Friday, September 20, 2019

Another Government Agency Finds Deficiencies in its Internal Controls over Employee Travel Card Usage

Do you give out credit cards and travel cards to your employees? If so, how confident are you that your internal controls are working, if you have any internal controls at all? If you're like most small firms, your policies are largely based on trust. But, as you no doubt know, 'trust' is not an internal control. Trust is important in any organization, but it is not an internal control.

The Government is a major user of travel cards but audit after audit show that the Government, with all of its controls and oversight (approvers checking the travelers, managers checking the approvers, and auditors checking the managers) they still have issues and deficiencies in managing their credit/travel card programs.

The Government Charge Card Abuse Prevention Act of 2012 requires OIGs (Office of Inspector Generals) of agencies with more than $10 million in travel card spending to conduct period audits of reviews of travel card programs to analyze risks of illegal, improper or erroneous purchases and payments.

The EPA (Environmental Protection Agency) Office of Inspector General (OIG) recently completed a risk assessment of the Agency's travel card program and decided there was enough risk to merit a full audit. The OIG found employees who had been separated from service with active travel cards. They found irreconcilable differences between transactions and bank records (Citibank records in this case). The OIG found reports with 'blank' columns where data should be listed. They also found that they couldn't determine how much 'credit' was remaining on travel cards.

You might want to read how one highly trusted contractor employee used a company issued credit card to embezzle $825 thousand from his company.

You might also be interested in our article on how to improve controls over credit card usage.

Thursday, September 19, 2019

Improper Business Practices - Gratuities to Government Personnel

This is the third installment in our periodic series on improper business practices as laid out in FAR (Federal Acquisition Regulations) Part 3. FAR Part 3 includes sections on the prohibitions of gratuities to Government personnel, contingent fees, subcontractor kickbacks, buying-in and anti-trust matters. It also offers whistleblower protections to contractor employees, requires contractors to establish and implement codes of business ethics and conduct, and more. In Part 1, we discussed the requirement for contractors and subcontractors to implement reasonable procedures to prevent and detect violations of the Anti-Kickback Act. In Part 2, we discussed the practice of "buying in" and tools for contracting officers to use to prevent subsequent cost growth when contractors do buy in. Today, in Part 3, we will be discussing the prohibition against offering gratuities to Government personnel.

One of the standard contract clauses included in Government contracts is found in FAR 52.203-3, Gratuities. It holds that the rights of contractors to proceed may be terminated by written notice if the Government determines that the contractor (or its agency, or another representative) offered or gave a gratuity (e.g. entertainment or gift) to a Government employee and intended, by the gratuity, to obtain a contract or favorable treatment under a contract. If the contract is terminated under this clause, the Government is entitled to pursue the same remedies as in a breach of contract and to seek exemplary damages (if the contract involves Defense Department funds).

In addition to terminating the contract (or contracts), the Government may also initiate debarment or suspension measures (FAR 9.4). Government employees, under the same FAR provision, are obligated to report such gratuities as well as attempts by contractors to offer gratuities.

Termination, debarment, and suspension is bad enough but the consequences could get much worse for both contractors and Government employees caught exchanging gratuities for favored treatment. As readers of this blog are aware, the Government prosecutes these activities under several different criminal statutes resulting in significant monetary penalties and, in some case, prison time for the practitioners.

Many contractors have established a zero-tolerance policy for gratuities of any amount, including, in some cases, even a complimentary cup of coffee. Many Government employees (particularly audits and contracting officers) have also developed a zero-acceptance of any thing that could even be remotely construed as a gratuity, including refusing an "offered" cup of coffee.

Wednesday, September 18, 2019

Contractor Settles Double Billing Discovery for $1 Million

FAR (Federal Acquisition Regulations) limit the amount of rent or lease costs paid to related parties that Government contractors can claim under their contracts. FAR 31.205-36(b)(3) states that:
Charges in the nature of rent for property between any divisions, subsidiaries, or organizations under common control, to the extent that they do not exceed the normal costs of ownership, such as depreciation, taxes, insurance, facilities capital cost of money, and maintenance, are allowable.
We've written extensively on these limitations in past postings. See, for example, Rent Paid to Related Parties but we continue to find and hear about examples where contractors use bases other than cost of ownership when applying related party rental/lease payments to their Government contracts.

