Government Accounting Rules are Boring and Stupid, Unless Violating Them Costs You $377 Million
Wednesday, 09 August 2023 19:17
Nick Sanders
We’ve all been there. We’ve all been in meetings where our management team rolls their eyes and taps their fingers with impatience as we try—once again—to explain some CAS requirement that prevents them from doing what they want to do.
“But CAS 402,” we say. Or we try to. Because talking about CAS to non-accountants (especially engineers) is like banging your head against a wall. Afterwards, you wonder why you even bother. Still, they pay us, right? They pay us and we try to deliver our best advice. We try to add value.
But they so very rarely listen to us.
How do we live with the frustration?
Well, speaking for myself, I repeat over and over that I’m an advisor. I give advice. I give recommendations. I give recommendations to the people that have the authority to act on my recommendations, or not. My job is to advise them; what they do with that advice is on their shoulders, not mine.
Even more recently, I have redefined my job function. I used to say my job is risk management and litigation avoidance. Which is true! But I can’t manage risks if I don’t have the authority to do so—right? So, instead, now I define my job as “I read stuff almost nobody else in America wants to read. I read books, articles, and court cases on topics that would put 99% of you to sleep. I read this stuff; then I tell you what it says. That’s what I do. And you pay me well for that job.”
You pay me well for reading arcane quasi-legal accounting stuff and then advising you about the best course of action based on what I read. I advise you and I make recommendations, all grounded in what I’ve read and thought about. I do a lot of critical thinking. All that informs my recommendations, which management too often ignores because it keeps them from doing what they want to do. They roll their eyes and (metaphorically) pat me on the top of my head; they tell me that they’ll accept the risks involved.
Which is a weird position because almost none of them have the knowledge or expertise to actually assess the risks involved—the probability of occurrence or the likely consequences if the risk materializes. They don’t really know, but they’re willing to accept the risk.
(Note: we have discussed risk management extensively on this website. Do a keyword search and you’ll see a plethora of articles on the topic. Not that anyone ever acts on those articles. Sigh. Writing blog articles that are never acted upon is not unlike giving advice that is ignored. But I digress. Forgive me.)
Telling us they accept the risk is fine. That’s management’s job, I guess. They pay us so well to ignore so much of what we tell them. My paychecks all clear and I assume yours do as well. So … what’s the issue here, really?
The issue is that sometimes—just sometimes—we are right in a big way. The risk materializes and the consequences are devastating. We get to be right, even though we would much rather not have been.
Today we are discussing the recent False Claims settlement by Booz Allen Hamilton. We are going to discuss details of the Settlement Agreement, which is found via a link to a .pdf file at the bottom of the DoJ press release.
It’s been a decade since we last mentioned Booz Allen Hamilton (Booz Allen) on this site. In 2012, the company had a local business unit suspended by the Air Force for improper conduct. Okay; it was a few bad apples—or so we thought. But if you read subsequent articles on the company, articles that related a similar pattern of improper conduct at yet another business unit, we started to wonder how many bad apples it took to spoil the entire company (ethically speaking).
Coincidentally, at about that time (starting in 2011), Booz Allen started to engage in a pattern of alleged accounting manipulations that ended in one of the Top 5 largest FCA settlements of which we’ve ever heard. $377,453,150. Call it $377.5 Million. With $69.8 Million going to the qui tam relator (whistleblower).
How do you like them apples now?
To be clear, Booz Allen denied all allegations; the Settlement Agreement expressly stated that the company was not admitting any guilt. Still … $377.5 Million. That’s a heckuva lot of money to fork over for something one denies ever happened.
What did Booz Allen do that was so heinous? It violated the requirements of the Cost Accounting Standards.
You know, the stuff that only a few of us ever read? Yeah, those Cost Accounting Standards.
According to the Department of Justice and the Settlement Agreement, Booz Allen (allegedly) engaged in the following practices:
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Contrary to the Cost Accounting Standards (“CAS”) and the Federal Acquisition Regulation (“FAR”), Booz Allen allocated indirect costs that supported Booz Allen’s commercial and/or international businesses to Government contracts and subcontracts that should have been allocated to commercial and/or international contracts or should have been treated as unallowable costs, including but not limited to: costs identifiable as commercial and/or international costs using the criteria reflected in the spreadsheet exchanged between the parties as of the Effective Date of this Agreement, burdens applied to such costs (including but not limited to G&A, fringe, and intermediate cost allocations), and directly associated costs (as that term is defined in FAR 31.001 and FAR 31.201-6).
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Booz Allen created and maintained indirect cost pools that included commingled costs supporting both (i) commercial and/or international contracts and (ii) Government contracts and subcontracts, and by virtue of such commingling allocated indirect costs disproportionately between commercial and/or international contracts and Government contracts and subcontracts, and thus were not in compliance with the CAS or FAR, including but not limited to the homogeneity and proportionality requirements in CAS 418 and the allocability requirements in FAR 31.201-4.
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Booz Allen used costs and cost rates that included indirect costs supporting Booz Allen’s commercial and/or international businesses to seek inflated payments and reimbursements under its Government contracts and subcontracts, and failed to disclose current, accurate, and complete cost or pricing data related to such costs resulting in inflated prices for Government contracts and subcontracts.
