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.

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.

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 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