Dear SAIC: When Will You Learn?
Monday, 17 June 2013 00:00
Nick Sanders
The government contractor, Science Applications International Corporation (SAIC), is in a transition period at the moment. The publicly traded company is splitting itself into two independent pieces. The effort to make the split is not without cost. The Washington Post recently estimated that SAIC’s “Project Gemini” has spent nearly $40 million so far, including $1 million spent on a branding firm to develop the name of one of the new entities. (The new name is Leidos, for those who may be interested.) And that’s just for starters. Company executives reportedly told investors that they would spend in the neighborhood of $140 million in FY 2014 on Project Gemini, according to WaPo. The story (link above) reported—
A large chunk of the expense —$55 million — will cover fees for bankers, lawyers, accountants, and consultants and to cover severance, among other things, said Mark W. Sopp, SAIC’s chief financial officer, during the call. The contractor also anticipates spending about $65 million to shrink its real estate footprint. It will cost another $20 million to complete the move of corporate employees who have remained in San Diego — where the company previously was based — to McLean and other offices.
How much of the nearly $200 million will be recoverable as “restructuring costs” remains to be seen. Certainly, SAIC expects to see cost savings from its changes. As WaPo reported—
[SAIC Chief Operating Officer] Shea said the contractor plans to cut about $350 million in annual costs, including $220 million by simplifying its organizational structure and cutting ‘indirect’ staff not tied to specific contracts.
To put that figure in context, the company reported that in the fiscal year ended Jan. 31, it paid $576 million in general, administrative and bid and proposal expenses.
Another $70 million in savings will come from reducing SAIC’s facility footprint by about 30 percent, which would be about 2.8 million square feet of the company’s 9.2 million total square footage. The contractor also plans to save about $30 million through improving its corporate procurement.
Another interesting aspect of the transition from one to two companies is that it gives each company a “fresh start”—an opportunity to evaluate its practices and discard those that haven’t proven optimal, and to replace those suboptimal practices with better ones. The WaPo story quoted Byron Callan (of Capital Alpha Partners) as follows—
… the split is providing an opportunity for SAIC to reconsider the way it has done business. ‘With the cost structure they had ... in some of these services [competitions], they were not going to be as competitive,’ [Callan] said.
It is perhaps obvious that a VC Partner would focus on the cost aspects of the transition. And it’s perhaps obvious that WaPo would focus its reportage on the dollars involved. But we want to focus on another, different, aspect of the transition.
Project Gemini gives SAIC to rethink its corporate culture and commitment to ethical business practices. The transition gives SAIC a chance to deploy better internal audit functionality, better internal controls, and better management dashboards. Each of the two new companies will be smaller—and presumably more manageable. The two new entities—both of which will be government contractors with annual revenues of roughly $5 billion—will have an opportunity to focus on their business, and to ensure that their processes (and employees) adhere to the standards of integrity expected of a government contractor.
It’s clear that the company’s current organization and culture has failed to instill those standards and values across the $11 billion entity.
We’ve written about SAIC before. Type “SAIC” into the site’s search feature and you’ll see that we’ve written more than a dozen articles that either mentioned SAIC or focused on the company as the main topic. In one of those focus articles, we opined on SAIC’s relatively sad record with respect to controlling rogue employees. We wrote—
In SAIC’s case, one single state/local project led to a $500 million settlement, and one single failure to secure client data has led to eight separate lawsuits and a potential legal liability of more than $5 billion. How much more can one corporation, no matter how large, afford? At what point does the Board of Directors—or the shareholders—start to lose confidence in the executive leadership team?
Remember, SAIC only recently became a publicly traded company. From its founding in 1969 through 2005, it was an employee-owned company. … The thing is, the SAIC of today isn’t the SAIC of 1969 or even 1999. It’s a publicly traded company with responsibilities to its shareholders. We wonder if perhaps it’s time, or even past time, for the company to consider changing its entrepreneurial culture and move toward a more centralized command-and-control structure—one that might act to mitigate some of the corporate risks that do not seem to be fully managed by its employees.
We wrote that piece in March, 2012. Now, more than a year later, we read that SAIC has settled another lawsuit, this time one involving allegations of False Claim Act violations. It cost SAIC nearly $12 million of shareholder profits to do so. Here’s a link to the Department of Justice press release that triggered today’s blog article.
According to the DoJ press release, SAIC received subgrants from the New Mexico Institute of Mining and Technology (New Mexico Tech). New Mexico Tech had received six federal grants “to train first responder personnel to prevent and respond to terrorism events involving explosive devices.” New Mexico tech had given SAIC funds to “to provide course management, development, and instruction.”
