The double-edged sword of oversight

Is increased oversight a burden, or an opportunity to stand apart from the crowd?

We've been reporting for some time now that government contractors and subcontractors are coming under increased scrutiny. Previously, small business subcontractors were somewhat immune from harm, but this immunity is rapidly being whittled away. The Washington Post has noticed this phenomenon:

"The days of 'No one is checking,' are over. For too long, there was inadequate oversight." --Daniel Gordon, an administrator at the White House Office of Federal Procurement Policy

Washington Technology is reporting the same thing this week.

This increased focus on procurement regulations might have some contractors and subcontractors quaking in their boots. Oversight tends to send business owners into a panic, because it often means increased costs in a world of razor thin profit margins. No one wants to risk being debarred or suspended, or have payments withheld, especially when federal contracting can provide a crucial stream of profitable business in many industries.

But the costs need not be prohibitive, and this negative can be turned into a strong positive for contractors and subcontractors. Increased oversight is bad news for those who don't follow government regulations, but good news to those who know and observe the rules!

There are great benefits to proving competence with federal procurement regulations. A contractor who can say they have a procurement regulations management system in place is going to be much more attractive to contracting officers than those who don't. Competence is a crucial factor among contracting officers when evaluating the competition--you can place yourself above your competitors by showing that this new focus on oversight doesn't burden or scare you because you have already taken steps to ensure compliance.

FARSmarterBids.com offers the most extensive library of federal procurement regulations in one place. Not only that, but regulations can be managed: contractors and subcontractors can store key regulations in their own virtual filing cabinets for easy, repeated access, meaning they can save valuable time and energy, preserving their profit margins. Many contractors use what they learn from the service to supplement the knowledge they receive from attorneys and consultants, thus shaving hundreds to thousands off these professionals' fees. All of this is offered for a low monthly or quarterly fee--as low as $55 per month.

Of course, just knowing the federal procurement playbook in general confers benefits of its own. This knowledge helps you compete because you have a better grasp of the regulatory costs and can use that knowledge to decide on what contracts to bid.

Subcontractors, too, can use this knowledge to better compete for work. Any smart businessperson will tell you how crucial it is to know your customer--and that includes being familiar with their regulatory landscape. Subcontractors who understand what the primes are up against--including payment withholding and evaluating supply chain risk--are attractive competitors. Often, subcontractors must comply with regulations when completing work for a prime contractor--those who work within the scope of those regulations are going to find themselves better positioned for repeat work.

Also, subcontractors can better insulate themselves from lawsuits and disputes if prime contractors face penalties levied by federal contract managers or agency heads if they know their regulations. This means potentially averting costly, even business-killing litigation in the unfortunate event a prime contractor tries shifting the blame to a subcontractor in such a situation. The knowledge contained within FARSmarterBids provides a cost-effective "keep off the grass" sign to prime contractors who might try an underhanded technique to keep the heat off themselves.

We find that, far from being a costly burden, compliance with federal procurement regulations can be turned into a net positive. At very little cost, prime contractors and subcontractors can market themselves as the most capable, competent, efficient organizations with which to do business. Instead of groaning at the thought of increased oversight, companies can relish the thought of beating out the competition by playing the government's game.

Your Supply Chain at Risk: A Secret Blacklist for Government Contractors? Part 2

While Congress dithers about tax rates, a crucial piece of legislation, the National Defense Authorization Act of 2011, is still not resolved. This legislation may allow government officials to secretly blacklist contractors, with no notice, and no public accountability.

We examined some of the potentially alarming implications of Section 815 of this Act last week, and continue our analysis here.

Section 815 of the 2011 NDAA defines a supply chain risk as:

(4) The term ‘supply chain risk’ means the risk that an adversary may sabotage, maliciously introduce unwanted function, or otherwise subvert the design, integrity, manufacturing, production, distribution, installation, operation, or maintenance of a covered system or a covered item of supply so as to surveil, deny, disrupt, or otherwise degrade the function, use, or operation of the system or item.

An "adversary" is not defined by this legislation, and there is no reference to an accepted definition in the U.S. Code. An obvious example would be an al Qaida terrorist. No one wants such a person working for a government contractor or subcontractor.

But what about a mischievous person? Someone who slips in a line of code as a joke or calling card? How about a careless programmer? A quick jaunt around StackOverflow.com can yield plenty of examples of funny comments, little "features," and all manner of bugs that made it into programs because programmers were coding for three days straight on only eight hours' sleep and gallons of coffee. If a little joke affects the performance of a "covered system," will the whole company be debarred?

What about a bug? The section mentions "maliciousness," but it also says "and otherwise subvert"--meaning that maliciousness may not be a criteria for deciding whether a programmer's actions fall under the definition of subversion. All code has bugs; the open-ended language of this legislation makes it ambiguous whether those bugs could be fixed with a patch or bankrupt the contractor.

This bill basically puts a premium on prime contractors to closely monitor the actions of all their employees as well as the employees of their subcontractors. While a terrorist might not have the patience to infiltrate a major prime contractor, build up years of trust, and then quietly place malicious code into crucial systems, contractors will still face devastating outcomes if an employee goes rogue.

No prime contractor is going to have the ability to examine every line of code in every program supplied by a subcontractor for bugs, pranks, or malicious code. The cost of doing so is prohibitive. This doesn't even cover the intellectual property issues that might come into play; subcontractors may have trade secrets to protect in their code that they do not want a larger company to co-opt. Subcontractors may find that the increased scrutiny or intellectual property risks are not worth it, and are, in effect, self-selected out of government contracting. And, of course, the cost of whatever "qualification requirements" could be prohibitive to smaller businesses, leading to either more self-selection out of contracting or the de facto debarment that the American Small Business League warns about.

It is important to remember that we already have measures in place to effectively debar contractors who deal with foreign terrorists or whose practices might weaken the supply chain. In addition to the measures identified in the Federal Acquisition Regulations and supplements, the Excluded Parties List provides a means of achieving the goal of excluding potentially terrorist-linked firms without the secrecy and potential abuse at the hands of a consolidated few heads of agencies.

Even if Section 815 of this Act does not survive the legislative process to become law, a seed has been planted. The notion of withholding payments from contractors with "inadequate" business systems started in a proposed DFARS, and subsequently appeared in a modified form in Section 841 of the 2011 NDAA. Another version of Section 815 may crop up in the Federal Acquisition Regulations.

Not only that, but these legislative and regulatory moves point to a larger trend: federal government officials are increasingly seeking to monitor prime contractor and subcontractor work, with potentially crippling consequences if they don't like what they see. Subcontractors are coming under increasing scrutiny; they are taking unnecessary risk if they do not have an effective means to manage the information in the Federal Acquisition Regulations. Meanwhile, prime contractors are forced to become increasingly risk-averse and only deal with companies they can trust to follow regulations while they, themselves, grapple with managing the regulations that apply to them.

Your Supply Chain at Risk: A Secret Blacklist for Government Contractors? Part 1

The American Small Business League recently released a statement that Section 815 of Senate bill 3454, the National Defense Authorization Act of 2011, "may allow senior Department of Defense (DoD) officials to secretly 'blacklist' government contractors at their discretion and without notice to the contractor or accountability to the public."

This is, of course, the same bill that contains provisions for withholding payment from contractors whose business systems are deemed inadequate. The bill follows proposed changes to the DFARS that would withhold payments up to 100% for "inadequate" business systems, including purchasing systems, which in turn includes subcontracting.

That federal government officials want more and more control over the contracting and subcontracting process is nothing new. Section 815, which covers risk to the supply chain, poses additional challenges for contractors and subcontractors.

At first glance, Section 815 seems to apply only to technology vendors and their suppliers, and it seems to be intended to block terrorists and hackers from maliciously manipulating mission-critical hardware and software. It appears to be a well-intended provision for ensuring that crucial tech vendors--and the military groups who depend on them--can't be shut down by a weak link in the supply chain. Who would be against that?

But the devil is in the details. A more thorough reading reveals some very open-ended wording that could lead to the section being used to justify draconian measures taken arbitrarily against contractors and subcontractors, leaving them with no recourse to restore their businesses and good names.

Section 815 starts by giving the head of "an agency" (which agencies are allowed this power is not specified) to establish qualification requirements for the reduction of supply chain risk, and restrict competition to companies who can meet those requirements. Apparently irrespective of these qualification requirements, the agency head can establish supply chain risk as a major criteria for evaluation of a bid. This begs the question of whether Section 815 could be construed as giving agency heads the ability to exclude non-tech contractors and subcontractors.

The statute does not cover what happens when different agencies establish different qualification requirements. How can a small business keep up with these requirements on top of all the Federal Acquisition Regulations, even if it has an effective FAR management system? These requirements are only available upon request--so contractors must know to request them and contracting officers must be knowledgeable enough to deliver them.

