Government Disapprove's Bechtel's Purchasing System

FAR Part 44 lays out the case for Government reviews of contractor purchasing systems. The objective of a "Contractor Purchasing System Review" (CPSR) is to evaluate the efficiency and effectiveness with which the contractor spends Government funds and complies with Government policy when purchasing and subcontracting. CPSRs provide the contracting officer a basis for granting, withholding, or withdrawing approval of a contractor's purchasing system.

The Defense Contract Management Agency (DCMA) is the organization with primary responsibility for reviewing contractor purchasing systems. DCMA has a CPSR review team that specializes in performing these reviews. The basis threshold for performing CPSRs is $25 million in cost type contracts during the next twelve months but that is somewhat fluid. The ACO (administrative contracting officer) determines the need for a review and considers other risk factors beyond the $25 million. Generally, CPSRs are conducted once every three years (Note, DCMA's Guidebook for performing CPSR's is available here).

The CPSR team conducting these reviews perform a deep dive into the policies, procedures, and practices for purchasing and subcontracting. It's not often that the team finds issues with policies and procedures as most contractors have had years to develop and evolve those documents. It is very easy for them to find non-compliance issues however. No one or no company is perfect and its not uncommon to overlook a checkbox, omit some documentation, or fail to obtain a required signature. The CPSR team writes up these infractions, the contractor promises to do better, and everyone goes on with business as usual for the next three years when the cycle begins again. If the deficiencies are significant enough, the contracting officer can withhold approval of the purchasing system which then requires contractors to obtain contracting officer approval prior to purchasing materials or entering into contracts.

It is very uncommon for CPSR reports to become public but it happened recently as at least two newspapers ran stories about a CPSR review performed at Bechtel National Industries that resulted in the Government pulling the contractor's procurement authority. Bechtel is the prime contractor on a $17 billion project to design, construct and commission a plant to turn radioactive waste into glass logs (the process is called vitrification). The plant was initially budgeted at less than $5 billion but that is a different story.

Without an approved purchasing system, Bechtel must obtain consent from a Energy Department contracting officer to award any fixed price contracts in excess of $150 thousand. The Energy Department stated that the new process will stay in effect as long as Bechtel's purchasing system remains "disapproved". Purchasing system deficiencies reported in the press include:

• Missing paperwork to document that the subcontractor had not been suspended or debarred.
• Missing certifications that subcontracted funds would not be used for lobbying
• Missing information as to how subcontractor was selected.
• Failing to notify the Energy Department 24 hours in advance of awarding a subcontract.

Bechtel, for its part, promised to conduct additional oversight on its practices to ensure compliance but indicated the added burden of obtaining Energy Department approval for every new purchase would not affect the construction schedule. 

New DoD Rule on Review, Audit, and Approval of Electronic Parts Purchases

DoD issued a final rule last week that makes contractors and subcontractors subject to approval, review and audit by DoD officials when identifying a contractor-approved supplier of electronic parts.

DoD was quick to point out however that this new rule shouldn't be too much of a burden on contractors as the review, audit, and approval of contractor-approved suppliers will generally be in conjunction with a contractor purchasing system review (CPSR) or other surveillance of purchasing practices by the contract administration office. However, if the Government has credible evidence that a contractor-approved supplier has provided counterfeit parts, it can, and will initiate a separate review, audit, and approval.

This new process relate only to electronic parts that are not in production by the original manufacturer or an authorized aftermarket manufacturer and that are not currently available in stock from the original manufacturer, their authorized suppliers, or suppliers that obtain such parts exclusively from the original manufacturers.

Contractors have already been required to establish counterfeit electronic part detection and avoidance systems under DFARS 252.246-7007 (if that clause is included in a DoD contract) as part of their established purchasing systems. Any deficiencies in a purchasing system, including counterfeit electronic parts, will impact across the board to all contracts.

