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.

What Are Defective Pricing "Offsets"?

Since 1987, there has been statutory recognition for contractor offsets for defective cost or pricing data that resulted in understated costs. Whenever the Government challenges a contractor for failing to submit current, complete, and accurate cost or pricing data, the contractor is entitled to offset the cost impact of that defective pricing with other facts that went in the Government's favor.

Offsets must meet the same factual requirements that TINA (Truth in Negotiations Act) requires; must be factual data that existed at the time of agreement on price that was reasonably available to the contractor. Contractors cannot claim intentional understatements as offsets nor can contractors claim such things as unsupported "bottom-line" management adjustments.

To be considered, offsets against defective certified cost or pricing data

• must be certified to the contracting officer that, to the best of the contractor's knowledge and belief, the contractor is entitled to the offset in the amount requested,
• proves that the cost or pricing data were available before the date of agreement on the price of the contract (or modification), and
• proves that the data was not submitted before such date.

Offsets will not be allowed if

• the understated data was known by the contractor to be understated before the date of the Certificate of Current Cost or Pricing Data, or
• the Government proves that the facts demonstrate that the contract price would not have increased in the amount to be offset even if the available data had been submitted before the date of agreement on price.

So, for example, offsets are prohibited if the contractor intentionally withheld from the Government information showing a higher cost for an item or service.

Offsets are permitted among and withing various line items of certified cost or pricing data but never for more than the maximum defective overstated costs. Offsets can never result in an increased contract price.

One final note, generally, the Government will not entertain offsets unless and until the contractor certifies to its allowability. There have been a few exceptions for whatever reason but exceptions to certification are not the norm.

Voluntary Post-Award Disclosure Program of Defective Pricing

The Department of Defense is trying to encourage contractors to voluntarily disclose instances of defective pricing - situations where factual data did not get to the negotiating table for consideration in determining fair and reasonable pricing.

In the interest of promoting voluntary disclosures, the Department is revising its policy on requesting an audit on the voluntary disclosure. Heretofore, voluntary disclosures have been automatically referred to DCAA (Defense Contract Audit Agency) for a full audit. Under new procedures published today, contracting officers will be given discretion over whether to request an audit at all or limit the scope of an audit to just those areas affected by the voluntary disclosure.

Contractors have been requesting for years for DoD to change its policy that require repeated submissions of certified cost or pricing data. Sometimes, especially on major acquisitions, negotiations are protracted over several months and contractors find they need to continuously update their cost or pricing data to defend against subsequent defective pricing claims. This continual updating requires a lot of resources, which becomes very costly.

One of the initiatives under BBP 3.0 (Better Buying Power) was to look for ways to remove unproductive requirements imposed on industry. One of the specific actions under this initiative was to revise FAR 15.407-1(c) to eliminate the requirement that a contracting officer shall request an audit if a contractor voluntarily disclosed defective pricing (see BBP 3.0 - Removing Unproductive Requirements Imposed on Industry). This new policy accomplishes that goal.

Don't Audit, Discuss

The final rule removes the mandatory requirement to conduct an audit in all cases of a contractor's voluntary disclosure of defective pricing. However, in order to calculate appropriate price reductions as required by 10 USC 2306, it is necessary that contracting officers, at a minimum, discuss the disclosure with the Defense Contract Audit Agency (DCAA) to determine the completeness of the contractor's voluntary disclosure and the accuracy of the contractor's cost impact calculation for the affected contract, and the potential impact on existing contracts, task or delivery orders, or other proposals the contractor has submitted to the Government.

This discussion will assist the contracting officer in determining the involvement of DCAA, which could be no audit at all, a limited-scope audit (e.g., limited to the affected cost elements of the defective pricing disclosure), a full-scope audit, or technical assistance.

Here's the specific regulatory wording:

When a contractor voluntarily discloses defective pricing after contract award, the contracting officer shall discuss the disclosure with the Defense Contract Audit Agency (DCAA). This discussion will assist in the contracting officer determining the involvement of DCAA, which could be a limited scope audit (e.g., limited to the affected cost elements of the defective pricing disclosure), a full-scope audit, or technical assistance as appropriate for the circumstances (e.g., nature or dollar amount of the defective pricing disclosure). 

At a minimum, the contracting officer shall discuss with DCAA the following:
     (A) Completeness of the contractor’s voluntary disclosure on the affected contract.
     (B) Accuracy of the contractor’s cost impact calculation for the affected contract.
     (C) Potential impact on existing contracts, task or deliver orders, or other proposals the contractor has submitted to the Government. 

This new policy does not remove DCAA's ability to initiate its own defective pricing reviews. A voluntary disclosure on a particular contract however should reduce the risk factors that DCAA considers when deciding whether defective pricing audits need to be initiated.

Defective Pricing Indicators

Government contractors know and understand that where they were required to submit certified cost or pricing data and where the Government relied on that certified cost or pricing data when negotiating the contract price, are also subject to "defective pricing" audits after the contract is awarded. A defective pricing audit looks for factual information that existed at the time negotiations were completed, were not disclosed to the Government, but if had been disclosed, would have had a significant impact on the negotiated price.