The section goes on to outline how a company that either cannot meet qualification requirements or has been deemed to pose a "supply chain risk" can be restricted from competition either as a contractor or subcontractor. It then states that a determination against a company must be in writing but does not have to be disclosed via Federal Register, that it is at the sole discretion of the agency head or senior procurement executive, and is not subject to review by either a GAO protest or the Federal court.

It doesn't take a contracting expert or attorney to point out the obvious potential for abuse by agency leaders. There are no apparent checks and balances to this system. On top of this, there is another problem that the bill doesn't even address--how the actions of one agency head affects another. Can the head of one agency blacklist a contractor who does business with multiple agencies and therefore cause other agencies to terminate contracts and blacklist the contractor as well? If the answer is yes, then what happens when one agency head blacklists someone another agency head needs to provide crucial systems? And what about contractors who are caught in the middle of inter-agency power struggles?

This is only part of the problem with this pending legislation. We'll examine some of the implications for prime contractors as well as smaller subcontractors next week.

New Regulations Needed for Government IT Contracting

It's generally known that government IT projects are some of the riskiest projects out there. They are often enormous projects, with complicated specifications and requirements. At the same time, the nation has a greater need for efficient systems than ever before. Civilian and military agencies have a lot to manage, with projects ranging from defense systems for battlefield wireless networks to systems that support the recent changes in health care.

"Cloud computing" is one hot area of research and development, and a new GSA contract will have 11 different vendors providing cloud computing and storage to a number of different government agencies. Such interagency cooperation may require new ways of defining contracts, especially for projects that require delivering a wide array of services, from storage to software licensing. This is in keeping with President Obama's creation of a new task force on interagency contracting cooperation.

Meanwhile, government contracting specialists and industry analysists are experiencing a shift in perspective. Our current contracting models simply don't work for IT projects. Software cannot be produced the same way as, say, the F-22 Raptor, or a new levee for New Orleans. Our enemies and our project requirements are constantly evolving; massive contracts with set requirements are an anathema to our ability to respond.

On top of this, massive IT projects lend themselves to poor contracting procedure, a subject we've covered in our article series "Contracting Principles the DoD Forgot," about the DoD's withholding contractor payments due to poor contract management. When you combine this new penchant among legislators and members of the Executive branch to hold back payments, with little recourse and devastating consequences for small businesses, the implications are enormous. If we do not change how IT contracts are developed and written, it will be a wonder if we have any IT vendors willing to assume the risk of contracting with the federal government at all.

Two recent articles discuss some remedies: "Bite-size procurements can minimize big-time problems" at Federal Computer Week, and "Gov't IT Contracting Reform Needed" at PCWorld. Both suggest a smaller, bite-sized, incremental approach.

What this means for federal procurement regulations is up in the air right now, but it's clear that federal acquisition regulations would need to change to better accommodate this incremental approach. Contractors need to be familiar with the FAR now, but IT vendors in particular need to keep an eye on the regulations for the foreseeable future as the President's Interagency Task Force keeps working.

Government Contractors: Know Your Regs, or Else?

We wanted to give a shout-out to Mike Anderson over at Tech Biz Blog for noticing the same thing we have: contracting regulations matter more now than ever before. This is true not only for the big guys, but small businesses and everyone who subcontracts. No one--prime contractor, subcontractor, or federal agency--is going to want to risk working with your company unless you have a good handle on the FARS.

Implications of the GTSI Suspension: FARS Management

Jonathan S. Aronie over at GovernmentContractsLawBlog.com pointed out some interesting implications of the recent GTSI suspension.

He astutely points out some possible consequences:

"Prime contractors reassessing their current relationships with small businesses. (And small businesses doing the same.)

Greater contracting officer focus on the SBA’s rules, and greater scrutiny of proposals in set-aside procurements.

SBA OIG audits of large and small teammates on set-aside contracts, like SEWP or FirstSource."

A greater focus on the rules. Audits. Sound familiar? Anyone who has been following contracting news knows that the Obama Administration has placed a greater focus on oversight and regulations. But what is a contractor to do about it?

Small businesses that find themselves under greater scrutiny by prime contractors should take a look at how they manage the FARS. Proving competence with the FARS is a good way for contractors to keep each other comfortable with the arrangement. Would you do business with someone who doesn't keep track of the terms of the contracts you make with them? Someone who ignores applicable regulations--which may in turn get you suspended, or get you negative ratings in the FAPIIS system, or may cause the DoD to withhold payments? Someone who would make you look less trustworthy to the greater contracting community?

Yet the FARS and their supplements are a monstrosity. How can a small business compete? It's increasingly apparent that in order to stay competitive, a FARS management system is crucial. It's not enough to print out regulations, stuff them into a folder and never look at them again. It's not enough to keep them in overflowing email inboxes. Competitive contractors of all sizes face the need to prove regulatory competence, the same way ISO-certified companies must.

Mr. Aronie also points out in his post:

"When push comes to shove, you may not get the expected mileage from a defense based upon the oral advice of a contracting officer."

Contractors shouldn't take the word of others; they need to be responsible for this information themselves. Competitive contractors must show that they have the regulations at their fingertips, and that applicable regulations are revisited frequently to ensure compliance. ISO certified companies often attest to the increased business brought by their certifications; we believe the same will be true of contractors who can show good FARS management.

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Contractor GTSI suspended; who is next?

As we reported earlier on our Twitter feed, the SBA has suspended GTSI from government work based on allegations of contracting fraud. According to a Washington Post article:

"There is evidence that GTSI's prime contractors had little to no involvement in the performance of contracts, in direct contravention of all applicable laws and regulations regarding the award of small business contracts," an SBA official wrote in a letter to GTSI's chief executive, Scott W. Friedlander. "The evidence shows that GTSI was an active participant in a scheme that resulted in contracts set-aside for small businesses being awarded to ineligible contractors."

The article goes on to say it's the first time in decades that such an action has been taken.

This comes as no surprise to government contracting newshounds. This administration has stated many times that stopping contracting fraud, waste, and abuse is a priority. President Obama's memorandum back in March challenges federal agencies to ferret out companies that don't follow contracting rules.

Contracting and subcontracting, including small business contracting, have become increasingly important targets in Congress; as we reported earlier, the new Small Business Jobs and Credit Act aims to enforce subcontracting plans. Congress is looking at agencies like the Department of Homeland Security to ensure proper management and oversight of contracts. And Congress may yet pass a version of the DoD's payment withholding plan in the National Defense Authorization Act 2011 for contractors who don't follow the rules.

If a large contractor like GTSI can be taken to task under this increased oversight, it is likely that other contractors will as well. Furthermore, knowledge of the Federal Acquisition Regulations is increasingly at a premium; even the smallest subcontractors could stand to lose business if they are not followed. No prime contractor will want to assume the risk of being suspended because of a failure to follow regulations along the supply line. Contracting officers will be on the lookout for companies that can demonstrate good management of the applicable regulations. An effective FARS management system reduces the regulatory burden and ensures compliance, which in turn protects against suspension.

It will be interesting to see what other companies may be suspended by the SBA; if what is alleged against GTSI is true, it is possible there are many other "GTSIs" out there that could be suspended. Time will tell, but in the meantime, contractors and subcontractors should take a close look at their FARS management and ask themselves if they can prove their competence in this era of increased oversight.

Follow your subcontracting plan, or else?

We recently posted a series of articles on FAPIIS, the Federal Awardee Performance Integrity Information System, and some of the consequences of this system's introduction. New legislation has passed that makes use of FAPIIS. It seems the government is interested in holding contractors to their plans, and those contractors that don't may reap the consequences.

The newly-passed Small Business Jobs and Credit Act (H.R. 5297) mandates that prime contractors have to follow their subcontracting plans. An article by Washington Technology states that written explanations are required when a prime contractor doesn't follow its subcontracting plan, and that if those statements aren't to the satisfaction of the contracting officer, it may "hurt the evaluation of the prime contractor's performance on the contract".

As if a negative evaluation wasn't bad enough, this evaluation may also be made public under the FAPIIS past performance reporting system. This new law makes it even more important to know the rules when doing business with the government, a trend on the rise in recent months.

For more information on FAPIIS, check out some of our recent articles:

• Tax Penalties and FAPIIS Part 1, Part 2
• Is FAPIIS the Business Equivalent of "Pick-Your-Poison?" Part 1, Part 2
• Publicly Available FAPIIS – Consequences For Grant Recipients?

Contracting Principles the DoD Forgot, Part 4: The Proposed Purchasing System DFAR: Consequences for Subcontractors and Prime Contractors

Our last closely examined area of the proposed rule brings us back to the topic of subcontracting. The following Purchasing System Administration clause is noteworthy for subcontractors as well as prime contractors.