The first thing that comes to mind when reading the foregoing is, if SAIC was developing the courses, teaching the courses, and managing the courses, then what the heck was New Mexico Tech doing? Where were New Mexico Tech’s value-added services? One is very much tempted to think that New Mexico Tech was acting as a shell, a façade through which the federal funds passed on their way to SAIC. But that wasn’t the focus of the suit.
The FCA suit, filed by a former SAIC employee, focused on the allegation that SAIC used bait-and-switch tactics in its proposal to New Mexico Tech. As the DoJ press release stated—
SAIC’s cost proposals falsely represented that SAIC would use far more expensive personnel to carry out its efforts than it intended to use and actually did use, resulting in inflated charges to the United States.
We used to call that “defective pricing” and there was a legal remedy for such tactics to be found within the Truth-in-Negotiation Act (TINA). But apparently somebody was going for bigger game, because SAIC found itself with a FCA suit on its hands, one initiated by its own (former) project manager who led the program.
The fact of the matter is that this is not the first time that government attorneys have linked defectively priced contracts to the False Claims Act. In our experience, the contractor’s intent is one of the key factors in the government’s decision to move beyond TINA and into FCA territory. Apparently, the government was confident that it could prove its allegations—that SAIC always intended to use lower-priced personnel than it had bid—it this particular case.
But this particular case is simply one of several recent SAIC compliance missteps that have cost its shareholders dearly. As we have asserted, it appears that the company, admittedly staffed by entrepreneurs and managed on a largely decentralized basis, is not controllable by the executive management team. Thus, perhaps the split should be seen as a win/win scenario: where the span of control associated with each of the two smaller entities is more manageable, and where the rate of compliance missteps is reduced, leading to more profit dollars to be returned to shareholders.
And we see it as an opportunity to move away from the “cowboy culture” developed by Dr. Beyster, which seems to have outlived its usefulness. We see it as an opportunity to instill a culture devoted to ethics and integrity, rather than to scheming and gaming “the system” so as to avoid necessary oversight and control. We see it as an opportunity to turn a corner and move forward in a new direction.
We hope SAIC will seize the opportunity. We hope the company will learn from its mistakes, and stop paying fines and penalties for the actions of its employees. If it doesn’t learn, we suspect its shareholders may run out of patience.
Court of Federal Claims Considers Challenges with CAS 413 Compliance
Wednesday, 12 June 2013 00:00
Nick Sanders
There are some who think they “get” the Federal Cost Accounting Standards (CAS) … and then there are those who know its compliance challenges and are more humble. Make no mistake: CAS is hard. It was designed to be hard by those who were convinced that large defense contractors were gaming the pre-CAS system. It was written by accountants with input from lawyers and it was written by lawyers with input from accountants.
As a result, it’s written in a language all its own.
One of the most challenging Standards is CAS 413. We’ve written about it fairly extensively on this site because we are fascinated by the evolution of the legal interpretation(s) of its requirements. Plus, it’s the Standard that generates the most litigation, because it deals with big dollars.
Unless you have (or had) a defined-benefit pension plan, you probably don’t care very much about CAS 413. We get it. Why worry about something hard that’s got no impact on you? So feel free to skip this article.
For the rest of you (assuming there is a “rest of you”), we want to discuss Judge Firestone’s recent decision in the matter of Unisys Corporation v. United States.
If you’ve read any of our previous articles on CAS 413, you might remember that Judge Firestone is the Judge at the U.S. Court of Federal Claims who gets the CAS 413 cases. She gets them because she “gets” CAS 413. Her decisions on CAS 413 are well-written, reflect tremendous knowledge—and are rarely (if ever) overturned on appeal. As a result, she is the Court’s CAS 413 “expert” and gets these tough cases.
Before Judge Firestone was a Motion for Summary Judgment. The facts were undisputed and the only issue to be resolved was “the correct methodology for calculating Unisys’s segment closing adjustment under CAS 413.”