Contract auditors routinely perform defective pricing audits - not on every contract but on select contracts. The larger the contract, the higher probability it will be selected for a defective pricing audit. The type of contract also has a bearing on the audit selection. Fixed price have a higher probability of being selected because of the potential for a greater return. On a fixed price contract, defective pricing findings will result in a dollar for dollar reduction in the contract price. On a cost-reimbursable contract, the impact only affects how much fee a contractor is entitled to.

In order to expend resources wisely, contract auditors perform risk assessments designed to identify and explore conditions suggesting possible defective pricing. Items normally examined for indications of defective pricing include historical unit cost records, vendor quotes, purchase orders, voluntary refunds or credits from suppliers, cost trend records, sales and manufacturing volume projections, profit and loss statements, and product cost and profit analyses. Over the years, auditors have developed a corpus of "indicators" that if present, suggests a possibility (not a probability) that defective pricing occurred. These indicators include the following:

a. Significantly lower actual cost of individual items and cost elements as compared with the amounts included in the last submitted proposal. When this condition exists, auditors will perform additional tests to determine whether the lower costs reflect defective data.

b. Operations not actually performed or items of cost not incurred, although included in the contractor's proposal. (For example, changes made in the make-or-buy program, a special testing program not performed, or Government-owned equipment rental not paid.) Contract auditors will explore the reasons for not incurring the cost.

c. Items of direct cost included in the contract pricing proposal at prices higher than appropriate based on information available to the contractor (and not disclosed to the Government) at the time of contract price agreement. Examples include

• After submitting the original proposal but before price agreement, the contractor receives a firm quote from an established source which is significantly below the cost included in the original proposal. 
• A previously used supplier not solicited this time but who normally submits a low bid. The contractor later purchases the material from this vendor at a price lower than proposed. 

d. Closing or cutoff dates for recording transactions or for computing summary indirect cost rates or production cost data that did not coincide with the date negotiations concluded. For instance, the contractor's proposal included indirect or other cost data as of a prior cutoff period. In this case, the contractor is responsible for the currentness of its certified cost or pricing data, if a cutoff date for this information was not agreed to and identified on the Certificate of Current Cost or Pricing Data, the Government would consider significant matters in the books or records on the date of price agreement as reasonably available to the contractor for purposes of defective pricing.

If advised that the Government plans to perform a defective pricing audit of a particular contract, these indicators can be used by contractors as a self-assessment prior to the audit.

Is Your Contract Subject to a TINA Audit?

Now that DCAA (Defense Contract Audit Agency) is nearly current in its audits of contractor incurred cost proposals and the new Administration has lifted it federal hiring freeze, the Agency is preparing to hire as many as 500 new auditors and may be turning its attention to other types of audits that have been curtailed in favor of higher priority assignments. One of those program areas where DCAA has been eager to resume, with the DoD Office of Inspector General's active encouragement, is contractor compliance with the Truth-in-Negotiations Act (TINA).

The Truth-in-Negotiations Act applies to negotiated contracts where contractors submitted certified cost or pricing data to the Government. You can determine whether TINA applies by looking for the contract clauses at FAR 52.215-10, 11, 12, or 13. The absence of one or more of these four clauses doesn't necessarily mean the contract is not subject to TINA however. The Government makes mistakes from time to time in drafting their contracts and has been know to inadvertently omit the TINA clause. Since TINA is a statutory requirement, the Government sometimes invokes the Christian Doctrine to "read" the clause into the contract. Refer to DCAA's Contract Audit Manual (CAM) 14-112.1 for information on the Christian Doctrine.

Just because a contractor submitted certified cost or pricing data and the respective clauses are included in the contract however, doesn't mean the contract is subject to TINA. The Government must also have relied on the certified cost or pricing data. In many negotiations, the Government does not rely on submitted certified cost or pricing data in arriving at a fair and reasonable price, but instead, relies on other factors such as previous prices paid. DCAA has been burned many times where alleged TINA violations have been discarded by contracting officers because either the contractor or contracting officer has shown that the agreed-to price was based on something other than certified cost or pricing data. Here's where contractors can be pro-active when DCAA begins a TINA review - someone knowledgeable about the negotiations should assess whether certified cost or pricing data, even though submitted, was relied upon by the Government in establishing the negotiated price.

The Government PNM (Price Negotiation Memorandum), which is the Government's view of what transpired during negotiations, usually includes a statement as to whether the Government negotiator relied upon certified cost or pricing data. DCAA will rely on this statement when initiating its TINA review however that particular statement is usually "boilerplate" verbiage and can and should be refuted if it is not true. Contractors will not usually have access to the Government PNMs but should be in the practice of writing up their own view of negotiations, giving clear narrative as to what was submitted and what was relied upon in arriving at a negotiated price.

To learn more about TINA (i.e. Defective Pricing) refer to our eight part series from 2010.

Pilot Program for Increased Cost or Pricing Data Threshold

The Fiscal Year 2016 National Defense Authorization Act (NDAA) authorized a pilot program to test the "efficacy" of using a risk-based approach to increasing the threshold for submission of cost or pricing data. Currently, the threshold sits at $750,000. Under the pilot program, that threshold significantly increases to $5 million.