Earlier this month, the Justice Department announced a settlement wherein a Michigan Government contractor (and two of its employees) will pay back $1 million to resolve allegations that it did not comply with this related party rent/lease limitation. In addition, the Contractor and two of its employees are prevented from bidding on federal awards and contracts for the next three years. The company is also required to maintain an ethics and compliance program and retain a Corporate Ethics Monitor to review and report on the company's compliance with Government contracting requirements.

According to the Justice Department, GS Engineering, Inc. (GSE) double-billed the Government by fully depreciating certain data acquisition equipment, charging that depreciation to Government contracts, then transferring the same equipment to a related company at lease rates that exceeded the cost of ownership. A significant cost of ownership on most leased equipment is depreciation. GSE did this for eight years before a DCAA (Defense Contract Audit Agency) audit disclosed the practice and brought it to a halt.

This area is one in which DCAA has identified as a high audit risk area. If you are claiming rental/lease payments on your Government contracts, expect auditor queries into such payments.


Tuesday, September 17, 2019

GSA Price Reduction Clause

When GSA negotiates its 'multiple award schedule' (MAS) contracts, it relies on discounts, terms, and conditions that contractors offer to other customers. This is commonly referred to 'most favored customer' pricing.

However, the negotiated prices stated in a MAS contract are not necessarily fixed for the entire term of the contract. Most MAS contracts (perhaps all MAS contracts) contain a Price Reduction Clause (GSAR 552.238-81) which imposes a duty to report certain changes in its commercial pricing terms. In some cases, the Price Reduction Clause will require contractors to adjust their fixed prices downward.

The Price Reduction Clause specifies two events that will require contractors to reduce their prices. If the contractor later reduces the list price or otherwise revised the price list or offers more favorable pricing, discounts, or terms to another customer, the contractor must also offer the same deal to the Government. The other requires that the discount percentage offered to the Government must be maintained. If the contractor offers the Government a 15 percent discount off of list price, but later lowers its list price, the contractor must offer the Government the 15 percent discount off of the new list price, even if the old Government price is still most favored.

UPS (United Parcel Service) found about this clause the hard way. The Justice Department just announced a settlement with UPS for $8.4 million to resolve allegations that it overcharged Federal agencies for package delivery services under its GSA contract. From 2007 to 2014, UPS failed to follow the Price Reduction Clause of its GSA contract.

MAS contractors need to establish internal mechanisms to ensure that it maintains pricing integrity on its contracts. Without such internal controls, it is too easy to forget about contractually require duties and obligations like the Price Reduction Clause.

Monday, September 16, 2019

DCAA to Triple The Number of Defective Pricing Audits

Bloomberg published an article last week reporting that DCAA (Defense Contract Audit Agency) plans to triple the number of defective pricing audits in the upcoming fiscal year. Defective pricing audits are tests for contractor compliance with the Truth in Negotiations Act (TINA).

According to the article, DCAA intends to complete 60 defective pricing audits in the coming fiscal year.  During fiscal years 2017 to 2019, the Agency completed 26, 21, and 20 respectively. Bloomberg notes that at least two congressional committees are reviewing the Pentagon's enforcement of TINA, a law intended to prevent unjustified profits based on incomplete, flawed or inaccurate cost or pricing data (actually the term "flawed" is not part of TINA. TINA refers to 'current', 'complete', and 'accurate').

Not only does DCAA intended to triple the number of audits it intends to complete but it also plans to quintuple the number of audit hours applied to those reviews.

One of the reasons, besides ongoing Congressional oversight, for the increase in the number of defective pricing audits is the track record of positive audit findings. The former Director for defense pricing noted that during his tenure, 100 percent of the contracts examined at one top-25 defense contractor had 'suspect' defective pricing. And he also added that "If one looks deep enough there is some element of fraud typically lurking". For example:
In a number of cases we expected profit outcomes of 12% to 15% ... but (the auditors) found levels of between 25% and 80% on some sole-source weapons contracts. That does not happen by outstanding performance but by faulty contractor cost estimating or in the worst case, fraud.
Since fiscal year 2015, nearly 75 percent of defective pricing audits have uncovered potential noncompliances with TINA. The amount challenged is almost $600 million (though after the issues are settled, will be something less than that). Ten of those audits have been referred to investigators as suspected irregular conduct and eight of those ten are currently active cases.