"252.244–7XXX Contractor purchasing system administration.
As prescribed in 244.305–7X, insert the following clause:
Contractor Purchasing System Administration (Date)
(a) Definitions. As used in this clause—
Deficiency means a failure to maintain any element of an acceptable purchasing system.
Purchasing system means the Contractor’s system or systems for purchasing and subcontracting including make or buy decisions, the selection of vendors, analysis of quoted prices, negotiation of prices with vendors, placing and administering of orders, and expediting delivery of materials."

Note that the defined purchasing system includes systems for subcontracting and information related to subcontractors and their proposals to, and contracts with, the prime contractor. It is important to note that this proposed rule 252.244–7XXX is a business-transaction-information-and-documentation-requirement as well as a business systems and business systems administration rule. It almost looks like the beginning of a required ISO quality management system for purchasing transactions and documentation. Also, please note that there is no exception or exclusion in this definition for very small vendors.

The clause continues:

"Purchasing system includes, but is not limited to—
(1) Internal audits or management reviews, training, and policies and procedures for the purchasing department to ensure the integrity of the purchasing system;
(2) Policies and procedures to assure purchase orders and subcontracts contain all flow down clauses, including terms and conditions required by the prime contract and any clauses required to carry out the requirements of the prime contract;"

Training for many contractor purchasing departments is often occasional and insufficient. If adopted in some similar form, such a final rule may trigger greater attention to in-house and externally sourced training. Also in that event, more attention by contractors to their policies and procedures for purchasing departments will likely be necessary to avoid possible deficiency findings. An annual review of all purchasing department policies and procedures, and documentation confirming the thoroughness of that review, will now be more important than ever before. These points seem supported by subsequent paragraphs of this proposed FAR that are noted below. Overall, a final rule similar to the proposed rule would discourage caviler treatment of company policies and procedures. The withholding penalties would be too extreme to risk.

The clause continues:

"(3) An organizational and administrative structure that ensures effective and efficient procurement of required quality materials and parts at the most economical cost from responsible and reliable sources;
(4) Selection processes to ensure the most responsive and responsible sources for furnishing required quality parts and materials and to promote competitive sourcing among dependable suppliers so that purchases are reasonably priced and from sources that meet contractor quality requirements;"

Given such requirements in a final rule, increased use of ISO qualified subcontractors seems highly desirable.

The clause continues:

(5) Performance of price or cost analysis on purchasing actions; and

Presumably explanatory documentation of these analyzes would be necessary. Paragraph 252.244–7XXX(c)(5) below seems to support that thought.

The clause continues:

(6) Procedures to ensure that proper types of subcontracts are selected and that there are controls over subcontracting, including oversight and surveillance of subcontracted effort.

It will be interesting to see whether supplemental requirements will be added over time such as details of necessary elements in a subcontracting and subcontracts oversight and surveillance procedure. How far will contractors have to go in their subcontracting procedures in order to satisfy the government? Will a new internal or external legal audit and formal opinion-letter certification eventually become viewed as helpful or necessary?

The clause continues:

(b) General. The Contractor shall establish and maintain an acceptable purchasing system. Failure to maintain an acceptable purchasing system, as defined in this clause, may result in disapproval of the system by the ACO and/or withholding of payments.
(c) System requirements. (1) Have an adequate system description including policies, procedures, and operating instructions that comply with the FAR and DFARS.

Note in 252.244–7XXX(c)(1) above the words "policies, procedures, and operating instructions that comply with the FAR and DFARS". Couple these requirements with 252.244–7XXX(b)’s statement above that: "Failure to maintain an acceptable purchasing system, as defined in this clause, may result in disapproval of the system by the ACO and/or withholding of payments." What do you conclude? Consider the following possible conclusions.

1) Perfection Required Regarding DFARS. Under the proposed 252.244–7XXX(b) and (c)(1) it appears that less that perfect (i) awareness or knowledge, (ii) interpretation and understanding, and (iii) application or implementation, of all applicable then-current DFARS in "policies, procedures, and operating instructions" may result in payment withholding or purchasing system disapproval.

Requirements for contractor perfection are often problematic. In connection with 252.244–7XXX(b)’s statement above, how will "an acceptable purchasing system" be defined specifically or precisely, in other words, in greater detail than by 252.244–7XXX(c)’s criteria? To illustrate, how quickly must subcontractor invoices be approved or rejected, and if approved, paid? Is it "acceptable" to pay a subcontractor within 60 or 90 days of invoice receipt, or of invoice approval? Will delays longer that a few weeks or a month be viewed as a deficiency? Software systems for the purchasing function are common among contractors. Is it "acceptable" if a new release from a software licensor contains a bug that takes weeks or months to be fixed when the bug affects the contractor’s purchasing system, for example, changing the calculations or other content in invoices or purchase orders? It is hard to be perfect when you do not know the details of all requirements.

2) Confusing "Mandatory" Versus "Optional" Inconsistency. There appears to be a confusing inconsistency between "252.242–7XXX, Business Systems" that we previously reviewed, and "252.244–7XXX Contractor purchasing system administration".

(i) In 252.242–7XXX, Business Systems, we see a mandatory penalty. Note the mandate in 252.242–7XXX(c)(2): "If the ACO determines that the Contractor’s business system contains deficiencies, the final determination will include a notice of a decision to withhold payments." Next, note the mandate in 252.242–7XXX(d)(1) to "immediately withhold ten percent of each of the Contractor’s payments under this contract" for deficiencies in a business system. We must remember of course that a purchasing system is a type of covered business system.

(ii) However, in 252.244–7XXX(b)’s statement we see an optional penalty: "Failure to maintain an acceptable purchasing system, as defined in this clause, may result in disapproval of the system by the ACO and/or withholding of payments."

Which is it, "will" or "may" withhold payments? There appears to be no explanation.

3) ACO Inconsistency. We must recognize the probability that ACOs will not be consistent across contracts and over time. Inconsistency in ACO actions is a major danger in the near future after the final rule issues, and years later, because of potential unexpected withholdings for reasons not triggering a withholding under (i) a contractor’s other then-current, in-progress contracts, (ii) a competitor’s then-current contracts, or (iii), in the future, under a contractor’s old contracts. The same ACO may be consistent, but the consistency issue clearly arises with different ACOs. Inconsistent withholding decisions seem unavoidable even if ACOs receive training in an attempt to minimize them. After all, ACO actions are not the actions of judges in courts of law who are bound by precedent. Undoubtedly there will be some inconsistencies across contracts or over time that will be reasonable and fair given the respective surrounding circumstances, but equally undoubtedly other inconsistencies across contracts or over time will be unreasonable, unfair, costly, and may lead to considerable harm to the contractor involved and its workforce, shareholders, and senior management.

4) Uncertainty. The lack of details in DFAR requirements, on the one hand, and ACO inconsistency, on the other hand, will likely initiate and maintain some degree of contractor uncertainty over which application or implementation imperfections or idiosyncrasies will be "acceptable" in any particular newly-awarded contract and at any particular point in time. Focusing only on purchasing systems for the moment, the potential withholding or system disapproval consequences of a purchasing system imperfection are draconian. The risk of payment withholding or purchasing system disapproval due to imperfections is too dire to treat lightly. Assuming the requirements of the final Business Systems DFAR are at least somewhat similar to those of the proposed DFAR, it will be highly desirable for contractors to undertake any reasonable steps to improve DFAR (i) awareness or knowledge, and (ii) interpretation and understanding. Contractors would not want one of these more controllable sources of risk to trigger a withholding. Application or implementation imperfections or idiosyncrasies will cause more than enough problems. Overall, awareness and knowledge failures, and interpretation and understanding failures, must be minimized.

5) Best Solutions. It follows that prudence suggests discontinuing any reliance on sources for DFARS, and FARS as well, that are unnecessarily incomplete or less than reasonably current. Prudence further suggests more vigilant research into and analysis of new DFARS, and FARS as well, rather than accepting prevalent internal interpretations without question because they may be blind to, or may incompletely recognize, some potential dangers.

Assuming the requirements of the final DFAR Business Systems rule are at least somewhat similar to those of the proposed rule, the time will have come for more attention to, and more professionalism in, FAR/DFAR awareness/knowledge, and FAR/DFAR interpretation and understanding. Occasional and piece-meal updating of FARS and DFARS is no longer adequate in an environment of countless new grounds for a withholding penalty. Occasionally discussing proposed or new FARS/DFARS is insufficient. Occasionally finding and reviewing an article on the interpretation of a proposed or new FAR/DFAR is insufficient. Contractors need a FAR/DFAR management system.

Contracting Principles the DoD Forgot, Part 3: “Business Systems” Excerpts From The Proposed Mandatory Withholding DFAR

The following passages from the proposed rule will disclose some key processes and begin to suggest its penalties. For those readers unfamiliar with the terminology, an "ACO" is an Administrative Contracting Officer.