Unisys sold four divisions to Loral in 1995. As part of the sale, Unisys transferred $43.8 million in pension plan funds to Loral. That transfer did not relieve Unisys of its obligation to calculate a segment closing pension adjustment, nor did it relieve Unisys of its obligation to give the Government its calculated share of any pension plan surplus. As Judge Firestone wrote—
Under the CAS and the precedent of this court and the Federal Circuit, the calculation of a segment closing adjustment payment involves three major steps. First, as noted above, the contractor must determine the difference between the market value of the assets and the actuarial liability in the relevant pension plan as of the date of the segment closing, as provided for in CAS 413.50(c)(12). Second, the contractor must determine the share of the pension surplus assets (or deficit) attributable to the government. … This share is referred to as the ‘Teledyne share,’ and is discussed in more detail below. … The product of the pension surplus assets calculated under CAS 413 and the Teledyne share is the amount of pension surplus owed by a contractor to the government. This product is referred to as a contractor’s segment closing adjustment obligation (‘SCAO’). Third, the SCAO may be offset by the ‘measurable benefit’ that the government received because of an acknowledged surplus of pension assets transferred from the seller of a segment to the buyer of a segment. … This inquiry is governed by the standards of the FAR, and, in particular, the Allowable Cost and Payment Clause, 48 C.F.R. § 52.216-7(h)(2), and the Credits Clause, 48 C.F.R. § 31.201-5.
Although the parties agreed on the steps outlined above by Judge Firestone, they disputed the detailed methodology used by Unisys. The Government calculated a SCAO of $38.64 million, to be reduced by $26.18 million of the funds that Unisys transferred to Loral. Accordingly, the Government demanded a payment of $12.456 million from Unisys.
Unisys calculated a SCAO of $16.567 million, and argued that the Government received $28.844 million in benefit from funds transferred to Loral. Accordingly, Unisys argued that the Government actually owed it money—though it did not ask for any monies from the Government in the litigation.
The parties disputed several methodological aspects, but the largest dollars involved the treatment of pre-1968 pension contributions and the percentage of fixed-price incentive type contracts that should have been included in the “Teledyne share” calculation. We’re not going to get into the discussion of the pre-1968 contributions—except to note that in 2013 a legal decision was required for a 1995 transaction involving funds dating back to before 1968. For many folks who aren’t involved with government contract accounting matters, we think this would be mind-blowing. But after 30 years of doing this stuff, we’re used to it.
But we do want to discuss the issues involving fixed-price incentive (FPI) contracts, because they’re a problem in other areas, such as preparation of the annual proposal to establish final billing rates.
In the Unisys case, the Government argued that FPI contracts should be treated just like cost-type contracts for purposes of calculating the Teledyne share. Judge Firestone didn’t buy that argument, writing—
… the government’s argument that its FPI participation rate must be equivalent to its cost-reimbursement participation rate improperly assumes that FPI contracts are the same as cost-reimbursement contracts for CAS 413 purposes. This assumption is contrary to both experts’ opinions, the fixed-price aspects of FPI contracts, and the Teledyne decisions. … the government’s assumption that its participation rate should be valued at 100% ignores both parties’ experts, who agree that the actual costs reimbursed by the government under an FPI contract is less than that made under cost-reimbursement contracts when the price ceiling is reached.
In its ill-advised revisions to CAS administration, the FAR Councils adopted the DCAA’s grouping of contract types into “fixed-price” and “flexibly priced” types. In point of fact those two groupings do not exist in the FAR. FAR Part 16 describes many contract types and never, ever, groups them as does FAR 30.6 or as does the CAS Administration contract clause (52.230-6). As a result of this situation, the CAS cost impact process has been stretched to absurd lengths. For instance, a Time and Materials contract must be treated as two separate contracts in the cost impact analysis: one a fixed-price type and the other a flexibly priced type. Moreover, DCAA continues this misguided approach today, where it requires all “flexibly priced” contracts to be included in certain “ICE Model” Schedules (notably Schedule I), even though some of those “flexibly priced” contracts do not include the Allowable Cost and Payment Clause.
Judge Firestone’s decision is the first (that we know of) where the government’s ill-advised and illogical approach to contract type grouping has been rebuked and rejected. We hope it will not be the last.
Meanwhile, Unisys does not have to pay the Government $12 million (plus interest dating back to 1995).
Last Updated on Monday, 10 June 2013 20:45
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DCAA Gives Back Audit Work to Canadian Auditors
Friday, 14 June 2013 00:00
Nick Sanders
Hmm. If we didn’t know better, we might think that common sense was breaking out at the Pentagon.
Remember this story we published back in November, 2012? In it, we told you about a change in audit cognizance. DCAA was taking over audit work that had previously been performed by PWGSC—Canadian auditors. DCAA was scheduled to begin performing “the same pre-award and post-award range of audit services [on Canadian companies] that DCAA conducts for U.S. Government contractors.”
Yeah, we thought that was pretty stupid.
