AU-C 240.A75 contain fraud risk indicators that auditors might face in a broad range of situations. These are categorized generally as:

• Incentives and pressures
• Opportunities
• Attitudes and rationalizations

Regardless of the sources for fraud risk indicators or the relevance of published indicators, auditors are still bound by professional standards to consider the risk of fraud in every audit they undertake. Don't be dismayed when auditors ask some penetrating questions. They're just doing their job.

If you would like to have a copy of the now obsolete DoD-IG Handbook of Fraud Indicators, lets us know and we'll email you a copy.

Timecard Fraud - One Employee May Be Facing Jail

The Department of Justice (DoJ) announced yesterday that a Government contractor employee had plead guilty to submitting false timecards. That employee now faces a maximum sentence of five years in prison and a $250 thousand fine.

In 2008, the employee was hired by a DoD subcontractor to perform work on a specific contract. She was required to submit timesheets to both her employer and the prime contractor. The prime contractor paid the subcontractor a fixed amount for every hour this employee worked.

Beginning in 2010, this employee began working full time for another contractor while, at the same time, continued to submit timecards as if she were still working full time for her previous employer. The Government's investigation revealed that she was working full time for her new employer yet at the same time, continued to submit timecards to her previous employer. Her former employer continued to bill the prime contractor who in turn, billed the Government. Before the scheme was halted nine months later, the Government had been overbilled by $65 thousand.

There are so many internal control deficiencies in this story that we don't know where to begin is describing them or ranking them in importance. First of all, where was the supervisor? One of the elements of an adequate timekeeping system is that after employees submit their timecards, the supervisor, with first-hand knowledge of what the employee was working on, reviews and approves the timecard. Secondly, the same question. Where was the supervisor? How can this fraud go on for nine months before someone wises up and notices that the employee is not performing her assigned tasks. This is one reason why contract auditors sometimes asks whether supervisors observe the comings and goings of their subordinates. Thirdly, this illustrates one of the big problems with cost-reimbursable contracts. Everyone, the employee, her employer and the prime contractor have no real incentive to control costs. Those costs are just passed along to the Government and everyone goes home happy and rich. Fourthly, was this job even necessary in the first place? If you can go on for nine months and not even notice that a position was not producing any output or deliverable, you have to question the necessity of that job in the first place.

Contractors (and subcontractors) really need to beef up their timekeeping procedures when they have employees assigned to remote sites or to a Government facility. "Trust" is not an internal control.

Prohibitions Against Awards to Inverted Domestic Corporations (IDCs)

Inverted Domestic Corporations (IDCs) are companies that used to be incorporated in the US (or used to be partnerships in the US), but are now incorporated in a foreign country, or are subsidiaries whose parent corporations are incorporated in a foreign country. You can read more about IDCs by clicking here.

FAR 9.108 prohibits the Government from contracting with IDCs. In responding to solicitations, offerors must represent that they are not IDCs. If they can't make such a representation, they are ineligible for award of a contract. The contracting officer is obligated, by the same FAR provision to "rigorously examine circumstances known to them that would lead a reasonable business person to question the contractor's self-certification. After consultation with legal counsel, the contracting officer is required to take appropriate action where that questionable self-certification cannot be verified. Presumable, the appropriate action in this case would be to make that offeror ineligible for award of contract.

With this background, we now come to a recent bid protest decision by the Comptroller General in a case where the protestor claimed that the winning bidder was not eligible for award because it was an IDC (see GAO Bid Protest B-409465 dated May 12, 2014).

The protestor contended that the contracting officer's determination was flawed because the contracting officer had reason to question whether the winning bidder's representation concerning IDC was valid. The protestor argued that the contracting officer had reason to question the representation because it had alerted the contracting officer of the issue in a previous protest.

The contracting officer was indeed aware of the prior protest. In the previous protest, the matter had been submitted for legal review and the counsel issued a detailed factual and legal bases in concluding that the winning bidder was not an inverted domestic corporation. Based on that legal determination, the contracting officer's boss believed the issue had been vetted and resolved though appropriate agency channels. The boss advised the contracting officer that he could rely on the IDC representation.

GAO denied the protest, stating that the contracting officer had done everything required of it and there was no basis for overturning the award.