"Subpart 242.70—Business Systems
242.70X1 Business system deficiencies.
(a) Definitions. "Acceptable business systems" and "Business systems" are defined in the clause at 252.242–7XXX, Business Systems.
(b) Reporting of deficiencies. The auditor or other cognizant functional specialist shall document deficiencies in a report to the ACO. The report shall describe the deficiencies in sufficient detail to allow the contracting officer to understand what the contractor would need to correct to comply with the applicable standard or system requirement, and the potential magnitude of the risk to the Government posed by the deficiency. Follow the procedures at PGI 242.70X1(b) for reporting of deficiencies.
(1) Initial determination of deficiencies. If the ACO makes a determination that there is a system deficiency, the ACO shall provide an initial determination of deficiencies and a copy of the report to the contractor and require the contractor to submit a written response in accordance with the clause at 252.242–7XXX, Business Systems.
(2) Evaluation of contractor's response. The ACO, in consultation with the auditor or cognizant functional specialist, shall evaluate the contractor's response and make a final determination.
(3) Notification of ACO final determination. The ACO shall notify the contractor in writing of the ACO's final determination with copies provided, as applicable, to the auditor; other cognizant functional specialists; and affected contracting activities and contract administration offices. The ACO shall take one of the following actions—
(i) Withdraw the initial determination of deficiencies. The ACO shall withdraw the initial notification if the contractor has corrected all deficiencies or the ACO agrees with the contractor's written response disagreeing with the initial determination of deficiencies; or
(ii) The ACO shall notify the contractor of the ACO's decision to implement payment withholding in accordance with the clause at 252.242–7XXX, Business Systems. The notice shall—
(A) Identify any deficiencies requiring correction;
(B) Inform the contractor that—
(1) The contractor must correct the deficiencies;
(2) The contractor must submit an acceptable corrective action plan within 45 days if the deficiencies have not been corrected within that 45 day timeframe;
(3) Payments shall be withheld in accordance with 252.242–7XXX, Business Systems, until the ACO determines that all deficiencies have been corrected; and
(4) The ACO reserves the right to take other actions within the terms and conditions of the contract.
(c) Monitoring contractor's corrective action. The Government shall monitor the contractor's progress in correcting the deficiencies and shall notify the contractor of the decision to decrease or increase the amount of payment withholding in accordance with 252.242–7XXX, Business Systems.
(d) Correction of system deficiencies.
(1) If the contractor notifies the ACO that the contractor has corrected the system deficiencies, the ACO shall request the auditor or other cognizant functional specialist to review the correction to determine if the deficiencies have been resolved.
(2) The ACO shall determine if the contractor has corrected the deficiencies.
(3) If the ACO determines the contractor has corrected all deficiencies, the ACO shall discontinue withholding payments.
(e) System review matrix. Refer to the matrix at PGI 242.70X1(e) to crossreference DCAA internal control reviews and other business system audits to the list of "business systems" defined at 252.242–7XXX, Business Systems."

Note the mandate above in 242.70X1(b)(3)(ii)(B)(3) to withhold payments until all deficiencies have been corrected. Note also in 242.70X1(c) above the ability of the ACO to decrease or increase the amount of payment withholding. Then in 242.70X1(d)(3) above the ACO may discontinue withholding payments when the ACO determines the contractor has corrected all deficiencies. The proposed rule continues:

"242.70X2 Contract clause.
Use the clause at 252.242–XXXX, Business Systems, in solicitations and contracts when the solicitation or contract includes any of the following clauses:
(a) 52.244–2, Subcontracts.
(b) 52.245–1, Government Property.
(c) 252.215–7002, Cost Estimating System Requirements.
(d) 252.234–7002, Earned Value Management System.
(e) 252.242–7004, Material Management and Accounting System.
(f) 252.242–7YYY, Accounting System Administration."
* * * * *

Note the reference in 242.70X2(a) above to subcontracts. Subcontracting is addressed in several subsequent locations within the proposed rule including at the end, in the topic area of contractor purchasing systems. Before that point we see other major systems of the contractor addressed in Part 252—Solicitation Provisions and Contract Clauses. We also see in Part 252 the proposed clause at 252.242–7XXX, Business Systems, addressing some key processes and the withholding-payments penalty.

"252.242–7XXX Business systems.
As prescribed in 242.70X2, use the following clause:
Business Systems (Date)
(a) Definitions. As used in this clause—
Acceptable business systems means business systems that comply with the terms and conditions of this contract.
Business systems means—
(1) Accounting system, if this contract includes the clause at 252.242–7YYY, Accounting System Administration;
(2) Earned value management system, if this contract includes the clause at 252.234–7002, Earned Value Management System;
(3) Estimating system, if this contract includes the clause at 252.215–7002, Cost Estimating System Requirements;
(4) Material management and accounting system, if this contract includes the clause at 252.242–7004, Material Management and Accounting System;
(5) Property management system, if this contract includes the clause at 52.245–1, Government Property; and
(6) Purchasing system, if this contract includes the clause at 52.244–2, Subcontracts.
(b) General. The Contractor shall establish and maintain acceptable business systems in accordance with the terms and conditions of this contract.
(c) System deficiencies.
(1) The Contractor shall respond in writing within 30 days to an initial determination of deficiencies from the ACO that identifies deficiencies in any of the Contractor's business system.
(2) The ACO will evaluate the Contractor's response and notify the Contractor in writing of the final determination as to whether the business system contains deficiencies. If the ACO determines that the Contractor's business system contains deficiencies, the final determination will include a notice of a decision to withhold payments.
(d) Withholding payments.
(1) If the Contractor receives a final determination with a notice of the ACO's decision to withhold payments for deficiencies in a business system required under this contract, the ACO will immediately withhold ten percent of each of the Contractor's payments under this contract. The Contractor shall, within 45 days of receipt of the notice, either correct the deficiencies or submit an acceptable corrective action plan showing milestones and actions to eliminate the deficiencies.
(2) If the Contractor submits an acceptable corrective action plan within 45 days of receipt of a notice of the ACO's intent to withhold, but has not completely corrected the identified deficiencies, the ACO will reduce the amount withheld to an amount equal to five percent of each payment until the ACO determines that the Contractor has corrected the deficiencies in the business system. However, if at any time the ACO determines that the Contractor fails to follow the accepted corrective action, the ACO will increase the amount of payment withheld to ten percent of each payment under this contract until the ACO determines that the Contractor has completely corrected the deficiencies in the business system.
(3) If the ACO is withholding payments for deficiencies in more than one business system, the cumulative percentage of payments withheld shall not exceed fifty percent on this contract.
(4) Notwithstanding any other rights or remedies of the Government under this contract, including paragraphs (d)(1) through (d)(3) of this clause, if the ACO determines that there are one or more system deficiencies that are highly likely to lead to improper contract payments being made, or represent an unacceptable risk of loss to the Government, then the ACO will withhold up to one-hundred percent of payments until the ACO determines that the Contractor has corrected the deficiencies.
(5) For the purpose of this clause, payment means any of the following payments authorized under this contract:
(i) Interim payments under—
(A) Cost reimbursement contracts;
(B) Incentive type contracts;
(C) Time-and-materials contracts;
(D) Labor-hour contracts.
(ii) Progress payments.
(iii) Performance-based payments.
(6) The withholding of any amount or subsequent payment to the Contractor shall not be construed as a waiver of any rights or remedies the Government has under this contract.
(7) Notwithstanding the provisions of any clause in this contract providing for interim, partial, or other payment on any basis, the ACO may withhold payment in accordance with the provisions of this clause.
(8) The payment withholding authorized in this clause is not subject to the interest penalty provisions of the Prompt Payment Act.
(e) Correction of deficiencies.
(1) The Contractor shall notify the ACO in writing when the Contractor has corrected the business system's deficiencies.
(2) Once the Contractor has notified the ACO that deficiencies have been corrected, the ACO will take one of the following actions:
(i) If the ACO determines the Contractor has corrected all deficiencies in a business system, the ACO will discontinue the payment withholding under this contract associated with that business system and release any monies previously withheld that are not also being withheld due to deficiencies on other business systems under this contract. Any payment withholding in effect on other business systems under this contract will remain in effect until the deficiencies for those business systems are corrected.
(ii) If the ACO determines the Contractor has not corrected all deficiencies, the ACO will continue the withholding payments in accordance with paragraph (d) of this clause and not release any monies previously withheld.
(End of clause)"

Note the general requirement in 252.242–7XXX(b) above to establish and maintain acceptable business systems. Note the mandate in 252.242–7XXX(c)(2) above: "If the ACO determines that the Contractor's business system contains deficiencies, the final determination will include a notice of a decision to withhold payments." Next, note the mandate in 252.242–7XXX(d)(1) above to "immediately withhold ten percent of each of the Contractor's payments under this contract" for deficiencies in a business system. Then note 252.242–7XXX(d)(3) above explaining that deficiencies in more than one business system can justify withholding up to 50% of payments under the contract.

