Wednesday, January 16, 2019

Labor Department Compliance Audits

The Department of Labor's Wage and Hour Division (WHD) investigators have been pretty busy lately, investigating contractor violations of certain labor related regulations. For contractors subject to the minimum wage and reporting requirements of Davis-Bacon (DB) and the Service Contracting Act (SCA), the probability of being audited for compliance is actually quite high and the consequences for failing to comply can be significant. The Labor Department recently sent out press releases concerning the outcome of two such investigations.

In the first case, a roofing contractor out of Tuscaloosa Alabama agreed to pay $57 thousand in back wages, overtime and fringe benefits to 41 employees after the Labor Department investigation found the company (employer) violated requirements of the Davis-Bacon Act (DBA), the Contract Work Hours and Safety Standards Act (CWHSSA) and the Fair Labor Standards Act (FLSA). The company failed to pay one employee for overtime hours on a DBA project and several employees for overtime when they worked more than 40 hours on a commercial project. Additionally, the roofing company failed to submit accurate certified payroll records and maintain accurate daily records of the number of hours employees worked.

In the second case, a Texas-based contractor paid $24 thousand in back wages to ten employees after investigators found the company had inaccurately classified several employees as exempt from the overtime requirements of the FLSA when none met the requirements for exemption. The company paid the affected employees flat weekly salaries regardless of the number of hours they worked, resulting in overtime violations when they worked more than 40 hours per week without overtime payment.

These two cases almost sound like "honest mistakes" where very small contractors did not have the internal resources to know all the rules and regulations that applied. We see honest mistakes happen frequently in our consulting business. However, when it comes to labor law, employees are often more informed about such matters than their employers and with the abundance of hotlines and other avenues for whistleblowing, the , it only takes a phone call to have investigators show up on your doorstep.

Tuesday, January 15, 2019

Subcontract Pricing Considerations - Prime Contractors Must Demonstrate Reasonableness of Proposed Subcontract Costs

Earlier this month, we highlighted a revised audit policy from the Defense Contract Audit Agency (DCAA) concerning the evaluation of subcontract costs included in forward pricing proposals. FAR 15.404-3(3)(b) requires prime contractors to perform whatever cost/price analysis is necessary to determine the reasonableness of proposed prices. Sometimes they don't do that so historically, DCAA has considered them unsupported and perhaps identified the omission as an estimating deficiency. That policy did nothing to advance contract negotiations nor help procurement offices to negotiate fair and reasonable prices. Under the new guidance, DCAA is to provide whatever information it has available or conduct additional analytical work (i.e. develop decrement factors) to assist in any way it can. See "Revised Audit Policy for Reviewing Subcontractor Costs" for more information on the new policy.

Contractors need to be cautioned however that DCAA's performance of alternative procedures (or requesting an assist audit) does not relieve prime contractors or upper-tier contractors from their responsibility to perform cost or price analyses of subcontract proposals.

Whatever analytical work the auditors might perform, the procurement regulations stand. FAR 15.404-3(3)(b), Subcontract pricing considerations, unequivocally requires prime contractors and higher-tier subcontractors to conduct appropriate cost or price analyses to establish the reasonableness of proposed subcontract prices. It also requires the prime or higher-tie contract to include the results of these analyses in its price proposal.

When auditors encounter situations where contractors or higher-tier subcontractors have not met the regulatory requirement to prove the reasonableness of proposed subcontract prices, they will include that omission as a material noncompliance with FAR 15.404-3(b) in the audit report. What are the consequences of an inadequate estimating system? Well, it could be significant. It could result in additional auditing, additional oversight, the necessity of getting contracting officer consent to subcontract (with all the additional documentation that requires), and loss of future contracting opportunities.

Monday, January 14, 2019

Cash Flow Shortages Caused by Partial Government Shutdown

The partial Government shutdown is having financial ripple effects on, not only the furloughed Government employees, but on Government contractors. For contractors and subcontractors, the disruption of Government payments for work performed makes it difficult for some contractors (and subcontractors) to meet their own financial obligations.

Some contractors are contemplating borrowing money to tide them over. That is certainly one strategy to keep funds flowing but keep in mind that the interest on those borrowing is unallowable (see FAR 31.205-20, Interest and Other Financial Costs). There is no "wiggle room" in that cost principle to make interest costs allowable - not even if the cash shortage was caused by a Government shutdown.