The purpose of increasing the TINA (Truth in Negotiations Act) threshold is to make things easier on contractors and contracting officers. Auditors are generally opposed to the increased thresholds however, there is a probability that by October 2018 when the pilot program ends, the test will be rendered a success and the $5 million threshold will be made permanent.

The Department of Defense is now seeking candidates to test this authority and has requested the Army, Navy, and Air Force to each nominate at least one candidate program. The nominations must address the following six elements/questions.

1. Whether the Government received, within the previous 12 months, adequate certified cost or pricing data and completed cost analysis, with similar configuration, and quantity and delivery schedules.
2. Whether the price analysis demonstrates historical pricing stability with no significant expectation of future deviation.
3. Report any deficiencies with DFARS 252.215-7002 (estimating system requirements) or DFARS 252.242-7006 (accounting system administration)
4. Have contractors/subcontractors demonstrated a history of providing quality products in accordance with delivery terms?
5. Have contractors/subcontractors demonstrated a history of providing data required by the contracting officer to determine the proposed prices are fair and reasonable?
6. Identify any significant previous audit findings or other required previous contract adjustments.

If you think that you or one of your programs is a candidate for this pilot program, it wouldn't hurt to nominate yourself. Let your contracting officer know of your interest. 

You can read the entire guidance memorandum here.

Voluntary Defective Pricing Disclosures - Proposed Rule Will Limit Audit Rights

DoD published a proposed rule last week that would require DoD contracting officers to request "limited-scope" audits in the interest of promoting voluntary contractor disclosures of defective pricing.

Currently, FAR 15.407-1(c) requires that whenever contracting officers learns or suspects that certified cost or pricing data furnished in support of contract negotiations were not current, complete, or accurate, or were not adequately verified by the contractor as of the time of negotiation, to request an audit (by DCAA) to evaluate the propriety of the data furnished.

 DoD is proposing to revise the DFARS (DoD FAR Supplement) to "stipulate" that contracting officers shall request a limited-scope audit when a contractor voluntarily discloses defective pricing after contract award (unless, of course, a full-scope audit is appropriate for the circumstances). This proposal is a response to an initiative to eliminate requirements imposed on industry where costs outweigh benefits.

Specifically, contractors recommended that DoD clarify policy guidance to reduce repeated submissions of certified cost or pricing data. Frequent submissions of such data are used as a defense against defective pricing claims by DoD after contract award, since data that are frequently updated are less likely to be considered outdated or inaccurate and, therefore, defective. This proposed rule impacts the regulatory guidance regarding the requirement for contracting officers to request an audit even if a contractor voluntarily discloses defective pricing after award. If this new rule is implemented, contracting officers will request a limited scope audit on just the data that has been disclosed by the contractor and its impact on the negotiated contract price.

This proposed rule will have no impact on DCAA's current program of auditing contracts for compliance with TINA (Truth in Negotiations Act). That program (which has become dormant because of "higher risk" audits) randomly samples contracts for in-depth defecting pricing audits.

Avoid "Courtesy Bids" - Government Considers Them to be Fraud Indicators

Although the number is down from a few years ago, the Government still performs audits of contractor compliance with TINA (Truth-in-Negotiations Act). These audits are also referred to as Defective Pricing audits. Under TINA, contractors have the affirmative duty to ensure that the cost or pricing data submitted to support a proposal to the Government is based on data that is current, complete, and accurate. Under current audit guidance, all instances of defective pricing are considered for possible fraud referral. That does not mean that all instances of defective pricing are ultimately reported as potential fraud - it means that the auditors will discuss among themselves and consult the DoD-IG's (Inspector General's) listing of fraud indicators to assess whether the submission defective cost or pricing data was laced with fraud.

The DoD-IG maintains a listing of Fraud Red Flags and Indicators on its website. DCAA auditors, as part of every audit they perform, are required to consult one or more of the indicator listings as pertinent to the particular audit they are performing. One of the fraud risk indicators for defective pricing is the contractor's use of vendor "courtesy bids".

In a published case study, DCAA reviewed the contractor's estimate for material pricing and found that the contractor's estimates for five of 40 parts selected for audit were based on courtesy bids. Vendors confirmed to the auditors that they issued courtesy bids when requested but they refused to do business with the contractor because of the complicated Government regulations that would have to be followed. The contractor used these courtesy bids to price the material, but later, purchased the parts from other vendors at lower prices.

Requests for competitive bids sent to vendors that a contractor knows will be either too high to be considered or does not meet contract specifications are not current, complete, and accurate cost or pricing data. The purpose of these bid solicitations is to create the appearance of competition and conceal secretly inflated prices included in the proposal.

Now here's the bottom line. According to the DoD-IG, such courtesy bids (also called complementary, or cover bids) are a form of bid rigging. Bid rigging occurs when competitors conspire to raise prices or keep prices artificially high when competitive bids are solicited prior to contract or subcontract award. Auditors will now be specifically looking for instances of courtesy bids. Contractors will do well to avoid even the appearance of incorporating them into cost or pricing data.

