False Claims Settlement Stats: Yellow Light For Contractors

On November 19 the Justice Department released statistics on False Claims Act recoveries for Fiscal Year 2009 reported as the second highest total ever, $2.4 billion.  But if you look behind them, as the nonprofit watchdog Taxpayers Against Fraud does, you can see there is a record high tide in recovers, roughly twice as much.

So what? While you have to find “procurement fraud” at the very bottom of the DOJ press release cited above, and recognize it is small compared to the false claims dollars generated by Big Pharma and other healthcare firms, government services contractors need to be alert to likelihood, if not a certainty, or more and larger cases on their turf.

Why?  It is not as simple as former deputy attorney Paul McNulty and others in law enforcement claim, that is, more contract spending = more fraud.  He has no stats to document a relationship, even an indirect one.  No body has such statistics.

Other, less tangible factors combine to make more FCA suits and settlements (or trials) a near-certainty.

1. The success of FCA cases is likely to breed more cases, promoting latent or hesitant whistleblowers to come out and make their case (which takes years and takes a personal toll in most case one can read about).

2. The government will begin to find more cases without the help of whistleblowers. There is simply more scrutiny of contractors.  While the media still only rarely originates a story on contract misbehavior, the government is coming up on two years since the “rebirth” of oversight when Congressman Henry Waxman took over the Government Oversight and Reform Committee.  That was enough impetus to motivate agencies to scrutinize contracts more carefully and for Congress and others to take a step up in rebuilding and enlarging the government’s acquisiton workforce.

3.  Contractors, regardless of good intentions, have not kept up with internal surveillance and compliance of operations. Years of double-digit growth, turnover in managers, use of more junior staff in management, and shortfalls in management information all create a blindspot for some of our most successful firms.  If one talks with executives of large and mid-size companies about the risks, most, in our experience, say they are worrying more about enforcement of policies on pricing, contract administration, and daily work supervision.  This  area of risk factors is the flip-side of what worries the government–inexperienced COTRs, too few experienced auditors, inadequate contractor surveillance systems, and

Contractor Regulation Growth Spurt—Don’t Bet On It

When the Obama administration took over, there was already a set of new, and a backlog of in-process, regulations washing over the industry.  They focused on, among several thrusts, increasing transparency and nurturing competition.  As  political momentum and a pipeline for regulations are now fixtures, we haven’t seen the end of regulatory increases.

And it is a one-way phenomenon for the most part.  When was the last time that you saw the withdrawal or the softening of regulation of contractors?

But we were wrong nearly a year ago when we prognosticated that regulation of contracting would rise as a secondary effect of the understandable loud calls to re-regulate with some stringency Wall Street and other financial services industries.  While still necessary–in terms of public opinion polls and the sincere or postured mutterings from Congress, and even some business leaders–it seems clear we will not see that. Somewhat reminiscent of health care reform, we are seeing a dilution in sentiment and political feasibility for making significant financial regulation a reality.

Not only officials of the last administration, such as Treasury secretary Hank Paulson, but also current officials have softened their stance on financial industry regulation.  As a result, financial regulation will turn out to be wimpier and partial. 

Accordingly, we do not see a marked increase of business regulation generally, including on federal contractors.  Again, we are talking about an acceleration in the pace and boost in stringency of regulation, not the pre-existing baseline trend to progressively more regulation of the industry.

Personal Conflict of Interest Regs: Good Start, Minefields Ahead

When the government announced its intention last year to come up with regs on contractors’ personal conflicts of interest (PCOI), there was almost an audible dread in the industry.  Already under the gun with renewed and heightened oversight, a growing we-they fissure with civil servants, and amplified bad press for a handful of deeply troubled contracts, the new regs spelled trouble.

So what? Now that the proposed regs are out , industry anxiety should decline, especially for firms that have been working this problem in advance.  Still, for all of industry, minefields can be expected because of plentiful gray areas and the potential misuse of the regs in some cases by civil servants and/or contractors.  But don’t get us wrong; the regs are needed; as always, the magic is in the “how.”

