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A Roadmap forManaging DCAA AuditsJuly 10, 2018Stuart Young, Senior Vice President & General CounselAECOM MANAGEMENT SERVICESStephen D. Knight, MemberSMITH PACHTER MCWHORTER PLCSuzanne F. Roske, PartnerPRICEWATERHOUSECOOPERS (PWC)

SpeakersStuart Young Senior Vice President & General Counsel AECOM Management ServicesStephen D. Knight Member, SMITH PACHTER MCWHORTER PLC E-Mail: [email protected] F. Roske Partner, PRICE WATERHOUSE COOPERS E-Mail: [email protected]

OverviewA Roadmap for Managing DCAA Audits1. Basic rules – what DCAA can and cannot demand FAR 52.215-2, FAR 52.216-7DCAA demandsMust audit comply with GAGAS?Subcontract audits2. Management of audits Single point of contact Record-keeping tips Written questions and responses3. Recent developments that in-house counsel should consider FY 2018 NDAA Direct Assist Audit Pilot Program FY 2019 NDAA proposals to amend DCAA audit process

Overview (Cont)4. Current cost and audit issues arising during audits Recent case law Kellogg Brown & Root Services, Inc., ASBCA No. 58175 Northrop Grumman Corporation, ASBCA No. 60190 Luna Innovations, Inc., ASBCA No. 60086 DCAA Memos OUSD Memos5. Litigation of audit findings Forum (BCA vs. CFC)ProcessContractor defensesGovernment claimsRight to offset/withhold

Basic Rules – What DCAA Canand Cannot Demand

Source of DCAA Audit Rights FAR 52.215-2, “Audit and Records – Negotiation” (a): “Records” includes: “ books, documents, accounting procedures and practices, and otherdata, regardless of type and regardless of whether such items are inwritten form, in the form of computer data, or in any other form.” (b): For CR, incentive, T&M, labor-hour, or priceredeterminable contracts: Contractor “shall maintain and theContracting Officer, or an authorized representative of theContracting Officer, shall have the right to examine andaudit all records and other evidence sufficient to reflectproperly all costs claimed to have been incurred oranticipated to be incurred directly or indirectly inperformance of this contract.”

Source of DCAA Audit Rights FAR 52.215-2, “Audit and Records – Negotiation” (c): Certified Cost or pricing data: if provided by contractor, theCO, or an authorized representative of the CO, “in order toevaluate the accuracy, completeness, and currency of the certifiedcost or pricing data, shall have the right to examine and audit all ofthe Contractor's records, including computations andprojections ” (f): Availability. Contractor must make available at its office at allreasonable times the records, materials, and other evidencedescribed in the Clause “until 3 years after final payment under thiscontract or for any shorter period specified in Subpart 4.7,Contractor Records Retention, of the [FAR], or for any longerperiod required by statute or by other clauses of this contract ”

Source of DCAA Audit Rights FAR 52.216-7, “Allowable Cost and Payment” (d): Submission of final annual indirect cost rate proposal inaccordance with FAR 42.7 (g): CO may have invoices, vouchers, statements of costaudited, payments reduced for unallowable costs oradjustments for under/overpayments.

Source of DCAA Audit Rights FAR 31.201-2(d) Contractor is responsible “for accounting for costsappropriately and for maintaining records, includingsupporting documentation, adequate to demonstrate that costsclaimed have been incurred, are allocable to the contract, andcomply with applicable cost principles . . . The [CO] maydisallow all or part of a claimed cost that is inadequatelysupported” Few regulations seem to impose specific requirements FAR 31.205-33(f), “Professional and Consultant ServiceCosts” FAR 31.205-46(a)(7), “Travel Costs”

Source of DCAA Audit Rights BearingPoint, Inc., ASBCA Nos. 55354 et al. (Oct. 16,2009) USAID determined contractor security costs in Iraq notallocable due to lack of contemporaneous documentation “We reject AID’s central argument that the disputed laborcharges are unallocable for insufficient documentation. Thecontract clauses do not impose the stringent requirements ofeither ‘nice neat little files’ that [the CO] sought or thecontemporaneous records for which AID appears to bearguing . . . [FAR 52.215-2(b)] prescribes no form that the‘records’ or the ‘other evidence’ must take, and in fact wehave read the clause more liberally than AID’s positionsuggests.”