FAR Council Proposing to Raise Certified Cost or Pricing Data Threshold to $750,000

The FAR Council today published a proposed rule that will raise the threshold for for certified cost or pricing data from $700 thousand to $750 thousand. Under FAR 15.403-4, contractors and prospective contractors are required to certify that the cost or pricing data submitted in support of a proposal is current, complete, and accurate. The actual certification states:

This is to certify that, to the best of my knowledge and belief, the cost or pricing data (as defined in Section 2.101 of the Federal Acquisition Regulation (FAR) and required under FAR subsection 15.403-4 submitted, either actually or by specific identification in writing, to the Contracting Officer or to the Contracting Officer's representative in support of ________ are accurate, complete, and current as of ____________. This certification includes the cost or pricing data supporting any advance agreements and forward pricing rate agreements between the offeror and the Government that are part of the proposal.

The intent for increasing the TINA threshold (Truth-in-Negotiations Act), according to the FAR Council, is not to reduce Government oversight but to maintain the status quo, by adjusting thresholds to keep pace with inflation. If the threshold was not adjusted for inflation, the number of contracts subject to TINA would continue to grow, because more and more contracts will be above the stated threshold.

The new threshold will probably become effective on October 1, 2015.

Contractor Pays $10 Million to Settle False Claims Act Allegations

Another day, another press release from the Department of Justice announcing yet another Government contractor has paid a bucket load of dollars to settle False Claims Act Allegations. There was no admissions of guilt, mind you, nor a determination of liability - only some money changing hands to settle some allegations. In this case, the contractor settled for $10 million.

It looks to us as if the charges began as defective pricing. Justice referred to "misrepresentations during contract negotiations" and "false statements to inflate the price of goods or services sold to the government". Those statements sound like the contractor did not furnish current, complete, and accurate cost or pricing data as required by the Truth in Negotiations Act.

At one time, the Government had a robust program for reviewing contracts for compliance with the Truth in Negotiations Act (TINA). Those reviews (audits) have all but disappeared. In fact, DCAA has programmed only 35 staff years out of a workforce of 4,668 to perform TINA reviews. That's less than one percent. We don't know why the significant drop-off except perhaps the feeling by Agency management that there was not sufficient payback on those kinds of audits.

The Government approaches TINA violations (i.e. failure to furnish current, complete, and accurate cost or pricing data during negotiations) as potential referrals for violations of the False Claims Act. In fact, every "positive" defective pricing audit report had to be either referred for investigation or a written justification as to why the auditor did not believe a referral was warranted had to be prepared.  It is, of course, easier to refer a defective pricing finding for investigation than it is to write up justification as to why it should not be referred and have that judgment questioned by supervision and management up the line.

The DoJ press release did not state the manner in which this alleged False Claims Act violation came to their attention. It could have been a contract auditor, a contracting officer, or perhaps a whistle-blower. Whatever manner, contractors should be aware that there is a panoply of Government oversight activities just doing their jobs and internal whistle-blowers looking to strike it rich.

Defective Pricing Risk Assessments

The Truth in Negotiations Act (TINA) was enacted to provide the Government with a contract price reduction mechanism if a contractor fails to disclose the most accurate, complete and current data as of the date of agreement on price, and the contract price was increased as a result of that failure. TINA applies to negotiated contracts greater than $700 thousand, regardless of type.

In order to determine whether Government contractors comply with TINA, auditors from various agencies conduct systematic reviews of contracts subject to TINA. The GAO (Government Accountability Office, the various IGs (Inspector Generals') offices, and DCAA (Defense Contract Audit Agency), are among those agencies. As a general rule, the larger the contract, the more likely it is to be audited for compliance with TINA. There is a threshold above which audits are certain. At one time, this threshold was $100 million. There are other factors that affect the number of audits to be conducted at a particular contractor. These include, but are not limited to (i) prior findings, (ii) the adequacy of a contractor's estimating system, and (iii) "audit leads" derived from any number of sources.

Once a contract has been selected for review, the auditor will perform a risk assessment to determine the likelihood that defective pricing occurred. Based on the risk assessment, the auditor will decide whether to continue the review or cancel it. In order to perform the risk assessment, the auditor will, at a minimum, request the following items from the contractor. The Government (the auditor) has a contractual right, affirmed by various courts, to access this data.

• Copies of the initial and any revised proposal
• Identification of significant subcontract
• Identification of significant inter-organizational transfers
• Final Certificate of Current Cost or Pricing Data
• Identification of all cost or pricing data submitted before or during negotiations
• A listing of additional data submitted after date of agreement on price (if any)
• Costs incurred to date by cost element and estimates at completion (EAC) by cost element

Recently, the audit program for TINA compliance (i.e. defective pricing) was modified to include a significant new step to the "risk assessment" phase of the audit. This new step, called the "walk-through" is potentially onerous and we advise contractors to prepare ahead of time. This new audit step reads:

Coordinate a date with the contractor to provide a walk-through of its certified position and the major events associated with this pricing action.  Invite the Contracting Officer.  This should include the following:
     a. Highlighting all significant cost or pricing data provided to the contracting officer (e.g., latest certified proposal plus any subsequent cost or pricing data submitted up to the time of price agreement to include sweep data) to include a discussion of the contractor’s documentation of negotiations.
     b. A discussion of the contractor’s internal controls in place at the time of negotiations to ensure that the most accurate, complete and current data were disclosed to the Government.  
     c. Have the contractor identify how the costs were accumulated in the accounting system to facilitate a comparison of the actual costs to the proposed/negotiated costs.  For example, if the contractor proposed by WBS, have the contractor identify the charge numbers for each WBS.  Another example would be if the actual costs were accumulated in more detail than the proposed costs.  In this case, the contractor would need to identify how the actual costs roll up to the proposed costs in order to perform an accurate over/underrun test. 