The scope of the regs is flawed by definition because they apply only to contractor activities that are “closely associated with inherently governmental functions” in the acquisition sphere.  Inherently governmental is hotly debated in general, but the still-gray line is clearer when it comes to acquisition support, in our view.  Nonetheless,  there has been no fresh guidance from OFPP since 1991.  OFPP has committed to issue an updated, crisper definition by the end of December.

The FY09 Defense Authorization Act only required OFPP to address personal conflicts of interest only in the acquisition area, even though they can intrude with great damage later on in the contracting cycle.  PCOI could make a big difference, for example, when it comes to:  the drawing of conclusions in studies of a diagnostic nature, the management of indicators that shape award-fee determinations, or in key contract staffing decisions.

In our view, there is actually little documented intrusion of personal conflicts of interest in acquisition; note the lack of specifics in claims that contractors are taking over governmental functions.  And to state the obvious, whatever contractors do, the government solicited the services.  You could almost say contractors have been drafted as the acquisition workforce shrank.  But some experienced contractor executives we know would rather give up business than be subject to draining intense scrutiny, doubt, and contention because they work in the acquisitiion zone.

Another  feature, far more good than bad, is that contractors make the calls and keep the records on personal conflicts of interest.  This includes the filing of annual financial disclosure forms, a process that government employees in policy- and acquisition-related positions have been used for around 15 years.

However, there is a problem because, faced with the same regulations, different companies will set the threshold of potential PCOI differently. Some will be conservative, others not.  This inconsistency echoes what we see in government, where agencies often differ, for example, in their tolerance for organizational conflicts of interest and the stringency of mitigation measures.

We see no way to achieve alignment–out of fairness and to protect the government’s interest–except by judicious audits every once and awhile.  But you can be sure that allegations will be used, out in the open, indirectly, or furtively by some companies and some civil servants who may want to keep the playing field other than level. We see this today in aspects of some significant acquisition (e.g., questionable choices of vehicle, cryptic statements of work, overly constrained evaluation factors, gamey sole-source justifications).  There is every reason to expect such games to be played with respect to personal conflicts of interest.

The defenses are:  career civil servants and political appointees who actually manage and act as alert stewards for the taxpayers, continued good-ethics behavior by the majority of contractors.  They recognize that in the long run there is far more to be gained from good values than looking the other way, or worse.

Reference: Federal Acquisition Regulation; FAR Case 2008-025, Preventing Personal Conflicts of Interest for Contractor Employees Performing Acquisition Functions. The draft appeared in the November 13, 2009 Federal Register. Comments are due by January 12, 2010.

Cyber Alliance Raises Mores Questions Than It Answers

On November 12, 14 companies that play in the cyber security business announced an alliance. Built around some well known capabilities in software (such as RSA’s in encryption), hardware, and services, the group offered itself as a  collective resource to the government and other customers.

So What? Right now, the government can draw on almost any combination of companies and universities it wants through a variety of vehicles. Funding is increasing smartly, but product and company differentiation are hard to achieve.

This alliance is purely for marketing, as well as creating some identity for upcoming cyber bids. Some of the 14 firms already team—or compete.

The 14 companies clearly believe there is magic in their assemblage, led by the biggest government contractor, Lockheed Martin. Last week LM christened a laboratory and testing facility, with capabilities that other, larger players in cyber
security, such as SAIC and Booz Allen Hamilton, already have for cyber solutions research and evaluation.

In addition, with some potentially vexing legal and business challenges to form an alliance, and the government’s  hesitance to say what incentives are acceptable between alliance members, customers  may have some reluctance to deal with the alliance.

Among the subjects that must have kept quite a few attorneys and business executives busy when forming the alliance are the following:  (1) organizational conflicts of interest identification and mitigation; (2) safeguarding national security and
proprietary information held by one alliance members from others without a need to know); (3) respective roles in opportunity management and revenue generation; (4) dealing with existing contractual and teaming arrangements with
companies in and outside of the alliance.

As they are not cornering the cyber market, there’s no particular anti-competition angle to defend against, but there may not be squawks from small business if the alliance ever makes a splash.

Further, there is an elephant-in-the-room issue regarding what is permissible to bind together companies in IT-related alliances. It is coming up on two years since the Justice Department threw a chill into IT suppliers of all sorts when it joined a whistleblower’s suit regarding the incentives IT alliance team members give each other. The suit remains
unsettled, and even firms that have voluntarily come in for settlements, such as IBM, don’t know what the government will find acceptable. The three companies being sued—Accenture, Sun, and HP—show no sign of settling.