Deferred Research and Development Costs

Yesterday we discussed a little-known, seldom invoked, and rarely controversial cost principle prohibiting losses on other contracts to be charged to a Government contract (read it here). Today we want to discuss a similarly obscure cost principle - this one concerning deferred research and development costs. The cost principle is found in FAR 31.205-48 and in some respects is similar to the losses on other contracts cost principle in that contractors may not charge overruns to any other Government contract.

Research and Development Costs (R&D) must be distinguished from Independent Research and Development Costs (IR&D). IR&D costs are paid for with company funds and the definition and other coverage is contained in FAR 31.205-18. R&D costs, on the other hand, are of the same type of technical effort described in FAR 31.205-18 but are paid for (sponsored) by a grant or required in the performance of a contract.

Deferred IR&D costs are allowable so long as the contractor meets the criteria listed in FAR 31.205-18(d)(1); when a contractor has developed a specific product at its own risk in anticipation of recovering the development costs in the sale price of the product provided that:

1. The total amount of IR&D costs applicable to the product can be identified;
2. The proration of such costs to sales of the product is reasonable;
3. The contractor had no Government business during the time that the costs were incurred or did not allocate IR&D costs to Government contracts except to prorate the cost of developing a specific product to the sales of that product; and
4. No cost of current IR&D programs are allocated to Government work except to prorate the cost s of developing a specific product to the sales of that product.

Deferred R&D costs, on the other hand, are never allowable under Government contracts. When costs are incurred in excess of either the price of a contract, or amount of a grant for research and development effort, the excess is unallowable under any other Government contract.

Losses on Other Contracts

It should really go without saying that contractors cannot charge off losses from other contracts onto a Government contract. Yet, the FAR Councils saw fit to keep such a prohibition into its library of cost principles. It doesn't take up much space. In fact, the entire cost principle reads as follows:

An excess of costs over income under any other contract (including the contractor's contributed portion under cost-sharing contracts) is unallowable (see FAR 31.205-23).

This cost principle has been around since 1940 and has remained essentially unchanged since that first publication.

The logic behind this cost principle is simple. Each contract action stands alone. The Government cannot use contractor profits from another contract on the current contract to reduce its costs. Similarly, the contractor cannot use losses experienced under another contract to justify a higher price.

The prohibition applies even if the Government were the cause of the losses under the other contract. Presumably, if the Government caused a loss, a contractor would have a basis for an equitable adjustment claim under the loss contract.

Fiscal Year 2015 National Defense Authorization Act (NDAA) - Part 2 in an Occasional Series

This is the second part in a periodic update on the progress of the Fiscal Year 2015 NDAA. You can read the first in the series here. There is nothing new to report as to the Bill is progressing. It still has to be voted on by the entire House and then on to the Senate and probably on to Conference Committee after that. But there are a couple of other provisions that came to our attention after our first posting that will be of interest to some contractors.

First, the bill contains an extension of a spending cap on contract services. This spending cap prevents the Department of Defense from cutting civilian employees and transferring the work to contractors. The following comes from Representative Hanabusa's (Hawaii) official website:

A ... measure ... will extend caps on service contract spending, helping to ensure that work will not be arbitrarily shifted from the civilian workforce to contract workers. Hanabusa's amendment extends the cap on service contract spending through FY15, and would impose no new cuts in contracts.

Secondly, the bill contains a provision that forces DoD to eliminate any unauthorized personal services and contracts for any inherently government functions and reduce the spending on contractors for work close to being inherently governmental. The following also comes from Hanabusa's official website:

A(n) ... amendment would enforce an existing requirement that the Department of Defense eliminate any unauthorized personal services contracts and contracts for the performance of inherently governmental functions, and reduce the number of contracts for the performance of closely associated with inherently governmental functions to the "maximum extent practicable". After five years, the GAO reports that DoD has made little progress towards identifying "at risk" contracts, let alone correcting them. This amendment sets realistic deadlines for compliance and ensures that the Department continues to comply for the next five years.

These two provisions, if they're ultimately passed, will limit opportunities for growth among the services industry sector. In the first case, the Government is prohibited from outsourcing Government civilian jobs. In the second provision, the Government needs to pull back some contracted jobs for positions that involve inherently Government functions.

