The Devil is in the Details Compliance with the Business Systems Rule

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1 Metropolitan Area Corporate Counsel Association WMACCA Conference on Ethics and Compliance for Government Contractors The Devil is in the Details Compliance with the Business Systems Rule April 1, 2014 #

2 Justin A. Chiarodo Partner at Dickstein Shapiro LLP Over ten years representing companies in government contracts litigation, compliance, and regulatory matters, including DCAA audits, internal investigations, mandatory disclosures, bid protests, and the defense of False Claims Act cases Graduate of Virginia Tech and the University of Virginia School of Law twitter.com/justinachiarodo

3 Anne M. Donohue Senior Vice President & General Counsel, SRA International, Inc. Manages all corporate transactions along with business, employment and contract law activities Graduate of the University of Michigan and The Catholic University of America Active in the American Bar Association Section of Public Contract Law 3

4 Jason Foster Senior Associate, Regulatory Compliance, Booz Allen Hamilton Leads Booz Allen s Business System Compliance team Over 20 years of experience in government contract industry compliance, including Disclosure Statement, Incurred Cost, Business Systems, Forward Pricing, and Timekeeping Extensive interaction with DCMA, DCAA, and KO community on audit and compliance matters 4

5 Highlights of the Business Systems Rule 2012 DFARS regulations that apply to CAS-covered DOD contracts Allows government to withhold contractor payments if one or more significant deficiencies are found in any of six contractor business systems DOD may withhold up to 5% for each disapproved system with a 10% maximum withhold for multiple disapproved systems $300+ million withheld as of October 2013 Today we will review the rule and discuss practical experiences and compliance strategies with our panelists 5

6 History and Purpose Major systems reviews performed for decades Internal controls under increased focus since FAR (Contractor Code of Business Ethics and Conduct) Business Systems requirement mandated by the FY 2011 Ike Skelton National Defense Authorization Act (PL ): Contractor business systems and internal controls are the first line of defense against waste, fraud, and abuse. Weak control systems increase the risk of unallowable and unreasonable costs on government contracts, unnecessarily draining limited DoD resources at the taxpayers expense. Two proposed rules (January 15 and December 3, 2010); Interim Rule effective May 18, 2011 Final Rule effective February 24,

7 The Details: Coverage Applies to DOD Contracts subject to the Cost Accounting Standards (CAS) (modified or full coverage) Contract must contain DFARS and the specific business system clause within the contract DFARS clause is self-deleting if inapplicable Rule does not apply to small business primes (who are not subject to CAS) University Research Centers excluded Clause not required to be flowed down 7

8 The Details: The Six Systems Six contractor business systems are covered by the rule: System Accounting (Indirect/ODC, Control Environment, Billing, Labor, General IT) DFARS Clause Earned Value Management Estimating (Budget/Planning) Material Management & Accounting Property Management Purchasing

9 The Details: Systems Review Cognizant Contractor Officer, supported by DCAA/DCMA, determines acceptability of business systems Acceptable contractor business system? One that complies with the terms and conditions of the applicable clause Systems are either approved or disapproved (or not evaluated) Significant Deficiency a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes Materiality is the key concept 9

10 The Details: DCAA/DCMA Roles DCAA s responsibilities include: Audits of the Accounting Systems, Estimating Systems, and Material Management & Accounting Systems Following up on prior reported deficiencies and evaluating contractor corrective action plans DCMA s responsibilities include: Oversight of all 6 business systems Conducting reviews for the Purchasing System, Government Property System, and EVMS (in coordination with DCAA) Determining whether significant deficiencies exist, issuing notifications, pursuing correction of significant deficiencies, and withholding payments 10

11 The Details: Timeline The CO communicates approval or disapproval within 10 days of receiving a functional specialist report The CO must describe significant deficiency in sufficient detail to allow the contractor to understand the deficiency The contractor has 30 days to respond to the initial determination COs must issue a final written determination of system adequacy within 30 days of receipt of the contractor s response (WITHHOLDING BEGINS HERE) The CO must obtain the review of the Contractor Business Systems Review Panel if the decision would be contrary to a DCAA audit recommendation 11

12 The Details: Timeline The contractor has 45 days to respond to the final determination of system adequacy. During this time, contractors can correct deficiencies or submit a corrective action plan (CAP) COs have 15 days to review the CAP and/or corrective actions Once a final determination has been issued, the contractor may also dispute the final determination that a significant deficiency exists by submitting a Contract Disputes Act claim 12

13 The Details: Withholding After a final written determination, the CO identifies one or more covered contracts containing DFARS from which payment will be withheld DOD may withhold 5% for each disapproved system, up to 10% If the CO determines that the contractor s CAP is acceptable, the CO can reduce withholdings to 2% If the CAP is not followed, withholding will be increased to the original amount If the CAP is not evaluated within 90 days, the CO is required to reduce remaining withholds by 50% 13