For contractors that already have approved purchasing systems, the prior approval remains in effect. That approval remains in effect for three years. After three years, the purchasing system is no longer approved. The status is listed as "not applicable" which means it is neither approved nor disapproved. It seems likely that such systems would have an increased chance of being subjected to review, audit and approval of electronic parts purchases.

To read more about the new rule, click here.

DoD's Procurement Management Reviews Offer Good Advice for Contractors

The Defense Contract Management Agency (DCMA) conducts independent reviews of the procurement function of other Defense agencies and field activities that perform contracting operations. These reviews are designed to assess the effectiveness of the contracting function, analyze and assist in resolving identified problem areas (yes, we're from the Government and we're here to help), and identify noteworthy practices that may be beneficial to all organizations. These reviews are called "Procurement Management Reviews" or PMRs.

So what do these reviews have to do with contractors? Well, aside from the fact that Government contractors should appreciate well-run, efficient, and effective procurement departments that get the job done and don't dwell on minutia that bogs down procurement and cost contractors time and money, these reviews can help contractors improve their own procurement practices.

A recent summary of PMR reviews performed in fiscal years 2016 and 2017 included a listing of 22 recommendations appearing in more that 50 percent of the reviews. Many of these recommendations, resulting in identified deficiencies in the procurement process, apply equally to contractor purchasing departments. Contractors would do well to use this listing as a tool to assess the effectiveness of their own procurement functions.

Some of the recommendation that seem most applicable to contractor procurement functions include the following:

1. Verify that contract files clearly demonstrate how source selection evaluations were conducted and decisions were made
2. Files must document adequate market research was performed to clearly record how research informed the acquisition strategy.
3. Documentation in contract (and subcontract) files must be sufficient to constitute a complete history of the traction.
4. Ensure small business subcontracting goals are considered.
5. For sole source awards, ensure there is adequate determination of fair and reasonable pricing.
6. For commercial items, ensure there is documentation of the commercial item determination.
7. Ensure that adequate and measurable performance standards are stated in contracts for services and that sufficient surveillance methods are identified.

As we stated, these recommendations arose in more that 50 percent of the PMR reviews. If the Government finds such deficiencies in its own house, its not difficult to conclude that similar deficiencies exist within contractor purchasing departments.

Prison Time for Accepting Kickbacks from Subcontractor

Have you ever discounted the importance of good, sound internal controls over your purchasing system? You shouldn't and here's why.

A former employee of a U.S. Government contractor in Afghanistan will spend the next 21 months in prison because he accepted more than $250,000 in kickbacks from one of the contractor's Afghan subcontractors. These kickbacks were given in exchange for assistance in obtaining subcontracts.

The employee (or, now the former employee) admitted that while he was employed as a project manager, he an Afghan executive agreed that in exchange for illicit kickbacks, the employee would ensure that the Prime Contractor awarded "lucrative" subcontracts to the Afghan company.

How did the employee do it? He admitted that he repeatedly told his supervisors that the Afghan subcontractors should be awarded "sole source" subcontracts, which allowed them to supply services to the Prime contractor without having to competitively bid on them.

That must have really been some convincing sole source justifications, or the superiors weren't all that concerned, or they had a big cost-type contract so no skin off their back. Or perhaps, this employee was highly trusted. But, as we've repeated here in this blog over and over, "trust" is not an internal control.

The value of the subcontracts totaled $1.6 million and the contractor employee got 15 percent of that. That should be a good indication right there that the prices were overstated. He stored the cash payments into his personal effects and when he got back to the states, he deposited the funds into several bank accounts.

No word in the DoJ Press Release as to how the kickback scheme was uncovered. Perhaps someone started looking into why so many sole-source subcontract awards were being made.

You can read the entire DOJ Press Release here.

Is Your Purchasing System Adequate?

How do you know whether your purchasing system is good enough for Government contracting? There are guidelines in the FAR (Federal Acquisition Regulations) and various FAR supplements (e.g. the DoD FAR Supplement or DFARS) to help contractors make self-assessments as to whether their purchasing systems are adequate for Government purposes. Often, when people hear about purchasing systems they have subcontracting in mind. However, the term purchasing system can also encompass the full range of material purchases. Ultimately, the Government is most concerned that contractors spend Government funds most efficiently and effectively. To the extent that your purchasing system can provide that assurance, you should be good to go.