Public Relations and Advertising Costs - Part 4

Today we're going to conclude our brief series on Advertising and Public Relations costs and their treatment under Government contracts. This has not been a particularly litigious area since the cost principle was revised in 1986. Prior to that, public relations costs were not specifically addressed in the FAR. In the early 80s, auditors were being very aggressive in their reviews of public relations costs and variously called them "advertising" or sometimes took exception based on "unreasonableness". There were Congressional hearings in 1984 where DCAA and GAO testified about the huge loopholes in the Advertising cost principle that allowed contractors to recover public relations costs. These hearings ultimately led to a significant revision to FAR 31.205-1 to include Public Relations costs in addition to Advertising.

Recent conflicts over allowability seem to focus on the term "primary purpose" about which we discussed yesterday. Depending upon the "primary purpose", the costs could be allowable or unallowable. Contract auditors will often try to build a case to show that the primary purpose was for unallowable activities. Usually however, the contracting officer, who has to adjudicate differences of opinion, are unable to sustain the audit position.

For many FAR cost principles, Agencies have, from time to time, adopted supplemental provisions. That is the case here with the Public Relations and Advertising cost principle. The DoD FAR Supplement (DFARS) adds additional prohibitions to what can be claimed under this cost principle.

Sometimes, Government contractors lease back some of the airplanes, tanks, or ships they build for the Government in order to display them at air shows and the like. The Government usually charges those contractors a leasing fee for the privilege. DFARS prohibits contractors from including those lease fee arrangements, including reimbursements for support services in their proposals and claims - even though the activity itself is allowable under other provisions of the FAR cost principle. This DFARS prohibition does not apply to FMS (Foreign Military Sales) which means that contractors affected by this prohibition will need to calculate separate rates for FMS.

There was a Board case (ASBCA or Armed Services Board of Contract Appeals) from 1973 that addressed the allowably of public relations costs (The Boeing Co., 73-2 BCA 10325). In this case, the Board found that costs incurred in connection with Boeing's 50th Anniversary celebration, including printing and postage expenses for a city-sponsored anniversary banquet, chartering a plane for dignitaries who would otherwise have been prevented from attending the banquet because of an airline strike, producing a movie and paying to have it broadcast on TV, were allowable public relations costs. This decision predates the FAR cost principle revision so it would need to be considered in light of current regulatory framework before using it as precedent.

If you missed the earlier postings in this series, use the following links:

• Part 1
• Part 2
• Part 3

Public Relations and Advertising Costs - Part 3

This is the third in our series on public relations and advertising costs. We have been examining how such costs are treated by the FAR (Federal Acquisition Regulations) cost principles, particularly FAR 31.205-1, Public Relations and Advertising Costs. If you've been involved in Government contracting for awhile, you probably think that advertising is unallowable as is the cost of most public relations efforts. That's because, for the most part, such costs are unallowable. However, there are two things to consider. First, the cost must meet the FAR definitions of advertising and public relations (see Part 1) and then, FAR provides some examples of advertising and public relations costs that are specifically allowable (see Part 2). Sometimes, Government auditors see an account entitled "Advertising" and simply question the total account without looking into the detailed transactions that make up the account. Don't let them do their quick and dirty analysis. Make sure the review transactions in the account(s).

After defining public relations and advertising and then listing related activities that are allowable, FAR 31.205-1 lists eight different public relations and/or advertising activities that are specifically unallowable. These activities include:

1. All public relations and advertising costs, other than those specified in Part 2 of this series, whose primary purpose is to promote the sale of products or services by stimulating interest in a product or product line, or by disseminating messages calling favorable attention to the contractor for purposes of enhancing the company image to sell the company's products or services.
2. All costs of trade shows and other special events which do not contain a significant effort to promote the export sales of products normally sold to the U.S. Government.
3. Costs of sponsoring meetings, conventions, symposium, seminars, and other special events when the principal purpose of the event is other than dissemination of technical information or stimulation of production.
4. Costs of ceremonies such as corporate celebrations and new product announcements.
5. Costs of promotional material, motion pictures, videotapes, brochures, handouts, magazines, and other media that are designed to call favorable attention to the contractor and its activities.
6. Costs of souvenirs, models, imprinted clothing, buttons, and other mementos provided to customers or the public (note, it does not say "employees")
7. Costs of memberships in civic and community organizations.
8. Costs associated with the donation of excess food to nonprofit organizations in accordance with the Federal Food Donation Act of 2008 (this applies only to contracts for the provision, service, or sale of food in the United States).