Another strategy is to defer payments to vendors and subcontractors. This strategy has some potential risks. Many vendor invoices come with fees and interest for late payment. Such fees and interest would, of course, be unallowable. Ultimately however, vendor and subcontractor need to be paid prior to invoicing the Government for those goods and services (or accrued and paid in the normal course of business - usually 30 days - for small businesses). This could create audit issues with DCAA (Defense Contract Audit Agency) or other contract auditors who perform "testing of paid vouchers" audits.

"Testing of paid vouchers" are conducted at every contractor. For non-major contractors, testing is performed on at least one voucher per year - more often if problems are identified and the auditors will specifically focus on payment timeliness.

One of the audit steps reads:

  • Verify that the contractor is not delinquent in the payment of cost incurred in the performance of the contract in the ordinary course of business. 
  • Review the contractor’s aging of accounts payable schedule. Discuss any significant amounts over 30 days old with the contractor. 
  • Based on the risk assessment, select a minimum number of items (e.g., five items) charged direct to the contract and trace the amounts from voucher(s) to evidence of payment. 
  • If the contractor is delinquent in paying costs in the ordinary course of business, the costs are not reimbursable in accordance with FAR 52.216-7(b) Reimbursing costs. 

Our advice to contractors facing cash flow shortages caused by the partial Government shutdown is to engage your contracting officer early on to document the issues and the ultimate resolution plan. If possible, obtain an advance agreement (see FAR 31.109) to avoid future disagreements.

Friday, January 11, 2019

Once You've Graduated, You Cannot Go Back

Graduation day is a good thing. Why would someone want to keep hanging around the old haunts after graduation? Wouldn't that be a little weird?

That's what Miracorp wants to do. Back in July of last year, DOE (Energy) issued a solicitation for administrative support services. The solicitation was set aside for companies in SBA's 8(a) program. Miracorp was the incumbent contractor but had graduated from the 8(a) program the prior February. After DOE eliminated Miracorp from competition because it was no longer an 8(a) contractor, the company appealed to the GAO  (Government Accountability Office).

GAO denied the protest on the grounds that Miracorp was not an "interested party" because it was not a member of the 8(a) program. Miracorp acknowledged that although it had graduated, it retained its 8(a) status because it was an 8(a) company when the original multiple-award contract was awarded.

GAO (and SBA) didn't agree. The agencies explained that to be an eligible 8(a) concern, the firm must be a current 8(a) participant as of the date specified for receipt of offers contained in the request for quotations for the order. Miracorp was not an 8(a) participant on the dated specified in the RFQ for receipt of quotations and therefore not eligible to receive the order.

The purpose of the 8(a) program is not to encourage entities to feed from the public trough forever. Companies get up to nine years to bid on contracts restricted to small disadvantaged businesses during which time the experience and seed money should be sufficient to give them a chance for success without the Government incentives.

You can read the full GAO decision here.

Thursday, January 10, 2019

Justice Department Recovered $2.8 Billion under the False Claims Act in Fiscal Year 2018

Late last month, the Justice Department issued its annual report on recoveries under False Claims Act (FCA) cases during fiscal year 2018.  The amount of recoveries was impressive (nearly $2.8 billion) but no where near the $6.1 billion recovered in fiscal year 2014.

The preponderance of the recoveries (87 percent) related to what we can generically refer to as Health Care fraud. The largest of these recoveries came from the drug and medical device industry. For example, the Department recovered $625 million from a company that circumvented safeguards intended to preserve the integrity of the nation's drug supply by repackaging drugs supplied to cancer-stricken patients. In another case, a medical device manufacturer paid $33 million for selling a materially unreliable testing device that was intended to aid clinicians in the diagnosis of drug overdoses and other serious conditions.

Recoveries for procurement fraud paled in relation to health care fraud. The Department recovered only $107 million (only?). The most significant recovery was $66 million from a company selling defective fiber used in bullet proof vests. Another $20 million came from a company that over-billed the Navy by overstating the quantity of goods and services it delivered. The Department recovered $12 million from a company that misrepresented its status as a small business. We previously reported on these cases and many others on these pages.

Interestingly, most of the recoveries were the result of whistleblower actions (a.k.a. Qui Tam). Of that $2.9 billion recovered, $2.1 billion was the result of lawsuits filed by whistleblowers. The whistleblower payouts during the year totaled $301 million. We don't know how much of the payout went to whistleblowers and how much to their attorneys. We know of one case, years ago, where the attorneys took the preponderance of a whistleblower's payout.

The Justice Department report stated:
Whistleblowers have played a vital role in unmasking fraudulent schemes that might otherwise evade detection. The taxpayers owe a debt of gratitude to those who often put much on the line to expose such schemes.
You can read more about the Annual report and download related statistics here.