Perhaps the most comprehensive listing of the characteristics of a purchasing system are found in DFARS 252-244-7001. There are 24 of them but we'll just examine a few.

The most important thing about a "system" is its documentation. There needs to be a system description that includes policies, procedures, and purchasing practices. These policies, procedures, and practices must comply with FAR and DFARS (or other Agency supplements, although many Federal agencies defer to DoD anyway). If you don't have a system description, you will fail right out of the gate. Your purchasing system will not be adequate because no one will have the road map.

Flow-down clauses. Many of prime contract clauses are required to be flowed down to subcontracts. This is not as easy as it sounds because there is no centralized listing of what needs to be flowed down for each type of contract. At a minimum, contractors need to identify the mandatory clauses but that would not be sufficient for most purposes. For example, the Government's termination for convenience clause is not a required flow-down clause but a contractors would certainly want that clause in any subcontract that it awards if it is in their prime contract.

Lines of authority. Does the purchasing organization have clear lines of authority and responsibility? Is there a division of responsibility that reduces the likelihood of fraud in the purchasing organization? Many of the reported fraud investigations were the result of someone messing with the purchasing function. Many frauds could have been avoided with the proper internal controls, lines of authority, and division of duties.

Are purchase orders based on authorized requisitions and include a complete and accurate history of purchase transactions to support vendor selections, and prices paid. The Government will, at some point, request PO/Subcontract files and would expect to see this information/data.

Does the system show evidence that price, quality, delivery, technical capabilities, and financial capabilities of competing vendors were considered and properly evaluated to ensure fair and reasonable prices? Or, to state it differently, how do you prove to the Government that you got the best price?

Regardless of whether a company has Government contracts, the purchasing function is critical to the organization and will ultimately affect its bottom line.

Estimates for Complying with Government Regulations

From time to time, the FAR Councils publish notices asking for public comments regarding an extension to a previously approved information collection requirement. These notices are required under the provisions of the Paperwork Reduction Act.

These are primarily formalities and most of the time, no one from the public bothers to comment. We don't pay much attention to them either except when they pertain to matters that we write about in this blog and even then, we read them only to learn what the Government's estimate for contractor hours required to comply with the collection requirements.

As an example, today the FAR Councils published a notification pertaining to purchasing systems. FAR Part 44 discusses contractor purchasing system reviews (CPSRs), the objective of which is to evaluate the efficiency and effectiveness with which a contractor spends Government funds and complies with Government policy when subcontracting.

A CPSR provides the administrative contracting officer (ACO) a basis for granting, withholding, or withdrawing approval of a contractor's purchasing system. A review is generally required for contractors expected to receive $25 million or more in the upcoming 12 months but that threshold can be raised or lowered depending upon perceived risk to the Government.

A CPSR covers such things as market research accomplished, price competition obtained, pricing policies and techniques, methods of evaluating subcontractor responsibility, implementation of small business goals, compliance with Cost Accounting Standards, management controls systems, and more.

The FAR Councils estimate that the Government will perform 1,580 CPSR reviews per year. That estimate doesn't sound out of line. But here is what's laughable. They estimate that contractors will expend an average of 25 hours preparing for and supporting each CPSR. We have been involved in many CPSR reviews, primarily as Government auditors in support of DCMA (Defense Contract Management Agency) review teams and have never experienced one where the contractor expends only 25 hours. Contractors are more likely to spend ten times that number of hours by the time the review is completed.

How Long Do You Spend Preparing for a CPSR?

The objective of a contractor purchasing system review (CPSR) is to evaluate the efficiency and effectiveness with which the contractor spends Government funds and complies with Government policy when buying materials and for subcontracting some of the required effort. The review provides the administrative contracting officer a basis for granting, withholding, or withdrawing approval of the contractor's  purchasing system.

