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DoD withholds pay from contractors with faulty business systems

Oct. 4, 2012 - 08:09PM   |  
By SARAH CHACKO   |   Comments

For the last year, the Pentagon has withheld at least $42 million in payments from contractors.

The step is aimed at pushing contractors to quickly fix faulty contractor business systems that bill the government, manage government property, estimate costs and track performance, among other things.

So far, at least five companies have been docked payments for Defense Department work:

• BAE Systems Land and Armaments in Arlington, Va.: $400,000 in payments was withheld because of a faulty accounting system. DoD did not disclose what contract was affected.

• Lockheed Martin Aeronautics in Fort Worth, Texas: $27.8 million in payments was withheld for its work on the F-35 Strike Fighter because of a faulty Earned Value Management system, which is used to manage large projects.

• Lockheed Martin Space Systems in Denver: $8.7 million in payments was withheld because of a faulty Earned Value Management system. DoD did not disclose what contract was affected.

• United Launch Alliance, a joint venture between Lockheed Martin Corp. and Boeing Co., in Denver: $2.8 million in payments was withheld because of a faulty accounting system. DoD did not disclose what contract was affected.

• Huntington Ingalls Industries in Newport News, Va.: $2.6 million in payments was withheld because of a faulty Earned Value Management System. DoD did not disclose what contract was affected.

DoD could not confirm that these five contractors were the only ones subjected to payment withholdings since the department put a new contracting rule allowing the withholdings into effect in February. The department made a preliminary decision to withhold money against at least one other contractor, CACI of Arlington, Va., because of problems with its labor accounting system, department spokeswoman Army Lt. Col. Elizabeth Robbins said in an email. But it is unclear how much, if any, money was withheld before the company submitted a corrective-action plan that satisfied DoD’s concerns.

Information from the department and contract experts suggests that few, if any, other companies have seen payments withheld so far.

The rule allowing the payment withholdings took effect in May 2011, although enforcement picked up after it was finalized in February. It allows the Pentagon to withhold up to 5 percent of contract payments if there is a deficient business system and up to 10 percent if there are problems in multiple systems.

The rule applies only to contracts awarded since the rule took effect, and it does not apply to small businesses.

The Pentagon’s two audit agencies — the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA) — are responsible for inspecting contractors’ business systems. If problems within those systems are identified and contractors fail to draw up sufficient plans to fix them, contracting officers can begin withholding payments.

DCAA is responsible for auditing contractors’ accounting, estimating and material management systems. DCMA reviews contractors’ purchasing, property management and Earned Value Management systems.

The get-tough approach appears to be working, experts say: Contractors are moving more swiftly to correct problems with their business systems.

Lockheed Martin Aeronautics is working on a corrective-action plan to resolve its issues, a company spokesman said. However, the company has been working to improve its Earned Value Management System for several years, according to DCAA records.

Meanwhile, DCMA increased its withholding on the company’s new F-35 contract, from 2 percent when the withholding started in February to 5 percent in June.

In contrast, the Naval Sea Systems Command this month lowered its withholding on Huntington Ingalls’ contract for the construction of an Arleigh Burke-class destroyer from 5 percent to 2 percent, nearly a year after it began withholding payments.

Most of the time, deficiencies can be corrected within a year, consultant Mike McNew, a former DCAA auditor, said in an email. Contractors that have taken longer than that in the past were not penalized for not getting into compliance, he said.

Before, “they haven’t had penalties assessed, they haven’t lost contracts, and they haven’t been denied awards because of the deficiencies,” he said. “Now there are cash flow penalties for not correcting the deficiencies.”

The Pentagon views faulty contractor business systems as a potentially costly liability.

For example, DCAA cited a contractor for failing to control its timekeeping system. While the contractor had policies regarding who could enter or change an employee’s time on the job, it did not have controls to ensure that policies were being followed, Robbins said. One employee could change another employee’s recorded time and it would not raise any red flags.

“The lack of controls increases the risk for costs to be inaccurately or inappropriately charged to government contracts,” Robbins said.

Contract experts and industry groups say contractors are concerned about how DCAA and DCMA will determine what constitutes a significant deficiency and whether a disapproved system will prevent a company from winning new awards.

For example, the systems must be able to allow the contractor to perform an adequate price analysis, but there is not a set standard for what qualifies as “adequate,” said Jeffery White, who consults with contractors on how to bring their business systems into compliance with Pentagon standards. One auditor may find a contractor’s system is adequate, while another auditor may look at the same system and determine it is inadequate, he said.

Aside from affecting cash flow, the withholdings could put contractors at a disadvantage when they bid on new awards, contract experts said.

“They want to be in a situation where they can clearly say all their business systems are adequate,” White said. “That’s huge for them from a strategic standpoint.”

Contracting officers can still award contracts to companies with disapproved systems, but, “in the minds of the evaluators, it’s an area of heightened concern,” White said.

While the rule is intended to save the government money by preventing fraud and waste, the government will bear the cost of compliance.

At large companies, business systems are complex and touch on other systems that may also have to be corrected, contract experts said.

“I am not sure I have seen one of these systems implemented fully, and correctly, in less than a year and for less than $500,000,” McNew, the former DCAA auditor, said. “Most systems of that size typically cost into the millions.”

Those costs to correct business systems are rolled into contractors’ overhead rates, which are charged to the government on individual contracts, contract experts said.

“The cost, it can be very significant,” said Robin Schulze, director of government contractor advisory services at Baker Tilly Virchow Krause and a former employee of DCAA and DCMA. “I think, much like some of the other regulations, we’re willing to spend an awful lot of money to build the Cadillac when in all cases it’s certainly not necessary to ensure the allowability of the cost.”

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