Wednesday, January 9, 2019

"War Hazard" Premium Payments

Contractors operating in unusually dangerous situations find they must offer hazardous duty payments to attract employees willing to work under those conditions. Probably everyone at some point has been regaled with accounts by a relative, friend, neighbor, or acquaintance about the bucket loads of money they accumulated by taking a contract gig in Iraq or Kuwait, or Afghanistan. Unfortunately, more than 1,600 of those contractor employees did not make it back alive and that's why war hazard pay becomes necessary.

Incentives vary among contractors and usually reflect differences in individual circumstances and reasonableness must be established on a case by case basis. Sometimes contract solicitations will provide guidance. Among contractors operating in hostile areas, there are standards and unwritten rules. The State Department may also be a source of premium amounts applicable to specific locations.

Contractors proposing (and paying) premium pay will, at some point, be asked to justify the reasonableness of the premium pay amounts. This could get a little tricky because it involves a high level of judgment in evaluating factors such as:

  1. Country and city where assigned
  2. Distance of work site from actual battle lines and surrounding areas of imminent danger
  3. War hazard differentials being offered by other defense contractors in the same location
  4. Employee response to any lower war hazard differential pay offers made by the contractor
  5. Availability of alternate workers at appropriate skill level, and
  6. Other compensation offered, such as bonuses and insurance coverage.

Because these premiums can be subjective and to avoid disputes down the road, we recommend that any contractor (or subcontractor) pursuing work where war hazard pay is necessary to enter into an advance agreement with their cognizant contracting officer over the amount and breadth of such payments.

Tuesday, January 8, 2019

Procurement Related Legislation Introduced in the New Congress

The new Congress has been in session only a few days and already have introduced a number of procurement related bills. At this point, they've only been introduced and no action has been taken except for referral to a committee (or two). It's a fact that most introduced bills never make it to passage. And perhaps none of these will either. Or, they may be folded into another bill like the NDAA (National Defense Authorization Act), as sometimes happens.

Anyway, here's a few of the bills just introduced.

  • H.R. 246 - Requires senior procurement executives, procurement center representatives, and the Office of Small and Disadvantaged Business Utilization to assis small business concerns participating in the Small Business Innovation Research Program and the Small Business Technology Transfer Program. We're not so sure that this will accomplish anything. We have yet to encounter anyone in the Government that can answer specific questions that small businesses have when entering the Government contracting arena. Questions like: What accounting software should I use? How should I set up my chart of accounts? What timekeeping software should I use? How do I establish an indirect rate structure?
  • H.R. 190 - Eliminates the inclusion of option years in the award price for sole source contracts. We're sure that contracting officers relish the idea of coming back to the negotiating table every year instead of every five years. We're sure that contractors will want to do the same. Any idea of what this will cost contractors or the Government?
  • H.R. 206 - Encouraging small business innovation act. This bill would include testing and evaluation in the definition of research and development, include small business investment companies in SBIR and STTR program limited to 33 percent of ownership, allow points in past-performance ratings for businesses that serve as mentors under the mentor-protege program, and a few other provisions.
  • H.R. 227 - specifies what credit is given for certain subcontractors and to provide a dispute process for non-payment to subcontractors. There must be subcontractors out there that are not being paid by their primes or are not being paid in a timely manner.

We'll keep you informed and provide more details if any of these progress beyond the committee stage.

Monday, January 7, 2019

DCMA Stands-up Its Commercial Item Determination Group

The Defense Contract Management Agency (DCMA) established a Commercial Item Group (CIG) in response to Congressional direction to DoD to establish a cadre of experts to leverage the use of commercial items and emerging technologies.

DoD has now approved DCMA CIG contracting officers to serve as determining officials for commercial items. DCMA CIGs have been trained and have developed "expertise" in a multitude of commodity groups spread across six geographical locations:

  • Boston - maintenance, repair, and overhaul (MRO) services, chemicals and materials
  • Philadelphia - naval transport and equipment, troop supply
  • Phoenix - heavy machinery, missiles
  • Indianapolis - automotive, aeronautics, aircraft engines
  • Denver - space, C41, unmanned aerial systems
  • St. Petersburg - vehicles, weapons, ammo
Effective now, DCMA CIG contracting officers will serve as determining officials for all commercial item review requests submitted to DCMA. Such determinations will relieve buying activity PCO's (Procurement Contracting Officers) from duplicating effort such as trying to determine wether the item being offered meets the definition of commercial item as well as provide consistency in the commerciality review process.