DCMA (Defense Contract Management Agency) is the Agency responsible for conducting CPSRs. Among other things, the Agency looks at the adequacy of the system description (e.g. policies, procedures, and operating instructions) and that those policies and procedures are being followed.

These CPSR reviews are far from routine or perfunctory. DCMA's own guidebook for performing CPSRs is 40 pages by itself. The DCMA Instruction adds another 40 pages. DCMA's notification of a pending review also requests that the contractor compile and submit reams of data prior to the initiation of fieldwork. Understandably, a CPSR notification begins a flurry of contractor activity to prepare for the review.

With this background, we were amused at the Government's estimate of the time required by contractors to prepare for and support such a review. The FAR councils estimate that it takes an average of 25 hours of contractor time for "reading information and preparing for a CPSR". That estimate is laughably and significantly understated, perhaps intentionally so. In our own past involvement in CPSR activities, both as team members on the Government side and support for the contractor's side, we know that contractor effort alone will run into the hundreds of hours by the time the review is completed.

When promulgating regulations, it seems to us that the FAR councils consistently underestimate the true cost of compliance. Perhaps if the estimates were more realistic, someone might question the cost/benefit of these regulations.

Contractor Purchasing Systems - Source Selection Considerations

FAR (Federal Acquisition Regulations) 52.244-2 requires prime contractors to provide contracting officers notification before the award of many subcontract and to obtain contracting officer consent to subcontract. See Government's Consent to Subcontract for more information on this subject. The objective of requiring consent to subcontract is to evaluate the efficiency and effectiveness with which the contractor spends Government funds and complies with Government policy when subcontracting.

With this in mind, Government agencies have devised a variety of checklists they use when reviewing contractor notification and consent packages. One of the most important aspects in determining contractor compliance with Government policy is in the source selection process. Following is a compendium of items taken from several of those checklists. Contractors would do well to ensure that their own purchasing systems address these areas.

• Adequately address make-or-buy considerations.
• If procurement is from a contractor-controlled source, provide adequate justification.
• Consider soliciting labor surplus areas and small business sources, including small business owned and controlled by disadvantaged individuals.
• Compliance with contract requirements regarding small business subcontracting, including, if applicable, plans for subcontracting with small, veteran-owned, service-disabled veteran-owned, HUBZone, small disadvantaged and women-owned small business concerns.
• Agreement to provide progress payments on fixed-price subcontracts with small business concerns in conformity with FAR 32.502-3 and not consider such payments as an adverse factor in selection.
• Ensure adequate price competition or properly justify the absence of adequate price competition.
• Ensure a sound basis for determining the responsibility of a particular subcvontractor.
• Ensure that the proposed subcontract type is appropriate for the risks involved and consistent with current policy.
• Ensure that the proposed subcontract does not appear on the Excluded Parties List System (see FAR 9.404).
• Ensure that OCI (Organization Conflicts of Interest) analysis has been performed.

Government Consent to Subcontract - Does the Requirement Serve a Useful Purpose?

It’s been some time since we last wrote about the requirement for contractors to notify contracting officers before the award of certain subcontracts and obtain their consent to subcontract. In fact, it was back in 2010 that we discussed these requirements in some detail. To read those timeless postings, see Part 1 and Part 2.

Federal Acquisition Regulation (FAR) 52.244-2, Subcontracts, requires prime contractors to provide contracting officers notification before the award of any cost-plus-fixed-fee subcontract, or certain fixed-price subcontracts. This requirement for advance notification is driven by statutory requirements in 10 U.S.C. 2306 and 41 U.S.C. 3905. FAR clause 52.244-2 also requires prime contractors to get consent to subcontract for cost reimbursement, time-and-materials, labor-hour, or letter contracts, and also for unpriced actions under fixed-price contracts that exceed the simplified acquisition threshold. 