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Booz Allen submitted inaccurate and/or misleading statements (including but not limited to in its CAS Disclosure Statements) regarding the methods by which it accounted for, and the nature of, indirect costs supporting its commercial and/or international businesses.
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Booz Allen shifted employees and work relating to its commercial and/or international businesses between Responsibility Centers in violation of the requirements of the FAR and CAS, thereby creating and maintaining indirect cost pools that were not in compliance with FAR or CAS resulting in misallocations of indirect costs to government contracts.
(Emphasis added, of course.)
The DoJ summarized the foregoing allegations as follows—
… from approximately 2011 to 2021, Booz Allen improperly charged costs to its government contracts and subcontracts that instead should have been billed to its commercial and international contracts. In particular, the government alleged that Booz Allen improperly allocated indirect costs associated with its commercial and international business to its government contracts and subcontracts that either had no relationship to those contracts and subcontracts or were allocated to those contracts and subcontracts in disproportionate amounts. The government further alleged that Booz Allen failed to disclose to the government the methods by which it accounted for costs supporting its commercial and international businesses. As a result, Booz Allen obtained reimbursement from the government for the costs of commercial activities that provided no benefit to the United States.
Okay. There’s a lot to unpack in the allegations. There are violations of multiple FAR cost principles. There is a violation of CAS 418. There are allegations that the Disclosure Statement was “inaccurate and/or misleading” and that the company violated the Truthful Cost or Pricing Data Act (“TINA”) by failing to disclose the truth during price negotiations. So … yeah. Not so great from a government contract cost accounting and compliance viewpoint.
Reminder: the cost principle at 31.201-4 (“Allocability”) requires that indirect costs other than G&A expenses must be allocated to final cost objectives (let’s call them “contracts” but they need not be) “in reasonable proportion to the benefits received.”
Further reminder: CAS 418 (“Allocation of Direct and Indirect Costs”) requires (among other things) that “indirect costs shall be accumulated in pools which are homogeneous” and that “pooled costs shall be allocated to cost objectives in reasonable proportion to the beneficial or causal relationship of the pooled costs to cost objectives ….” There’s a lot more to that Standard, but you can read the rest yourself. You also may want to type “Sikorsky” into this site’s keyword search feature to see how Sikorsky dealt with an allegation of non-compliance with the requirements of CAS 418. There was also a relevant legal decision or two in the matter of AMC General, LLC. I mean, only if you want to put in the work. Unless you do this for a living, you probably won’t want to.
Of course, the requirements of CAS 418 only apply to fully CAS-covered contracts. But for the other contracts, the contracts that are not subject to Full CAS Coverage, see the requirements of FAR 31.201-4.
The point is that, while CAS 418 expressly requires indirect cost pool homogeneity, FAR 31.201-4 basically requires the same thing.
So, what is “homogeneity?”
According to CAS 418-50(b)—
(1) An indirect cost pool is homogeneous if each significant activity whose costs are included therein has the same or a similar beneficial or causal relationship to cost objectives as the other activities whose costs are included in the cost pool. It is also homogeneous if the allocation of the costs of the activities included in the cost pool result in an allocation to cost objectives which is not materially different from the allocation that would result if the costs of the activities were allocated separately.
(2) An indirect cost pool is not homogeneous if the costs of all significant activities in the cost pool do not have the same or a similar beneficial or causal relationship to cost objectives and, if the costs were allocated separately, the resulting allocation would be materially different. The determination of materiality shall be made using the criteria provided in 9903.305.
As has been pointed out by people wiser than I am, the CAS 418 homogeneity rules establish two criteria: (1) each significant activity in the pool has the same or a similar beneficial or causal relationship to the cost objectives in the allocation base, and (2) allocation of the costs of the activities in the pool is not materially different than would be the case if those costs were disaggregated and allocated to the cost objectives in the allocation base separately. Compliance with either of the two criteria is sufficient to lead to a determination that the indirect cost pool is homogeneous.
As Terry L. Albertson and Linda S. Bruggeman, attorneys in the Government Contracts Practice Group of Crowell & Moring LLP, wrote in 2006: “… to establish that a pool is not homogeneous, the Government must prove both that the activities in the pool do not have a similar relationship to the activities in the base and that a different allocation of costs would produce a materially different result.” (Emphasis in original.)
Apparently, given the willingness of Booz Allen to settle the allegations made by the relator and the Government, somebody was prepared to make just that showing.
So, the next time somebody in management rolls their eyes or taps their fingers when you try to explain CAS or FAR requirements to them, or the next time somebody with authority tells you they are willing to “accept the risk,” then remember this settlement. Ask them if they truly understand the risks, including the probabilities and possible consequences.
Then if they nod, pat you on your head, and send you back to your office that’s filled with compliance-related books, you can go with pride, secure in the knowledge that you have done your best.
Last Updated on Thursday, 10 August 2023 14:01
Oh, Boeing! What’s Happened to You?
Tuesday, 20 December 2022 00:00
Nick Sanders
Hello! Well, hasn’t this just been the year? Over on this side of the monitor, in the past three months I’ve had both COVID and RSV. (Courtesy of my son’s high school.) But I’m through both now—and looking forward to next year.