TINA applies to negotiated contracts over $700 thousand or $2 million, depending upon when the contracts were negotiated. Competitively awarded contracts and contracts based on commercial item pricing are not subject to TINA. It is likely that DCAA will be concentrating its efforts on the larger Defense contracts; the top 10 or the top 25. If you don't fall in those categories, it is unlikely that your contracts will be selected for audit.




Friday, September 13, 2019

Impartiality Impairments


The standards of ethical conduct for Government employees require that employees take appropriate steps to avoid an appearance of loss of impartiality in the performance of his or her official duties. To do this, the standards require that an employee should not participate in a particular matter involving specific parties with whom they had a covered relationship without prior authorization from the agency designee. Two things in this prohibition require definitions; 'particular matter' and 'covered relationship'.

A 'particular matter' includes, among other things, a contract in which the United States is a party or has a direct and substantial interest. A 'covered relationship' would include a former employer with whom the employee worked for within the last twelve months.

Typically, when we read about violations of ethical standards, it involves a former Government employee who left and went to work for company with Government contracts where that employee had substantial involvement over the negotiation, award, and administration. But it could apply the other way as well - where a contractor employee goes to work for the Government. A recent audit report by the GSA (General Services Administration) Office of Inspector General (OIG) illustrates the later point. The OIG found that GSA and one of its employees violated these standards of ethical conduct.

Northern Management Services has an O&M (Operations and Maintenance) contract with GSA to maintain three Federal buildings in the Ft. Worth, TX area. A project manager for Northern who assisted in preparing cost proposals for the company, left and went to work for GSA, whereupon he participated in negotiating costs for task orders for projects which he had prepared the cost estimates.

The OIG found that this employee had an "impartiality impairment" and that neither he nor GSA took necessary steps to avoid an appearance of loss of impartiality in the performance of his official duties. The OIG ordered GSA to take immediate steps to address the impartiality impairment which presumably (though not stated) would require someone to take a second look at the negotiation process to ensure that the Government's interests were protected.


Thursday, September 12, 2019

Honest Services Fraud


"Honest services fraud" is a relatively new criminal statute added to the federal mail and wire fraud statute in 1988. Persons convicted of honest services fraud have been convicted of a scheme or artifice to deprive another of the intangible right of honest services.

This statute has been most often applied by federal prosecutors in cases of public corruption. The statute is limited to "fraudulent schemes to deprive another of honest services through bribes or kickbacks supplied by a third party who has not been deceived. The traditional mail fraud and wire fraud statutes are limited to schemes that defraud victims of tangible property, including money. Congress added the 'honest services' provision in 1988 to included defrauding victims of honest services. Generally, there are two main areas of honest service fraud; bribery (either direct or indirect) and failure to disclose a conflict of interest resulting in personal gain.

Anthony Daguanno was recently sentenced to a year in prison after pleading guilty to 'honest services fraud'.

The Treasury Department gives cities with blighted areas, money each year to demolish vacant houses. Detroit hired a company called Adamo to help administer the program. Specifically, Adamo assembled bid packages in response to RFPs issed by the City, communicated with subcontractors and kept track of bids submitted. Mr. Daguanno worked for Adamo and was primarily responsible for these tasks.

On numerous occasions, 'Contractor A' paid Daguanno money for disclosing confidential information about competitors' bid; information such as the lowest competitor bid which allowed Contractor A to submit a lower bid, ensuring that it got the contract. Over an eight year period, Daguanno accepted more than $372 thousand in bribes and kickbacks on 71 occasions.

As part of the sentencing, Mr. Daguanno must forfeit the $372 thousand in bribes and pay a $10 thousand fine. Read more about the case in the Justice Department press release.