14 The Details: Corrected Deficiencies When the contractor notifies the CO that significant deficiencies have been corrected, the CO will: Request a verification from an auditor/functional specialist and Make a determination of correction The amount withheld will be released once all deficiencies have been corrected and systems have been deemed approved DCAA/DCMA do not intend to be prescriptive regarding what must be done to correct a deficiency since there may be more than one way to meet the criteria set forth for each system 14

15 DCAA Guidance: Accounting System Audits DCAA issued internal guidance in April 2012 shedding light on significant deficiency and materiality (See DCAA Memorandum No. 12-PAS-012(R) (April 24, 2012)) In making a materiality determination, auditors will consider factors such as: The nature/frequency of the noncompliance Whether the noncompliance is material considering the nature of the compliance requirements The root cause of the noncompliance The effect of compensating controls Possible future consequences of noncompliance Qualitative considerations such as serving the public interest 15

16 DCAA Guidance: Accounting System Audits Not necessary to show an actual monetary impact to support a finding of a significant deficiency/material weakness Auditors instructed to also consider the following indicators of a significant deficiency/material weakness: History of noncompliance found in contractor assertions (e.g., public vouchers, incurred cost submissions, proposals) requiring correction Material noncompliance with laws and regulations Key instruction: There only needs to be a reasonable possibility that the noncompliance with the DFARS criteria will result in a material noncompliance with other applicable government contract laws and regulations, thus materially affecting the reliability of the data produced by the system. 16

17 Statistics As of October 22, 2013: $305.9 million in withholding 64 systems have been disapproved Of those, 16 systems were subsequently approved Of the 48 remaining systems, 17 still had withholds 9 systems are subject to 5% withholding 7 systems are subject to 2% withholding 1 system is subject to 1% withholding In February 2013, DCMA said that approximately 1/3 of all systems disapproved/subject to withholding were Accounting systems; 1/3 were Purchasing systems; 1/3 all other types 17

18 Statistics Risk of significant withholdings: As of September 2013, DOD reported $195 million withheld relating to F-35 Joint Strike Fighter contract Withholding started at 2%; was later increased to 5% As of November 30, 2013: Major withholdings from contractors of $19 million, $5.2 million, $1.2 million 75 systems have been reviewed by the Contractor Business Systems HQ Review Panel (as of Oct. 2013) 88% concurrence with CO s recommendation for disapproval 30 Accounting; 16 Government Property; 14 Estimating; 10 EVMS; 5 Purchasing; 0 MMAS 18

19 Emerging Issues: Counterfeit Parts DOD has issued two proposed rules relating to Section 818 of the FY 2012 National Defense Authorization Act to define, identify, and prevent the use of counterfeit electronic parts in DOD procurements DFARS Case 2012-D055 (May 16, 2013) DFARS Case (December 3, 2013) The proposed rules impose significant requirements for a contractor s purchasing system to be deemed acceptable : The contractor must ensure that deliverables meet specified quality standards, which may be unilaterally selected by the CO Significant detection and avoidance requirements 19

20 Emerging Issues: Counterfeit Parts Counterfeit parts are defined broadly as any new, used, or outdated, expired item from a legally authorized source that is misrepresented by any source to the end-user as meeting the performance requirements for the intended use. The proposed rules place the responsibility of detecting and avoiding the use or inclusion of counterfeit parts on the contractor Essentially a strict liability standard Contractors responsible for any rework or corrective action that may be required to remedy the inclusion of counterfeit parts 20

21 Emerging Issues: Counterfeit Parts Under the proposed rule, purchasing systems must have counterfeit avoidance procedures No specific standards, benchmarks, or best practices have been identified by DOD Places significant risk on contractors to develop an appropriate system out of an abundance of caution Non-compliance may trigger withholding The Purchasing system is most directly implicated One counterfeit incident could cause DOD to withdraw its approval of the Purchasing system Could impact other systems too e.g., Material Management and Accounting 21

22 Emerging Issues: Beyond DOD? The Department of Energy has issued an Acquisition Letter implementing its own business systems rule, which largely parallels that of DOD The Acquisition Letter states that it is effective upon issuance First issued 5/2/13; revised 2/12/14 DOE has also issued a notice of proposed rulemaking regarding its business systems rule The rule does not apply to Management and Operating contractors The rule adopts five of the six DOD business systems (all but MMAS) Will other agencies follow suit? 22

23 Nine Tips for Effective Compliance 1. Have a written compliance program and follow it 2. Know your business systems and routinely evaluate them 3. Document, document, document 4. Monitor enforcement actions and regulatory developments 5. Understand your exposure and potential cash flow issues 6. Invest the needed resources (people and technology) 7. Educate your team at all levels 8. Communicate internally and externally (subs, auditors, etc.) 9. Be proactive, not reactive 23

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