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WMACCA November 11, 2008

WMACCA November 11, 2008. Current Issues in Defective Pricing: When Defective Pricing Becomes Fraud Richard C. Johnson D. Joe Smith. Topics. A. What triggers a defective pricing audit and how DCAA structures the audit B. Current focus areas C. How defective pricing morphs into fraud.

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WMACCA November 11, 2008

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  1. WMACCANovember 11, 2008 Current Issues in Defective Pricing: When Defective Pricing Becomes Fraud Richard C. Johnson D. Joe Smith

  2. Topics A. What triggers a defective pricing audit and how DCAA structures the audit B. Current focus areas C. How defective pricing morphs into fraud

  3. What Triggers a Defective Pricing Audit • High value fixed-price contracts • Risk factors – the DCAA “PASS” system • Hard leads

  4. SAMPLE

  5. How a Defective Pricing Audit is Conducted Non “Hard Lead” Audits • Determine the experienced profit rate and compare to negotiated profit • Determine which cost area was responsible for any increased profit • Labor • Material • Subcontracts • Indirect costs • Determine reason for the differential

  6. How a Defective Pricing Audit is Conducted • Review estimate and related cost data • Match the cause of the differential with the data provided • Did the contractor fail to disclose an item of factual data? HANDOUT: Defective Pricing Audit Program

  7. Key Action Points in Defective Pricing Audits • The Audit Entrance Conference • Contacts During the Audit • The Audit Exit Conference • The Draft Audit Report • The Final Audit Report and Contractor Response to the ACO

  8. The Audit Entrance Conference • Required by the DCAM • What DCAA will ask for • Records • Summaries and compilations • Interviews • What you should try to learn • What triggered audit? • Target of audit • Contract? • Modification? • Type of data suspected • Labor, Material, Subcontracts, Indirect Costs

  9. The Audit Exit Conference • All key company personnel should attend • Ask questions • Any positive defective pricing findings? • Obtain maximum details • Ask for draft report • Negotiate time for response

  10. The Draft Audit Report • Do you understand allegations? • Agree? • Disagree? • Check the math • Contact DCAA if you do not understand the calculations • Ask for supporting work papers • Assign rebuttal tasks • Refuting the allegations • Offsets • Draft the response • Staff the response for accuracy and consensus • Request DCAA to include the response in its final report

  11. The Final Audit Report • Review the final report for changes • Did DCAA respond to your rebuttal? • Determine whether your response should change • Prepare final response to ACO • Acceptance of DCAA position • Rejection of DCAA position • Offer to negotiate

  12. Current Focus Areas • Subcontractor Data • Audit Program, page 12 • Material • Audit Program, page 9 • Rates: Labor and Indirects • Audit Program, pages 8, 11

  13. Prime Subcontractor Strict Liability for Subcontractor Defective Pricing • Although TINA is a “no fault” statute, prime contractors have control over their own estimating practices and can minimize risk • Prime contractors have no control over actual or prospective subcontractor estimating, but are strictly liable for subcontractor violations

  14. A Recent Example: McDonnell Aircraft Co. (McAir), ASBCA No. 44504, 03-1 BCA ¶ 32,154 The Players • McAir is prime contractor for F-18 • Ford Aerospace is first tier sub for FLIRs • Ferranti is second tier sub for laser subsystem

  15. A Recent Example: McDonnell Aircraft Co., ASBCA No. 44504, 03-1 BCA ¶ 32,154 The Chronology • October 1987: Ferranti provides a price proposal to Ford, updated February 1988 • December 1987: Ford provides a price proposal to McAir which includes the Ferranti quote. Ford meets the “prospective sub” test • March 1988: Ford conducts analysis of Ferranti pricing • March 1988: McAir provides the Ford quote incorporating the Ferranti quote to the Navy

  16. A Recent Example: McDonnell Aircraft Co., ASBCA No. 44504, 03-1 BCA ¶ 32,154 The Chronology cont. • April 1988: Ford completes an initial and preliminary analysis of the Ferranti proposal, reflecting price reductions. • April-June 1988: McAir asks Ford for its cost or pricing data, but Ford fails to include preliminary analysis. McAir has no knowledge of it. • June 16, 1988: Navy and McAir agree on price • June 24, 1988: Certificate “as of” date • January 16, 1989: McAir and Ford agree on fixed price for the Ford subcontract and Ford executed a certificate as of that date. • March 1992: Issuance of defective pricing COFC based on non-disclosure of Ford’s preliminary analysis of Ferranti quote

  17. A Recent Example: McDonnell Aircraft Co., ASBCA No. 44504, 03-1 BCA ¶ 32,154 McAir’s Arguments • There was no subcontractor violation because a sub is only required to certify when agreement is reached on the subcontract price – January 1989 • McAir had no knowledge of the Ford analysis which was not “reasonably available” to it • McAir furnished the Navy all data in its possession and had no reason to believe there was more • McAir had no way to force Ford to disclose the analysis, as there was no contract with Ford at the time • The Government would impose an unfair standard of strict liability

  18. A Recent Example: McDonnell Aircraft Co., ASBCA No. 44504, 03-1 BCA ¶ 32,154 The Board’s Holding • McAir had a duty to certify to subcontractor data as of date of agreement on the prime contract. This is separate and distinct from the sub’s duty to certify at date of agreement on the subcontract. • McAir was responsible for Ford’s data even if it did not know about it and could not obtain it. In this sense, McAir is correct that the statute imposes strict liability • McAir could have protected itself by suitable agreement with Ford.