We underscored the terms "primary purpose" and "principle purpose" in the foregoing listing for a purpose. Some activities are dual purposed. Web sites come to mind. Certainly there is an element of public relations and advertising inherent in most websites. However, websites are also used to disseminate technical information, for customers (including the Government) to place orders, to inform the public, or to provide contact information. So, what is the "primary purpose" of a company website? And who's going to make that call? Perhaps someday, this area will be litigated but so far, we haven't seen the Government take aggressive stances against the cost of websites.

Tomorrow we will look at a couple of board cases where public relations and advertising costs were considered.

Public Relations and Advertising Costs - Part 2

This is the second in our series on looking into what the Federal Acquisition Regulations have to say concerning the allowability of public relations and adverting costs (refer to FAR 31.205-1). Yesterday we laid out the definitions as FAR would have them. Its important that when contractors consider the allowability of costs, they do so using the correct definitions. The Government often times performs nomenclature reviews based on account titles and often questions entire accounts based simply on a name. Advertising is one of those. The Government sometimes throws out the entire account without analyzing any transactions. It could be that costs charged to, say, an account called "advertising" do not meet the FAR definition of "advertising" and therefore should not be evaluated using the criteria in this standard.

While most advertising costs are unallowable, FAR specifically lists cost that are allowable. These include:

1. Costs specifically required by contract, or that arise from requirements of Government contracts, and that are exclusively for
• Acquiring scarce items for contract performance, or
• Disposing of scrap or surplus materials acquired for contract performance
2. Costs of activities to promote sales of products normally sold to the U.S. Government, including trade shows, which contain a significant effort to promote exports from the United States. Such costs are allowable, notwithstanding restrictions listed elsewhere. However, such costs cannot include memorabilia, alcoholic beverages, entertainment, and physical facilities that are used primarily for entertainment rather than product promotion.
3. Allowable in accordance with FAR 31.205-34; essentially "help-wanted" advertising.

If a cost meets the definition of "advertising" and does not meet one of these "allowable" examples, the cost is unallowable.

FAR also specifically lists the type of public relations that are allowable under Government contracts. These include:

1. Costs specifically required by contract
2. Costs of
• Responding to inquiries on company policies and activities
• Communicating with the public press, stockholders, creditors, and customers, and
• Conducting general liaison with news media and Government public relations officers, to the extent that such activities are limited to communication and liaison necessary to keep the public informed on matters of public concern such as notice of contract awards, plant closings or openings, employee layoffs or retirees, financial information, etc
3. Costs of participation in community service activities (e.g. blood bank drives, charity drives, savings bond drives, disaster assistance, etc (but there are restrictions here that we'll discuss later).
4. Costs of plant tours and open house (also subject to restrictions discussed later)
5. Costs of keep laying, ship launching, commissioning, and roll-out ceremonies, to the extent specifically provided for by contract.

Tomorrow we will look at examples of unallowable public relations costs.

Public Relations and Advertising Costs - Part 1

This is the first of a four-part series on Public Relations and Advertising Costs. To read the subsequent entries in this series, follow these links:

• Part 2
• Part 3
• Part 4

Prior to 1986, FAR 31.205-1, Public Relations and Advertising Costs simply covered costs. In 1986, the standard was revised to include public relations costs in addition to advertising. The "advertising" component of this standard is relatively straight-forward. Most advertising costs are going to be unallowable. The "public relations" part is more complex and each case needs to be considered on its merits. The Government is fond of trying to force fit activities into the public relations definition when in fact, they don't meet the definition of public relations.

Over the next few days, we are going to unpack the FAR cost principle on Public Relations and Advertising costs. To begin, we need the FAR definition of the two terms.

Public relations means all functions and activities dedicated to

• Maintaining, protecting, and enhancing the image of a concern or its products, or
• Maintaining or promoting reciprocal understanding and favorable relations with the public at large, or any segment of the public 

The term public relations includes activities associated with areas such as advertising, customer relations, etc.

