Keeping Auditors On Course

When it comes to estimating indirect rates for proposal pricing purposes, contractors utilize many methodologies, techniques, data and resources. Estimates can be based on historical data, regression analysis, projections of future sales, parametric estimates, and many others and a combination of all the above.

While evaluating contractor estimates of forward pricing rates, auditors have an innate desire to try and come up with their own estimates. Coming up with independent estimates is not auditing of course, the auditor is not attesting to and reporting on contractors' assertions. Nevertheless, auditors do it anyway - they will try to find a way to justify lowering indirect rates.

It is extremely important for contractors therefore to help auditors remain focused on evaluating the proposed bases of estimates. Contractors should be assertive in explaining their methodology and why they have determined it is an acceptable basis or even the best basis for estimating indirect rates for that particular pricing action. Contractors should also be prepared to answer what alternative methods were considered and why they were discounted.

We'll give you an example. If indirect rates are based on historical data, contractors must be prepared to show why that particular data will provide a reasonable basis for estimating future costs. If the rates are based on six months of history and the auditor asks for eight months of history, contractors must be prepared to explain why eight months of history is not necessarily applicable. Perhaps the additional two months of data has not been validated. Perhaps a contractor accrues depreciation and other expenses (insurance, pension contributions, etc) on a quarterly basis so that eight months of actual costs would not be representative.

Contractors must maintain an awareness of the trajectory of an audit. Its much more efficient to address methods, judgments, and assumptions during an audit than to do so after a report is issued.

Government Withholding Payments for Inadequate Business System

Aviation Week and Space Technology reported this week that the Defense Contract Management Agency (DCMA) has increased the amount being withheld from Lockheed Martin on the F-35 program from two to five percent because the company has not made satisfactory progress in correcting deficiencies in its EVM (Earned Value Management) system.

EVMS is one of the six business systems that must be adequate or contractors face potential withholds on their billings to the Government. The other five are accounting, estimating, purchasing, MMAS and Government property (in the hands of contractors).

Lockheed was awarded a $4 billion LRIP (low rate initial production) contract for 30 F-35 aircraft last December. The contract included the EVMS clause which requires compliance with 32 different EVM guidelines. The Government's review of Lockheed's compliance with those guidelines disclosed significant deficiencies in 19 of them. Lockheed had promised to have them corrected by June. In June however, the Government found that Lockheed had not made sufficient progress in correcting the deficiencies which led to the 5 percent withhold.

Five percent is a significant withhold. One estimate we read stated it would cost Lockheed $2 million per month. That might be underestimating the amount since the contract is $4 billion. Regardless, it represents a significant amount and is sure to affect the company's bottom line.

This incident is evidence that the Government is serious about enforcing the business system requirements laid out in the DoD FAR Supplement and is willing to invoke the withhold provisions when significant deficiencies go uncorrected.

GSA Revises Local Mileage Reimbursement Rates

We were visiting a client late last week and noted that they were still using an old rate for reimbursing employees for using privately owned vehicles (POVs) for company business. Many companies have tied their reimbursement policies into rates published by GSA (General Services Administration). Some companies check these rates at the beginning of the year and forget to monitor them for changes throughout the year.

GSA revised the local mileage rate effective April 17, 2012 from 51 cents to 55.5 cents per mile. Companies that have pegged their reimbursement policies to the GSA rate should note the change. FAR does not require companies to follow the GSA local mileage reimbursement rates. It only requires that reimbursement be reasonable. Most companies however, tie their policies into either the GSA rate or the IRS rate (there are often differences between the two) as a matter of convenience.

Sometimes these reimbursement rates fall. In January 2010, the GSA reimbursement rate fell from 55 cents to 50 cents per mile. One company failed to make corresponding changes to their own policy until later in the year. Consequently, the company reimbursed employees for their POV usage at the old rate and subsequently charge the cost to Government contracts.