Speaking of challenging years, though, let’s talk about The Boeing Company. Boeing Defense has had a very challenging year, a year that follows previous challenging years. In fact, Boeing as a company has had a challenging past few years and its stock price has reflected those challenges. The company’s stock price hit a high of just under $441 per share on March 1, 2019. In contrast, on December 16, 2022—less than four years later—the stock price stood at $185 per share. That’s a drop of nearly 60 percent.
That’s not the end of the story. In 2020, the company was paying shareholders a dividend of about $2.00 per share. Then dividends were suspended. In 2021, Boeing paid shareholders nothing. The story was the same for 2022.
Sucks to be a shareholder in The Boeing Company, right?
You know, we’ve made that point before. Oh, yes—we have!
For example, in a 2018 article, we wrote—
And what about big versus small contractors? If the Pentagon is going to award contracts based on the amount of investment that contractors are willing to make, then only the largest of contractors will win awards. The smaller contractors will be locked out of the ‘pay for play’ competitions.
To sum up these thoughts, it seems that certain larger contractors are willing to pay to play in long-term Pentagon contracts, betting that they will earn back developmental losses over the lives of the programs. They may be right; but we remember the story of that DOE contractor, whose program investments turned out to be larger than it ever dreamed of.
The point was (and still is): making a known investment to win a major program only works if your investment stays the same size as you first predicted. Should circumstances change and your initial investment prediction becomes “overtaken by events” then your initial Return on Investment (ROI) analysis is thrown in the trash can. At that point, you and your shareholders are well and truly screwed because you are now locked into a fixed-price (or FPIF) development program that you must deliver, regardless of supplier programs and regardless of COVID impacts and regardless of inflationary impacts on your budgeted costs. You must deliver, regardless of what it costs you.
If you don’t deliver, you will be Terminated for Default.
You have to deliver no matter what it costs; if you have schedule slips and subcontractor issues and technical issues that you thought you could solve (but which turned out to be tougher problems than your engineers predicted) and if you have ridiculous cost growth in materials and labor—and if you have labor shortages because your people are leaving in droves because you don’t pay them well or maybe they’re sick of a toxic (or inept) management culture—and if your cash-cow commercial side of your business tanks at the same time you need a cash infusion to cover your program losses … well, then. You just might be The Boeing Company.
Talk about grabbing a tiger by the tail!
In 2022, the tiger bit Boeing.
What do we mean?
Under Shadow of Financial Losses, Boeing Makes Sweeping Changes to Defense Biz (Breaking Defense, 11/17/2022)
The changes, including halving business divisions, come as Boeing’s defense sector [BDS] finds itself at a crossroads, with new leadership contending with systemic financial issues tied to its large number of fixed-price contracts with the US government. …
BDS has racked up about $4.4 billion in losses so far this year on fixed-price programs, primarily driven by the KC-46 tanker and the VC-25B programs (the latter effort better known as the next-generation Air Force One), but also including the T-7A Red Hawk trainer, MQ-25 tanker drone and Commercial Crew program with NASA.
Boeing Reorganizes Defense Business After Financial Troubles (Air & Space Forces Magazine, 11/17/22)
Boeing has faced companywide losses, including in its commercial sector. Its defense business has been a significant drag on the company’s recent financial performance following losses incurred on fixed-price government contracts. In October, Boeing reported a loss of $3.3 billion in the third quarter of 2023, with its defense business $2.8 billion in the red. …
The KC-46 and VC-25B, which will become the new Air Force One, have been a significant financial drag for Boeing. The KC-46 program lost $1.2 billion, and the VC-25B program lost $766 million in the third quarter. The KC-46 has been troubled from the start, problems in its refueling system requiring a revamp and leading to delays. The VC-25B program was priced too cheaply, according to Boeing, making it a loss generator for the company. Supply chain issues and labor shortages have increased problems.
Boeing Reorganizes Defense Division After Third-Quarter Losses (Aviation Week, 11/17/2022)
Boeing’s Defense, Space and Security (BDS) division announced an organizational streamlining on Nov. 17 as the $26.5 billion business unit seeks a return to growth and to curtail mounting losses on fixed-price development programs. … Boeing also announced the restructuring three weeks after BDS reported a 20% reduction in quarterly revenues and a $2.8 billion reach-forward loss on five fixed-price development programs. Those same programs have accounted for $11.5 billion in reach-forward losses overall since 2014.
But in addition to the impacts to shareholders, there are more subtle and perhaps far-reaching impacts from Boeing’s management mistakes. Richard Aboulafia discussed those impacts in a recent editorial at Aviation Week.
He wrote that Boeing’s current situation “is not good for the long-term health of the U.S. aerospace industry, the broader U.S. economy or the aerospace workforce. But one overlooked consequence of Boeing’s woes is the possible impact on U.S. defense.” He cites three potential impacts to the United States’ national security posture, as follows:
First, BDS execution problems mean the U.S. military services will have to keep using older, less reliable systems that are costly to operate. With KC-46 and T-7 delays, even the oldest KC-135 tankers and T-38 trainers will soldier on well past 60 years of age. Pentagon efforts to procure interim or supplemental systems—an Air Force/Navy trainer or the Air Force’s KC-Y tanker—are uncertain.