Determinations made by the DCMA CIG will be contained in the commercial item database available for all DoD contracting officers to rely upon for future purchases of the same item or service. 

Contractors who sell commercial items to the Government should ensure that information entered into the DoD wide commercial item database accurately reflects their products and services.

Friday, January 4, 2019

Revised Audit Policy for Reviewing Subcontractor Costs

DCAA (Defense Contract Audit Agency) recently announced a significant policy change in the way it reports on deficient (i.e. incomplete or inadequate) prime contractor cost or price analyses of subcontractor proposals.

Until now, whenever a prime or higher-tier contractor had not competed the required subcontractor cost or price analysis at the time it submitted its own proposal, auditors would simply classify the costs as unsupported. This policy, while technically accurate, added no value to the procurement process and in some cases, delayed contract negotiations.

Under the new policy, auditors are now required to perform alternative procedures to establish a reasonable basis for the audit opinion. Depending on the overall risk and materiality, the auditors can consider a variety of procedures including, but not limited to, the following:

  • Create a decrement based on purchase order history
  • Create a decrement based on other relevant information (e.g. comparisons of prior subcontract proposals to historical cost or price analyses or negotiated amounts); and/or
  • Coordinate with the subcontract audit team and request a DCAA assist audit based on the prime/higher-tier audit team's risk assessment.

This doesn't relieve the prime/higher-tier subcontractor from the requirements of FAR 15.404-3(b), Subcontract pricing considerations which requires the prime contractor or higher-tier contractor to conduct appropriate cost or price analyses to establish the reasonableness of proposed subcontract prices and to include the results of these analyses as part of its proposal o the Government. Contractor failure to do that will result in a material estimating deficiency report and could result in some form of adverse action such as increased audit coverage.

Decrement factors have been used in pricing forever. Many contractors develop decrement factors because they know that ultimate purchase prices will be lower than initial quotations. Contractors who do not prepare their own decrement factors often find that auditors (and sometimes cost/price analysts) will do it for them. Its better to be pro-active otherwise, contractors find themselves in a defensive posture trying to explain the inaccuracies in the auditors' analyses.

The new DCAA policy can be found here.

Thursday, January 3, 2019

Waivers of Penalties for Unallowable Costs

Expressly unallowable costs are particular items or types of costs which under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable (FAR 31.001). Contractors who include expressly unallowable costs in their final indirect cost rate proposals are subject to penalty equal to the amount of the expressly unallowable costs (FAR 42.709-1). We have written extensively about expressly unallowable costs in past years and how DCAA (Defense Contract Audit Agency) continuously tries to expand the definition to make almost any cost exception an "expressly unallowable" costs with the ASBCA countering their push by narrowing the definition and throwing out the Agency's charges. For a recap of these issues, see "Expressly Unallowable Costs - ASBCA Narrows the Definition" and follow the various links.

The distinction between "unallowable costs" and "expressly unallowable costs" is significant. The latter carries penalties while the former classification does not. The broad purpose of the penalty provisions was to ensure that contractors, rather than the Government, bear the burden of assuring that contractor submissions for reimbursement of costs on Government contracts do not include unallowable costs. Congress was concerned with ending the "cat-and-mouse game", namely, "a game in which the cost of an item is submitted regardless of whether it's allowable, and the burden is placed on the Government auditors to identify and disallow the item(s).

The contracting officer can (and must) waive penalties in certain situations. The contracting officer must waive any penalties if the contractor withdraws the proposal before the Government formally initiates an audit, the amount of the unallowable costs which are subject to the penalty is less than $10 thousand, or the contractor demonstrates, to the contracting officer's satisfaction, that (i) it has established policies and personnel training and an internal control and review system that provides assurance that unallowable costs subject to penalties are precluded from being included in the contractor's final indirect cost rate proposal and (ii) the unallowable costs subject to the penalty were inadvertently incorporated into the proposal (i.e. their inclusion resulted from an unintentional error, notwithstanding the exercise of due care (see FAR 42.709-5).

In a recent ASBCA (Armed Services Board of Contracts Appeals) decision (Energy Matter Conversion Corporation (EMC2), ASBCA No. 61583), a contractor attempted to avoid penalties with other rationale.

EMC2 argued that the Government failed to inform EMC2 that it was disallowing legal costs for 2010/2011 until after it submitted its 2012/2013 incurred cost submissions. The Board was not persuaded stating that EMC2 cannot avoid the penalty by placing the burden of identifying and disallowing legal costs on the Government.