Since many of these legal issues tend to raise red flags and yellow lights, it is one more reason to view the alliance as a trial balloon at best. The mechanics–the fall out of all the issues that need to be resolved within the collective of the 14  firms—may be of more interest to government and industry than some of the cyber capabilities being offered.

The Not So Subtle Shift in Contract Costs

Alan Chvotkin, Executive Vice President and Counsel, Professional Services Council

On October 14 the FAR Councils issued two interim rules that will significantly shift the burden to contractors for demonstrating that costs incurred in cost-reimbursement contracts are billable to government contracts and that incentive award fees are properly earned. By congressional mandate, both rules apply government-wide and became effective immediately upon publication.

And both will have a significant impact on contractors and their business relationships.

Congressional concerns about “excessive pass-through” costs on contracts have risen since Katrina and since the Government Accountability Office provided several reports to Congress. Congress imposed similar restrictions on the Department of Homeland Security (DHS) in 2007 and on DoD in 2008 before imposing this restriction government-wide and those agencies already have rules on the books.Both agency-specific rules will be repealed when this interim rule is finalized.I covered the DHS rules in my June 2007column.

Excessive pass-through limitations.The first rule, “Limitations on Pass-Through Charges,” is designed to minimize the “excessive pass-through” of subcontractor charges and prime contract expenses when a substantial amount of actual work will be (or was) performed by subcontractors. For civilian agencies, the rule applies to cost-reimbursement contracts greater than the simplified acquisition threshold ($100,000). For DoD, the rule applies to certain fixed price contracts, and to cost-reimbursement contracts, greater than the threshold to obtain cost or pricing data ($650,000).

The rule requires that proposals disclose the total value of work to be performed by the prime and each subcontractor, respectively. If subs are to perform over 70 percent of the total value of work, additional detail is required on the prime’s indirect costs and profit/fee applicable to the subs’ work and a description of the prime’s“added value” to the  subcontractor’s work.It’s then up to the contracting officer to “determine” – by an analysis not described in the rule – if that added-value work is a benefit to the government.If not, those costs are “excessive” and will not be allowed.

Second, the rule provides that, if a subcontractor’s effort exceeds 70 percent of the value of the work actually performed, the prime must demonstrate to the contracting officer that the prime added value to the subcontracted work; if not, the “excessive” costs will be disallowed. Finally, where “excessive” pass-through costs are not allowable, even in certain fixed-price DoD contracts, the government is entitled to a price reduction equal to the amount of those costs in the contract price.

To monitor compliance, the rule gives the contracting officer access to subcontractor records to determine whether the subcontractor proposed, billed or claimed excessive pass-through charges.

Award fee restrictions. This interim rule imposes restrictions on the use and implementation of new  cost-reimbursement, award fee, contracts. No award fee contract may be awarded unless (i) all of the FAR limitations on
cost-reimbursement contracts are met; (ii) the government completes an award fee plan as required by the FAR; and (iii) the head of the contracting activity issues a “determination and finding” that addresses the three FAR suitability factors relating to incentive contracts.

Any proposed award fee must be linked to the contractor’s cost, schedule and technical performance as measured against the contractor’s objectives. A contractor’s performance will be ranked according to a five-level adjectival award-fee evaluation scale detailed in the interim rule. Each performance level assigns a fixed range of available fee percentages. Furthermore, no award fee can be earned if the contractor’s cost, schedule and performance is rated “below satisfactory.”No unearned award fee may be rolled over into subsequent rating periods.

Five agencies – Defense, NASA, Energy, Homeland Security, and Health and Human Services – award over 95 percent of all federal government award fee contracts, and many of the provisions in this rule are already used by these agencies. In addition, in December 2007, the Office of Federal Procurement Policy published a memo entitled “Appropriate Use of Incentive Contracts” providing additional guidance to agencies when considering using award fee contracts.

This past August, I testified on award-fee contracts before a subcommittee of the Senate Committee on Homeland  Security & Governmental Affairs. I’m pleased that several of my recommendations were adopted in this rule.