Wednesday, September 11, 2019

FAR Update for Definition of "Affiliates"

The FAR (Federal Acquisition Regulations) Councils issued an amendment this week to revise the FAR definition of "Affiliates".

FAR 2.101 - The basic definition did not change. It read and still reads:
Affiliates means associated business concerns or individuals if, directly or indirectly either one controls or can control the other; or third party controls or can control both.
The change is the 'exceptions' to the definition. In the old definition, there were no exceptions. In the new definition, there are two:

  1. For the use in subpart 9.4 (Debarment, Suspension, and Ineligibility), see the definition of 'affiliates' at 9.403
  2. For the use in subpart 19.1 (SBA Size Standards), see the definition of 'affiliates' at 19.101. 
The definitions are similar but each take it a step further to detail or give examples of what the word "control" means.
9.403: Affiliates - Business concerns, organizations, or individuals are affiliates of each other if, directly or indirectly, either one controls or has the power to control the other or a third part controls or has the power to control both. Indicia of control include, but are not limited to interlocking management or ownership, identity of interests among family members, shared facilities and equipment, common use of employees, or a business entity organized following the debarment, suspension , or proposed debarment of a contractor which has the same or similar management, ownership, or principal employees at the contractor that was debarred, suspended, or proposed for debarment.
19.101: Affiliates means business concerns, one of whom directly or indirectly controls or has the power to control the others, or a third party or parties control or have the power to control the others. In determining whether affiliation exists, consideration is given to all appropriate factors including common ownership, common management, and contractual relations. SBA determines affiliation based on the factors set for at 13 CFR 121.103
The CFR reference is an extensive list describing how SBA determines 'affiliations'. SBA wants to make very sure that they are not awarding contracts to businesses that are affiliated with large businesses.



Tuesday, September 10, 2019

Summary Judgments - What Are They?

In law, a summary judgment is a judgment entered by a court for one party and against another party without a full trial. Either party can request the court (e.g. the Board of Contract Appeals) for a summary judgment and often times, both parties will make cross-motions for a summary judgment.

In the context of ASBCA (Armed Services Board of Contract Appeals) and civilian agencies Boards of Contract Appeals, motions for summary judgement are evaluated under well-settled standards.

First, summary judgments are properly granted only where there is no genuine issue of material fact and the party that requests the summary judgment is entitled to judgment as a matter of law.

Second, the moving party bears the burden of establishing the absence of any genuine issue of material fact and all significant doubt over factual issues must be resolved in favor of the party opposing summary judgement.

Third, in the course of the Board's evaluation of a motion for summary judgment, its role is not to weigh the evidence and determine the truth of the matter, but rather to ascertain whether material facts are disputed and whether there exists any genuine issue for trial. A material fact is defined as one which may make a difference in the outcome of the case.

Fourth, the opposing party must assert facts sufficient to show a dispute of material fact. To ward off summary judgment, the non-moving party must do more than make mere allegations, it must assert facts sufficient to show a dispute of material fact.

Once these four standards are met, the Board can and does render summary judgments.


Monday, September 9, 2019

Contractor Pays $500 Thousand to Resolve Allegations It Misrepresented its HUBZone Status

HUBZone (Historically Under-utilized Business Zones) is a SBA (Small Business Program) for small businesses that operate it and employ workers living (mostly) in historically under-utilized business zones. To be more specific, HUBZones are metropolitan and rural areas with low income, high poverty rates, and high unemployment rates. The program is now a little more than 20 years old. There are about 2,500 designated HUBZones in the United States. The best way to view them is with SBA's HUBZone Map. HUBZones are periodically added and subtracted from the list.

Other than being a 'small business' with majority ownership by U.S. Citizens, businesses eligible to participate in the HUBZone program must meet two important criteria.

  1. the firm's principal office (the location where the greatest number of employees perform their work, excluding contract sites) must be in a HUBZone, and
  2. 35 percent of the firm's total workforce must reside in a HUBZone.
The Government targets three percent of contracting be set aside for HUBZone qualified contractors. This works out to about $2 billion per year. Based on a study performed a few years back, this program has not had significant economic impact on HUBZone areas (counties, census tracts, and Indian reservations).

