On November 2, 2009 the Commission on Wartime Contracting (CwC) held yet another hearing on “contractor accountability” in Iraq and Afghanistan.  The most recent hearing, “Counting Contractors: Where are They and What are They Doing?” was a wide-ranging affair, featuring testimony from the GAO, military services, DCMA, OUSD (AT&L), and DCAA Director April Stephenson.  The CWC divided the hearing into three parts, each with its own panel:  (1) Problems gaining an accurate count of contractor employees supporting the warfighters in Southwest Asia, (2) Managing contractors during the drawdown of forces in Iraq, and (3) DCAA and DCMA “coordination and cooperation.”

With such an embarrassment of riches to write about, we hardly know where to start.  We’re going to focus on just a few aspects of the hearing; the entire cornucopia of testimony can be found here. Our focus will be on the third panel, consisting of Mr. Shay Assad, Director of Defense Procurement and Acquisition Policy (DPAP) for the Office of the Under Secretary of Defense (Acquisition, Technology & Logistics), Mr. Charlie Williams (Director, Defense Contract Management Agency), and Ms. April Stephenson (Director, Defense Contract Audit Agency).  We’ll note for the record (as CWC co-Chair Thibault did) that this would be Ms. Stephenson’s last official testimony before her reassignment to a position on the staff of the Under Secretary of Defense (Comptroller) Robert Hale. We’re focusing on this panel because of the importance of the testimony and its foretelling of impacts that will be felt by all DOD contractors, not just those supporting warfighters in Southwest Asia.  Several bombshells were dropped and we will be quoting extensively from the written testimony.

Co-Chair Thibault (a former long-time employee of the DCAA) noted—

A Commission hearing in August on contractor business systems revealed significant differences between DCMA’s and DCAA’s evaluations and assessments of contractor systems for cost estimating, purchasing, subcontracting, and other functions.  The evidence showed that DCMA frequently took untimely—or no— action on DCAA findings, or issued contrary opinions, and often failed to ensure that contractors took corrective actions for deficiencies.

DOD’s Subcommittee on [Contractor] Business Systems

Mr. Assad started his testimony by noting actions DOD has taken in response to various issues raised by the GAO and others.  In particular, he noted the creation of the Panel on Contracting Integrity and its Subcommittee on Business Systems, which will be chaired by the DPAP Deputy Director for Cost, Pricing, and Finance (Brian George).  Other members of the panel will include the new Director of the DCAA (Pat Fitzgerald), Mr. David Ricci (DCMA), and a “senior representative” from the U.S. Army, and other DOD employees.  According to Mr. Assad’s testimony, “The new subcommittee has a broad mandate to explore issues related to contractor business systems and the roles and responsibilities of DCAA and the DCMA administrative contracting officers (ACO’s) in determining and correcting deficiencies in contractor business systems.” Mr. Assad continued—

Key focus areas for the subcommittee include:

• Clearly defining the roles and responsibilities of the DCMA contracting officer and DCAA auditor in determining the adequacy of contractor business systems;
• Assessing the need for standards, such as those already published for Earned Value Management System (EVMS), for the various business systems;
• Recommending procedures for higher level adjudication of differences between audit recommendations and the DCMA contracting officer determinations of adequacy; and
• Recommending appropriate contract remedies that DCMA contracting officers can use when a business system has been determined to be deficient.

The subcommittee will review current policy, processes, and practices within the DoD regarding the audit, evaluation, and administration of contractor’s business systems to include contractor internal control systems or other contractor systems the subcommittee may identify. In order to ensure consistency in the Department’s oversight of contractor business systems, the subcommittee will examine the need to establish a “common list” of contractor business systems with defined expectations or criteria for each system to determine adequacy. In addition to establishing a common set of standards for measuring the adequacy of contractor business systems, the subcommittee will determine the need for additional contract clauses or regulations for each system to include remedies such as withholds and guidelines for audit frequency. Currently, contractor business systems are not specifically defined in our regulations. We expect the work of the subcommittee will result in recommendations for new regulatory language in the Federal Acquisition Regulations (FAR) or the Defense FAR Supplement (DFARS). For example, the DFARS may need to be revised to prescribe roles and responsibilities and standards that will be employed to determine compliance. I expect the subcommittee will be examining the existing FAR and DFARS contract clauses used for enforcement and remedies for non-compliance.

Mr. Assad continued in a like vein, discussing an adjudication process to be used when DCAA auditors and DCMA contracting officers disagree on how to evaluate a contractor’s business system.  Moreover, Mr. Assad testified that “Audits of contractor business systems comprise only 5 % of DCAA’s audit workload based on 2009 incurred hours, which also include CAS non-compliances, and cost proposals for cost impacts, indirect rates, forwarding pricing rates, and other contract negotiations or awards. We will be working with DCAA to determine if some work currently being performed by DCAA could be performed by others or if the priority for some reviews should be lowered until additional resources can be made available.”