This already shocking proposed rule now gets worse. Note the 100% mandate in 252.242–7XXX(d)(4) above: "if the ACO determines that there are one or more system deficiencies that are highly likely to lead to improper contract payments being made, or represent an unacceptable risk of loss to the Government, then the ACO will withhold up to one-hundred percent of payments until the ACO determines that the Contractor has corrected the deficiencies." Please note that there is no maximum time limit for withholding in this clause 252.242–7XXX. Instead, under 252.242–7XXX(e)(2)(ii) above it appears that withholding could theoretically continue indefinitely.

Most of the points noted above will be discussed later in this article. For the present, an observation appears warranted. If not earlier, then by this point it seems obvious that the decision makers behind this proposed rule would flunk our hypothetical Introduction to Procurement course. In fact, in my role as their helpful teacher I would encourage them to find a career outside the field of procurement.

Contracting Principles the DoD Forgot, Part 2: Introduction to the Proposed Mandatory Withholding DFAR

On January 15, 2010 the Federal Register published the Department of Defense (DoD) proposed rule "to amend the Defense Federal Acquisition Regulation Supplement (DFARS) to improve the effectiveness of DoD oversight of contractor business systems." Interested parties were invited to submit comments referencing DFARS Case 2009–D038, and a few dozen responses were submitted. At this time we are awaiting further action from the DoD, but it seems unlikely that the DoD will simply drop this proposed rule entirely.

In the Federal Register the DoD provided the following background explanation for the proposed rule:

"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. To improve the effectiveness of Defense Contract Management Agency (DCMA) and Defense Contract Audit Agency (DCAA) oversight of contractor business systems, DoD is considering a rule to clarify the definition and administration of contractor business systems as follows:

1. DoD is proposing to define contractor business systems as accounting systems, estimating systems, purchasing systems, earned value management systems (EVMS), material management and accounting systems (MMAS), and property management systems.

2. DoD is proposing to implement compliance enforcement mechanisms in the form of a business systems clause which includes payment withholding that allows administrative contracting officers to withhold a percentage of payments, under certain conditions, when a contractor's business system contains deficiencies.
Under such circumstances, payments could be withheld on—

• Interim payments under—
  • Cost reimbursement contracts;
  • Incentive type contracts;
  • Time-and-materials contracts;
  • Labor-hour contracts;
• Progress payments; and
• Performance-based payments."

The very first sentence of this background statement illustrates the fundamental flaw in the DoD's thinking about its procurements. It is not "Contractor business systems and internal controls" that serve as "the first line of defense against waste, fraud, and abuse". This statement ignores the customer's responsibilities and conceptually shifts all risk of waste, fraud, and abuse to the contractor. You might ask: "How else could it be?" You might say: "After all, the contractor controls its own actions including wasteful, fraudulent, and abusive actions, and the customer does not commit waste or fraud against itself, or abuse itself." There are some qualifications and exceptions to these thoughts that we could explore, but more importantly, it is the customer's fulfillment of its responsibility to define what it wants in a comprehensive, clear, and timely manner, and the customer's treatment of the contractor in a fair manner, that serves as "the first line of defense against waste, fraud, and abuse". At most, contractor business systems and internal controls are a secondary or tertiary line of defense against waste, fraud, and abuse. The DoD has forgotten some of the basic principles of procurement in our culture.

Coming soon: Part 3: "Business Systems" Excerpts from the Proposed Mandatory Withholding DFAR

Contracting Principles the DoD Forgot, Part 1: Mandatory Payment Withholding Consequences for Contractors

If you were to design an Introduction to Procurement course for undergraduates enrolled in a Business College of a University, during the first or second class you would introduce basic general concepts, and some customs, traditions, and tendencies that have historically formed the environment for procurements in our culture, and that still form that environment. The American concept of “fairness” as perceived and applied in the realm of business and more specifically in the context of procurements would be one of the important general cultural concepts introduced and would likely generate lively discussion. The American “can do” mindset, particularly among vendors, would be another cultural discussion point. This traditional attitude is so deeply ingrained within us that often we are not aware of its influences. The tradition of the American work ethic would also be mentioned in class, and some enjoyable debate might arise over which parts of the country exhibited the greatest degree of this work ethic of our forefathers. Along with many other customs you would go on to mention the typical responsibilities of the parties at a high level of abstraction—at the “50,000 foot level”. For example, you might explain that customers usually have two major responsibilities at the 50,000 foot level: (a) to define what the customer wants; and (b) to pay for it.

The customer’s first responsibility is to (i) define its required product or service deliverables, results, research, engineering, efforts, or other commitments from the vendor in advance of entering into a contract; or (ii) hire a consultant or a vendor to help specify them in advance; or (iii) require samples or a prototype that must be approved before the customer fully commits; or (iv) provide safe harbors for the vendor; or (v) specify some other requirements. A safe harbor in this general procurement context might include a commitment and a set of required conditions that, if completed or satisfied by the vendor, trigger payment, or earn other consideration, and protect the vendor against unreasonable rejection, termination, and/or liability. The set of conditions might include a vendor’s certification on certain ISO standards, a customer’s pre-contract inspections of required operations, or a customer’s acceptance criteria that are clear and comprehensive.

Since our hypothetical course is a basic introduction to procurement, a young student might ask: “Why must the customer define requirements for the vendor in advance of entering into a contract?” One answer is because the vendor is not a mind reader. Another answer is that fairly often the vendor needs to know the customer’s requirements in order to set a price including any applicable discounts or premiums. Still another answer is that customers often have only a poorly defined notion of what they want, and if they do not improve that notion and also clearly communicate what they want, it is not the vendor’s fault.

Without a comprehensive notion of what they want that is clearly and timely communicated to their bidders or vendor, customers may very well not be happy with what they receive, and they may reject, terminate, litigate, or pay more to get what they decide they really want. In fact, this situation of customers not knowing what they want, or having only a vague notion about it, and often not clearly or timely communicating their poorly-thought-out requirements, is a reality in both commercial and government procurements, and is a major cause of cost overruns. If customers could better define what they wanted—comprehensively, clearly, and in a timely manner, then some noticeable excess expenditures could be avoided.

Further, if a customer poorly defines its requirements, or delays in defining them, and attempts to shift to its vendor the risk of resulting cost-overruns and performance glitches or delays, the situation quickly becomes unfair, and it justifies the vendor, among other reactions, in requiring a premium for accepting a high-risk procurement. One of the traditions surrounding procurements in our culture is that with higher than normal risk goes greater than normal reward. If the customer refuses to pay a premium in a higher-than-normal-risk context and still imposes these risks, the customer encourages the vendor to (i) hide extra profit; or (ii) ignore non-standard requirements, especially if they are communicated after contract commencement; or (iii) take other steps intended to balance reward with risks. Under no circumstances will the vendor want to accept a penalty due to the customer’s poorly defined requirements or delays in defining them.

The second customer responsibility—to pay for its requirements--includes making payments to vendors on schedule and without unreasonable or capricious payment lateness, withholding or denial. Denying payments earned, and, in the alternative, lengthy withholding periods for payments earned through performance, are each a very serious matter. Each situation has the tendency to at least diminish business relationships, and often generates disputes. Small, and even mid-sized, vendors have been known to go out of business fairly quickly if the size of the payment denied or withheld is noticeable.

As our final academic point, near the beginning of our hypothetical basic procurement course you might also explain that, considering all procurements in the country at any given point in time, more often than not neither party to a typical contract may unilaterally change its terms or conditions in any significant way during its life. Of course, customers with unusual leverage, such as government customers, may make such demands. However, even in the face of considerable leverage, absent additional discussion and accord, and absent mutually-acceptable change mechanisms built into the contract in advance and reasonably implemented, disputes will often arise as a result of significant unilateral changes in contracts during their term. Such disputes commonly give rise to procurement delays, unforeseen costs, and sometimes other unforeseen consequences.

This is a general academic review, and these are all basic procurement concepts, customs, traditions, tendencies, and commonplace results. In the United States, everyone with any measurable experience in procurement should be very aware of them. They are not advanced course or graduate course material. Yet earlier this year our federal government appears to have forgotten some of them.

Coming soon: Part 2: Introduction to the Proposed Mandatory Withholding DFAR

Tax Penalties and FAPIIS--Part 2

Part 2 of "Tax Penalties and FAPIIS" discusses some examples of tax penalties and their possible relation to the FAPIIS database.