Limits to DCAA’s Demands Although the right to audit is broad, the contract termsdefine the limit DCAA cannot demand as a matter of right Employee interviews Office space Creation of documents, analyses for special purpose Many contractors accommodate DCAA demands tomaintain business relationship

GAGAS Generally Accepted Government Auditing Standards(GAGAS) Incorporated into DCAA Contract Audit Manual (DCAM),DCAA Instructions Types of work covered by GAGAS are classified asfinancial audits, attestation engagements, or performanceaudit Several reports on DCAA compliance with GAGAS DoD IG (DODIG-2015-061): substantiated complaint alleging thatDCAA field office did not comply with GAGAS or agency policywhen it questioned 6.6M in contractor-claimed subcontract costs GAO (GAO-09-468), Widespread Problems with Audit QualityRequire Significant Reform

Subcontract Audits Prime contractors typically require subcontractorproposals to be subject to audit rights FAR 15.408, Table 15-2 Prime contractors typically flow down required auditrequirements to subcontractors FAR 52.215-2, Audit and Records—Negotiation FAR 52.216-7, Allowable Cost and Payment FAR 52.230-2, Cost Accounting Standards

Subcontract Audits Significant Issue for Subcontractor Who conducts theaudit – US Government or Prime Contractor? Does subcontractor want to disclose financial/costinformation to prime? Does subcontractor want to permit US Government into itsbooks and records? Subject of prime/subcontractor negotiation Subcontractors must carefully review subcontract terms andconditions

Subcontract Audits Lockheed Martin Integrated Sys., Inc., ASBCA No.59508, 17-1 B.C.A. ¶ 36597 May 2014: DCAA issued audit report questioning subcontractorcosts; COFD mirrored DCAA audits Alleged Lockheed failed to maintain documents to substantiate itreviewed subcontractor’s resumes/timesheets Claimed a “literal interpretation of FAR 42.202 requires the primecontractor to act on behalf of the Government and serve as both theContracting Officer (CO) and the Contracting Administrative Office(CAO) for each subcontract that it awards under a Governmentflexibly priced contract.” Board granted Lockheed’s Motion to Dismiss FAR pts. 42 and 44 did not impose specific responsibilities onLockheed to manage subcontractors because they were notincorporated into contracts Even if provisions were incorporated, do not impose the dutiesGovernment alleged were breached such as requiring subcontractorsto submit incurred cost submissions to prime or requesting auditsfrom DCAA if subcontractors refuse

Management of Audits

Management of Audits – General Considerations Document entire process, starting with entranceconference During entrance conference establish audit scope andduration Maintain a single point of contact for consistency Establish clear channels of communications Keeping a record of: DCAA requests; documentsprovided; dates on which documents provided

Management of Audits – General Considerations Keep track of audit request response time (bothcontractor and government auditor) Track all written questions and written responses (bothcontractor and government auditor) Consider pressure on DCAA to reduce audit completiontime Request an Exit Conference Document any disagreement with audit findings

Management of Audits – Specific Cost Concerns Risk based auditing DCAA policy: all adequate incurred cost proposals under 250 million auditable dollar value (ADV) will be assessedfor high or low risk using the Risk Assessment Checklist Statistical sampling Selects a representative sample of a group of transactions –unallowable costs identified then projected to the universesubject to sample DCAA EZ-Quant software used for statistical sampling Track DCAA Audit Alerts on cost areas DCAA Audit Alert on Identifying Expressly UnallowableCosts – (December 18, 2014 & January 7, 2015)

Management of Audits – Specific Cost Concerns Clarify with government auditor nature of the costbeing questioned, reason for questioned cost Questioned due to cost reasonableness? Allocability? FARPart 31 cost principle? Establish applicability of Cost Accounting Standards(CAS), FAR, or other contract provisions / guidance If contractor has any large, non-recurring costs,consider preparing justification memos Mass relocation, mass severance