Mr. Assad also testified that –

The subcommittee will also focus on the type of input the DCMA contracting officer needs from DCAA in order to make decisions regarding adequacy of contractor business systems. We know for certain that DCMA contracting officers need to know the specific deficiencies in contractor business systems and the significance of those deficiencies on defense contracts. One approach that is under consideration is having DCAA report on the materiality of the deficiency it finds instead of opining on the overall system. That would enable DCMA contracting officers to use audit reports to determine what needs to be corrected and the degree of risk the deficiency imposes on the government.

He concluded his testimony by discussing the “chronically short staffed” agencies and how the lack of resources has impacted both DCAA and DCMA.  He testified that “Until the staffing issues are resolved, it will not be possible for DCAA to perform at the level of quality and efficiency that is desired.”

DCMA Initiatives

Next Mr. Williams spoke to the CWC, testifying “I fully support guidance and regulatory changes in this area and believe the entire DoD procurement community needs to work together to send a clear message of compliance and accountability to contractors.” He also offered the following initiatives that DCMA is currently pursuing:

• We plan to expand the DCMA Contractor Purchasing System Review Center that over the next two years will triple the size of that organization as well as provide for additional managerial oversight of its operations. This expansion is planned to increase our ability to accomplish our reviews more frequently, and not because the reviews have been found inadequate. Further, when we are aware of issues with a certain contractor, this will provide us the capacity to expand the scope of our reviews.
• We are implementing a stronger set of internal controls through establishment of a “Board of Review” process. This process … mandates that any determination inconsistent with DCAA recommendations is subject to a higher level review within DCMA.  Complementing this is an Office of the Secretary of Defense policy currently being coordinated that provides a process for resolving contracting officer disagreement with DCAA audit findings.
• We are developing a quality assurance plan for the resolution and disposition of reportable audit findings. It is unacceptable to me that we do not accomplish timely follow-up. This plan will ensure appropriate and timely administrative contracting officer resolution and disposition of reportable audit findings and employee and contract leadership accountability.
• We are establishing a Cost and Pricing Center primarily responsible for forward pricing and indirect cost issues, and proposal and data analysis. The Center will serve as a repository for cost and pricing data across the Department of Defense and conduct special cost reviews for the DoD enterprise. It will centrally manage the recruitment and education of cost monitors and price analysts across the Agency. The Center efforts will increase accountability for accuracy and predictability of rates, improve business base forecasting, and reduce the backlog of final overhead rate settlements, cost accounting standards issues and other reportable audits.

Last to speak was Ms. Stephenson.  In her testimony she focused first on alleged misbilling by KBR of at least $20 million (and perhaps as much as $400 million) in private security costs under its LOGCAP III contract.  This issue is currently in litigation, as KBR filed an appeal with the Armed Services Board of Contract Appeals (ASBCA) over the matter.  She also accused KBR of failing to drawdown its support staff in levels commensurate with the military force drawdown.  (We note that the CWC itself predicted that contractor support levels would actually increase as military forces decreased.) Ms. Stephenson asserted that KBR’s “excessive” staff levels would result in $193 million in “excessive costs” that would be paid by the U.S. Government.

Important Changes in DCAA’s Approach to Auditing Contractor Internal Controls

Ms. Stephenson also discussed the controversial approach DCAA has recently taken with respect to its audit of contractor internal control systems.  She testified—

Based on our analysis of the relevant auditing standards, we determined that DCAA is not required to audit and report on the overall adequacy of the contractor’s system and related internal controls. We believe reporting significant deficiencies/material weaknesses on contractors’ various subsystems comprising the overall accounting system (e.g., billing, purchasing), as opposed to an overall audit opinion on the adequacy of each of those systems, may be a better approach because it would place the focus on the significant deficiencies/ material weaknesses instead of the contractor’s system as a whole. This revised audit approach would eliminate the concerns of a pass/fail rating as was raised at the hearing in August. We believe this audit approach would help DCMA and DCAA work together to ensure the contractor takes the appropriate corrective actions. [But] until we have completed this assessment, we will continue to issue audit reports on internal controls with two opinions – adequate and inadequate. We believe it would be counter-productive to revise the process for a month or two and then revise it again at the end of the calendar year when we complete our analysis of the revised auditing process and procedures.  To ensure our FY 2010 audits of contractor business systems reflects the revised audit process, no new internal control audits will be started until the revised audit process is tested and distributed to the field audit offices.

Ms. Stephenson closed with the following statement: “DCAA will continue to work closely with all acquisition organizations to promote an integrated, well-managed contract audit process in-theatre. I believe Mr. Assad’s establishment of the new subcommittee is a positive step to improving the oversight of contractor systems.” Although we have in the past disagreed (rather vehemently) with her posture on various audit issues, we wish her well in her new assignment.

In conclusion, we believe the testimony proffered to the CWC by the third panel offered a bit of hope for DOD contractors while threatening them in a number of areas.  We recommend that the testimony of each of the three speakers (to which we have linked) be reviewed in detail, and that contractors brace for a reinvigorated focus on internal control systems.  We look forward to elimination of the current binary pass/fail overall assessment, where every mistake is deemed a significant system deficiency.  However, the penalty for inadequate control systems is likely to increase in the near future, and may include imposition of significant monetary penalties.