Advertising means the use of any media to (i) promote the sale of products or services and (ii) to accomplish activities required by contract, acquiring scarce items for contract performance, or disposing of surplus property and scrap. To be advertising, the advertiser must have control over the form and content of what will appear, the media in which it will appear, and when it will appear. Advertising media include but are not limited to conventions, exhibits, free goods, samples, magazines, newspapers, trade papers, direct mail, dealer cards, window displays, outdoor advertising, radio, and television. Today, we would add the "internet" to this listing of media.

Public relations and advertising costs include the cost of media time and space, purchased services performed by outside organizations, as well as the applicable portion of salaries, travel, and fringe benefits of employees engaged in the functions and activities meeting the definition of public relations and advertising. The later category of costs is something that many contractors overlook - they forget to exclude salaries and related fringe costs (as well as other directly associated costs) from their proposals and incurred cost submissions..

Tomorrow, part 2.

Independent Contractors May Not Be "Employees" for Satisfying Limitation on Subcontracting Thresholds

In the case of set asides for small businesses, FAR 19.5 restricts the ability of contractors to subcontract some of the effort. This requirement is designed to reduce the frequency where small businesses act as mere "front companies" for non-small businesses. For supplies and services contracts, the contractor must perform at least 50 percent of the work. For construction contracts, the contractor must perform at least 15 to 25 percent of the work (depending upon whether its general construction or construction by special trades).

Where this restriction applies, most solicitations will require the bidders to demonstrate that their proposals meet the limitation on subcontracting criteria. Those that do not meet the criteria, are usually deemed "unacceptable" and eliminated from further consideration.

In a recent GAO bid protest, a company called MindPoint attempted to argue that an independent contractor was really an employee for purposes of satisfying the limitation on subcontracting requirement. MindPoint asserted that it properly considered one of its two proposed systems administrators - an independent contractor - to be an employee for purposes of calculating whether MindPoint would meet the minimum percent cost of performance requirement.

In its proposal, MindPoint represented that it would perform 53 percent of the contract effort using seven individuals including a systems administrator who was not a true employee but an independent contractor. Adjusting out the system administrator, the Government calculated that MindPoint would only perform 45 percent of the personnel costs of performance with its own employees.

MindPoint argued that the Government should have instead considered the systems administrator to be an employee because the independent contractor would "function more akin to an employee of MindPoint than a subcontractor". This argument, the GAO noted, rested entirely on information not contained in MindPoint's proposal. GAO has repeatedly ruled that it is a contractor's responsibility to provide an adequately written proposal that establishes its capability and the merits of its proposed approach in accordance with the terms of the solicitation. An offeror that does not affirmatively demonstrate the merits of its proposal risks rejection of its proposal. In this case, MindPoint consistently referred to the system administrator as an independent contractor and made no mention that the system administrator would be more "akin" to an employee than a subcontractor.

In the end, GAO didn't address whether an independent contractor could be considered an employee for purposes of satisfying the limitation on subcontracting criteria. It simply ruled that the Government acted reasonably in eliminating MindPoint's proposal from competition and as a result, denied MindPoint's appeal.

Disposing Accounting System Deficiency Audit Findings

Contractors receiving cost reimbursable contracts, incentive type, time-and-material, labor-hour, or contracts which provide for progress payments based on costs or a percentage or state of completion, must maintain adequate accounting systems. Sometimes, contract awards are conditional upon demonstration that the accounting system is adequate. In some cases even, prospective contractors cannot even bid on a job unless they have adequate accounting systems.

We have discussed the attributes that make up an adequate accounting system on these pages several times so we need not review them again (see for example this article from last November). Its not all that difficult for a contract auditor (or a contracting officer's "functional specialist" to find inadequacies in contractor accounting systems. Any auditor so predisposed, can find a deficiency or two. Sometimes those deficiencies rise to the level where they are "significant" and the Government loses confidence that the accounting system can produce reliable cost and billing data.