Second, an industrial base decision might have been made for the Pentagon, whether it wants one or not. BDS losses reflect low bids on relatively low-tech programs; it is not clear whether Boeing can hope to bid on new programs that require more advanced engineering, particularly if past performance is a key selection factor. … Boeing could also be disadvantaged by Pentagon concerns about the company’s in-house design capabilities. Boeing’s 2015 Long-Range Strike Bomber loss to Northrop Grumman in part reflected Air Force concerns about Boeing’s strategy of relying on Lockheed Martin for much of the design work. Relying on Saab for much of the T-7 design may be viewed as a risky tactic, too. … The Air Force’s Next-Generation Air Dominance program looms large over this. If it excludes Boeing, and if the Navy’s F/A-XX either stalls or excludes Boeing, we can assume there are now two competitors for new fixed-wing military contracts, not three. The Defense Department does not want less competition for future programs and has signaled opposition to mergers resulting in that outcome, but it might have to live with that reality anyway.
Finally, the nation’s ability to design large aircraft must be considered. The C-17 fleet is wearing out at a rate faster than expected, and the C-5M is getting quite old, too. Given the relevance of strategic airlifters for operations in the Pacific, the Pentagon will need to start funding a new program sometime in the next 10 years. … Calhoun’s new jetliner deferral means Boeing design teams will not hire new talent, resulting in smaller numbers and a much older demographic by the 2030s. We cannot rule out mass layoffs of these engineers, either. In the late 1980s and early 1990s, the C-17 program was plagued by serious overruns and delays, largely because McDonnell Douglas’s aircraft design teams were in a state of atrophy. Boeing is at risk of entering that phase and perhaps an even worse one.
So … is there a lesson or two that might be learned here?
Well, yeah. First of all, beware fixed-price (or FPIF) development contracts. We’ve sounded that warning before. (See this 2018 article.) Just … don’t.
Second, let’s talk about workforce decisions. As Aboulafia’s editorial noted, without a strong engineering workforce, you don’t get new products. You don’t get innovation. You don’t get clean-sheet anything. Somewhere along the line, The Boeing Company stopped being a engineering company and started being a for-profit company run by the business folks. (That’s not just our outsiders’ opinion. See Flying Blind: The 737 MAX Tragedy and the Fall of Boeing, by Peter Robison.)
You’d like to think that as older folks depart, they would be replaced by a cadre of young engineers, trained in the latest and greatest design tools. New blood, fresh energy, buzzing with ideas for the future. But where do those folks come from?
They don’t come from St. Louis.
No offense to St. Louis! But it’s not especially known for its depth of engineering talent. Not a lot of engineering schools in the area, compared to, say, Southern California. Which is where BDS’s headquarters used to be, before it moved to the St. Louis area in 1997. (We should note that the HQ moved from Hazelwood to Washington, D.C. in 2016, but that didn’t impact the engineering staff.)
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In November, 2015, the final C-17 left Boeing’s Long Beach, CA, facility and 2,500 people were laid-off. Per a 2019 article, the C-17 plants in Wardlow “remain largely vacant.”
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In December of that same year, Boeing announced that 2,400 jobs would be leaving its Huntington Beach, CA, facility over the next four years (with some going to other Southern California facilities). Importantly, Boeing’s Huntington Beach campus “spread across some 28 buildings on 178 acres, include[d] a design and research center focused on space access, networked systems, cybersecurity, unmanned underwater vehicles and advanced manufacturing, along with key programs in the highly classified Phantom Works program.” In other words, exactly the engineering talent you would want to retain. However, Boeing was prepared for attrition. A company spokesperson was quoted as saying: “Most [job losses] would come from attrition. Some people will decide they don’t want to move and will leave the company. Some number will be layoffs. All will receive separation assistance.”
In summary, Boeing made several decisions over the past twenty years that negatively impacted its critical engineering workforce. Seemingly driven by a need to cut costs, it made a decision to move away from its traditional facilities—places where the company had been for decades—and consolidate to less traditional areas. Critically, it consolidated in areas that didn’t have the same robust engineering talent feeders.
We get it. It’s popular to hate on California. It’s super-regulated. It’s practically a Socialist Paradise. It’s one of the most expensive places in the US to live, with high taxes imposed on both individuals and corporations. Most of those less-than-charitable accusations are true (to some extent). And yet … where is Cal-Tech located? Where is the Jet Propulsion Laboratory located? Where is Edwards Airforce Base located?
According to the 2023 graduate school rankings by U.S. News & World Report, four of the top ten engineering schools in the United States are located in California, as are six of the top twenty. Washington University in St. Louis is #48; Missouri University of Science and Technology (Rolla) is #92. Good schools, for sure! Yet …. We think you get the point.
The fact of the matter is that most people like living in Southern California. They like only dealing with snow when they choose to deal with it by driving an hour or two into the mountains. They like being able to walk on the beach if they want to, or to surf in the Pacific Ocean during January. They like living in close proximity to culture. They like it where they live and many of them don’t want to move away. They won’t move away if their jobs move; instead, they’ll find another job in a competitor.