Most of the contracts awarded to HUBZone contractors are 'set-aside' by SBA for that purpose and often awarded on a sole-source basis. For companies operating in the HUBZone environment, getting a non-competitively awarded contract offers unique financial opportunities.

But there are some companies that have abused the system. MASS Service and Supply is one that recently came under scrutiny for falsifying records to show that at least 35 percent of its workforce resided in a HUBZone. Before the falsification of employee residences was discovered, MASS had been awarded several HUBZone set-aside contracts. MASS even went so far as to falsify spreadsheets to show fictitious employee addresses to give to Federal investigators. That wasn't too smart as it would not be particularly challenging for an investigator to confirm employee addresses.

MASS agreed to pay $500 thousand to resolve the False Claims Act (FCA) allegations that the company misrepresented its HUBZone status and lied to Federal investigators. That probably wiped out most of the company's profits earned under the HUBZone contracts. 

Friday, September 6, 2019

Prison Time for Selling Non-Conforming Parts to the Government

The owner of two companies with defense contracts will now spend the next three years in Federal prison and must also pay $8 million in restitution for selling non-conforming parts to the military for use on fighter jets and helicopters. Mr. Sobrado was convicted of a number of charges including conspiracy to commit wire fraud, conspiracy to violate the Arms Export Control Act, and income tax evasion but the root cause that precipitated all of these charges was selling non-conforming parts to the Government and certifying that they met contractual requirements.

According to a Justice Department press release announcing this sentencing, the particular contracts specified that the parts in question were critical application items for military equipment, including fighter jets and helicopters. Additionally, the contract required that these parts be purchased from one of a small group of 'authorized manufacturers'. Mr. Sobrano found local manufacturers to supply non-conforming parts at significantly reduced cost. As a result, Mr. Sobrano made windfall profits, some of which was not reported for income tax purposes.

Another aspect to this case was Mr. Sobrano's application to DoD for access to export controlled drawings and technical data on behalf of a family member's company. Access was to be restricted to U.S. Citizens and to those lawfully in the United States. The family member in question was in the United States illegally but was able to access and download hundreds of drawings that were sensitive in nature and that required special access.


Thursday, September 5, 2019

Self-Disclosure Law - Contractor Returns $2.6 Million to the Government

Last month, we posted an article about the requirement for contractors with "credible evidence" of violations of criminal law, violations of the False Claims Act and significant overpayments on Government contracts to self-disclose that evidence to the Office of Inspector General (OIG). The Defense Department's OIG had just reported that over the ten years since inception of that law, Government contractors had returned more than $200 million to the Government based on these mandatory disclosures. (See DoD Contractors Return $200 Million to Government through Mandatory Disclosure Program).

Well, DoD just added another $2.6 million to that total.

Yesterday, the Justice Department announced that it had reached agreement with a Defense contractor in New York after it self-disclosed over-billings to the Government and to its prime contractors.

The contractor, Arkwin Industries, detected errors in its accounting system that resulted in double-counting worker hours spent performing inspections of its products. Arkwin then self-disclosed the discovery to the Government and then undertook an internal investigation using the outside services of a forensic accounting team. After concluding its investigation, Arkwin reported its findings to the Government.

After receiving Arkwin's findings, the Government made its own independent investigation including a determination of whether the over-billing had been intentional or accidental. Arkwin cooperated fully throughout the investigation, providing documents, making witnesses available for interviews and responding to Government inquiries. Following this investigation, the Government concluded that the over-billing was accidental and negotiated the $2.6 million settlement.

This resolution demonstrates how the self-disclosure process should be working, according to the Justice Department. "When a Government contractor self-discloses billing errors and cooperates in the Government's investigation, (the Government) will work with them to arrive at a fair and just resolution".