The objective of requiring consent to subcontract, as discussed in FAR Part 44, is to evaluate the efficiency and effectiveness with which the contractor spends Government funds, and complies with Government policy when subcontracting. The Government requires a contractor to provide certain information (e.g., subcontractor’s name, type of subcontract, price, description of supply or services, etc.) reasonably in advance of placing a subcontract to ensure that the proposed subcontract is appropriate for the risks involved and consistent with current policy and sound business judgment. The information provides the Government time and a basis for granting, or withholding consent to subcontract. 

These requirements should be addressed in every contractors' purchasing system description, policies, and procedures. In fact, if they're not covered and DCMA decides to perform a CPSR (Contractor Purchasing System Review), the lack of coverage would probably be written up as a deficiency.

The consent to subcontract exercise comes at a cost however and this is another one of those areas where unique Government contracting requirements adds cost to the process. The Government estimates that each Government contractor will submit an average of three advisories/consent to subcontract per year and each of those submissions will take about two hours to prepare. We think that two hours per submission significantly understates the actual time required. Multiply that out by your hourly rate and you'll get an estimate of the cost to comply. 

The FAR Councils are now asking for public input on the efficacy of these procedures to produce the results intended when Congress passed the law. If you care to comment or wish to read more, click here.

For Contractors Contemplating the Award of T&M Subcontracts

T&M (Time and Material) contracts represent high-risk contracting vehicles to the Government. The Government has special requirements that Agencies must meet before awarding T&M contracts and many of these flow down to T&M subcontracts awarded under Government prime contracts (see for example FAR 16.601 and DFARS 216.601). The Government requires that procurement files justify and document the rationale for T&M award (prepare a D&F or Determination & Finding) and contractors would do well to implement similar requirements.

T&M contracts are high risk for a number of reasons. First, it does not incentivize contractors to control costs. In fact, just the opposite. The more labor hours a contractor can throw at a task, the more profit it will make. Secondly, and this happens a lot, contractors sometimes provide a lesser skill than contemplated in the T&M rate. For example, the rate may have been developed for an Electrical Engineer II but the contractor uses an Electrical Engineer I for the task and bills at the Level II rate. From the Government's perspective, it doesn't matter that the work was performed satisfactorily by a lesser qualified individual - the Government paid for a higher skill level than it received. By comparison, under a cost-type contract (also considered a high-risk contracting vehicle), if the contractor utilized a lower skilled worker, the Government would have reimbursed it for the lower skill, not something higher.

T&M contracts can also be high-risk for contractors. T&M rates are fully burdened rates and include fringe, overhead, and G&A allocations. If the contractor (or subcontractor) understates any of these factors, it will be at risk of losing money on the deal (which may be one reason that some contractors are tempted to substitute lower skilled workers for the higher-rate jobs.

When awarding (or contemplating) T&M subcontracts, contractors should insure that their files contain sufficient facts and rationale to justify that no other subcontract type is suitable. Subcontract files should

• Include a description of the market research conducted
• Establish that it is not possible at the time of placing the contract or order to accurate estimate the extent or duration of the work or to anticipate costs with any reasonable degree of certainty
• Address why a cost-plus-fixed-fee or other cost-reimbursement, incentive, or fixed-price contract or order is not appropriate. Generally, a cost-plus-fixed-fee contract is preferred over a time-and-materials (or labor hour) contract type
• Establish that the requirement has been structured to minimize the use of T&M requirements
• Describe the actions planned to minimize the use of T&M (and labor-hour) subcontracts on future acquisitions of the same requirements.

Government reviews of contractor purchasing systems will undoubtedly include reviews of T&M subcontracts. It would be beneficial for contractors to have their files, justification, and support in order.

Purchasing Systems and Their High Propensity for Fraud

According to the 2014 Association for Financial Professionals Payments Fraud and Control Survey, a staggering 60 percent of businesses were exposed to actual or attempted payments fraud in 2013. The typical fraud-related loss experienced by businesses was $23 thousand. Ten percent of businesses recovered the full amount of money defrauded from them. Thirty percent of those impacted by fraud recovered nothing.