Penalty Example One

It is hard to imagine what could connect a contractor’s tax penalties with the award to the contractor of a Federal contract, or with the contractor’s performance under that contract. Putting our imagination in overdrive, what if the Federal contract is performed partly by subcontractors that the prime contractor should have treated as employees, and after an IRS audit the prime contractor pays employment-related taxes and penalties? Should these penalties be reported in FAPIIS? In the FAR quoted above, it appears that the elements of requirement (c)(1)(iii) could be satisfied. For example, in an IRS audit and offer-in-compromise context, or in an appeal to the IRS Office of Appeals, liability that results in a penalty of $5,000 or more is certainly possible. In addition, the payment of a reimbursement, restitution, or damages in excess of $100,000 is not unheard of in such an administrative proceeding context. The taxpayer is not being sued in court here, but the pressure that the IRS can apply to resolve the dispute is considerable. Thus, in this example there does appear to be a connection between our hypothetical contractor’s tax penalties and his performance under a Federal contract.

We could stop here and conclude that we have shown a "sometimes" positive answer to the question of whether IRS penalties must be listed in FAPIIS, but we should also consider requirement (c)(1)(iv). Note in (c)(1)(iv) the words "a disposition of the matter by consent or compromise with an acknowledgment of fault by the Contractor". Wherever else they may be found, we see tax concepts here that we can find in the Internal Revenue Code sections quoted above—note the word "compromise" for example. An arguably broader, context-neutral word like "agreement" could have been selected. Settlement agreements are sometimes achieved by capitulation rather than compromise. Thus, logic suggests that the selection of "compromise" held one or more specific intentions, and the Internal Revenue Code’s tax concept of a "compromise" fits like a glove. Also, liability for some portion of taxes due is acknowledged in an offer-in-compromise, at least when it is accepted if not before. Finally, as we have seen, "the proceeding could have led to" the outcome specified in paragraph (c)(1)(iii). Looking at all of (c)(1)(iv), it appears that example number one could satisfy all of its elements.

Given two ways this example number one could satisfy the criteria of FAR 52.209-7, one through satisfying (c)(1)(iii) and the other through satisfying (c)(1)(iv), it appears that FAR 52.209-7 contemplates tax penalties within FAPIIS and hence tax penalties must be reported in FAPIIS under certain circumstances.

Penalty Example Two

Another example might arise where a contractor simply did not pay employment-related taxes for employees working on a Federal contract project, and after an IRS audit the contractor paid employment-related taxes, interest and penalties. In 2009 a failure to pay employment-related taxes generated the greatest volume of penalties in the employment taxes category. (See this IRS spreadsheet.) It appears that the elements of requirement (c)(1)(iii) of FAR 52.209-7 could be satisfied by this example, which again seems to suggest that some tax penalties must be reported in FAPIIS. It appears that (c)(1)(iv) also could be satisfied, and again that possibility seems to suggest the intention that some tax penalties must be reported in FAPIIS.

Penalty Example Three

Perhaps an award-related example might be helpful now that we have seen two contract performance examples. Imagine the contractor using a consultant, or perhaps a supplier or a subcontractor to help prepare an unsolicited proposal in a new product area. Then imagine that the contractor took excessive expense deductions for this proposal-preparation assistance that were caught in an IRS audit, after which the contractor paid additional taxes and penalties. Yet again it appears that the elements of requirements (c)(1)(iii) and (c)(1)(iv) of FAR 52.209-7 could be satisfied, which again seems to suggest that some tax penalties must be reported in FAPIIS.

Penalty Example Four

Are there any future-oriented examples? It has been reported that starting in a few years businesses will have to file with the IRS additional documents, known as 1099 forms, which state the total value of goods they buy from a single vendor if that total exceeds $600 annually--goods, for example, such as office supplies. (See the report for example in the July 17, 2010 article in The Wall Street Journal’s online Opinion Journal entitled "Lost in Taxation, The IRS's vast new ObamaCare powers".)

Before this rule was enacted businesses only had to tell the IRS the value of services they purchased. Imagine for the sake of discussion that this new rule is not repealed, and that our hypothetical contractor does not file 1099s for parts purchased that were built into products sold to the govenrment. Then imagine this failure to file 1099s was caught in an IRS audit, after which the contractor paid penalties. This situation is one more example in which it appears that the elements of requirements (c)(1)(iii) and (c)(1)(iv) of FAR 52.209-7 could be satisfied, which in turn further suggests that some tax penalties must be reported in FAPIIS.

Penalty Example Five

What about state tax penalties? To name just one state, California considers and accepts some offers in compromise from companies. Let us use penalty example number two again, but apply it at the state level. Imagine our hypothetical contractor did not pay state employment taxes for employees working on a Federal contract project, and that after a state audit the contractor paid the state a failure-to-pay tax penalty. Once again it appears that the elements of requirements (c)(1)(iii) and (c)(1)(iv) of FAR 52.209-7 could be satisfied, which suggests fairly clearly that some state tax penalties must be reported in FAPIIS.

Other Examples

You may think of better, or at least additional, examples. Comments are welcome.

Conclusion

How will government procurement personnel react to a contractor’s self-reported tax penalties found in the FAPIIS database? Will any of them ever overreact notwithstanding any contractor comments in FAPIIS? I believe that we will see instances of a large or mid-sized contractor found lacking for a major contract award by government contracting personnel who review the contractor’s self-reported negative data in the FAPIIS database and decide subjectively and excessively that there are sufficient responsibility concerns to warrant bid rejection.

In addition, what will competitors without tax penalties in their FAPIIS record do with the information that the contractor in question has paid tax penalties? Perhaps as much or more than in government procurements, in the world of commercial procurements such negative information about a contractor is potentially helpful to competitors.

Is tax penalty data a good indicator of a contractor’s contract-performance history? Or has the information net been cast too wide by FAPIIS? Could it be that tax penalties must be reported in FAPIIS under certain circumstances due to concerns about contractors living up to their tax payment "responsibility of citizenship"? Note a January 20, 2010 Presidential Memorandum that might be interpreted as supporting this view.

AF

Tax Penalties and FAPIIS--Part 1

It seems safe to say that most Americans and American companies regard tax audits with some dread. After all, an IRS Revenue Agent’s determination that taxes are due may well lead to the payment of interest on top of the taxes due, and, possibly, lead to the payment of penalties.

A few examples of grounds for tax penalties and of their respective possible fines and sentences are quoted below from the United States Code.

Example 1

"26 U.S.C. § 7201: Attempt to evade or defeat tax

Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution."

Example 2

"26 U.S.C. Section 7206: Fraud and false statements

Any person who -
(1) Declaration under penalties of perjury
Willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter;
* * * * *
shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 3 years, or both, together with the costs of prosecution."

Example 3

"26 U.S.C. Section 7207: Fraudulent returns, statements, or other documents

Any person who willfully delivers or discloses to the Secretary any list, return, account, statement, or other document, known by him to be fraudulent or to be false as to any material matter, shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both. . . ."

Reading these statute sections can be unsettling, and perhaps equally unsettling is the Internal Revenue Manual for IRS personnel, especially in Part 20, Penalty and Interest, and sub-part 20.1, the "Penalty Handbook".

Of course, even if you are audited and find the prospect of penalties looming in your future, there is a possibility, however slim, that you may be able to reduce your taxes due and potential penalties. For example, with those goals in mind you could offer a compromise settlement. Note the following section 7122 from the Internal Revenue Code.

"26 U.S.C. Section 7122: Compromises

(a) Authorization
The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.
(b) Record
Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate, with his reasons therefor, with a statement of -
(1) The amount of tax assessed,
(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed
* * * * *
(c) Standards for evaluation of offers
(1) In general
The Secretary shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.
* * * * *
(3) Special rules relating to treatment of offers
The guidelines under paragraph (1) shall provide that -
(A) an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer; and
(B) in the case of an offer-in-compromise which relates only to issues of liability of the taxpayer -
(i) such offer shall not be rejected solely because the Secretary is unable to locate the taxpayer's return or return information for verification of such liability; and
(ii) the taxpayer shall not be required to provide a financial statement.
(d) Administrative review
The Secretary shall establish procedures -
(1) for an independent administrative review of any rejection of a proposed offer-in-compromise or installment agreement made by a taxpayer under this section or section 6159 before such rejection is communicated to the taxpayer; and
(2) which allow a taxpayer to appeal any rejection of such offer or agreement to the Internal Revenue Service Office of Appeals."

We see here in section 7122 of the Internal Revenue Code some references to the tax assessed, to interest, and to an assessable penalty, but this section 7122 at least gives one some small hope of a possible compromise. Also potentially helpful is the administrative review option for rejections of this offer in compromise. The administrative process begun with filing an offer in compromise would then extend to the appeal at the IRS Office of Appeals.

FAPIIS Connection?