Interest on Defective Pricing Now Compounded Daily

DoD, GSA, and NASA issued a final rule amending the Federal Acquisition Regulation (FAR) to require compound interest calculations be applied to Government overpayments as a result of defective cost or pricing data.

On September 14, 2009, the U.S. Court of Appeals for the Federal Circuit (CAFC) issued a decision regarding the method of interest calculation on Cost Accounting Standards (CAS) cost impacts (see GATES v. Raytheon Co., 584 F.3d 1062 (Fed. Cir. 2009)). The interest on CAS cost impacts is set by reference in the enabling statute to 26 U.S.C. 6621. The CAFC ruled that the citation led to calculation of the interest using daily compounding.

The Truth in Negotiation Act (TINA) also references 26 U.S.C. 6621 for interest calculation. (See 41 U.S.C. 3507 and 10 U.S.C. 2306a) and so FAR needed to be modified so as to require compounding of interest on Government overpayments as a result of defective cost or pricing data.

This new rule replaces the term ``simple interest'' as the requirement for calculating interest for Truth in Negotiations Act cost impacts with the phrase ``Interest compounded daily as required by 26 U.S.C. 6622.'' Thus, compound interest calculations will be applied to Government overpayments as a result of defective cost or pricing data.

This could have a significant impact on contractors with TINA violations. Often, these issues take years to resolve and if the Government ultimately prevails, the difference between simple and compounded interest could be significant.

Defective Pricing Lead Sheets - Part 4

This week we have been discussing the Government's practices and methods for selecting contracts to perform defective pricing reviews. The Government's selections of contracts to review for defective pricing are not ramdon. The selection is based on a number of risk factors that include contract value, audit leads, and prior experience. In this series of posts, we've been concentrating on the audit lead sheets and the methods used by the Government to assign "probability" ratings to specific contracts. If you missed the earlier posts in this series, you can read them here: Part 1, Part 2, and Part 3.

Contractors with effective estimating systems will generally have lower probability ratings than those that do not. And, since the estimating system is one of the six business systems subject to payment withholds when found to be inadequate, there is extra incentive to ensure that an adequate system has been developed and implemented.

Here are a few tips that should be incorporated into your estimating system policies and procedures and should help lower your "Defective Pricing Probable" rating at the same time.

1. Recognize that the requirement to submit costs or pricing data is a process, not an event. The process extends from the initial stages of proposal preparation right up until the date of agreement on price.

2. When you provide cost or pricing data subsequent to submitting the proposal, inform the Government its impact on the proposed price.

3. Submit everything in writing. That way there can never be an argument about whether it was submitted or not.

4. Explain why certain cost or pricing data was not used. For example, if there is history available but that history is not relevant to the current proposal, disclose the fact that history exists but was not used and state the reason for not using it.

5. If you make any accounting system changes, describe for the Government the impact that those changes will have on all active proposals.

6. If there is any uncertainty regarding make/buy decisions, make certain that you inform the contracting officer of that uncertainty and the potential impact on the contract price of going one way or the other.

7. Perform a "sweep". Just prior to settling on a price, go back to your company and involve anyone that had anything to do with preparing the proposal to make one last check to ensure that the most current, complete, and accurate cost or pricing data was submitted.

Defective Pricing Lead Sheets - Part 3

We've been discussing the "lead sheets" that the Government uses to aid in selecting contracts to review for compliance with the Truth in Negotiations Act (TINA). In Part 1, we discussed the preparation and use of the Defective Pricing Lead Sheet. Yesterday in Part 2 we discussed Section A of the form that is completed at the time a proposal is evaluated by the Government. Today we discuss Part B which is completed after receipt and analysis of the PNM.

A PNM or Price Negotiation Memorandum is the Government's view of the events that transpired during a negotiations and justification for negotiating a fair and reasonable price. It is usually quite detailed and explains the contractors proposal and the extent that it used audit results and technical reviews in establishing the price. There are ten questions that the reviewer must answer regarding the negotiated price. After answering the questions, the reviewer must rate the probability of defective pricing from a 1 to a 10 with 10 being the highest probability.

1. Was there a significant amount of elapsed time between proposal audit and negotiations? A contractors responsibility to submit current, complete, and accurate cost or pricing data does not end when it submits its proposal. It continues right up to the date of agreement on price. The longer the period of time between the proposal and the conclusion of negotiations, the more chance there is that updated cost or pricing data became available.

2. Has there been a major change in the accounting system between the date the proposal was prepared and the date of agreement on price? Accounting system changes could affect the nature of direct and indirect charging patterns among other things.