While their substance has been around in various forms for several years, these interim rules introduce new elements
and significant compliance challenges for both government and contractors. In both cases, the rules put a premium on up-front contractor planning and proposal disclosures, along with careful monitoring during contract performance. For example, a prime could demonstrate added value where it is integrating the work of several subcontractors and  synthesizing their input to meet government requirements, or, where it is providing the supervision, security controls and billing for several task-oriented small businesses.

Expect both of these new requirements to be included in all new contracts but you should strongly resist having them applied to existing contracts.

What’s a contractor to do?

First, examine your internal “make-buy” and small-business subcontracting processes and be sure they are up-to-date. Both of these processes are pivotal in the determination of “excessive” pass-through and contribute to your decision of what work will be done with your workforce and what will be subcontracted.

New proposals will have to address both the excessive pass-through requirements as well as the significant criteria that benchmark an award fee plan, if applicable.As a prime contractor, you will want to contribute to both elements. If you’re a subcontractor, be prepared to address how your efforts will add significant capabilities to the prime and be ready to
work with the prime on addressing both the “added value” they bring and the award fee criteria you contribute to during your teaming negotiations and the prime’s proposal submission.

Second, if either rule applies, all primes and subs should be particularly alert to the performance and compliance challenges that kick in immediately after contract award.By creating the necessary reporting and monitoring provisions from the outset, you significantly minimize the risk of losing substantial costs and fees during performance.

Finally, prime contractors should involve your key subcontractors and vendors early in the proposal strategy to ensure that they are familiar with your processes and decisions, as well as the critical importance of satisfying the compliance and performance obligations under both new rules.

With these rules, the government is further intruding into a contractor’s business relationships and further dictating how it will manage its prime contractor relationships. Those firms that promptly address the requirements of the new rules, that demonstrate the significant value they bring, and that pay attention to the cost, schedule and technical performance elements of the contract stand to minimize their financial risk exposure and maximize successful contract execution.

Don’t Expect Dan Gordon to Move Mountains

This is no criticism of the president’s nominee for administrator of OMB’s Office of Federal Procurement Policy. He’s exceptionally well qualified to be the top government procurement policy official, a role that’s been lackluster for several years.

The usual suspects in the acquisition community had been implying for months that if only the position were filled,  reforms could proceed. Now that the position is almost filled, let’s take a deep breath.

So what? At his confirmation hearing this week, Gordon disclosed an agenda that had no surprises. It contained the same hardy perennials that the community has ruminated over for years: grow the acquisition workforce, strengthen acquisition planning, reduce the government’s risk, improve contract oversight, and cut wasteful contract spending.

To play on Hillary Clinton’s book title, it will “take a village” to reform procurement. The energizers are a committed president, an understanding Congress, agencies that give a darn, and an industry that will accommodate some changes.

Unfortunately, the White House procurement reform campaign set itself up with the $40 billion savings bogie. As a result, it is already playing oddly: forcing agencies by rote, and in the exact same proportions, to reduce contract spending and high-risk contract cuts; letting the agencies believe there is an insourcing mandate when there is
none, allowing way too many lobbyists into political posts, and letting the mice play on fair cost comparisons between contractor and government employee costs.

Congress keeps on adding regulations, some of them sensible, some over-reaching (see Alan Chvotkin’s column in the Insider). The agencies, with a few exceptions such as VA, are not buckling down to weeding their weak contracts and gearing up seriously for stronger oversight.

The industry is playing defensive ball after trying to get along with the new administration on every issue. That’s probably unavoidable.

So look for Dan Gordon to do more than fill an empty chair. He can coordinate policy better, ride herd on the agencies that are weaker in contracting, and open up a more effective dialog with industry that many in government still hesitate to
do. He can also interpret acquisition to the White House, which still is not sufficiently aware of how reform can actually be accomplished. That alone would be a great contribution. But moving mountains? That’s not Dan Gordon’s job.

Partnering: Dead? Was It Ever Alive?

Some recent public mourning of the death of government-contractor “partnering” has a nice, wistful feel.  But did partnering ever really have a pulse?

Here are seven reasons that suggest partnering never really existed, and may be unhealthy for contractor and customer alike.