The auditors (a commercial accounting firm hired by DoE to conduct incurred cost audits) made an issue of this, claiming that the costs were unreasonable and threatened to issue a system deficiency report because the contractor had not adjusted its reimbursement rates downward. Ultimately things ended well for the contractor but there was a lot of time and effort spent in resolving the matter. The incident does illustrate the need to stay abreast of changes in regulations and reimbursement caps.

DCAA Clearing Out the Incurred Cost Backlog

Missing Schedule T 

Executive Compensation - The Government Loses Again

The next time the Government challenges your compensation levels, you have two new ASBCA decisions (one this month and the other from January) that call into question their methodologies for determining "reasonableness", and these cases may help in your defense.

The ASBCA (Armed Services Board of Contract Appeals) handed down a decision earlier this month that again, calls into question the Government's (and specifically DCAA's) methodology for evaluating the reasonableness of contractor employee compensation. This particular decision involving a Washington DC area contractor, Metron, Inc., follows the J.F. Taylor decision from January of this year which we blogged about here and here.

Compensation charged to Government contracts must be reasonable for the work performed. FAR 31.205-6.(b)(2) provides some factors that may be relevant in determining reasonableness. These include conformity with the compensation practices of other firms;

1. Of the same size
2. In the same industry
3. In the same geographic area, and
4. Engaged in similar non-Government work under comparable circumstances.

In order to make such a comparison, contractors and the Government rely on commercially available surveys. There are a number of these surveys, both national and regional in scope. The national surveys include:

• Radford
• Watson Wyatt
• Economic Research Institute

The Washington Technical Professional Forum Compensation Survey Report would be an example of a regional survey for technology companies in the Washington DC area.

In the Metron case the contractor based the reasonableness of compensation on the Radford survey. The Government countered using averages of a number of surveys which produced lower numbers.

The Board was persuaded by Metron's methodology for determining reasonableness. 

Based on the entire record, we conclude that Metron has sustained its burden of proving that the ... executive compensation costs in dispute were reasonable....After analyzing available surveys, Metron concluded that the Radford Survey best matched the company, among other things, in terms of size/revenue ... industry ... and geographic location.

The Board also fully considered the Government's contentions regarding the use of additional surveys to "average" in determining reasonableness. However, it determined that on the facts of this case the Radford Survey data alone provides a sufficient foundation for proving the reasonableness of Metron's executive compensation. The additional surveys relied upon by the Government were less appropriate, comprehensive, reliable, or persuasive than the Radford Survey for the positions in dispute.

We Were Auditors Once, and .... (Part 5)

We were auditors once, and contractors were seldom excited to see us coming. We understood the feeling. There was always the chance that after we left, contractors would be a little poorer. Our jobs were to make sure that the dollars being transferred from taxpayers to contractor bank accounts were proper. We got called a lot of things and maintained an aloofness rooted in trying to maintain independence in fact and in appearance. We brought some disdain upon ourselves when we had t-shirts and coffee mugs emblazoned with the phrase: "In God We Trust, All Others We Audit".

Its a myth however that auditors dislike contractors. Contrary to appearances, we really liked 99.99 percent of the contractor personnel we dealt with. Under different circumstances, we might be playing golf, attending family birthday parties, or enjoying a dinner on the town together. But it wasn't to be. Independence trumped friendship, as it should have. We admired and respected the people who took some risks, started companies, filled needs, created jobs, and hopefully at the end of the day, made a buck or two.While we were neither advocates nor champions for their causes, we always wished them the best.

We Were Auditors Once, and .... (Part 4)

We were auditors once and we absolutely hated audit programs (and working papers). Yes, we are borderline heretics here. We know that audit programs are road maps for conducting thorough audits but after a few trips to work and back, how many people still need to consult their GPS device to make the right turns? Same thing with audit programs. If an auditor having done the same kind of audit a few times still needed to consult an audit program, he's not a thinker, he's a robot. Yet, if an auditor does not follow the audit program and dutifully document his work and sign off on each and every audit step, the "gotcha guys" in headquarters who secretly retrieve archived audit working papers in order to find inconsequential omissions will come down on he auditor like Thor. My goodness, how much less value can you add to a process than to be a checker of the checkers (and these "checkers of the checkers" are right up there with GSA's Las Vegas conference folks, compensation-wise).