3. Was the contractor's proposal updated to the date of agreement on price? See item 1.

4. If the proposal was revised prior to or during negotiations but not reaudited, does the PNM state whether the supporting data were also updated? There have been many cases where contractors have provided ostensibly updated cost or pricing data during negotiations that was not supported.

5. Does the PNM identify any supporting data introduced by the contractor subsequent to the audit but not submitted for audit review? Auditors get very suspicious when this happens. They sometimes believe that the contractor is withholding information from them on the assumption that it will undergo less scrutiny by the contracting officer or price analyst.

6. Is there a material difference between the negotiated amount and the audit recommended amount? There are a number of reasons why this might happen. This may indicate the submission of additional data subsequent to the audit. Or, quantities change from the numbers proposed.

7. Does the PNM identify any other conditions such as changes in design, production methods, make-or-buy decisions (etc) that might indicate potential defective pricing? Sometimes contractors propose to make parts in house but decide late to buy them (or vice versa). Maybe they didn't have the sufficient in-plant capacity or perhaps they determined later that it was cheaper to buy. Whatever the reason, the auditors will likely inquire as to when the decision to change from make to buy (or vice versa) was made.

8. Any peculiarities in the contract type or method? Was work started under a letter contract? Is this the last buy under a production or spares contract? If work was begun under a letter contract, some history should be available by the time negotiations commence. That historical data should be disclosed.

9. Does the PNM indicate what data the contracting officer relied upon? This is absolutely critical to any assertion of defective pricing. The contracting officer must have relied upon cost or pricing data to negotiate the contract price. There are situations where the contracting officer will not rely on cost or pricing data.

10 Does the PNM indicate any potential defective pricing on subcontracts or interdivisional work? Contractors are responsible for ensuring the reasonableness of subcontract and interdivisional pricing and should essentially follow the same steps in negotiating with its subcontractors that the Government takes in negotiating with its prime contractors. When negotiations with subcontractors have not been concluded at the time of prime contract negotiations, the Government is at risk.

Tomorrow we will conclude this series by offering some advise on how contractors should approach their responsibility to furnish current, complete, and accurate cost or pricing data thereby minimizing the chance of being rated highly probable for defective pricing.

Defective Pricing Lead Sheets - Part 2

The Government has a program for reviewing contractor compliance with the Truth in Negotiations Act (TINA). They're called post-award audits because the audits are initiated after contract award. Contracts are selected based on risk factors. Aside from contract value, there are other factors that play into the selection of specific contracts. One of those is the Defective Pricing Lead Sheet. The lead sheet is a two-part form. Part A is prepared when a contractor's proposal is evaluated and Part B is prepared when the PNM (Price Negotiation Memorandum) is finished. We began this series yesterday. If you missed that part, go here.

Today we will cover Part A of the form. There are nine questions that the reviewer must answer regarding the state of the contractor's proposal. After answering the questions, the reviewer must rate the probability of defective pricing from a 1 to a 10 with 10 being the highest probability.

1. Was there adequate lead time for the contractor to prepare the proposal? Its a simple fact that when people are in a hurry, they make mistakes. Contractors that are not given sufficient lead time to prepare their proposal, are more at risk for failing to submit all of the cost or pricing data available to it.

2. Was there adequate time for audit review? In the old days, Government auditors strove to be responsive to contracting officer requests. Sometimes these requests did not provide sufficient time for auditors to conduct an audit in the detail that was considered necessary to do a adequate job. Usually, this resulted in a qualified audit report but at the same time, generated an audit lead so that the auditors could take another look at the information down the road. In today's environment, the auditor is not as responsive to the contracting officer and generally takes whatever time is necessary to conduct its review, regardless of contracting officer need. Therefore, this question should always be marked "yes".

3. Was the contractor's supporting data generally adequate, complete and current? If not, did the contractor remedy the deficiency? Did deficiencies in the proposal necessitate a qualified opinion on the audit report? Some proposals are good and some are badly assembled and supported. The ones that have math errors, where summary numbers do not trace to supporting detail, where significant costs are unsupported, and where supporting information is out dated, have a higher probability of being defectively priced.

4. Was there any indication of potential defective pricing on subcontracts or interdivisional work? Prime contractors are responsible for determining the price reasonableness of their proposed subcontracts. Government auditors usually review the work of the prime contractor to ensure that they have done an adequate review and determination process. If the prime contractor has not yet completed its review of the subcontractor, there is no assurance that the subcontract price is based on current, complete, and accurate cost or pricing data.

5. Were any questioned or unsupported costs attributable to an estimating system defect? If so, was a flash report issued? Has the contractor corrected or initiated action to correct the defect? An estimating system is foundational to being able to consistently prepare and submit current, complete, and accurate cost or pricing data. This question focuses on the adequacy of the system, not inadvertent omissions or mathematical errors.

6. Has the contractor's estimating system been reviewed within the past three years? Have any noted defects been corrected? Could the defects lead to defective pricing? This question focuses on past reviews of contractor estimating systems. If prior reviews disclosed deficiencies, those deficiencies should have been corrected in a timely manner.