Recent Developments thatIn-House Counsel Should Consider

Incurred Cost Audit Backlog DCAA frequently waits several years before initiatingincurred cost audits DCAA may deem incurred cost proposal “inadequate,”and not start clock on review until it receives what itdeems an “adequate” submission As a result, DCAA and contractors may wait yearsbefore contractor costs and rates are settled forparticular year Section 803 in FY 2018 National Defense AuthorizationAct (NDAA) is the latest attempt by Congress toaddress this backlog

FY 2018 NDAA – Section 803 Permits use of “qualified private auditors” to performaudits to eliminate, by October 1, 2020, any backlog ofincurred cost audits of the DCAA “Qualified private auditors” must be: Free of conflicts of interest in performing the auditPossess “necessary independence”Sign non-disclosure agreementsLimit use of audit data only for purposes stated in contractTake “all reasonable steps” to protect proprietary andnonpublic data” furnished during audit Not use any data to compete for Govt. or non-Govt. work

FY 2018 NDAA – Section 803 Use of Qualified Private Auditors – Issues for In-HouseCounsel: Is there a contractual right for the government to use“qualified private auditors”? QPA’s potential conflicts of interest QPA’s access to the contractor's proprietary information Should counsel require nondisclosure agreements for QPAs? Are QPA work papers available under FOIA? Section 803 states: QPAs “shall develop and maintain complete andaccurate working papers on each incurred cost audit. All workingpapers and reports on the incurred cost audit prepared by suchqualified private auditor shall be the property of the Department ofDefense ”

FY 2018 NDAA – Section 803 Requires DOD to submit a plan to Congress by Oct. 1,2018 to reduce audit backlogs, including: Identifying audits appropriate for private auditors Estimating the number and value of audits to be performedby private auditors between FY 19 thru FY 25 Meeting all FAR requirements for acquisition plans

FY 2018 NDAA – Section 803 Audit timing requirements Requires DOD to ensure all audits performed by DCAA orprivate auditors are performed timely Requires DOD to notify a contractor within 60 days afterreceipt of an ICS whether the submission is a qualifiedincurred cost submission Establishes a deadline of one-year to complete the audit,subject to waiver As of Oct. 1, 2020, if audit findings are not issued within oneyear, the audit “shall be considered to be complete and noadditional audit work shall be conducted.”

FY 2018 NDAA – Section 803 Multi-Year Auditing Places certain limits on multiyear auditing to ensurethat multiyear auditing is conducted only— ‘‘(A) to address outstanding incurred cost audits forwhich a qualified incurred cost submission was submittedto [DCAA] more than 12 months before the date of theenactment of this section;” or ‘‘(B) when the contractor being audited submits a writtenrequest, including a justification for the use of multiyearauditing, to the Under Secretary of Defense(Comptroller).”

FY 2018 NDAA – Section 803 Multi-Year Auditing – Issues for In-HouseCounsel Is there a contractual right for multi-yearaudits? Should the company issue the letter drafted byDCAA requesting multi-year audits?

Direct Assist Audits – What are they? To address uncertainties regarding the use of third party auditors, contractors andDCAA are piloting the use of direct assist audits Direct assist audits represent a collaborativeaudit whereby contractor personnel andDCAA auditors are one team performing theaudit DCAA and contractor personnel participatein all parts of the auditoPlanningoFieldworkoReportingoCorrective Actions Contractor personnel performing the auditremain independent of the process beingaudited, similar to internal auditors DCAA maintains responsibility to issue itsopinion and recommendation to DCMA Reduce planningtime Increase contractorinput Influencemethodology andprocedures to beperformed Decreaseperiod ofwithholds Participate intesting ofcorrectiveactions Real time insight toresults Identification ofcompensatingcontrols iveActionsReporting Increase reportaccuracy Decrease reportdiscrepancies Identifysignificantdeficiencies

