Project Leadership Mark Zabarsky, AIG for Acquisition and Procurement Audits

1. OVERSIGHT OF DESIGN AND ENGINEERING FIRMS’ INDIRECT COSTS CLAIMED ON FEDERAL-AID GRANTSNASHTU ConferenceApril 28, 2009 Project Leadership Mark Zabarsky, AIG for Acquisition and Procurement Audits Kenneth Prather, Program Director Terrence J. Letko, Program Director

2. Why Is This Important Today? • The American Recovery and Reinvestment Act of 2009 (ARRA) – requires that the Heads of Federal agencies “manage and expend” significant funds made available by the ACT “as quickly as possible consistent with prudent management.” • DOT agencies: Amounts in Billions • Office of the Secretary $1.5 (discretionary –comp.) • FAA Airport Improvement and F&E 1.3 • Federal Highways Admin. 27.5 • FRA – High Speed Rail 8.0 • FRA – Amtrak 1.3 • Federal Transit Admin. 8.4 • Other .12 Total $48.12

3. Background • FHWA awarded about $30.6 billion annually for Federal-aid highway grants to states.(TEA-21, 7 years ended 2004) • $4 billion awarded annually to over 3,500 design & engineer (D&E) firms. • About $1.4 billion of the $4 billion was for indirect expenses, such as overhead charges. • Executive compensation was one of the largest components of overhead charges. • State officials expressed concerns that overhead rates were high and that excessive compensation was billed for executives.

4. Audit Objective Our audit was to determine whether: • Executive compensation charged to Federal-aid grants was excessive • D&E firms included other unallowable costs in overhead • Audit requirements specified in the National Highway Systems Designation Act (NHSDA) were properly implemented • In conjunction with the Defense Contract Audit Agency (DCAA), we statistically examined 41 D&E firms for excessive executive compensation

5. NHSDA Act • Section 307 requires states to accept indirect cost rates established in accordance with the FAR by cognizant Federal or State government agencies, if such rates are not currently under dispute. • 3 authorities for setting rates: • Cognizant Federal government agency • Cognizant state government agency • State Option (state statutory alternative process - Opt Out) • Reduced from 13 to 2 (WV & MN) in 2006 appropriation Act • The provisions of Section 307 are intended, in part, to eliminate the need for duplication of audits of consultant firms for purpose of establishing indirect cost rates for use on Federal-aid projects. • Once indirect cost rates established in accordance with the FAR are accepted, they shall be used in contract estimating, negotiations, administration, reporting and contract payment for the 1-year applicable period and shall not be limited by ceilings.

6. Audit Findings Results of our audit revealed: • 21 of 41 D&E firms included unallowable costs-some expressly unallowable-totaling about $15.7 million. Of that amount, state DOT contracts were charged about $5.5 million. • CPA firms did not perform sufficient transaction testing when determining the allowability of costs included in D&E firms’ indirect cost submissions. • D&E firms did not hire CPA firms qualified to perform indirect cost rate audits. • CPA firms did not have relevant training. • FHWA did not clearly define roles and responsibilities.

7. Audit Sample Statistics • 47 states provided payment data for 2003 & 2004. • $10.7 billion paid to 8,067 entities. • $7.8 billion of this was paid in to 3,580 D&E firms, averaging almost $4 billion per year (non-A&E firms were removed and related entities were combined.) • Our sample selected 49 firms from 46 state’s data with $1.2 billion in annual payments, 31 % of the total paid. • Payments more concentrated than expected - Around 25 % of payments went to top 13 firms, representing only 0.4 % of all 3,580 firms.

8. Audit Sample Statistics Average Annual Payments to A&E Firms

9. Finding 1Excess Executive Comp • 20 firms billed Federal-aid contracts for unallowable executive compensation of approximately $10.7 million; the state share was over $3.5 million and the Federal share was $2.8 million. • Four of the 20 firms claimed compensation in excess of the Federal cap ($280,609). • Based on the above sample results, we projected that, D&E firms overcharged state DOT contracts for unallowable compensation of $41.2 million (the Federal share being about $32.9 million). • We used a 95 percent confidence limit, and $41.2 million was our midpoint for the audit projection. There was a considerable margin of error, since over half the firms maintained reasonable executive compensation.

10. Finding 1 Other Unallowables Billed in Overhead • We judgmentally selected nine of the larger D&E firms in our sample, and reviewed the allowability of indirect costs more susceptible to unallowable charges. Eight firms had unallowable charges, some expressly unallowable. Total unallowables were over $5 million, state DOTs’ share was about $1.9 million and the Federal share was about $1.5 million.

11. Finding 2 Unallowables Billed in Overhead

12. Finding 1 Other Unallowables Billed in Overhead

13. Finding 1Cause: Lack of Accountability • Federal Government contractors are required to certify that no known unallowable costs have been charged to the Government, and can be assessed penalties if they falsely certify or include known unallowable costs in an indirect rate claim. To the contrary, neither FHWA or states have such requirements on state contracts. • When one D&E firm reviewed was required to prepare both Federal and state DOT claims using the same cost principles in FAR 31, the indirect cost claimed as “allowable” should have been identical. The firm was required to certify the Federal claim and removed $1.6 million in unallowable costs that should have been excluded from the state DOT claim, but were not.

14. Finding 2CPA Audits Did Not Consistently Identify Unallowable Compensation and Other Overhead Costs • Auditors from nine states provided unsolicited comments during our audit that they found little value in the work being performed by CPAs. • Not well versed in FAR cost principles. • Accounts not adequately tested. • Rely on testing internal controls and limit transaction testing. • For example, one firm’s transaction tests were limited to those transactions that the D&E firm voluntarily removed as unallowable costs from its indirect rate claim. This was done to determine if the Government can be billed for more. In this case, we identified over $950,000 in unallowable costs missed by the CPA firm.

15. Finding 2 Factors Contributing to CPA Firms Not Identifying Unallowable Costs • Audit Services not being effectively acquired. Since D&E firms are not required to certify claims, they have less incentive to hire CPA firms that are trained and experienced. They tended to hire firms with whom they had existing relationships-performing financial statement audits or tax returns. One D&E firm used low price as a factor. • CPA firms did not have relevant training. Six of nine firms did not have training related to FAR Part 31. Professional auditing standards require that audit organizations ensure staff have the necessary knowledge, skill, and experience before working on an assignment.

16. Finding 2 Factors Contributing to CPA Firms Not Identifying Unallowable Costs • Oversight of CPA Firms was not effective. Neither FHWA nor state DOTs consistently oversaw work of CPA firms hired by the D&E firms. States did not know what was expected of them. FHWA should assign responsibility to the state that has the largest financial interest with a contractor. • FHWA has oversight responsibility for all of its programs. FHWA did not maintain a tracking system to collect information on evaluating implementation of the audit requirements. Could not say which D&E firms were awarded contracts with Federal-aid funds.

17. Audit Recommendations

18. Audit Recommendations

19. Report Links Overhead Report: http://www.oig.dot.gov/item.jsp?id=2418 ARRA Risk Report: http://www.oig.gov/item.jsp?id=2450