New U.S. Law Targets Flawed Pricing, Auditing Systems

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WASHINGTON — The newly signed Defense Authorization Act gives the Pentagon nine months to launch a program to ensure that contractors’ business systems provide reliable information for pricing and auditing purposes.

For firms that fall short, the Pentagon could withhold up to 10 percent of some contract payments.

Department of Defense (DoD) officials are analyzing the law to decide how to proceed with their push for a similar policy, said Defense Department spokeswoman Navy Cmdr. Kathleen Kesler.

The Pentagon published its own rule in the Federal Register — first last January and again, in a revised form, in December — that would authorize DoD officials to withhold some payments to contractors that use flawed accounting and pricing systems to calculate invoices.

The revised rule drew scorn from contractor trade groups and law firms as being unfair. If the department proceeds with its own rule, it could publish an interim or final rule by May, Kesler said.

Defense consultant Nicholas Sanders said “it makes no sense” for the DoD to go ahead with its proposal when the Defense Authorization Act “establishes a similar — yet different — set of business system requirements for defense contractors.”

The Pentagon’s effort to get tougher with contractors who use faulty financial systems dates back to last January, after the independent, bipartisan Commission on Wartime Contracting reported that auditors had been unable to verify billions of dollars worth of vendor-claimed costs charged to DoD in connection with the military and reconstruction operations in Iraq and Afghanistan.

Under the proposed rule published last January, the department called for withholding 10 percent of contract payments if certain vendor business systems were found to be deficient. That approach is needed, the department argues, because flawed business systems could inflate charges for goods and services.

That proposal hit stiff resistance from industry groups. Under the revised version published in December, the department reduced the proposed withhold amount to 5 percent and capped it at 2 percent for small businesses. If a deficiency is considered high risk, a maximum of 20 percent could be withheld, down from 100 percent in the original proposal. Withholding payments would be a way to mitigate the government’s risks, not penalize contractors, according to the department.

“DoD offers no new justification for withholding contract payments,” David Churchill, a government contracts attorney at Jenner & Block, posted on Regulations.gov. “Thus, industries’ criticism of the initial rule’s intended purpose applies equally to the revised rule.” A primary shortcoming, Churchill added, is the potential to cause “significant cash flow shortfalls” that could cripple a contractor.

The comment period for the revision ended Jan. 10.

The Council of Defense and Space Industry Associations, a coalition of a half-dozen groups that includes the U.S. Chamber of Commerce and the Professional Services Council, said that although the revised proposal is an improvement over its predecessor, concerns remain. Among them: The amount of money withheld from a vendor could be considerable, even if known flaws in that vendor’s business system result in no or minimal additional cost to the Defense Department. As a result, the amount withheld could be “grossly disproportionate” to the impact of system flaws, the coalition said.

But lowering the percentage of payments that can be withheld also reduces the government’s leverage over contractors, said Scott Amey, general counsel for the Project on Government Oversight.

“Unfortunately, DoD and Congress see little need for a first-line defense against waste, fraud and abuse,” Amey added in an e-mail. “Good luck settling up billions of dollars in unallowable and unreasonable costs after the fact.”

Under the Defense Authorization Act, the Pentagon must spell out the requirements for each type of business system and also create a review process to flag problems. When problems are found, contractors would have a chance to make fixes before any contract payments are withheld.