Is there a connection between these tax considerations or proceedings on the one hand, and FAPIIS on the other hand? To the best of my knowledge no one has authoritatively answered this question to date. Consequently at this point in time reasonable people might disagree over the answer. Obviously that situation would not help a contractor who did not list tax penalties in FAPIIS and subsequently suffered negative consequences as a result.

So, must IRS penalties be listed in FAPIIS? I believe the correct answer may be "sometimes", or "it depends". I explain my suggested answer below. Unfortunately, the question of whether state tax penalties must be listed in the FAPIIS database also arises, and once again I believe the correct answer may be "sometimes". I also explain this answer below.

Consider the following.

We know that FAR 52.209-7 imposes the following contractual requirements upon the offeror:

"(b) The offeror [ ] has [ ] does not have current active Federal contracts and grants with total value greater than $10,000,000.
(c) If the offeror checked "has" in paragraph (b) of this provision, the offeror represents, by submission of this offer, that the information it has entered in the Federal Awardee Performance and Integrity Information System (FAPIIS) is current, accurate, and complete as of the date of submission of this offer with regard to the following information:
(1) Whether the offeror, and/or any of its principals, has or has not, within the last five years, in connection with the award to or performance by the offeror of a Federal contract or grant, been the subject of a proceeding, at the Federal or State level that resulted in any of the following dispositions:
(i) In a criminal proceeding, a conviction.
(ii) In a civil proceeding, a finding of fault and liability that results in the payment of a monetary fine, penalty, reimbursement, restitution, or damages of $5,000 or more.
(iii) In an administrative proceeding, a finding of fault and liability that results in—
(A) The payment of a monetary fine or penalty of $5,000 or more; or
(B) The payment of a reimbursement, restitution, or damages in excess of $100,000.
(iv) In a criminal, civil, or administrative proceeding, a disposition of the matter by consent or compromise with an acknowledgment of fault by the Contractor if the proceeding could have led to any of the outcomes specified in paragraphs (c)(1)(i), (c)(1)(ii), or (c)(1)(iii) of this provision.
(2) If the offeror has been involved in the last five years in any of the occurrences listed in (c)(1) of this provision, whether the offeror has provided the requested information with regard to each occurrence."

To a fair degree this FAR echoes section 872 of The Duncan Hunter National Defense Authorization Act of 2009 (the "ACT").

Let us assume for the sake of discussion that we are considering a contractor with current active Federal contracts and grants totaling more than $10,000,000. Note in requirement (c)(1) above the words "in connection with the award to or performance by the offeror of a Federal contract or grant". How broad or narrow is the (c)(1) concept of "in connection with"? Must the connection be direct or can it be indirect? What connects a Federal contractor’s tax penalties with "the award to or performance by the offeror of a Federal contract or grant"?

We will discuss examples of tax penalties in Part 2, to be posted on September 3rd.

Publicly Available FAPIIS – Consequences For Grant Recipients?

As OMBWatch explains here, FAPIIS becoming publicly available is a wonderful thing.

“When President Obama signed this year's supplemental appropriations bill, he delivered a big win for the good government community, as a little known transparency amendment attached to the bill became law. The amendment, introduced by Sen. Bernie Sanders (I-VT), will require the General Services Administration (GSA) to make most of the Federal Awardee Performance and Integrity Information System (FAPIIS) publically available.

Now, the public will have access to information on a contractor's past performance, specifically if the government has slapped them with any penalties, including non-responsibility determinations, terminations for default, administrative agreements over suspension or debarment, and criminal and civil proceedings.”

However, it remains to be seen whether the positive consequences of the FAPIIS database becoming publicly available will outweigh the negative consequences. Will the god of Unintended Consequences rule over the consequences of the FAPIIS database becoming publicly available? “To a degree” may be the correct answer, but only time will disclose how much. We know that FAR 52.209-7 imposes the following contractual requirements upon the offeror:

“(b) The offeror [ ] has [ ] does not have current active Federal contracts and grants with total value greater than $10,000,000.
(c) If the offeror checked “has” in paragraph (b) of this provision, the offeror represents, by submission of this offer, that the information it has entered in the Federal Awardee Performance and Integrity Information System (FAPIIS) is current, accurate, and complete as of the date of submission of this offer with regard to the following information:
(1) Whether the offeror, and/or any of its principals, has or has not, within the last five years, in connection with the award to or performance by the offeror of a Federal contract or grant, been the subject of a proceeding, at the Federal or State level that resulted in any of the following dispositions:
(i) In a criminal proceeding, a conviction.
(ii) In a civil proceeding, a finding of fault and liability that results in the payment of a monetary fine, penalty, reimbursement, restitution, or damages of $5,000 or more.
(iii) In an administrative proceeding, a finding of fault and liability that results in—
(A) The payment of a monetary fine or penalty of $5,000 or more; or
(B) The payment of a reimbursement, restitution, or damages in excess of $100,000.
(iv) In a criminal, civil, or administrative proceeding, a disposition of the matter by consent or compromise with an acknowledgment of fault by the Contractor if the proceeding could have led to any of the outcomes specified in paragraphs (c)(1)(i), (c)(1)(ii), or (c)(1)(iii) of this provision.
(2) If the offeror has been involved in the last five years in any of the occurrences listed in (c)(1) of this provision, whether the offeror has provided the requested information with regard to each occurrence.”

Much of this information is already publicly available—in the public domain. For example, with some qualifications and exceptions, criminal law convictions are available from court records, and most civil law court files will be available from the clerk of the court. Online databases make many reported cases available. However, as public-domain information publishers are aware, the power of collected, searchable, and online-assessable public-domain information is often greater than discrete components thereof. Obviously, without a comprehensive database some individual items of information may be difficult and time consuming to find, others may go unnoticed, and individual items do not illustrate or subtly suggest patterns of behavior that might be detected in a comprehensive collection of searchable and online-accessible data.

Nevertheless, such a database of public-domain information may have unintended and undesirable consequences as well. Other commentators have ably speculated about possible unintended and harmful consequences of making the FAPIIS database publicly available. It would be interesting to focus on some less recognized potential consequences. Let us consider federal grant recipients for a moment, and let us focus in particular on large grant recipients. How will they be affected by the FAPIIS database becoming publicly available?

Large charitable organizations and universities are two types of large federal grant recipients. Their purposes vary. Some large charitable organizations focus on community improvement activities, some focus on K-12 education initiatives, some focus on medical research, and so on. Within large universities it is commonplace to see an engineering college receiving grants. There are many other examples of federal grant recipients.

As we see above in FAR 52.209-7, FAPIIS-related regulations appear to require large Federal grant recipients to self report various types of negative data. These particular reporting requirements spring from The Duncan Hunter National Defense Authorization Act of 2009 (Public Law 110-417).

Now let us suppose for the sake of discussion that a large charitable organization or university annually receives grants with a value in excess of $10,000,000. How will such an institution be affected by the FAPIIS database becoming publicly available?

Assuming some negative data is reported to FAPIIS by such an institution, we can easily imagine that this negative data may be publicized by the press or in privately run blogs. FAPIIS will become a favorite news-item source for the press and news-oriented blogs. It will be a free buffet of bad news items, each admitted by the reporting institution. Patterns of negative events may become the most sensational news. Imagine the press claiming that a few instances of one type of negative event recorded in FAPIIS show a pattern—a pattern of insensitivity, a pattern of mismanagement or incompetence, a pattern of corruption, a pattern of oppression, a pattern of dangerous activity, etc. Perhaps the patterns of behavior detected in FAPIIS data, or concocted by the press from FAPIIS data, will become more troublesome for institutions than individual news items.

Will any large charitable organization or university be happy about negative data found in FAPIIS being publicized? Not likely. Why not? Well, for one thing publicized FAPIIS database content will draw public attention to the institution’s significant items of dirty laundry. That will be embarrassing. Historically, public embarrassment of a large charitable organization or university has fairly often negatively affected donations. Donations are one of the major sources of funding for such institutions—part of their lifeblood. Can you imagine the public relations groups of such institutions growing in size and importance as they tackle the difficult task of trying to minimize the donation blood letting that such publicity may trigger? It seems possible that institutional public image management may become more difficult than ever before.

Let us be more specific. What kinds of negative information might be reported to FAPIIS by large universities? Obviously, there may be quite a variety of types of negative data stemming from various types of proceedings, including civil law suits brought by parents of students who commit suicide on the university’s campus each year. Must they be reported? If damages in excess of $5,000 are paid, it appears that they should be reported.

In response to a FAPIIS listing of a few suicide cases in which damages are paid there is likely to be some increase in interest in the overall suicide rate at a university. After all, prospective student applicants and their parents are not stupid, and the safety of their child on campus is a common parental concern. Will such a broader interest in all suicides on campus each year cause university ranking organizations to create a new rating category addressing the number of suicides on campus each year? How many student suicides per year will it take to lower the ranking of a university? Will three or more suicides per academic year be enough to drop one of the top 10 or 15 into the ranks of second-tier universities? Will any significant loss in ranking have a bearing on what annual tuition increases can be justified?