One of the problems when a deficiency has been identified and cited is the length of time it takes the Government to review corrective actions and corrective action plans. Sitting around waiting for the Government to act can result is lost opportunities. There is nothing more frustrating to a contractor than having to wait around for the Government (i.e. the contracting officer) to act or make a decision. Yet, the DFARS (DoD FAR Supplement) doesn't intend it to take so long. The DFARS policy for resolving identified accounting system deficiencies (found in DFARS 42.7501) is replete with word "promptly"; e.g. promptly notify the contractor of a deficiency, promptly review corrective actions, promptly notify the contractor that the deficiencies are resolved, promptly advise the procurement community that the system is acceptable. In reality however, no one on our side of the table ever thinks the Government acts promptly in resolving system deficiencies. Some contractors have good communications with their contracting officers but sadly, that is not the norm.

So, if you find yourself in the position of trying to resolve system deficiencies and its not going as quickly as necessary, refer to DFARS 242.7501, 2 and 3 and see if the Government is keeping to its own obligations by following the policies and procedures for resolving issues. If not, it wouldn't hurt to bring it to their attention.

Fiscal Year 2015 National Defense Authorization Act (NDAA)

This is the first of an occasional update on the 2015 NDAA as the Senate and House versions proceed to a final bill by this Fall.

The House Armed Services Committee yesterday, unanimously passed H.R. 4435, The National Defense Authorization Act (NDAA) for Fiscal Year 2015. It is expected to be considered by the full house later this month. Of course, the Senate is proceeding with its own version of the bill and ultimately, differences will need to be worked out in a conference committee.

This year, the Committee's "markup" of the NDAA does not have as much in it that would be termed controversial or likely to impact a great number of contractors. For the past two years, compensation has been front and center as has been audit access to contractor internal audit reports. This year, none of that.

One thing we did note that will be of importance to contractors in the "service contracting" business is an $800 million drop in spending from the prior year. That's fairly sizable. Perhaps the war fighters will be performing their own barracks maintenance in 2015.

The House does seem to be interested in service contracts. Besides the drop in funding, there was this statement:

Acquisition Reform: Vice Chairman Thornberry’s acquisition reform effort aims to identify and drive out those disincentives that increase cost and schedule of major programs and delay delivery of capabilities to the warfighter. Additionally, the reform effort identifies services contracting as an area where major improvements can be made. While the FY08 NDAA established the requirement for an annual inventory of services contracts, the Department has yet to fully implement this requirement. The Chairman’s Mark encourages the Secretary to improve data collection for services contracting and conduct better analysis of the data to identify waste. GAO is tasked to report on opportunities to improve services contract processes.

We're not sure what kind of reforms they have in mind. Certainly compiling an inventory of service contracts isn't going to reform anything.

Stay tuned to these pages as we will be keeping you up-to-date on the NDAA's progression.

Counterfeit Electronic Part Detection and Avoidance Systems

This is the second of our two part series on the new DFARS (DoD FAR Supplement) requirements to prevent counterfeit electronic parts from entering the supply chain. To read Part 1, click here.

Contractors that are subject to CAS (Cost Accounting Standards) and that supply electronic parts or products that include electronic parts (as well as their subcontractors that supply electronic parts or products that include electronic parts), are required to establish and maintain an acceptable counterfeit electronic part detection and avoidance system. Failure to do so may result in disapproval of the purchasing system by the contracting officer and/or withholding of payments.

The "subject to CAS" requirements applies to both full and modified CAS coverage. DoD made that point clear in its promulgation comments. However, small businesses are exempt from CAS and therefore exempt from this new requirement. That won't remove any responsibility from prime contractors however. DoD stated that contractors using small businesses as part of their supply chain doesn't remove any responsibility for ensuring an effective avoidance system. Primes that cannot flow down the requirements because of a small business exemption (or another exemption from CAS), will have a more difficult time to ensure that electronics parts and products that include electronic parts are identified and excluded from the supply chain.

So, how does a contractor go about devising and implementing a counterfeit electronic part detection and avoidance system (CEPADAS)? The new DFARS requirements tells us. The CEPADAS must include risk-based policies and procedures that address, at a minimum, the following areas:

1. Personnel training
2. Inspection and testing of electronic parts, including criteria for acceptance and rejection.
3. Process to abolish counterfeit parts proliferation.
4. Process for maintaining electronic part traceability.
5. Use of suppliers that are the original manufacturer, sources with the express written authority of the original manufacturer or current design activity, including an authorized aftermarket manufacturer or suppliers that obtain parts exclusively from one or more of these sources.
6. The reporting and quarantining of counterfeit electronic parts and suspect counterfeit electronic parts.
7. Methodologies to identify suspect counterfeit electronic parts and to rapidly determine if a suspect counterfeit electronic part is, in fact, counterfeit.
8. Design, operation, and maintenance of systems to detect and avoid counterfeit electronic parts and suspect counterfeit electronic parts.
9. Flow down of counterfeit detection and avoidance requirements.
10. Process for keeping continually informed of current counterfeiting information and trends.
11. Process for screening the Government-Industry Data Exchange Program (GIDEP) reports and other credible sources of counterfeiting information.
12. Control of obsolete electronic parts.