You ever been to El Segundo? Northrop, Boeing, Raytheon Tech, Lockheed Martin – all with facilities located within two or three miles of each other’s. Sure, it’s not the same now as it was back in the day—but it’s still there, still an aerospace/defense engineering hub. The point is: if their job moves away, many people—including some of your high-potential, highly knowledgeable and experienced engineers—can just change employers without having to relocate from the West Coast to the Midwest. In fact, the better they are, the easier it will be to job-hop instead of relocate.
The question becomes: Do you put your facilities where costs are lower … or do you put them where the talent is? What’s the correct answer for the financial statements? What’s the correct answer for the future of your company?
In our view—and in the view of others—Boeing sold its future for short-term corporate profits long ago. What we are seeing now are the consequences of that decision. Unfortunately, that decision also seems to have had consequences for the national security posture of the United States.
Last Updated on Tuesday, 20 December 2022 13:51
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Raytheon at the Federal Circuit
Thursday, 15 June 2023 00:00
Nick Sanders
Hello. It’s been a while. For those who’ve asked where I’ve been, the truth is I’ve been where I always am, right here behind the monitor. I’ve been busy—too busy to update this blog—and there hasn’t been much I’ve wanted to say. It’s been a weird time in government contract cost accounting and compliance.
But today I want to talk about the January, 2023, decision at the Court of Appeals (Federal Circuit) in the matter of Secretary of Defense v. Raytheon Co. It’s a puzzling opinion and I’ve been letting it marinate for a while. Keep in mind that nobody over here is an attorney, so our opinions—such as they are—should be taken with a large grain of salt. If you want cogent legal advice, pay for it.
Background
I wrote about the original 2021 decisions at the ASBCA here on this blog. There was a lot to write about, and it took me four (4!) separate articles to do so. Here’s a link to the first article, from April, 2021.
To recap:
There were myriad issues at both the Raytheon Home Office and at the Raytheon Missile Systems (RMS) segment. There were allegations of violations of CAS 405. There were allegations that expressly unallowable costs had been claimed. There were allegations of insufficient supporting documentation. In total, the government sought roughly $15 million. The ASBCA sustained substantially all of Raytheon’s appeals of various Contracting Officer Final Decisions. It was a big victory.
The government appealed two (of the many) issues to the Federal Circuit. Both issues were Home Office issues. One issue dealt with “Corporate Development” costs and the other issue dealt with “Government Relations” costs. The ASBCA’s decisions on both issues were reversed by the Federal Circuit.
Let’s discuss.
Corporate Development
According to the original ASBCA decision—
Raytheon’s Corporate Development department was responsible for working with its business units in strategic development and growth opportunities, including strategic analysis of a business’ capabilities to market its products and services to the government and function in government work. Where there were gaps in business’ capabilities, Corporate Development would work with them to determine the right ways to fill the gaps, either through, inter alia, internal investment, research and development, licensing of intellectual property (IP), partnerships or acquisitions. This process was known as ‘gap analysis.’ Working with Raytheon’s businesses on M&A and divestitures was not Corporate Development’s primary role but was part of its work to find strategic growth initiatives.
Corporate Development made proposals for acquisitions or divestitures to the Acquisition Council which, in 2007 and 2008, consisted of senior Raytheon leaders, including the Chief Executive Officer, Chief Financial Officer, General Counsel and Vice President of Corporate Development. Raytheon declared its intentions regarding potential acquisitions and divestitures through the Acquisition Council. Corporate Development did not know which route Raytheon was going to follow until after the Acquisition Council made its decision. Occasionally, even after an Acquisition Council decision, Raytheon would change course based upon information developed during the acquisition or divestiture process.
(Internal citations omitted.)
In other words, one of Corporate Development’s role was Mergers, Acquisitions, and Divestitures—i.e., external activities that would “fill the gaps” between current company capabilities and what the experts believed the government was going to want and/or need in the future. Reminder: the cost principle at FAR 31.205-27 (“Organization Costs”) makes that stuff unallowable. (“… expenditures in connection with (1) planning or executing the organization or reorganization of the corporate structure of a business, including mergers and acquisitions, (2) resisting or planning to resist the reorganization of the corporate structure of a business or a change in the controlling interest in the ownership of a business … are unallowable.”)
Raytheon had policies and procedures to help its people distinguish between allowable economic planning costs and unallowable M&A activities. Consistent with its records and policies, Raytheon self-disallowed 50 percent and claimed the other 50 percent as being allowable non-M&A activities. DCAA disagreed and asserted that 100% of all Corporate Development costs were unallowable. The CACO agreed with DCAA and told Raytheon that not only were the costs unallowable, they were expressly unallowable—meaning that Raytheon owed the government penalties and interest. The CACO threw in a CAS 405 noncompliance, as well.