It would be one thing if audit programs were one-page checklists, but these Government audit programs are gargantuan monsters with sometimes dozens of pages. Most of the stuff in these audit programs are not even relevant to what the auditor wants to accomplish but they still need to labor though them and write up justification as to why this or that step doesn't apply. And because of this preoccupation with prettiness, there's less time for the actual audit (boots on the ground, as they say). Take, for example, a DCAA audit report issued earlier this year. The auditor charged 1,457 hours to the assignment of which only 169 of those hours were spent at the contractor's facility. Imagine spending three-quarters of a year on the same audit. Is there a pulse in that guy? Imagine also, spending eight of those nine months squirreled away in your cubicle. Some people might like to look at faded family pictures tacked to the cubicle fabric, watch old vacation pictures cycle through their screen saver, and suck stale coffee out of their stained mugs, but true auditing is performed out at the contractor's facility, not within the confines of the office. Back in the day, we would have found everything there was to find in 40 hours and then we would be off on the next assignment.


We hated it but we did it anyway. After all, we knew who signed our paychecks.

We Were Auditors Once, and .... (Part 3)

We were auditors once, and we didn't always get along too well with the Government's contracting officers. Its not that they weren't nice people, its just that they didn't often show us the appreciation we thought was due us and they didn't anticipate the release of our next audit report to the degree the millennium generation would expectantly wait for the next Apple iPad.

Audit reports are only advisory. The real decision makers in Government contracting are the contracting officers. Audit reports are sent to contracting officers and the contracting officers decide whether to pursue or drop particular audit issues. More than a few times, we would develop audit findings that we believed were sound, well-thought out, and defensible, only to have the contracting officer give it the same due as one would shoo a fly from their dinner plate. Of course, that would upset us to no end. We would silently fume and seethe within and plot ways to get even - until quitting time, that is.

What about you? Got any stories to share?

We Were Auditors Once, and .... (Part 2)

We were auditors once and we hated it when contractors agreed or concurred with our position too quickly. Its not that we liked to argue (although some of us did) but when a contractor agreed with us to easily, we were left with the uneasy feeling that we must have overlooked something more significant than what we found. The feeling was even more profound when our positions were, well, we shouldn't say "half-baked" but, were not necessarily based on the best of evidence.

We Were Auditors Once, and .... (Part 1)

As many readers of this blog know, we spent a considerable number of  years as contract auditors before venturing out and forming this consulting firm. Our experience gives us a little insight into the mindset and guiding philosophy of an auditor. Although the organization we worked for, Defense Contract Audit Agency (DCAA) has changed a lot during the ensuing years, the organization's focus has not. The focus has been, is now, and probably always will be saving money for the taxpayer. Over the next few days, we want to provide you a glimpse into the thinking of auditors as they go about their business. Obviously, these are going to be generalized statements and we're certain that many Government contractors have had experiences that diverge widely from what we're about to describe. Nevertheless, here's Part 1

We were auditors once and we had absolutely no concern about a contractor's cash flow. The only time cash flow entered our vernacular was when we were judging a contractor's financial capability for performing a prospective contract. Requests for expediting a provisional payment request or approving revised billing rates fell on deaf ears.We felt that cash flow was the contractors problem, not an audit issue. Many in the Government, not just the contract auditors, feel that contractors are morally obligated to invest some financial resource into the contract commensurate with the potential rewards (fee or profit) and the investment of working capital is a financial commitment.

We also did not care that a contractor might have to go out and borrow money for working capital. After all, interest on those borrowings are unallowable anyway so there's no cost to the Government if a contractor must borrow money to perform under the contract.