This new requirement applies to contracts awarded after May 6, 2014.

New Cost Principle added to DFARS - Counterfeit Electronic Parts

The Department of Defense has amended its FAR (Federal Acquisition Regulations) Supplement (DFARS) to address the cost of remedying the use or inclusion of counterfeit electronic parts. The new rule also addresses contractor responsibilities for detecting and avoiding the use or inclusion of such parts or suspected counterfeit parts, the use of trusted suppliers, and requirements for contractors to report counterfeit parts. Failure to detect and avoid could render a contractor's purchasing system inadequate and subject the contractor to billing withholds. Today we will address the cost principle aspects of the new rule. Tomorrow we will look at the purchasing system requirements of the new rule.

The new DFARS cost principle is located at DFARS 231.205-71 and is entitled: Cost of remedy for use or inclusion of counterfeit electronic parts and suspect counterfeit electronic parts. It states, in part:

(b) The costs of counterfeit electronic parts or suspect counterfeit electronic parts and the cost of rework or corrective action that may be required to remedy the use or inclusion of such parts are unallowable, unless -
     (1) The contractor has an operational system to detect and avoid counterfeit parts and suspect counterfeit electronic parts that has been reviewed and approved by DoD pursuant to 244-3303;
     (2) The counterfeit electronic parts or suspect counterfeit electronic parts are Government-furnished property as defined in FAR 45.1010; and
     (3) The contractor provides timely (i.e., within 60 days after the contractor becomes aware) notice to the Government.

Note the construct of this requirement; it is (1), (2), and (3), not (1), (2), or (3). That means in order for the cost of counterfeit parts and rework or corrective action required to remedy the use of such parts, all three conditions must exist.

Perhaps the most significant requirement among the foregoing is the requirement to have an "operational system" to detect and avoid counterfeit parts that has been reviewed and approved by DoD. We will discuss the basic requirements of an "operational system" tomorrow.

Unannounced Labor Flourchecks

Labor floorchecks are generally unannounced for obvious reasons - the auditor is testing for compliance with timekeeping policies and procedures. The auditor is determining whether contractor employees are completing their timecards on a daily basis, using ink, charging the correct project number, etc. If these floorchecks were announced, employees would be sure that their timecards were 100 percent compliant.

Typically, auditors will not call in advance to let contractors know they are coming or to request a "convenient" time to meet. The auditor will arrive at the contractor location and request to meet with a point of contact and then together, the auditor and the point of contact will proceed with the labor floorchecks. In actual practice, the surprise element of a floorcheck doesn't last for more than two or three interviews before word spreads like wildfire that auditors are in the building. Auditors realize this and put more credence into early interview results than in later interviews.

Unannounced interviews are different than unaccompanied interviews. An auditor has no right to insist on unaccompanied interviews. An auditor cannot freely roam a Government contractor's premises unaccompanied (unless such rights have been specifically granted by the contractor). There is no contractual requirement, regulation, or statute that requires contractors to provide such access. We recently became aware of a situation where two auditors (not DCAA auditors inn this case) barged into a contractor's commercially leased facilities, breezed through the reception area, and began interrogating employees and taking photographs of work products. Employees did not recognize these "strangers" and were very reluctant to answer their questions. The contracting officer, who had requested the floorcheck, was unaware of the floorcheck methodologies that were being employed had had to offer very serious apologies to the contractor.

Contractors, know your rights. If you are uncomfortable with some form of "oversight", call your contracting officer.