On appeal, the Board found that the Government had not met its burden, writing—
DCMA has not carried its burden to prove by a preponderance of the evidence that the amount of unallowable hours withdrawn by Raytheon’s personnel, which is supported by documentation and credible witness testimony (see, e.g., findings 41-45, 57-58, 60), from its CY 2007 and 2008 incurred cost proposals was inaccurate, nor that any of the included Corporate Development costs were unallowable, let alone expressly unallowable and subject to penalties. Thus, DCMA has also not met its burden to prove that Raytheon violated CAS 405 regarding those costs.
The Federal Circuit disagreed with that position, finding that “ample evidence before the Board established that at least some of Raytheon’s ‘allowable’ pre-decision salary costs related to planning mergers, acquisitions, or divestitures.” The Federal Circuit concluded—
Because the Board erred as a matter of law in concluding that Raytheon’s corporate-development policies were consistent with the FAR, its factual determination that the government was not charged for unallowable costs because Raytheon’s employees complied with those policies is also legally incorrect. We therefore reverse the Board’s conclusion and remand for the Board to determine the amount of unallowable costs improperly charged to the government. We again recognize that Raytheon’s policies make this a difficult task, but we reiterate our view that Raytheon should shoulder the burden its policies created.
Our Thoughts
The Federal Circuit essentially ruled that the Government didn’t have to prove anything. Simply finding that Raytheon’s policies and procedures led to the incurrence of expressly unallowable costs was sufficient to prevail. The fact that the Government was unable to quantify the amount of expressly unallowable labor costs stemmed from Raytheon’s policies, apparently.
Left unstated in the Appellate decision was the fact that Raytheon had already self-disallowed 50 percent of its Corporate Development costs. DCAA (and the Contracting Officer) asserted that 100% was unallowable—an assertion that was contradicted by testimony. So what is the correct amount to disallow? The Federal Circuit was silent on that, remanding to the Board to make that finding. Presumably, the right value is somewhere between 50 and 100 percent.
At the end of the day, Raytheon published a “bright-line” to aid its employees in accurate timekeeping. The ASBCA found the line to be reasonable, but the Federal Circuit disagreed. According to the Federal Circuit, simply identifying M&A targets—whether or not an offer was ever made or due diligence ever initiated—was itself unallowable. Okay. We get that.
In that regard, you could craft an analogy to FAR 31.205-47 (“Legal and Other Proceedings”). When does a legal proceeding start? Does it start when the claim or appeal is filed, or when a demand letter is received? Or does it start before the official “proceedings” start. We have long grappled with that question. Given the Raytheon decision, we suggest that unallowable costs associated with legal proceedings likely start before that time; perhaps at the moment somebody says “we’re going to court on this one.”
Something to think about?
Government Relations
The term “Government Relations” encompasses a number of activities, but prominent among them is lobbying—i.e., the effort to influence senior military officers and Congress folks to fund programs that are important to the contractor. FAR 31.205-22 makes lobbying and other political activity costs unallowable, but provides exceptions for certain specified activities. Among the exceptions is the effort to provide Congress with technical and factual information related to performance of one or more of the contractor’s contracts.
In a similar fashion to how it handled unallowable Corporate Development costs, Raytheon self-disallowed lobbying expenses. However, its methodology relied on labor records. In the original ASBCA decision, the Board found that—
For the lobbying cost withdrawal calculation, Raytheon established a ratio of unallowable hours worked by the Government Relations employees to their total hours worked. The ratio’s numerator was the total number of unallowable hours reported by the lobbyists. The denominator was the total number of work hours available during a given year to the employees who reported unallowable hours, based upon a 40-hour work week less vacation and holidays. Dividing the numerator by the denominator yielded a percentage—the lobbying disallowance factor. Raytheon applied this factor to what it deemed to be Government Relations’ recoverable expenses (including the salary and fringe benefits paid to its lobbyists and their administrative staff) to determine the costs associated with unallowable lobbying activities under FAR 31.205-22.
The problem with the above, according to the Federal Circuit, was that Raytheon failed to account for all lobbying hours expended by its employees. Both the numerator and denominator were inaccurate—they were both undercounted by the labor hours that Raytheon employees failed to record. (Though the Federal Circuit elided any mention of the problem with the denominator.)
Total-time accounting is popular among Government contractors—though proper treatment of uncompensated overtime is tricky. The point here is that there is no regulatory requirement that mandates total-time accounting; in particular, Raytheon eschewed it for many years—perhaps decades—requiring instead that its employees only record a 40-hour work week. That position, though accepted by the ASBCA, proved to be Raytheon’s undoing at the Federal Circuit.
Once again, though the Board found the Government had failed to carry its burden, the Federal Circuit disagreed, asserting that, because some labor hours were unrecorded, and that those unrecorded hours were lobbying and therefore unallowable. The Federal Circuit opined that “Raytheon, by ignoring after-hours lobbying, must have charged the government for unallowable lobbying costs.”
The Federal Circuit opinion added—
Raytheon’s time-paid accounting is a fiction that necessarily overcharges the government when it ignores time spent working on unallowable activities after regular business hours. Raytheon’s lobbyists worked on unallowable activities after-hours, and their salaries necessarily compensated them for that time. Raytheon’s policies ignoring after-hours time resulted in the government reimbursing Raytheon for unallowable costs.