We knew then and we know much better now that companies live and die by their cash flow. A disruption of  planned cash flows for even a few days can cost contractors money and that money comes out of profit. Disruption could result in interest on borrowing for cash flow needs, lost cash discounts on material purchases, delays in paying subcontractors, and even the ability to meet a timely payroll date.

The Prompt Payment Act has given contractors some relief - contractors are entitled to interest on payments not made with 30 days of a request. However, there is a significant difference between five days and 30 days. Contractors accustomed to five days from request to payment will complain if elapsed days extends much further.

So what do you think? Let us know.

What's In An Audit?

Audits performed by DCAA (Defense Contract Audit Agency) and other Government auditors (e.g. GAO, Office of Inspector General, etc) must comply with GAGAS (Generally Accepted Government Auditing Standards). Those standards require the auditor to apply audit procedures to provide reasonable assurance that material unallowable costs and other material noncompliances with applicable Government laws and regulations in the contractors assertion or subject matter of audit, are detected. This requirement applies whether the auditor is evaluating a forward pricing proposal, incurred cost, adequacy of internal control systems, billings, termination settlement proposals, claims, or defective pricing.

There are three broad categories of audit procedures under GAGAS that the auditor must consider in planning and performing the audit.

1. Risk Assessment Procedures. Risk assessment procedures are performed to obtain an understanding the the contractor and its environment, including its internal controls, to assess the risk of material unallowable costs and other material noncompliances (i.e. things that might affect the propriety of costs charged to Government contracts) and to design audit procedures in response to the assessed risk. Some audits are terminated after the risk assessment phase because there is no risk to the Government. For example, if an auditor is asked to audit a price proposal but finds that a contract has already been awarded, that audit will be terminated because there is no possibility that audit results would impact the contract price.

2. Tests of the Operating Effectiveness of Relevant Controls. Tests of controls are made to obtain evidence about their operating effectiveness when the auditor plans to rely on controls for a particular area. A good system of internal controls should reduce the amount of substantive testing needed to validate the propriety of costs. This answers the question of whether auditors can rely on the contractor's system (e.g. accounting system, billing system, estimating system, purchasing system, etc.) to provide good data. At very small companies, the audit effort required to test controls is not commensurate with the risk to the Government so the auditor will minimize effort in this area and compensate by doing more work in the Substantive Procedures phase of the audit.

3. Substantive Procedures. Substantive procedures are tests of specific cost elements or other areas within the contractor's assertion performed to detect material unallowable costs and other material noncompliances with the requirements relevant to that specific cost element or area being audited. Substantive procedures are always required but the amount required depends upon the results of the risk assessment and tests of controls (Items 1 and 2, above). Substantive procedures include analytical procedures (e.g. regression or trend analysis) and tests of details (e.g. inspecting supporting documentation that demonstrates that the claimed costs comply with applicable FAR requirements or verifying proposed costs to the basis of estimate or other supporting documentation such as vendor quotes).

Although it is absolutely imperative that auditors be independent with respect to the contractor being audited, contractors can have some influence in how the audit is planned and performed. First, contractors can ensure that internal controls are in place and operating effectively. This should reduce the amount of substantive procedures necessary during the audit. Secondly, contractors can make sure that auditors fully understand risks. For example, if final indirect expense rates are significantly higher than billing rates and there is no possibility that the contracting officer will increase funding under the contract, the auditor should be made aware in the risk assessment phase of the amount of potentially unallowable costs he/she would need to find before such costs would affect amounts charged to the Government.

Whistleblower Protection for Contractor Employees

Toady we are finishing our highlighting of selected sections contained within the fiscal year 2013 National Defense Authorization Act (NDAA) that are of interest to Government contractors. Of the four topics we've covered so far (compensation caps, access to internal audits, prohibition against excessive subcontracting, and contractor profits), all but the limitation on compensation will probably make it into the final legislation. The proposed limit on compensation ($250,300 per year) is extremely controversial and it is questionable as to whether it will survive in the present form, be modified in conference committee, or tossed out altogether. Today's topic on whistleblower protections will also probably make the final cut.