You've Turned in Your Incurred Cost Proposal - What's Next? - Part 3

This is the third and final posting on what contractors can expect once they have completed their annual incurred cost submission, turned it in to the Government, and have had the Government declare it to be"adequate". Remember, "adequate" does not mean that claimed costs are allowable, allocable, and reasonable to the contract. It only means that the submission itself includes all the requisite schedules and is internally consistent and reconcilable. Today we want to focus on best practices for getting the audit done in a timely manner so as not to expend resources that one wouldn't have otherwise expended.

Contractors should provide requested data as quickly as possible. Its to everyone's advantage. Prolonging an audit cost the contractor time, resources, and money that cannot be regained. There is no return on that investment - time lost due to inefficiency. Auditors are less efficient when they have to start and stop and start and stop. Not only does it waste time but auditors always have multiple assignments in their queues and while waiting for data from one contractor, are off performing another audit. So, who knows when they'll get back to your audit. When they eventually get back to your audit, they need to re-familiarize themselves with the status, the issues, and progress to date. Perhaps by then its even a different auditor and you have to reeducate a new auditor on your systems and processes. The best way to handle an audit is to prioritize it within your organization, dedicate whoever it is that is most familiar with the incurred cost submission and the location of the books, records, and supporting data, and stay focused on that singular event until the audit is completed.

Contractors should always be cognizant of what's hot and what's not. Contractors should be subscribing to industry newsletters and reading blogs such as this one to stay up to date on the "hot button" topics that are peculating throughout the Government in general and the audit and contract administration groups in particular. One are that is causing contractors a lot of grief lately is employee compensation. DCAA's got a few compensation benchmark surveys that they like to compare to contractor compensation levels. Anything above the benchmark average plus 10 percent gets questioned. Because of this, it would be wise for contractors to assess their own vulnerabilities in this area and be prepared to defend their compensation levels. Assessing the adequacy of business systems is another area getting a lot of audit coverage. If the Government can find fault with one of the six proscribed business system criterion, then they can withhold part of the billings. Withholding billings causes cash flow issues and generally harms contractors. Another source of "hot button" topics is to read DCAA's annual reports. There's a little bragging going on as DCAA spikes the football. The stories it tells about how they saved the Government a ton of money get passed around to other auditors who can and will apply the same techniques at other contractors.

We trust that you have enjoyed this short series. If you have any questions please contract us. Comments are always appreciated.

You've Turned in Your Incurred Cost Proposal - What's Next? - Part 2

This is the second part of our series on what contractors can expect after they submit their annual incurred cost claims in to the Government. (the terms "incurred cost claim", "incurred cost proposal", "incurred cost submission", "ICE" are all used interchangeably). Today we want to answer the question as to how deep will DCAA go in their audit. Contractors that have been around awhile have no doubt seen changes in the manner in which DCAA audits. Most contractors do not like the changes.

Incurred cost audits tend to be much more thorough and detailed then they were just a few years ago. That is primarily a result of DCAA's method of assessing risk.  Just a few years ago, auditors could assess the overall risk and make judgments about the amount of transactions testing needed to protect the Government's interest. For example, an auditor might see that a contractor has significantly overrun its contract and determine that there was a slim chance that he could find enough unallowable costs to offset the amount of the overrun. Based on that risk assessment, the auditor might not even do an audit. Under the new risk assessment procedures, the ability to make judgments and assess risk on the fly has been taken away from the auditor. Risk is now determined solely by the amount of dollars charged to the Government. The Agency continues to refine and adjust its materiality thresholds - usually resulting in fewer audits.

Because there are fewer audits (and coincidentally, more auditors), three is more focus and emphasis on detailed reviews. For an audit to be an audit, there needs to be some level of transaction testing. Auditors will pull a sample and ask contractors to provide whatever supporting data is available in order to determine whether the cost meet the FAR allowability criteria as well as any peculiarities set forth in the contract (e.g., some contracts limit the amount of overtime a contractor can charge). Contractors are always provided ample opportunity to provide the data requested. Sometimes, as in recent years, the data is so old that is has been archived or shipped off to long-term storage and takes time to find. Contractors are advised to adhere to FAR record retention requirements. Remember, just because the Government's right to audit extends for three years after final payment under the contract, does not mean that contractors are required to keep their records that long. Many companies dispose of their records as soon as legally permissible and this sometimes irritates auditors but there's nothing they can do about it.

Tomorrow - How best to interact with Government auditors and contracting officer personnel.