7. Is this a proposal for a follow-on contract? If so, was the prior (historical) experience considered in pricing this proposal? If deficiencies were noted, did the contractor submit an amended proposal? Did the circumstances require a qualified audit opinion? Was all the prior (historical) experience made available to the auditor? If so, was it audited? If it was not furnished, was a qualified opinion rendered? The use of prior "relevant" history is a solid estimating technique and should always be disclosed and considered in pricing follow-on contracts.

8. Are the contractor's estimating policies and procedures compatible with its method of recording data (is the contractor, whether or not CAS-covered, in substantive compliance with CAS 401)? Contractors must propose costs in a manner consistent with the way they record, accumulate, and report costs.

9. Were any other conditions indicative of potential defective pricing noted? This is the "catch-all" question to cover any concerns, conditions, or risks that might indicate an increased probability of defective pricing.

Defective Pricing Lead Sheets - Part 1

Contract awards that are based on cost or pricing data are subject to TINA (Truth in Negotiations Act) if they exceed $700 thousand. Essentially, TINA requires contractors to submit to the Government, current, complete, and accurate cost or pricing data in connection with negotiating contract prices. If it is discovered later that the contractor withheld or didn't otherwise submit all cost or pricing data that could have impacted the negotiated price, TINA gives the Government the right to take back some of the contract price.

The Government has a program to review awarded contracts to see if they are in compliance with TINA. Obviously the Government cannot review each and every award so they use a risk-based approach to select contracts for review. Awards that exceed a certain threshold, currently $100 million or more, are automatically selected for review. Everything else is thrown into buckets for judgmental sampling. Note the term "judgmental". Contracts are not randomly selected - there's usually some reason why a particular contract is selected for a review.

One of the primary tools the Government uses to select contracts for review is the "Defective Pricing Lead Sheet". This is a two part analysis. Part 1 is completed after the contractor's price proposal has been audited and Part 2 is completed after receipt of the Government PNM (Price Negotiation Memorandum). A PNM is the Government's view of what happened during contract negotiations. Each Part has a series of questions and concludes with a numerical "Defective Pricing Potential" score on a scale of 1 to 10 with 1 being "Not Probable" and 10 being "Probable".

Once completed, these Defective Pricing Lead Sheets are then used to decide which contracts should be audited for compliance with TINA - the higher the "probability" rating, the higher the potential for selection.

The Defective Pricing Lead Sheet is not the only basis for selecting contracts for post award reviews. Other factors include the adequacy of contractors' estimating systems and the frequency of past violations of TINA.

In the next two blogs, we will walk through the specifics of the Defective Pricing Lead Sheets, commenting on why certain questions, depending on how they're answered, could increase the probability of TINA violations.

Clerical and Math Errors Could be Costly

We've written frequently on the subject of defective pricing (Truth-in-Negotiations Act or TINA). Awards based on contractor submission of cost or pricing data are subject to TINA. Under TINA, contractors (or prospective contractors) have an affirmative duty to submit to the Government all factual information that could have a bearing on the contract price. The Government has a systematic program to test contractor compliance with TINA. The larger the contract, the more likely it will be flagged for review. Failure by contractors to furnish the Government all factual data, could lead to contract price adjustments.

TINA applies to factual data and information, not contractors use of estimates and application of judgment. Mathematical, clerical, administrative, and accounting errors fall into a gray area. These are netiher factual data nor estimates however the result of these kinds of errors could certainly lead to increases in contract prices.

The Government recently issued formal guidance to the effect that accounting, administrative, clerical, and computational errors attributable to underlying cost or pricing data are considered factual information and may result in defective pricing. Although a contractor proposal may contain mathematical errors that would not be considered defective pricing, mathematical errors attributable to the underlying factual cost or pricing data, not just the proposal calculations, can be considered defective pricing.

Facts underlying contractor opinions and projections are cost or pricing data; but judgments based on those facts are not. Therefore, errors in estimates i.e. estimated escalation factors, estimated direct labor rates, etc) generally would not result in defective pricing because these estimates represent judgments rather than factual, verifiable data (i.e. cost or pricing data).

Under this new guidance, auditors will probably be paying more attention to the accuracy of underlying data supporting contractor estimates.

Proposed FAR Revision for Computing Interest on Defective Pricing

The FAR councils have proposed to change the method of calculating interest on defective pricing from simple interest to interest compounded daily.

The councils do not expect this proposed rule to have a significant economic impact since the number of contractors found to have submitted defective cost or pricng data are a minute subset of contractors to whom the Truth in Negotiations Act (TINA) applies. While this may be so, the proposed change will have a significant effect on those contractors who are found to have violated TINA. First of all, defective pricing is not going to be alleged unless it is significant in the first place. Secondly, iinterest on defective pricing is calculated from the time the contractor receives a payment that was inflated because of defective pricing until it repays the Government. This is usually several years. Its not uncommon for these cases to extend five years. We've seen one at eight years. There are probably cases longer than that. Daily compounding is going to cost about 20%  more than simple interest over a five year period.

The comment period for this proposed regulation runs until November 22, 2010. Go to http://www.regulations.gov/ for details on how to comment.