EMC2 further asserted that it had updated its accounting policies in 2017 but provided no evidence to support the assertion. Even if it had, that would not be a basis for a penalty waiver because those policies would have had to have been in place at the time it submitted its erroneous incurred cost proposal in 2016.

Thirdly, EMC2 argued that it had underbilled the Government. The Board found no evidence that EMC2 underbilled but also noted that underbilling was not one of the enumerated bases for penalty waiver.

Fourth, EMC2 pointed to the fact that the contracting officer waived the penalty in prior years. The Board stated that a contracting officer's decision is not binding in any subsequent proceeding.

Finally, EMC2 areued that it should be liable for only 55 percent of the penalty reflecting an apportionment of legal costs attributable to its "success" in the investigation. The Board noted that FAR 42.709-5 does not authorize such apportionment and added that the Court of Appeals has rejected apportionment arguments in similar circumstances.

There is one aspect to the penalty provision that seems very unfair to contractors - the idea that there is no waiver if the expressly unallowable costs did not result in increased costs to the Government. Say for example, a contractor spent $2 million on an SBIR contract for $750 thousand. Because the amount incurred was so far in excess of the contract amount, the contractor did not perform adequate screening of unallowable costs. The contract auditor audited the full $2 million and found expressly unallowable costs of $20 thousand - not nearly enough to bring the $2 million incurred below the $750 thousand contract amount. The contract auditor recommended penalties be assessed but thankfully in this real case, the contracting officer exercised its discretion not to assess penalties. But the contracting officer was certainly with his rights to do so.

Wednesday, January 2, 2019

Comparative and Trend Analyses in Risk Assessments

Happy New Year everyone and welcome to our first blog post of 2019. As we begin this new year, the Government is in the midst of a partial shutdown. However, Defense, Energy, Education, VA, Labor, and Health and Human Services remain fully funded, open and are conducting business as usual. Agencies affected by the shutdown include Justice, Agriculture, Treasury, State, Interior, Transportation, Commerce, and HUD. Companies with contracts with those agencies might be feeling an impact, or soon will. No one is yet predicting how long the partial shutdown will last. If this one is like previous shutdowns however, all those furloughed Government employees will receive their full pay - they just get, what amounts to extra paid vacation.

But since contract auditors are, for the most part, open for business, this is not a time to sit back and let your policies, procedures, practices, and internal controls take a furlough. Those things are important - past, present, and future. They are important for supporting incurred costs, for supporting estimates of future costs, and used by auditors for trend analyses and comparative analyses. How do contract auditors employ trend/comparative analyses in their work and what are the results of those analyses used for? To answer those questions, we'll take a look at a standard audit program for evaluating labor costs using employee interviews. How do auditors decide who from hundreds or thousands of employees to interview? Their's is not a haphazard selection. Auditor's expend a lot of effort into a risk assessment, the results of which lead the auditor to select specific persons (or groups of persons) they need to check on. One of the steps in performing the risk assessment is the trend analysis/comparative analyses steps.

Auditors are free to and expected to exercise their professional judgment as to what kinds of comparative and trend analyses need to be performed. But there are two specific analyses called for in the standard audit program: ratio of direct to indirect labor and trend lines of sensitive accounts.

1. Ratio of direct to indirect. Auditors will perform trend analyses to disclose any significant increases in the ratio of direct to indirect labor accounts. If disclosed, contractors will be requested to explain those fluctuations. If there is no apparent (or satisfactory) explanation, auditors are instructed to further evaluate those fluctuations.

There was a not-so-famous case years ago - back when there were caps on IR&D/B&P expenditures - where such an analysis showed that indirect costs increased significantly in the last couple of months of the fiscal year. Further investigation disclosed that this increase coincided with the contractor reaching its maximum IR&D expenditures. A criminal investigation and subsequent settlement disclosed that employees were instructed to mischarge their time once the IR&D budget was exhausted. The contractor ended up sending a lot of money back to the Government.

2. Comparative analysis of sensitive labor accounts. Auditors are instructed to perform comparative analyses of sensitive labor accounts. What are sensitive labor accounts?  That's not stated but probably includes any labor accounts that are charged directly or indirectly to Government contracts - especially cost-type (or reimbursable) contracts. Again, contractors will need to be able to explain significant fluctuations. Auditors are looking for situations where labor is being excluded from an indirect allocation base or mischarged from the direct labor base to the indirect cost pool. By omitting a project or product line from the indirect allocation base, the resulting rate will be increased and the Government overcharged.