It’s no longer a hush-hush secret that DCAA is unable to perform the audits that it’s required to perform. Even resetting the dollar thresholds associated with proposal audits, so that only the highest dollar value proposals were audited, didn’t help. Even creating a “risk-based” approach to audits of contractors’ proposal to establish final billing rates (incurred cost audits), so that only the highest dollar value submissions were subject to audit, didn’t help.
Oh, sure. When the GFY 2012 DCAA Report to Congress is submitted circa next February, the agency will be sure to report progress. No doubt its backlog of some 25,000 incurred cost audits will be lower. But the numbers won’t obscure the fact that DCAA can no longer perform its audit workload. Opinions as to why that’s the case vary. But our opinion is that DCAA’s approach to complying with Generally Accepted Government Audit Standards (GAGAS) is fatally flawed. Plus we think there are some other management issues that we’ll skip over for now (having published our thoughts on those issues in the past).
Regardless of the root cause, it’s clear that DCAA cannot get its work done. And so, when we heard that DCAA was taking on even more work, we thought that was an absurd decision. Which is what we wrote.
But now, common sense seems to have broken out. The previous decision is being reversed and the Canadian audit work is being returned to the Canadian auditors. See the DPAP Memo here.
Effective July 1, 2013, the previous policy is being officially rescinded. No reason was given for the about-face. And really, who cares?
This is a good thing for DCAA, whose auditors now have one less thing to worry about.
Critical Analyses of BBP 2.1
Tuesday, 11 June 2013 00:00
Nick Sanders
The “Better Buying Power” initiative is the step-child of former Secretary of Defense Robert Gates’ 2010 call for $100 Billion worth of cuts to Pentagon overhead.
Gates called for cutting overhead costs so as to “convert sufficient ‘tail’ to ‘tooth’ to provide the equivalent of the roughly two to three percent real growth” via “root-and-branch changes that can be sustained and added to over time.” Then Undersecretary of Defense (AT&L) Dr. Ashton Carter translated this strategic imperative into a reduction of $66.3 Billion over five years, to be found on current programs and initiatives. Dr. Carter wrote in June, 2010—
We need to restore affordability to our programs and activities … by identifying and eliminating unproductive or low-value-added overhead; in effect, doing more without more. … The guidance will focus on getting better outcomes, not on our bureaucratic structures.
Dr. Carter’s “Guidance Roadmap” listed five specific attack vectors in the drive to reduce Defense acquisition costs. The five areas were:
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Target Affordability and Control Cost Growth
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Incentivize Productivity & Innovation in Industry
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Promote Real Competition
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Improve Tradecraft in Services Acquisition
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Reduce Non-Productive Processes and Bureaucracy
We’ve followed the evolution of BBP and written many articles on the topic. Recently, BBP morphed into BBP 2.0, and then was clarified by current USD (AT&L) (Frank Kendall) in a Memo that we sardonically dubbed “BBP 2.1”. We discussed BBP 2.1 here. We were not favorably impressed and offered words of criticism.
Apparently, we weren’t alone in having concerns about BBP 2.1. In late May, the Aerospace Industries Association (AIA) sent a letter to Mr. Kendall expressing concerns about the latest incarnation of BBP. The AIA wrote—
AIA is very concerned that the [BBP] section entitled “Eliminate requirements imposed on industry where costs outweigh benefits” was deleted in its entirety from the original document. This section was viewed by our Members as an important initiative to address key drivers of costs in the acquisition process.
Following that paragraph was a fairly lengthy bulleted list of specific AIA concerns. Some of those concerns were:
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DCAA Incurred Cost Submission backlog and settlement of open years
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Lack of clarification on profit policy, including policies for contractor profit on major subcontracts
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Lack of response to industry concerns about the onerous implementation of contractor financing through the use of Performance Based Payments …
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Continued alignment of DCAA and DCMA in scope and mission
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Lack of transparency in the use of cost-benefit analysis to support the efficacy of new regulations and oversight
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“One size fits all” approach to regulation for large and mid/small tier contractors
So notice, if you will, how SECDEF Gates’ call for a reduction in Pentagon overhead has evolved into a focus on contractors’ costs, and how even the notion that contractors’ costs can be reduced by reduction or elimination of non-value-added requirements has been erased from the areas of focus, in the time-honored sense of Soviet-style revisionism.
This chain of events is not really surprising. Indeed, we wrote about an academic who actually predicted something very much like it. It seems to be a fundamental organizational axiom that when you ask bureaucrats to streamline processes, the first thing they do is to add processes. Similarly, it seems to be equally fundamental that when you ask bureaucrats to reduce overhead, the first thing they do is to add people and form a team to study the overhead reduction problem.