DFARS Business System Audits – Benefits & RisksBenefitsDirect Assist Audits Planning the audit to focus on key controls Identifying compensating controls to reducedeficiencies before they are reported Understand deficiencies and implementcorrective actions in real time Minimize the impact to cash flow by reducingwithhold periods Reduce audit redundancy and timelineRisks Opportunity cost of using internal resourcesand/or hiring additional expertise Participating in pilot may result in deficienciesbeing identified more timely Contractor may have to realign organizationalstructure to demonstrate independence MMAS audit timeframe was reduced from 18 months to 8 months Estimating system audit timeframe was reduced to 6 months Accounting system audit timeframe is expected to be 6 months

DCAA MRD DCAA MRD 18-PIC-001(R) Audit Alert Audit Alert on 2018 NDAA Section 803 TimelinessRequirement for Incurred Cost Adequacy Reviews andAudits, issued on January 29, 2018 Confirms that Agency policy will be revised to requireincurred cost submissions to be reviewed for adequacy within60 days of receipt for any ICS received after Dec 12, 2017 DCAA CAM also updated to reflect this requirement Agency will be providing guidance for complying with theNDAA one-year requirement

FY 2019 NDAA In-house counsel should be aware of FY19NDAA provisions. H.R. 5515 passed in the House on May 24, 2018 Senate passed an amended version of H.R. 5515 onJune 18, 2018 H.R. 5515 as passed in the House included Section 915, Review ofFunctions of Defense Contract Audit Agency and Defense ContractManagement Agency Required DoD to conduct a review of the functions of DCAA andDCMA, including: 1) validation of the mission / function of eachAgency; 2) determination of whether there are functions performed byeither Agency that could be more appropriately performed by the otherAgency, other DoD Agency, or commercial providers Senate removed this Section from the Amended Bill

Current Cost and Audit IssuesArising During Audit

Current Cost & Audit Issues – Case Law Kellogg Brown & Root Services, Inc., ASBCA No. 58175(March 15, 2018) (denying contractor claim for subcontractcosts because contractor did not adjust troop levels in DFACcontract pursuant to ACO Letter of Technical Direction) Northrop Grumman Corporation, ASBCA No. 60190 (Jan.9, 2018) (government motion for reconsideration denied;Board rejects government position that contractor incurredcosts “by operation of law”) Luna Innovations, Inc., ASBCA No. 60086 (Nov. 29, 2017)(employee stock option costs calculated on Black-Scholesmodel were unallowable but not expressly unallowable)

Current Cost & Audit Issues – Memos Department of the Navy Memorandum, Allowability of EnvironmentalRemediation Costs (Jan. 12, 2018) Considerations for CO when making allowability determination include:negligence, responsible pursuit of insurance or contribution/subrogationrecovery, negligence, nature of business DCAA Memorandum, Audit Guidance on Application of DFARS231.205-18, Independent Research and Development and Bid andProposal Costs (Nov. 21, 2017) Provide auditors with guidance in applying the requirements of DFARS231.205-18 DPAP issued class deviation for rule where contractors required to engage inor document a technical interchange DCMA Memorandum, Sustention of Statistical Projection ofQuestioned Costs and Penalties (May 9, 2017) DCAA “expressed concern that DCMA sustention rates of costs questioned infinal incurred cost audits has steadily declined Although DCAAacknowledges there may be a number of barriers to obtaining sustention onquestioned costs, statistical sampling was identified as one of those barriers.”

Current Cost & Audit Issues – Class Deviations OUSD Memorandum, Class Deviation – Contract CloseoutAuthority (May 4, 2018) CO may close out contracts where: Contract was entered into on a date that is at least 17 fiscal years beforethe current fiscal year; Has no further supplies or services due under the terms of the contract;and Has been determined by an individual, at least one level above thecontracting officer, to be not otherwise reconcilable, OUSD Memorandum, Class Deviation – Threshold forObtaining Certified Cost or Pricing Data (April 13, 2018) COs use 2 million as the threshold for obtaining certified cost orpricing data