Whistleblower protections for contractor employees has been on the books for a number of years. The newly proposed legislation extends this protection to subcontractor employees. It significantly broadens the scope of the protection from violations of law, to violations of law, rule, or regulation. It also broadens the number of people to whom disclosure is protected. Under the proposed legislation, disclosures to the following will be protected:

• A member of Congress or a representative of a committee of Congress
• An inspector general
• The Government Accountability Office (GAO)
• A DoD employee responsible for contract oversight or management (this would included DCAA and DCMA)
• An authorized official of the Department of Justice or other law enforcement agency
• A court or grand jury.
• A management official or other employee of the contractor or subcontractor who has the responsibility to investigate, discover, or address misconduct.

Other changes to the whistleblower statute include:

1. Reprisal is prohibited even if it is undertaken at the request of a DoD official (we wonder what event might have prompted this prohibition).
2. Complaints must be brought within three years of the date on which the alleged reprisal took place.
3. Compensatory damages are now allowed (could be significant for a contractor or subcontractor and the cost would not be allowable under Government contracts).
4. Contractors and subcontractors must notify employees in writing of their rights and remedies (presumably, this will have to be more than something buried in fine print).

DoD to Conduct Study on Contractor Profits

The Federal Acquisition Regulations (FAR) expressly recognizes the importance of a contractor's ability to earn a reasonable profit. FAR 15.404-4(a)(2) states that it is in the Government's interest to offer contractors opportunities for financial rewards sufficient to stimulate efficient contract performance, attract the best capabilities of qualified large and small business concerns to Government contracts and maintain a viable industrial base."

The DoD has consistently maintained that contractor profits are not a target. At a Aerospace and Defense conference last fall, Shay Assad, DoD's Director of Procurement, told participants that the Pentagon is concerned with cost reduction, not margin reduction. "It wouldn't bother us at all if operating margins go up, so long as we're paying less".

Recent acquisition trends and policies, however seem to suggest otherwise. There have been elimination of fee on certain cost elements and reductions in fee as part of Government negotiation strategies. Policy changes regarding business systems are threatening to disrupt contractor cash flows. Additionally, the trend in research and development are favoring cost-share or cost-no-fee arrangements.

One of the provisions in the Senate version of the Fiscal Year 2013 National Defense Authorization Act (NDAA) requires DoD to review the DFARS (DoD FAR Supplement) profit guidelines to identify any modifications to such guidelines that are necessary to ensure an appropriate link between contractor profit and contractor performance (sounds very subjective to us).

Matters to be considered in this study include:

1. Appropriate levels of profit needed to sustain competition in the defense industry, taking into account contractor investment and cash flow,
2. Appropriate adjustments to address contract and performance risk assumed by the contractor, taking into account the extent to which such risk is passed on to subcontractors,
3. Appropriate incentives for superior performance in delivering quality products and services in a timely and cost-effective manner, taking into account such factors as prime contractor cost reduction, control of overhead costs, subcontractor cost reduction, subcontractor management, and effective competition at the subcontract level (applies to incentive fee and award fee contracts).

Assuming this provision is enacted, DoD gets 180 days to modify the DFARS profit guidelines.

Proposed Rule on Prohibiting Excessive Subcontracting

Yesterday we discussed a provision in the Senate version of the Fiscal Year 2013 Defense Authorization Act that, if enacted, will give the Government statutory access to contractor internal audit reports. This week, we will be looking at a number of provisions in the bill that affect government contractors. Today, we will discuss a provision that would limit the amount of subcontracting that a prime contractor can include in a price proposal.

The impetus behind this proposed regulation is the recent revelations, both in the news and later in Congressional hearings that large companies were using small companies as fronts for obtaining contracts that were intended for small businesses. Although the contracts were awarded to small businesses, the large businesses, acting as subcontractors, were essentially performing the entire contract. 