Defective Pricing - Contractor Offsets

This is our eighth and final posting in our series on defective pricing. If you missed any of the previous ones, you can find them through these quick links.

• Part 1 - What is Cost or Pricing Data?
• Part 2 - Government's Burden of Proof
• Part 3 - Facts vs. Judgement
• Part 4 - "Submission" of Cost or Pricing Data
• Part 5 - Contractor Obligation to Continuously Update Cost or Pricing Data
• Part 6 - Remedies Available to the Government
• Part 7 - Successful and Unsuccessful Defenses to Defective Pricing
• Part 8 - Contractor Offsets (this posting)

The 1987 Defense Authorization Act amended the TINA to give statutory recognition to contract offsets for defective cost or pricing data that result in understated costs. The amended TINA places the burden of proof for such offsets on the contractor and disallows using any intentional understatements to offset defective cost or pricing data that resulted in a price increase.

Contractors must certify to the contracting officer that, to the best of its knowledge and belief, it is entitled to the offset in the amount requested and proves that the cost or pricing data were available before the date of agreement on price and that the data was not submitted before such date.

According to the statute, there are two situations where contractor offset proposals will not be considered. First, offsets shall not be permitted if the understated data was known by the contractor to be understated before the “as of” date specified on the Certificate of Current Cost or Pricing Data. Secondly, the Government proves that the facts demonstrate that the contract price would not have increased in the amount to be offset even if the available data had been submitted before the date of agreement on price.

Offsets are not vehicles to increase contract prices. There is a limit to the amount of offset available to the contractor. The amount of the offset may equal, but not exceed, the amount of the Government’s claim for overstated cost or pricing data arising out of the same pricing action.

The offset does not have to be in the same cost grouping as the overstated cost or pricing data. So, for example, understated material costs could offset overstated labor costs. Offsets must be for the same contract as the defective pricing allegation however.

The key to prevailing in an offset proposal situation rests on three key elements. First, the contractor must prove that the higher cost or pricing data was available before the “as of” date specified on the Certificate of Current Cost or Pricing Data. Secondly, the contractor must show (or prove) that the data was not known to it before the date of agreement on price. And finally, the contractor must prove that the data was not submitted to the Government.

Defective Pricing - Contractor Defenses

This is the seventh part of our eight part series on defective pricing. In our final part on Monday, we will add links to all of the previous parts for ease of reference. Today we will address some of the defenses that are available to contractors facing a defective pricing allegation. These are not going to exonerate contractors who have not been fastidious in submitting current, complete, and accurate cost or pricing data. However, there has been considerable litigation in the defective priciing arena becasue, in part, the Government fails to make its case by satisfying the six elements that need to be present in order to sustain a defective pricing allegation.

If you are a contractor facing a defective pricing allegation, you will most certainly want to defend yourself to the extent you can. There are a number of defenses that have been successfully raised and adjudicated. There are also a number of defenses raised that have been unsuccessful. First we’ll discuss some successful defenses.

1. The information at issue was not cost or pricing data. Recall from our earlier posting that “cost or pricing data” is tightly defined in the FARs.

   Cost or pricing data means all facts that as of the date of price agreement prudent buyers and sellers would reasonably expect to affect price negotiations significantly. Cost or pricing data are factual, not judgmental; and are verifiable. While they do not indicate the accuracy of the prospective future costs or projections, they do include the data forming the basis for that judgment. Cost or pricing data are more than historical accounting data; they are all the facts that can be reasonably expected to contribute to the soundness of estimates of future costs and to the validity of determinations of costs already incurred.

   Within this definition, there could be any number of defenses. Perhaps the information in question was not factual. Perhaps it was such that it would not have affected price negotiations significantly. Perhaps the information in question would not have contributed to the soundness of estimates of future costs. And on and on.  
2. The government did not rely on the defective data. One of the five elements necessary for the Government to sustain an allegation of defective pricing is that the Government relied on the defective data. In order to determine whether the Government relied or did not rely on the defective data, requires access to the Government’s record of negotiation (usually referred to as a Price Negotiation Memorandum or PNM) and any other correspondence you can compile. Just because data was furnished, does not necessarily follow that the Government relied on it. 
3. The price offered by the contractor was a “floor” below which the contractor would not have gone. This, in our mind, would be difficult to sustain. There are situations where a contractor will offer a price and refuse to go below it. Even under those circumstances, the contracting officer must still ensure that a price is fair and reasonable. If he/she accepts that bottom line price, he/she has determined that the price is fair and reasonable. If the contracting officer had known the data was defective, he/she might not have been able to make that determination. 

Unsuccessful defenses to price reductions

1. The contractor or subcontractor was a sole source supplier or otherwise was in a superior bargaining position.  
2. The contracting officer should have known that the cost or pricing data the contractor or subcontractor submitted was defective 
3. The contract price was based on total cost and there was no agreement about the cost of each item procured under the contract. 
4. The contractor did not submit a Certificate of Current, Complete, and Accurate Cost or Pricing Data. The law requires contractors to furnish all cost or pricing data up until the date of agreement on price. The mere absence of a “certification” does not render the statutory requirement moot.