Our Thoughts
We would have liked to see the Federal Circuit align its opinion with the requirements of CAS 405 and FAR 31.201-6 (“Accounting for Unallowable Costs”). It is unsurprising that no mention was made of those requirements, because they might have undercut the legal position espoused by the Federal Circuit.
(e)(2) Salary expenses of employees who participate in activities that generate unallowable costs shall be treated as directly associated costs to the extent of the time spent on the proscribed activity, provided the costs are material in accordance with paragraph (e)(1) of this subsection (except when such salary expenses are, themselves, unallowable). The time spent in proscribed activities should be compared to total time spent on company activities to determine if the costs are material. Time spent by employees outside the normal working hours should not be considered except when it is evident that an employee engages so frequently in company activities during periods outside normal working hours as to indicate that such activities are a part of the employee’s regular duties.
(Emphasis added.)
In our view, a materiality analysis needed to be made by the Government. It might be based on interviews of personnel engaged in lobbying, or else by requiring employees to keep logs of after-hours efforts. Because no materiality analysis was performed, nobody knows whether Raytheon was required to record the unallowable lobbying costs of its employees who were engaged in after-hours efforts.
But none of that mattered to the Federal Circuit. Eschewing facts once again, the Judges preferred their own legal theory in which compensation covered both the standard 40 hours/week and after-hours efforts. In other words, the more total hours worked, the more employees should have been compensated. As a popular commercial once said: “That’s not how this works. That’s not how any of this works.”
We think that the Federal Circuit opinion conflates hourly and salaried compensation—a distinction clearly made by CAS 405 and the cost principle quoted above. As such, we would assert a legal error was made. But what do we know?
Conclusions
We don’t really care for this decision. However, unless Raytheon appeals to SCOTUS and the decision is overturned there (highly unlikely) it is the official interpretation. This decision deals with two issues—unallowable M&A activity and unallowable lobbying activity. Accordingly, it’s limited to those two areas. But the lesson is clear: when employees are engaging in unallowable activities, they need to record ALL time worked. Period. (We think legal proceedings are worth considering in this light as well as the other two areas specifically covered.)
Last Updated on Thursday, 15 June 2023 11:48
Audit Rights and Record Retention
Tuesday, 11 October 2022 07:49
Nick Sanders
Government contractors must comply with the requirements of many upon many contract clauses. It’s safe to say that the principle purpose of government contract compliance is to understand those requirements and to help the contractor adhere to them, and then demonstrate to the government auditors that the contractor has done so.
Two of the more important clauses are 52.215-2 (“Audit and Records-Negotiation”) and 52.216-7 (“Allowable Cost and Payment”). If you are a contract compliance professional you should have basically memorized those clauses. They are that important.
Generally speaking, 52.215-2 (which is a mandatory clause for all negotiated contracts unless the contract is exempted by 15.209(b)) is what gives auditors access to contractor records. It’s not unlimited access and you should understand the guardrails established by the clause. In addition, 52.216-7 (which is a mandatory clause for all cost-reimbursement contracts) establishes how billing rates are to be calculated, adjusted, and submitted for audit and finalization. It is also the clause that invokes the FAR Part 31 Cost Principles; without it contractors wouldn’t really need to worry about allowable and unallowable costs.
Both clauses are fundamental and you should study them thoroughly if you have not yet done so.
We have discussed both clauses before. One of interesting aspects of 52.215-2 is that it grants auditor access but that access may be worthless to the auditors. What do we mean? Well, in this ASBCA decision from 2017, we discussed the happy result that DCAA had audit access but the government was prevented from asserting a claim based on the DCAA’s audit findings, because the Contract Disputes Act (CDA) Statute of Limitations had been found to have passed before the contracting officer got around to asserting the claim. Oops!
We wrote:
But what about that 52.215-2 audit clause that gives the government the right to audit contractor costs up to three years after final payment? Sure. Absolutely correct. The clause requires that ‘The Contractor shall make available at its office at all reasonable times the records, materials, and other evidence … for examination, audit, or reproduction, until 3 years after final payment under this contract or for any shorter period specified in [FAR Subpart 4.7], or for any longer period required by statute or by other clauses of this contract.’ (Emphasis added.) Thus, the contractor has a duty to make documents available for audit and the government has the right to audit those documents, but the government does not have the right to assert a claim with respect to any audit findings related to costs that were invoiced and paid more than six years before. If the contractor’s final voucher doesn’t contain any new direct costs—which it shouldn’t—then the 52.215-2 audit right is essentially worthless—absent, perhaps, a claim of fraud.
So, in the case of Sparton deLeon Springs’s appeal of the Contracting Officer’s Final Decision (COFD), the government had moved too slowly to recoup any of the funds it believed had been insufficiently supported by the contractor. Sorry; not sorry.
More recently, the ASBCA dealt with a similar case that (largely) had a similar outcome.