The proposed legislation prohibits the award of contracts (or task orders) above $150 thousand unless the contractor agrees that at least 50 percent of the direct labor cost of services to be performed under the contract will be expended for employees of the contractor or of a subcontractor that is specifically identified and authorized to perform such work.

Exceptions are available if the contracting officer prepares a written justification that reliance on subcontractors making up more than 50 percent of the direct labor is in the best interest of the DoD. Also, the Secretary of Defense will have authority to override this provision.

It seems to us that this prohibition can be easily circumvented. Two parties can easily transfer employees from one to the other making it look like the small business has sufficient employees to perform at least 50 percent of the work.

Congress Moving to Require Access to Internal Audits

Government contractors have always played a little cat-and-mouse game with providing the Government access to their internal audits and  associated work product. When we were auditors, we always wanted to see them. After all, there might be information in them that we could rely upon thereby reducing the audit steps we had to perform. Why do the same thing twice? We sincerely thought that it was a win-win for both the contractor and the Government. Our position has not changed. We still think that contractors should provide access to routine internal audits to DCAA and other Government contract auditors.

Contractors are sometimes wary of providing the Government access to their internal audits. They ask such questions as why do you want them and what are you going to do with them? If those audits disclose an internal weakness or two in a control activity, contractors are concerned that the reports might might somehow be used against them.

As a practical matter, the ability to rely on contractor internal audits to reduce the amount of effort that Government auditors need to perform seems overrated. In our experience, there typically is not much savings to be achieved. Contractor internal audit and Government audit objectives rarely overlap. But internal audit reports are nevertheless useful to the extent that they demonstrate contractor commitment to maintaining good internal controls and for ensuring that any recommendations are followed up with corrective action plans.

Section 843 of the Senate Version of the Fiscal Year 2013 National Defense Authorization Act contains a provision that will require contractors to disclose their internal audit reports as an element of maintaining adequate "business systems". Specifically, the recently enacted "business system" rules will soon be modified to require the following:

1. ensure that any assessment of the adequacy of contractor business systems takes into account the efficacy of contractor internal controls, including contractor internal audit reports and supporting materials, that are relevant to such assessment; and
2. provide that the refusal of a contractor to permit access to contractor internal audit reports and supporting materials that are relevant to such assessment is a basis for disapproving the contractor business system or systems to which such materials are relevant and taking the remedial actions (i.e. billing withholds).

OMB's Pushing Agencies to Meet Small Business Goals

Small business contracting and subcontracting goals have been on the books for many years. Its a rare year however when Government agencies and prime contractors meet those goals. Generally, there is no penalty for failing to meet them. No one in the Government will be punished. Contractors are not going to lose work or lose money (although in some cases, award fees are based in part on meeting small business subcontracting goals). With no adverse consequences threatened, there's little incentive to strain oneself to meet some arbitrary goals.

The OMB (Office of Management and Budget) is at least trying to invigorate the program. They held a conference last April with many top Executive Agency procurement officials and asked each of them to take immediate steps to ensure small businesses are utilized to the maximum extent practicable. The steps include:

1. Maximizing opportunities for small businesses under the simplified acquisition threshold (generally under $150 thousand).
2. Increasing opportunities for small businesses under multiple award contracts; and
3. Strengthening accountability for small business goal achievement.

The first two items are nothing new. Agencies have never felt restricted in awarding small dollar purchases and multiple award contracts to small business firms. We would put this into the category of motivational talk. The third idea is a little different from what we've seen in the past. The OMB is asking executive agencies to "hold senior leadership accountable for meeting ... small business goals, including any of the statutory socio-economic  goals (Small Disadvantaged Business, HUBZone Small Business, Woman-Owned Small Business, and Service-Disabled Veteran-Owned Small Business)".

How does the OMB suggest that Agencies make senior leadership accountable? By including small business contracting goals in the performance evaluations of all Senior Executive Service (SES) staff members who oversee the acquisition workforce.

The OMB is convinced  that Agencies that have implemented performance evaluations containing small business contracting goal elements meet or exceed their small business contracting and socio-economic goals. 