Not surprisingly, small businesses are more susceptible to fraud than larger firms. Many small businesses do not have internal control systems, they're disorganized, they do not perform business fundamentals like reconciling checkbooks regularly, and they put a lot of trust in their employees.

There are many ways to defraud. If the fraud is the accounts receivable clerk kiting checks, the resolution is between the clerk, the company, and perhaps local law enforcement. But woe to the company where the impact of fraud is passed along to the Government through a contract or grant. That company will feel the immense weight of the Government investigative and judicial juggernaut as they pursue prosecution and/or settlement.

Consider the Department of Justice press release from yesterday. Sevenson was a company founded in 1917 by one man. The company was passed on in the 1940s to the man's sons and from the sons to the grandsons in the 1970s. Here was a nearly 100 year old environmental remediation company that became quite successful by any standard - except for one detail. They had some employees who exploited weak internal controls.

These employees accepted kickbacks, rigged bids, and passed inflated charges to the Government. The DOJ press release stated that the employees accepted more than $1.6 million in kickbacks from six companies in exchange for the award of subcontracts for work at a EPA clean-up site. Then, those employees conspired with the subcontractors to pass the majority of those kickbacks to the EPA through inflated charges.

Obviously, this kind of fraud is perpetrated through a contractor's purchasing system and that is one reason why the adequate purchasing system are so important to the Government (e.g. DCMA performs periodic Contractor Purchasing Reviews (CPSR) at larger contractors). Internal controls can be devised to prevent fraud. Contractors should implement sound policies, procedures, and practices before its too late.

How Good Are Your Purchasing System Internal Controls?

When companies first start out, the entrepreneur/founder does just about everything him/herself - engineering, manufacturing, purchasing, estimating, accounting, billing, and on and on. As the company grows, specialists are hired to take over these functions. As a sole proprietor, internal controls are not critical. But as employees are added and systems become more complex and vulnerable to fraud, internal controls become absolutely necessary.  Purchasing is a system that is highly vulnerable to fraud. Purchasing agents have a lot of opportunity and methods in which they can enrich themselves at the expense of the employer (e.g. the Government contractor) and ultimately the Government. All you need to do is peruse the DoJ's press releases to find dozens, perhaps hundreds of incidences involving procurement fraud by Government and contractor employees alike.

So one would think that a company like Boeing would have internal controls that would be impervious to procurement fraud. After all, their business systems are considered the gold standard for Government contractors, they are publicly held and responsible to stockholders and they are subject to all of the internal control requirements of the Sarbanes-Oxley Act. They probably have enough policies and procedures to fill a semi truck trailer.

But Boeing is not immune to fraud committed by employees and neither are you. Last Monday, a Federal grand jury in St. Louis indicted a Boeing procurement office on charges he gave inside information to a Washington state shop owner and others, netting the subcontractors more than $3.5 million in orders for aircraft parts. In this case, the Boeing employee gave the shop owner information about the competitors bids and also, historical price information in exchange for cash.

According to the indictment, the shop owner used the information from Boeing to prepare and submit bids to Boeing on behalf of his company. Ultimately, the shop was awarded seven purchase orders totaling $2 million. The Boeing employee also perpetrated his scheme with other suppliers.

FBI raided the shop owner's facility in Washington last May and hauled away lots of records. At that time, FBI refused to discuss what they were up to. Now we know.

The shop owner also appeared on a Bank of America promotional video in which he and employees talked about how the business grew with help from the bank. That video, which has since been taken down from Bank of America's website, included the following quote:

I just got into this trade without a formal business background. High school had a metal shop. It was a great place to fix my dirt bike. Couldn't afford to really go buy parts all the time. And this led to a job in a machine shop. Twenty-five years or so, it kind of just flies by, and here you are.

We guess he should have also mentioned the help he got by bribing Boeing purchasing agents for the company's growth.

So, how effective are your internal controls over purchasing?