What about on-campus violent crime, such as assault and sexual assault, and resulting litigation against the university for inadequate security measures? If there is a damage award in excess of $5,000, these civil cases against a university seem to fall into the “must report to FAPIIS” category.

What about on-campus personal injuries and the personal injury cases that follow? For example, what about student partying on campus during which students get hurt by doing stupid, often alcohol-fueled things like jumping or falling out a window or being thrown out a window that was not locked or blocked from opening enough to prevent the exit? Again, if there is a damage award in excess of $5,000, these civil cases against a university seem to fall into the “must report to FAPIIS” category.

Will a FAPIIS collection of information about legal claim damages over on-campus suicides, assaults, and personal injuries cause a reduction in applicants, or in the number of the smartest students, applying each year? Conversely, will low numbers of such events help to persuade more applicants, including more very smart applicants, to apply to the universities with the low numbers?

Will large universities launch on-campus security improvement initiatives such as hiring more guards or on-campus police and improving external lighting, in part, to reduce the volume of litigation and FAPISS disclosures of negative events? What other types of internal initiatives will be launched by large universities in an attempt to reduce negative events and thereby minimize the volume of negative data reported to FAPIIS? Some prestigious universities currently offer little or no training to their resident assistants or resident advisors (“RAs”), thereby arguably leaving themselves open to avoidable liability and avoidable reporting to FAPIIS. Universities offering new RAs a month of training in the summer before classes begin are much better situated to minimize liability and minimize reporting to FAPIIS.

Plaintiffs’ trial counsel will likely smile at least slightly over self-reported negative information available in FAPIIS, for example, data regarding on-campus suicides, violent crimes, and personal injuries, because it can be used as a basis to assert that there is a virtually self-admitted pattern of negligence by the university . . . and that pattern can be used to help support greater than average damage awards. Will tuitions go up as a result of greater damage awards?

Or now that FAPIIS has become publicly available will universities fall prey to threats of litigation, for example, from some unions threatening lawsuits? Will FAPIIS become an indirect lever used by unions to pressure university administrations?

It will take some time for the consequences of the public availability of FAPIIS negative data to fully unfold, but it seems reasonably clear now that large charitable organizations and universities may suffer significant unintended consequences from such public availability. It is certainly easy to speculate about the unintended consequences they may suffer, and this article does not pretend to include all possibilities.

What do you think?

AF

Is FAPIIS the Business Equivalent of “Pick-Your-Poison?” (Part 2)

Difficulties

We begin to see some difficulties when the above-referenced rules and regulations are applied to a contractor with current active Federal contracts and grants totaling more than $10,000,000. Intentionally, for discussion purposes, we are not considering a small business concern here, but instead consider a medium-sized or large company or grant-receiving organization. When we consider the multi-million dollar contracts commonly pursued in this larger contractor realm, one obvious difficulty is that a fine or penalty of $5,000 or any sum close to it is trivial and not hard to incur. By itself, this low threshold of "$5,000 or more" makes the ACT anti-business in nature. This low threshold aspect of the ACT and its related federal acquisition regulations should be revised and made more practical.

To add insult to injury, in subsection (f) of section 872 of the ACT we are advised that contractors must self-report the above-required content for the FAPIIS database. Subsection (f) states:

"f) DISCLOSURE IN APPLICATIONS.—Not later than one year after the date of the enactment of this Act, the Federal Acquisition Regulation shall be amended to require that persons with Federal agency contracts and grants valued in total greater than $10,000,000 shall—
(1) submit to the Administrator, in a manner determined appropriate by the Administrator, the information subject to inclusion in the database as listed in subsection (c) current as of the date of submittal of such information under this subsection; and
(2) update such information on a semiannual basis."

FAR 52.209-7 helps to implement the statute by imposing the following contractual requirements upon the offeror:

"(b) The offeror [ ] has [ ] does not have current active Federal contracts and grants with total value greater than $10,000,000.
(c) If the offeror checked "has" in paragraph (b) of this provision, the offeror represents, by submission of this offer, that the information it has entered in the Federal Awardee Performance and Integrity Information System (FAPIIS) is current, accurate, and complete as of the date of submission of this offer with regard to the following information:
(1) Whether the offeror, and/or any of its principals, has or has not, within the last five years, in connection with the award to or performance by the offeror of a Federal contract or grant, been the subject of a proceeding, at the Federal or State level that resulted in any of the following dispositions:
(i) In a criminal proceeding, a conviction.
(ii) In a civil proceeding, a finding of fault and liability that results in the payment of a monetary fine, penalty, reimbursement, restitution, or damages of $5,000 or more.
(iii) In an administrative proceeding, a finding of fault and liability that results in—
(A) The payment of a monetary fine or penalty of $5,000 or more; or
(B) The payment of a reimbursement, restitution, or damages in excess of $100,000.
(iv) In a criminal, civil, or administrative proceeding, a disposition of the matter by consent or compromise with an acknowledgment of fault by the Contractor if the proceeding could have led to any of the outcomes specified in paragraphs (c)(1)(i), (c)(1)(ii), or (c)(1)(iii) of this provision.
(2) If the offeror has been involved in the last five years in any of the occurrences listed in (c)(1) of this provision, whether the offeror has provided the requested information with regard to each occurrence."

As we see above, given "current active Federal contracts and grants with total value greater than $10,000,000", the contractor represents that the information he submitted to the FAPIIS database "is current, accurate, and complete".

Now we need to remember FAR 52.214-4 regarding false statements in bids which states in part:

"The penalty for making false statements in bids is prescribed in 18 U.S.C. 1001."

Title 18 of the United States Code tells us in section 1001 that anyone within the jurisdiction of "the executive, legislative, or judicial branch of the Government of the United States" who "knowingly and willfully" . . . "makes any materially false, fictitious, or fraudulent statement or representation" shall "be fined under this title, imprisoned not more than 5 years . . . or both."

Given the representation mentioned above, it appears that at least in some situations contractors may face fines or imprisonment for submitting incomplete or false information to the FAPIIS database.

How will government procurement personnel react to a contractor’s self-reported negative data found in the FAPIIS database? Will any of them ever overreact notwithstanding any contractor comments in FAPIIS? I believe instances of de facto debarment are inevitable and will be easily covered up by procurement personnel. A large or mid-sized contractor may be subject to de facto debarment from a major contract award by overreacting contracting personnel who review the contractor’s self-reported negative data in the FAPIIS database and decide subjectively, excessively, and without bothering to go through proper debarment procedures, that there are sufficient responsibility concerns to warrant bid rejection.

On the other hand, this hypothetical contractor may also be subject to fines and imprisonment if negative data reported is not complete and accurate and if the omissions or inaccuracies are caught.

This hypothetical scenario of (1) "possible de facto debarment due to reporting negative data" versus (2) "possible fines and imprisonment due to not reporting negative data" sounds like a theoretical Catch 22 situation, but the potential loss of huge contracts versus potential fines and imprisonment are too serious for the normal, every-day category of Catch 22 situations. Instead, this scenario places two vials of Hemlock in front of a business and asks it to drink one. It is the business equivalent of asking you to pick your poison. This poison may or may not kill you, but it definitely is not good for your health.

Is this picture too extreme? Tell that to a company that loses out on a multi-million dollar contract due to de facto debarment, even a one-time de facto debarment, especially if layoffs and facility closings follow the loss. Tell that to the laid off workers as they apply for unemployment compensation and food stamps, and then lose their homes because they cannot find other work in the current economy with its high unemployment rate. Ask these workers how they feel. Ask their family members how they feel. Then see if you say this suggestion of FAPIIS business equivalence with being forced to choose a poison is too extreme to have merit.

Do you retort that no federal government contracting personnel will excessively subject a bidder to de facto debarment? Then I ask, what is the source of your faith in their perfection? Then I ask, why does section 869 of the ACT say:

"(c) CRITERIA.—The Acquisition Workforce Development Strategic Plan shall include, at a minimum, an examination of the following matters:

(1) The variety and complexity of acquisitions conducted by each Federal agency covered by the plan, and the workforce needed to effectively carry out such acquisitions."

Federal agencies have undertaken diverse and complex acquisitions for decades, and many of them already have in place extensive training programs for procurement personnel. One possibility is that this call for The Acquisition Workforce Development Strategic Plan is more than an employment initiative and is intended, in part, to address the obvious potential for de facto debarment abuses and an increased volume of unofficial complaining and official protests alleging unjustified and unreasonable agency decisions regarding responsibility determinations. The FAPIIS database and its use are certainly not likely to make contractors less prone to complain and protest.

What do you think?

-AF