Maybe that will help - threaten to take away someone's bonus, that is.

Legislative Movement on Compensation Caps

The Senate Armed Services Committee has approved an amendment to the fiscal year 2013 National Defense Authorization Act (NDAA) that would limit reimbursement of salaries for DoD contractors to $230,700, the salary of Vice President Joseph Biden.

Senator Grassley pointed out that private companies can still pay their employees whatever they want but they should not be allowed to pass salaries on to the taxpayers that are three times what a cabinet secretary makes. (The current compensation limit on Government contracts is $763 thousand.) Senator Boxer stated: "This important reform will help rein in the exorbitant taxpayer-funded salaries paid to top defense contractor employees.

Compensation is not addressed in the House version of the NDAA and so the issue will probably be resolved in a future Senate-House conference committee.

Not surprisingly, the Senate amendment is supported by Government unions and opposed by contractor groups.

Anti-Kickback Act of 1986 - Part II

A couple of days ago we discussed certain provisions of the Anti-Kickback Act of 1986. Not only does the Act make it unlawful to pay and accept kickbacks, but it i) requires contractors and subcontractors to self-disclose any kickbacks it becomes aware of, and ii) requires contractors to implements and follow procedures designed to prevent and detect violations of the Act.

So, who's going to check and see whether contractors have implemented policies and procedures designed to prevent and detect violations of the Act? Well, DCAA (Defense Contract Audit Agency) for one. DCAA has reproduced the text of the Act in its Contract Audit Manual and has issued guidance to its auditors on how to report suspected violations of the act that they encounter during an audit. Additionally, auditors are required to "ascertain that contractors have informed their personnel...of the Act".

Most contractors have some sort of code of conduct and ethics program. We believe the easiest way to ensure compliance with the "prevention and detection" requirements of this Act is to modify existing ethics rules and employee training and awareness programs to include coverage of prohibitions against kickbacks. Annual employee declarations that they have violated no ethics rules would then cover kickbacks as well. Additionally, the "prevention and detection" provisions are not applicable to everyone in the company; only those personnel that have involvement with purchasing/procurement/subcontracting, or who might otherwise be in a position to influence the process.

Failure to Comply with Solicitation Requirements - You're Outta Here!

Back in May 2011, the EPA (Environmental Protection Agency) issued an RFP (Request for Proposal) for technical support services to support aquatic resource surveys including research and planning, field sampling-related activities, sampling logistics, laboratory analyses, analytically techniques and modeling, and reporting.

The solicitation included a standard FAR clause (FAR 52.219-14(c)) requiring at least 50 percent of the cost of the contract performance incurred for personnel shall be expended for employees of the concern. One of the bidders, EcoAnalysts submitted a proposal that included only 46.5 percent of the firm's personnel cost in its direct labor base. Because the proposal failed to conform to a material term or condition of the solicitation, the EPA ruled that it was unacceptable and threw it out of the competition. EcoAnalysts appealed the award to the Comptroller General (GAO).

The percentage of proposed contractor labor (46.5%) was not in dispute. However, EcoAnalysts argued that it was unreasonable for the EPA to conclude that EcoAnalysts could not and would not comply with the subcontracting limitation and reject its proposal, given that EcoAnalysts later assured the EPA that it would comply with the subcontracting requirements.

The GAO denied the protest. The GAO ruled that although EcoAnalysts offered to , and states that it could, comply with the requirement, the proposal was reasonably found to be technically unacceptable as submitted. EcoAnalysts' offers to comply with the subcontracting limitation do not render acceptable a proposal that is noncompliant on its face. To make EcoAnalysts proposal acceptable would have required the EPA to conduct discussions and allow EcoAnalysts to revise its cost proposal. However, the EPA was not obligated to conduct discussions with EcoAnalysts for this propose, where, as here, the agency made award without discussions to other offerors with technically acceptable proposals.

By failing to read and understand the solicitation requirements, EcoAnalysts lost out on the opportunity to compete for this work.