Doubleshot, Inc., a small business, had at least four cost-type (or partially cost-type) contracts that were characterized as R&D contracts. The earliest of those contracts was awarded in 2006; the latest was awarded in 2008. Now, before awarding those contracts, the various government contracting officers were required to find that Doubleshot possessed and accounting system adequate to account for contract costs. (See FAR 16.301-3(a)(3).) The record is silent on this point, but it is not disputed that, when DCAA showed up to evaluate Doubleshot’s accounting system in January, 2010, the contractor did not fare well.1 More than a year later, a “Flash” Report was issued. (“The report identified what can only be characterized as major problems with Doubleshot’s recordkeeping, which it does not dispute. Among other things, DCAA observed that Doubleshot did not maintain a general ledger and that its ‘accounting system is non-existent’.”)2
One manifestation of Doubleshot’s problematic accounting system was that the contractor did not submit its proposals to establish final billing rates on time as required by 52.216-7.3 DCAA also told a contracting officer that the audit agency would not longer be approving interim vouchers submitted by Doubleshot. The contracting officer deobligated remaining funds on two of the four contracts via unilateral modification. It very much appeared that Doubleshot was out of the cost-reimbursable government contracting business. Oops!
The contracting officer also demanded that Doubleshot immediately submit its overdue final billing rate proposals, under the threat that its contract costs would be unilaterally established at values that were 20% below whatever Doubleshot might claim. (Note that 20% decrement would include both direct and indirect costs, so kind of a big stick to hit Doubleshot with. We’ve written about unilateral decrements before; we’re not fans.)
For whatever reason, Doubleshot submitted adequate “incurred cost proposals” for its Fiscal Years 2009 and 2010 15 months later, in August, 2013.4 DCAA found the proposals to be adequate within 24 hours, except for minor issues that were satisfied via revised submissions a month later. DCAA started to audit in November, 2015 and, as part of that audit, received Doubleshot’s general ledger for review on December 29, 2015.5 On June 12, 2017, DCAA issued its audit report, questioning various direct and indirect costs.6 It took the contracting officer a hair less than another year to issue the COFD, demanding repayment of $804,979. (“She concluded that Doubleshot had been overpaid direct and indirect costs on contract Nos. 416, 386, and 497, and had been underpaid on No. 295.”)
Doubleshot appealed. Its first argument was that the government should have been on notice as early as 2010 that Doubleshot didn’t know how to account for its costs properly, and that’s when the government should have known that it was likely to have overpaid its contractor. (“… Doubleshot attempts to turn what could be considered an embarrassment – a non-existent accounting system – to its benefit.”) The ASBCA didn’t buy that argument, finding that “The undisputed evidence shows that on or before May 29, 2012, the government was aware of the inadequacy of appellant’s accounting system, but it also shows that Doubleshot was eventually able to produce the ICPs and a general ledger. There is nothing in the record that identifies specific costs that the contracting officer knew, or should have known, had been overpaid as of that date.”
First motion for summary judgment denied. Motion for reconsideration denied.
Because the motion for summary judgment based on the CDA Statute of Limitations was denied, the appeal proceeded. More recently, the ASBCA considered further motions for summary judgment based on the facts that were before it.
The majority of the government claim ($633,397 out of $804,979) related to “inadequately supported costs”. Why were the costs inadequately supported? Because Doubleshot was unable to produce employee timecards as source documents for its labor transactions, even though it was able to prove that the employees had been paid. The government’s argument hinged on FAR 31.202-1(d), which requires a contractor to “maintain[ ] records, including supporting documentation, adequate to demonstrate that costs claimed have been incurred, are allocable to the contract, and comply with applicable cost principles in this subpart and agency supplements.”
Doubleshot argued that it was not required to have retained those timecards. In its analysis, the ASBCA looked at the language of 52.215-2, particularly paragraph (f) (“Availabilty”.) That paragraph states—
The Contractor shall make available at its office at all reasonable times the records, materials, and other evidence described in paragraphs (a), (b), (c), (d), and (e) of this clause, for examination, audit, or reproduction, until 3 years after final payment under this contract or for any shorter period specified in subpart 4.7, Contractor Records Retention, of the Federal Acquisition Regulation (FAR), or for any longer period required by statute or by other clauses of this contract. ….
(Emphasis added by the court in the decision.)
As the ASBC decision noted, “FAR 4.705 sets forth various retention periods based on the type of documents. As relevant here, it provides ‘Clock cards or other time and attendance cards: Retain 2 years.’ FAR 4.705-2(b). Thus, if a contractor submitted its final ICRP on time (six months after the end of the FY), it would have to retain the time cards for 18 months after that date.”
But remember, Doubleshot was late submitting its required final billing rate proposals. So, by operation of the FAR, the record retention period was extended. Still didn’t matter. The timecards were not required to be retained to support a delayed DCAA audit, according to the decision. (“Because Doubleshot no longer had any obligation to maintain these records, the government’s claim fails to the extent it is based on the lack of such records.”)
Summary judgment granted in Doubleshot’s favor on the majority of disputed costs. The disposition of the remaining costs will require further litigation.
A cautionary note: legal practitioners are citing to dicta in another appeal at the Civilian Board of Contract Appeals (CBCA) (Mission Support Alliance, CBCA 6477), in which it appears that, if presented with facts similar to Doubleshot’s appeal, the judges at the CBCA may have ruled in the government’s favor. Hmm. We believe—to the extent our layperson’s judgment has any merit—that the ASBCA got it right here.
Last Updated on Tuesday, 11 October 2022 08:30
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