1. Federal contracts don’t read like partnership agreements as known in the private sector.  There’s no equitable  risk-sharing or provisions that reflect a high degree of trust between partners. And there’s no discernible trend in that direction.  Rather, it’s for more regulation and forced disclosure of contractor business details.

2. The re-emphasis on contract oversight that emerged when Rep. Henry Waxman’s became chair of the Government Oversight and Reform Committee in January 2007 noticeably rattled the industry. Since then, the rising tide of regulation proposed and signed into law suggests the Federal customer-partner has had declining trust in supplier-partners for a few years.

3. The ever-tightening rules and enforcement concerning organizational conflicts of interest demonstrate less government faith in companies’ ability to identify and mitigate such issues. And just wait for the soon to be unveiled personal conflict-of-interest regs.

4. Both government and industry routinely show their reservations about operating more transparently. On the government’s side, FOIA transactions still seem to take forever.  Contractors’ disclosures to government and the public are almost always in response to government requirements and pressure and are often opposed by industry in the rule-making process. What publicly owned companies reveal is mainly driven by SEC regs and to please Wall Street equity analysts, not taxpayers or government customers.

5. Small businesses—the vast majority of the contractor population but with constant market share of federal prime contract dollars—act less satisfied, and often aggrieved, concerning government set-aside program spending and enforcement of the rules. The government hasn’t delivered any more dollars in percentage terms for years.  And some large companies still get a startling amount of “small-business” set-asides due to unsettled policy guidelines and  administrative error.

6. Government agencies, according to the Professional Services Council, are acting as if there were a mandate to insource, even though there is none.  The Administration has been careful to state its goals for program budget cuts and procurement and management reforms in source-neutral terms.

7. When troubled contracts and programs come to light in audits, reviews, and hearings, contractors remain muzzled by their customers, who prohibit releases of information unless approved by the government. Either (1) the customer-partner wants only its side of the story to be heard, or, (2) it is protecting the contract or contractor.  Come to think of it, there may be a spirit of partnership in this behavior, but it’s not one that’s good for the taxpayers.

TASC’s New Ownership: Competitive Differentiator?

When Northrop Grumman’s sale of its TASC unit  closes, the new owners, private equity titan KKR and General Atlantic, tout that the stand-alone company will have unique standing, with no organizational conflicts of interest  (OCI) compared with other systems engineering and studies powerhouses.  Which companies will find the “nonconflicted” TASC more of a competitive threat?

Answer:  any that posture themselves as free of pertinent, unmitigated OCI and in a position to be objective advisers upstream of big buys of defense systems. Booz Allen Hamilton comes to mind, particularly in services like cost and economic analysis, and because it, too, is (~70 percent) owned by private equity investors, Carlyle Group.

Scanning the KKR portfolio, even a paranoid govt customer won’t find other government-contractor or overseas stakes owned by the parent that could spawn OCI worries about TASC at this time. The other TASC owner, General Atlantic, has more technology and country stakes, e.g. Lenovo/China, that could provide a wisp of worry for a few potential customers.

Carlyle, on the other hand, has had for decades full ownership or control of a variety of military hardware or government services firms (e.g., ARINC) suppliers, as well as overseas investors from the Middle East and potential-threat countries in its funds.  These other interests under the Carlyle umbrella reportedly gave pause to certain agencies when Carlyle’s purchase of BA was being reviewed.  Obviously, the government could accommodate those interests and any OCI  mitigations, which have not been publicly disclosed.

But OCI concerns remain a pop-up potential for any firms like TASC and Booz Allen owned by aggressive PEs.  It’s a  nature of the beast that they acquire aggressively, steadily diversify their portfolios, and are more open than ever to  foreign investors.

Congress may not believe the PE ownership structure is as insulating from organizational conflicts of interest, as the principals and agency customers do at this time.  It will be interesting to see how the TASC transaction refracts when it comes up in Congressional hearings, investigations, and plain old politics.

Finally, we got a kick out of the PR spin of the new TASC owners.  In their releases they speak of TASC as a national resource in the same sense that the FFRDCs,  often present themselves. But that’s for customer consumption rather than the PE investors grasping for high returns.  We doubt that MITRE and RAND are quaking.

Time will tell whether the claimed unique nonconflicted status of TASC makes a difference in the marketplace.