Another, similar, viewpoint on the efficacy of BBP was recently expressed by Dr. Daniel Goure, of The Lexington Institute, in an editorial entitled, “The U.S. Military Enemy: DoD Overhead.” Dr. Goure wrote—
There is an enemy. It is not America’s enemy but it is the enemy of the country’s military. It is the Department of Defense’s overhead functions and acquisition system. … According to the Defense Business Board, about a quarter of a million people -- civilian, uniform personnel and contractors -- now work in the Office of Secretary of Defense, Defense Agencies and Combatant Commands at an estimated price tag of no less than $116 billion. It may be even higher; the Department of Defense doesn’t have an accurate count of how many people work in the ‘back offices.’ Nor do they have a clue as to the total cost burden of a civilian employee, something which every defense contractor knows down to the penny since they have to report this number to the department.
Dr. Goure continued—
Every major review of the way DoD does business reaching all the way back to the Eisenhower Administration has emphasized the importance of streamlining processes, reducing overhead, employing modern management techniques and programs, reforming the acquisition system and reducing regulations. For decades Pentagon leaders have failed to implement the recommendations of these studies or, having begun to make changes, have allowed the system to backslide. Former Secretary of Defense Robert Gates tried to find $100 billion in savings by reducing overhead, including by shutting down Joint Forces Command. Unfortunately, since most of the personnel slots in the command were merely transferred to other parts of the Pentagon, the savings were minimal. Over and over again, DoD has announced a reform effort only to fail to achieve the desired results.
Dr. Goure evaluated BBP (or, if you will, BBP 1.0, BBP 2.0, and BBP 2.1) in the foregoing context. He wrote—
The current acquisition reform effort, known as Better Buying Power (BBP), is another example of this kind of insanity: doing the same thing over and over, expecting a different result. By imposing new behaviors, additional reporting requirements, and increased oversight of acquisition activities, BBP generally has increased costs to both private companies and government. For someone who prides himself on being data driven, Under Secretary of Defense Frank Kendall, needs to do the simple math. More activities, reports, audits and personnel mean higher costs.
Big business routinely responds to down markets by reducing overhead, streamlining their processes and making better utilization of human capital. Only government would do the opposite and increase its overhead costs when money gets tight.
As we said, when viewed in the historical context of past “acquisition reform” or cost reduction initiatives, it is hardly surprising to see the BBP initiative right where it is today. But what is perhaps more surprising is what the Pentagon personnel data shows.
In this Defense News article, readers learned that SECDEF Gates did more than merely call for a reduction to Pentagon bureaucracy and overhead; he actually tried to do something about it. In August, 2010, as part of his efficiency drive, Gates directed “a freeze on the number of OSD [Office of the Secretary of Defense], defense agency and combatant command [COCOM] positions, at the FY10 levels, for the next three years.” So how did the Department of Defense do? According to the Defense News article, “the size of the Pentagon’s vast oversight organizations grew by more than 15 percent from 2010 to 2012.”
Yes: you read that correctly. In response to Gates’ direction to freeze headcount, headcount grew significantly.
The article reported—
Between 2010 and 2012, OSD, the Joint Staff and COCOMs added about 4,500 positions, according to a Defense News analysis of multiple DoD personnel documents and interviews with experts. More than 65 percent of the staff size growth was within the Joint Staff, the organization at the Pentagon that oversees the uniformed military and global operations. The staff sizes do not include the thousands of contractors working within each organization.
Readers may recall that it was Gates’ call for headcount freezes and staffing reductions that prompted Congress to impose limits on funding available for contractor services. We wrote about that hairball right here. We’re not going to recap history here, but we do believe it’s ironic (at best) that, while contractor funding was being limited so as to prevent the back-office headcount from being shifted from the Pentagon to contractors, the Pentagon was actually increasing its back-office headcount.
In other words, the contractors have paid the price (in terms of contract award values, revenue and profit) for the Pentagon’s inability to solve its intractable personnel problems. The Pentagon bureaucracy has continued to build its satrapies, increase processes, and impose additional requirements on contractors, all in the name of cost-savings and overhead reduction. As pointed out by the AIA, the Pentagon bureaucrats don’t even bother to pretend otherwise anymore.
We can all see the truth now. The only meaningful overhead reduction that’s taken place over the past three years has been implemented by the contractors. The Pentagon continues to inflate its bureaucratic bloat. And so it goes ….
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