  19. How Defective Pricing Becomes Fraud TINA • A “no fault” statute • No element of intent • A purely contractual remedy • Price adjustment • Interest • Penalty for knowing submittal

  20. Civil and Criminal Fraud • Both require an element of intent or at least reckless disregard • Criminal fraud requires specific intent to assert a claim known to be false • Civil fraud requires only conduct that is utterly reckless or in deliberate ignorance of the truth • Criminal false statement requires a known false statement concerning a matter within the jurisdiction of an agency

  21. Other Potentially Applicable Statutes • Conspiracy to defraud • Mail and wire fraud • Qui tam

  22. Cost or Pricing Data Actions That Trigger Violations • Knowing submittal of false or erroneous data • Knowing omission of relevant data • Execution of a certificate known to be erroneous • Invoicing under a contract known to be infected with defective pricing

  23. False Claims and Defective Pricing • Obtaining a contract itself does not trigger a false claims violation • Invoicing under such a contract triggers the false claim • Invoicing after discovery of innocent defective pricing triggers a potential false claim unless there is immediate disclosure to the Government

  24. Corporate Exposure – Individual Exposure • The corporation can be found liable for civil or criminal fraud or related offenses • The problem of “corporate knowledge” – How far does it extend? • Individuals can be found liable only for their own acts

  25. DCAA and Fraud • DCAA is admonished to be on constant alert for fraud in its post award audits • “In planning and performing the examinations, consider the fraud risk indicators specific to the audit . . .” • “Document . . . any identified fraud risk indicators and your response/actions to the identified risks . . .” Audit Program Item 7

  26. DCAM Section 4-700: Detection and Reporting of Suspected Irregularities 4-702.2.a DCAA responsibilities “require constant alertness to the possibility of fraudulent activities.” 4-702.2.b “The auditor should follow-up on fraud indicators until . . . satisfied either that an innocent explanation . . . is not likely or no further relevant information can be generated through audit techniques. --- The auditor must avoid the appearance of conducting an investigation.” HANDOUT

  27. Fraud “Indicators” in Post Award Audits DCAM 14-121, “During post award audits of cost or pricing data, be constantly alert to identify any condition which might suggest wrongdoing against the Government.”

  28. Fraud “Indicators” in Post Award Audits DCAM 14-121.2, 12 Examples of Fraud indicators, including: • High incidence of persistent defective pricing • Denial of existence of records that later show up • “Repeated use of unqualified personnel to develop cost or pricing data used in the estimating process” • “Continued failure to make complete disclosure . . . of data known to responsible contractor personnel.” • Prolonged delay in release of data to prevent possible price reductions HANDOUT

  29. What if DCAA Discovers Something? DCAM 4-702.4 Promptly prepare a DCAA Form 2000 – Suspected Irregularity Referral (HANDOUT) “Continue with assigned duties and pursue development of factual information as appropriate . . .”

  30. What If DCAA Discovers Something? DCAM 4-702.5 Take no action that would compromise the investigation Do not inform the contractor Do not expand the audit “for the sole purpose of gathering additional information to support an investigation,” but audit scope may “be expanded to determine the impact of the suspected fraud.” Furnish “any information developed later, relating to the suspected wrongdoing . . . directly to the responsible investigative agency . . .”

  31. What Is Worse Than Defective Pricing? U.S. v. United Technologies (S.D.Ohio 2008) Pratt & Whitney won the multi-year Fighter Engine Competition and performed sole source for 1 year Air Force requested proposals from P&W and GE to obtain price competition and support industrial base for follow-on years Contract could be split or awarded to one offeror either on the basis of price or for other reasons Procurement was considered “negotiated” rather than competitive

  32. What Is Worse Than Defective Pricing? P&W priced proposal so per engine price would be higher if award was split P&W used decrement projections and inflation estimates to “game” the offer Decrement projection differed from P&W’s own estimate prepared by its cost accounting group • P&W had historical info to support the internal estimate, but chose not to use it P&W used escalation factors and claimed to reduce them to reflect standard inflation forecast, but applied only 75% reduction

  33. What Is Worse Than Defective Pricing? P&W also based pricing on BOM from prior engine model, which (1) had higher material prices and (2) included parts that were not in new model In ASBCA defective pricing action, Air Force claimed price overstated by $229 million ASBCA’s initial decision said P&W’s data was defective due to mistakes, but offsets made net impact zero On reconsideration, ASBCA found that Air Force did not even rely on the defective data since it did not review any of the data supporting the BAFO

  34. What Is Worse Than Defective Pricing? In meantime, Air Force filed civil False Claims Act case in Ohio District court found that P&W had made false statements to get their invoices paid • Decrement factors reflected past experience • Most recent inflation forecast used • Most current quotes for most current engine configuration used Reliance not an element for False Claims Act No actual damages 709 invoices @ $10K = $7,090,000 penalty

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