Wednesday, September 4, 2019

Improper Business Practices - "Buying-In"

Last week we began a series on improper business practices as defined in FAR (Federal Acquisition Regulations) Part 3. FAR Part 3 includes sections on the prohibitions of gratuities to Government personnel, contingent fees, subcontractor kickbacks, "buying in"and anti-trust matters. Specific to contractors and subcontractors, FAR Part 3 covers whistleblower protections to contractor employees, requires codes of business ethics and conduct, and prevention of personal conflicts of interest for contractor employees performing acquisition functions. Its also the section that we discussed in Part 1 of this series that requires contractors and subcontractors to implement reasonable procedures to prevent and detect violations of the Anti-Kickback Act. If you missed that post, you should go back and read it.

Today we will be covering the practice of "buying-in"

Buying-in as used in FAR 3.501 is the practice of submitting an offer below anticipated costs, expecting to either increase the contract amount after award (e.g. through unnecessary or excessively priced change orders) or receive follow-on contracts at artificially high prices to recover losses incurred on the buy-in contract.

The practice of buying-in can decrease competition or result in poor contract performance.

FAR does not prohibit contractors from buying-in. But it does caution contracting officers to ensure that buying-in losses are not recovered by the contractor through the pricing of change orders or follow-on contracts subject to cost analysis. FAR lists several safeguards that contracting officers should use to minimize the opportunity for buying-in:

  1. Contracting officers should seek a price commitment covering as much of the entire program concerned as is practical by using multiyear contracting with a requirement in the solicitation that a price be submitted only for the total multi-year quantity or priced options for additional quantities that, together with the firm contract quantity, equal the program requirements.
  2. Contracting officers should perform cost or price analysis to develop a negotiation position that permits the parties to reach agreement on a fair and reasonable price (see FAR 15.405).
Contractors and subcontractors might have valid reasons for buying into a program besides making up the losses on change orders and follow-on work. SBIR (Small Business Innovative Research) contracts are often 'loss' contracts but contractors are willing to take the contract(s) because it represents Government funding on research the contractor planned or desired to do anyway.

Its almost impossible for the Government to determine whether a contractor is "buying-in" to a contract. But contracting officers are not naive and can often sense when such a practice might lead to much higher costs in the long run.




Tuesday, September 3, 2019

When Will You Exceed 75 Percent of Contract Funding? Why Does it Matter?

Accounting systems for Government contracting must meet many requirements that are not necessarily needed to properly account for costs under commercial work. Most of these requirements are centered upon cost accounting - accumulating costs by contract, recording time by contract, establishing indirect rates to apply to direct costs by contract, etc. - as opposed to financial accounting.

There is one criteria that most new and prospective contractors and subcontractors have difficulty understanding and implementing. It shows up as Item 3.a on the SF 1408, Pre-Award Survey of Prospective Cotnractor - Accounting System, or Item 18 on DCAA's (Defense Contract Audit Agency) Preaward Accounting System Adequacy Checklist and Item (c)(15)(i) of the DoD FAR Supplement Clause 252.242-7006 and it requires contractors to notify the contracting officer when it is about to run out of money on cost-reimbursable contracts.

Specifically, contractors (and subcontractors) performing under cost-reimbursement Government contracts are required to notify the contracting officer, in writing, whenever they have reason to believe

  • the costs the contractors expect to incur under the contracts in the next 60 days, when added to all costs previously incurred, will exceed 75 percent of the estimated cost of the contract, or
  • the total cost for the performance of the contracts will be greater or substantially less than estimated.
Consider, for a moment, the data and accounting information necessary to comply. First, lets point out that no accounting system, except very expensive systems catering to Government contracting, costing hundreds of thousands of dollars to license and implement, is capable of providing this information. So if you're using QuickBooks or another entry level accounting system, you will need to augment it with will something else. Most contractors use Excel.

Obviously to project what costs will be in the next 60 days will require some sort of budgeting or forecasting system. This is where a lot of contractors fail - they do not perform budgeting. Some contractors will look at their historic 'burn rate' and project off of that. That usually results in imprecise estimate and moreover, its not necessarily tied in to the accounting system.

The other data point to the required analysis is 75 percent of the funded amount. It is surprising the number of contractors and subcontractors who haven't bothered to calculate this number. Without it, there is no means of determining whether contract costs will exceed that number in 60 days.

If you need some assistance in setting up a system to comply with this accounting system requirement, give us a call.