Anti-Kickback Act of 1986

The Anti-Kickback Act of 1986 was passed to deter subcontractors from making payments and contractors from accepting payments for the purpose of improperly obtaining or rewarding favorable treatment in connection with a prime contract or a subcontract relating to a prime contract. What had theretofore been considered merely improper or unethical, now carried potential criminal penalties.

The Act prohibits any person from (i) providing, attempting to provide, or offering to provide any kickback, (ii) soliciting, accepting, or attempting to accept any kickback; or (iii) including, directly or indirectly, the amount of any kickback in the contract price charged by a subcontractor to a prime contractor or a higher tier subcontractor or in the contract price charged by a prime contractor to the Government.

The Act imposes criminal penalties on any person who knowingly and willfully engages in such conduct and provides for the recovery of civil penalties from any person who knowingly engages in such prohibited conduct and from any person whose employee, subcontractor, or subcontractor employee provides, accepts, or charges a kickback.

The Act requires contractors and subcontractors to provide written notification to the Inspector General of the agency issuing the contractor whenever it has reasonable grounds to believe such violation may have occurred and requires that contractors and subcontractors give access to facilities and records to investigate such matters.

The Act has one other provision that contractors are often blissfully unaware of. The Act requires contractors and subcontractors (with negotiated contracts and subcontracts greater than $100 thousand) to have in place and follow reasonable procedures designed to prevent and detect violations of the Act. These include:

• company ethics rules prohibiting kickbacks by employees agents, or subcontractors
• education programs for new employees and subcontractors
• explaining policies about kickbacks, related company procedures and the consequences of detection
• procurement procedures to minimize the opportunity for kickbacks
• audit procedures designed to detect kickbacks to law enforcement officials
• annual declarations by employees of gifts or gratuities received from subcontractors
• annual employee declarations that have violated no company ethics rules
• personnel practices that document unethical or illegal behavior

Are you in compliance?

See FAR 3.5 for regulatory requirements.

Incurred Costs and Statute of Limitations

Yesterday we discussed a six-year statute of limitations provision that may or may not be applicable to incurred cost audits. This was based on news accounts of DCAA's growing backlog of incurred cost audits and the concern that the statute of limitation will kick in and the Government will be precluded from recovering any unallowable costs that it finds. Since then, we've dug a little deeper into this subject. Here's what we found.

The six-year statute of limitations was a provision included in the Federal Acquisition Streamlining Act of 1994. It requires each claim by a contractor against the Federal Government relating to a contract and each claim by the Federal Government against a contractor relating to a contract shall be submitted within six years after the accrual of the claim. It works both ways, Government against the contractor and contractor against the Government.

FAR 33.201 defines the "accrual of the claim" as

The date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim, were known or should have been known. For liability to be fixed, some injury must have occurred. However, monetary damages need not have been incurred.

So, what does this mean in the context of indirect rate proposals? We think that it means that the Government's claim to disallow indirect costs "accrues" when a contractor first claims and the Government reimburses the unallowable cost and the contractor submits its final indirect cost rate proposal for the fiscal year in which the cost was first incurred.

Here's an example. Let's say that a contractor submitted its 2005 incurred cost proposal in a timely manner on June 30, 2006. The final rates were higher than the billing rates so in July 2006, the contractor adjusted billings for 2005 to reflect the final rates. The Government reimbursed the contractor for the higher rates in August 2006. The statute of limitations clock starts ticking on August 2006. That means the Government must assert any claims related to the 2005 indirect costs by August 2012.

Contractors with unaudited incurred cost submissions from 2005 and prior (there are definitely some contractors in that category) should discuss statute of limitations concerns with the auditor to avoid spending a lot of unnecessary time to support an audit engagement.

This statute does not prevent DCAA from performing an audit. It simply provides that any findings on the auditor's part, cannot be pursued as a claim against the contractor.

Caveat - this is not legal advice. If you believe it may apply to your situation, we suggest you consult legal counsel.