Litigation of Audit Findings

Litigation of Audit Findings – ConsiderationsForum (BCA vs. CFC)Contracting Officer’sFinal DecisionCourt ofFederal Claims Appeal within 12 months fromCOFDGovernment counsel: DOJArticle I CourtFederal Rules of Evidence andProcedureBoards ofContract Appeals Appeal within 90 days fromCOFDGovernment counsel: AgencycounselAdministrative ForumSubject matter experience incost issues

Litigation of Audit Findings – Considerations Process considerations (BCA and CFC) Pretrial Discovery Motions Trials Decisions

Litigation of Audit Findings – Considerations Contractor defenses Statute of limitationLatchesAcceptancePaymentAccord and SatisfactionFailure to comply with contract termsSubstantive defense of costs questioned Government claims Right to offset/withhold

SpeakerStuart YoungSenior Vice President & General CounselAECOM Management ServicesE-Mail: [email protected] Young leads the legal function for AECOM Federal. His practice focuses on Government contracts,including claims and protests, compliance, cost type contracts, and risk management. He also provides legalsupport in the areas of labor and employment law, international law, export control, cyber security, corporate lawand intellectual property. He manages outside counsel and supervises litigation for AECOM Federal. Since1999, Mr. Young has been General Counsel for the legacy companies that merged into AECOM Federal,including URS, EG&G and Lear Siegler Services.From 1992 – 1999, Mr. Young served as Corporate Counsel at DynCorp. In this role he drafted teamingagreements, non-disclosure agreements, joint venture agreements and contract and subcontract documents. Mr.Young litigated bid protests and contract disputes, was admitted under GAO and GSBCA protective orders, andserved as first chair at bid protest hearings. He was heavily involved in international law issues, including thenegotiation of contracts with foreign governments, and foreign registration and tax issues.Mr. Young worked at the General Services Administration from 1984 – 1992. As Senior Assistant GeneralCounsel for GSA, he was in charge of handling bid protests filed against Federal Supply Service, and handledcontract formation, contract administration, cost and pricing issues, and GSA Multiple Award Schedules.

SpeakerStephen D. KnightMember, SMITH PACHTER MCWHORTER PLCE-Mail: [email protected] D. Knight is a member in the Vienna, VA law offices of Smith Pachter & McWhorter, PLC.Mr. Knight specializes in a variety of government contracts issues and has substantial expertise inthe area of claims and disputes, including defective specifications, delay and disruption, changes,and contract interpretation. He also handles matters involving complex questions of governmentcontract cost accounting, cost allocability, cost allowability, material accounting, labor accounting,contract payment, and defective pricing. He has advised clients on sensitive issues of governmentcontract compliance, disclosure, and the government's right of access to records. Mr. Knight hassubstantial experience in the area of procurement fraud, including the representation of clientsduring grand jury and Inspector General criminal investigations, as well as civil investigations, andlitigation pursuant to the Civil False Claims Act and its Qui Tam provisions.

SpeakerSuzanne F. RoskePartner, PRICE WATERHOUSE COOPERSE-Mail: [email protected] Roske is a Partner in the Government Contracts Practice of PricewaterhouseCoopers,LLP in Washington, D.C. Ms. Roske specializes in assisting clients in the areas ofbusiness consulting/strategic initiatives, transaction services and regulatory complianceactions. This includes assisting companies by: Providing expert advice surrounding the US government regulatory requirementsincluding Federal Acquisition Regulation (FAR), Cost Accounting Standards (CAS), Truthin Negotiations Act (TINA), cost allowability, allocation methodologies, disclosurestatement issues, pension and incentive compensation, claims, etc. Evaluating the adequacy of a contractor’s business systems as compared to the DFARSBusiness System requirements, developing corrective action plans, assessing theeffectiveness of remediation activities and responding to government notifications ofsystem deficiencies.

Questions?Stuart Young – [email protected] D. Knight– [email protected] F. Roske– [email protected]

Jul 10, 2018 · DCAA Instructions Types of work covered by GAGAS are classified as financial audits, attestation engagements, or performance audit Several reports on DCAA compliance with GAGAS DoD IG (DODIG-2015-061): substantiated complaint alleging that DCAA field office did not comply with GAGAS or agency policyFile Size: 594KB