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ACI’s 4th DCAA & DCMA Audit & Compliance Boot Camp

Dave Nadler Partner Dickstein Shapiro LLP

Hot Legal Buttons for Government Contractors: The Increasing Role of DCAA in False Claims

Cases and the Statute of Limitations

Christopher Wolf Vice President, Contracts & Procurement The Louis Berger Group

Bill Walter Partner Dixon Hughes Goodman‚ LLP

July 21-22, 2014

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Agenda

• Fraud Indicators

• DCAA Interviews to Detect Fraud

• Statute of Limitations

• Access to Records

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Fraud Indicators

• Increasing number of False Claims Act cases are being initiated after referrals to DoD IG based on DCAA’s application of fraud indicators during routine audits

• Although DCAA auditors are not trained fraud investigators, DCAA policy is to refer potential fraud to DoD IG for investigation

• DCAA recently canceled its Handbook on fraud indicators and replaced it with four contract audit fraud scenarios on its website

• Review of professional/consultant services

• Subcontractor/vendor kickbacks

• Adjusting journal entries-labor transfers

• Material transfers

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Fraud Indicators

• Although the audit scenarios provide specific examples of fraud indicators, the indicators are generally undefined and provide only vague generalities

• Auditors are encouraged to refer possible fraud to DoD IG, even when unconfirmed and even when the potentially improper costs have already been excluded as unallowable

• DoD IG has provided the following guidance:

• Auditors do not need proof that a fraud or other crime occurred prior to making a referral

• The auditor should err on the side of caution and, when in doubt, make a referral

• Auditors should be “proactive” in referring potential fraud 4

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Fraud Indicators

• Many indicators focus on a lack of documentation or lack of sufficient internal policies and/or training

• A lack of documentation may be a cause for disallowance, but it does not necessarily mean that a cost was not incurred or was fraudulent

• DCAA also focuses on whether actions seem to differ from the normal course of business activities or from internal policies

• Auditors are also encouraged to ask management whether they have knowledge of any fraud or suspected fraud

• Subjective opinions about whether fraud has occurred may prompt further review and an ultimate referral for fraud

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Discussion Points

• Auditors are questioning any irregularities as possible fraud, even in the absence of evidence of any fraudulent activity

• Auditors make fraud referrals even “when in doubt” as to whether improper activity occurred

• Subjective opinions of employees may be considered relevant to whether fraudulent activity has occurred

• Contractors should proactively implement policies designed to address fraud indicators identified by DCAA in its contract audit fraud scenarios

• These scenarios provide a roadmap of what DCAA looks for; internal controls should be designed to detect and prevent these types of occurrences

• Contractors should ensure that full explanations are provided to DCAA to mitigate fraud referral risk; address any auditor concerns in a timely manner

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DCAA Interviews to Detect Fraud

• DCAA issued MRD 13-PAS-014(R) on July 30, 2013, to encourage auditors to interview employees about allegations of fraud and to follow up as they deem appropriate

• DCAA is encouraging auditors to broadly interview employees about any actual or suspected fraud, including any allegations of fraud from any source

• The lines of questioning advocated by DCAA implicate the purely subjective opinions of company personnel

• There is no time period recommended by DCAA, so the questions could go back for years

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DCAA Interviews to Detect Fraud

• DCAA is encouraging auditors to use their “professional judgment” to determine who to interview, but that list should include anyone “responsible for the day-to-day management or accomplishment of major accounting/estimating functions”

• The list of interviewees deemed relevant by DCAA could be unlimited

• DCAA may ask managers for their subjective opinions as to whether fraudulent activity has occurred

• DCAA is encouraging auditors to conduct interviews on a face-to-face basis to:

• “Measure responses”

• “Ask follow-up questions”

• “Identify other employees than can corroborate responses”

• DCAA encourages interviews to be open-ended and expansive; audits may become more of an investigation than an audit

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DCAA Interviews to Detect Fraud

• DCAA cites no statutory, regulatory, or contractual authority for conducting these investigatory functions

• Although FAR 52.215-2 arguably gives DCAA access to records, it does not do so for individuals

• DCAA auditors are not authorized to undertake fraud investigations; they are only permitted to report suspected fraud through the referral process

• DCAA rejects this position:

• In response to objections from industry that access to employees was not authorized under the FAR, DCAA issued MRD 13-PPS-015(R) on July 30, 2013 to advise auditors that access to contractor employees is “essential to its audit activities”

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Discussion Points

• Given the inherently subjective nature of fraud, interviews could deviate from the objective facts that auditors are supposed to collect and review to form their own conclusions

• Auditors are not properly trained or equipped to conduct interviews regarding fraud or to conduct investigations

• Auditors are acting beyond their mandate by assuming roles and responsibilities reserved for investigators

• Audits may become even more prolonged and open-ended, with constantly moving targets 10

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Discussion Points

• Interviews could encompass potentially anyone in the company, including personnel responsible for other areas, such as mandatory disclosures, including decisions not to disclose

• Interviews will not be privileged and may also result in waiver of privilege of any underlying documents identified or discussed during the interview

• Any statements against interest made to auditors during the interviews could be used against the company in litigation

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Statute of Limitations

• Claims under the Contract Disputes Act (CDA)

• Claims must be asserted within 6 years of “accrual”

• Accrual is “the date when all events that fix the alleged liability of either the Government or the contractor and permit assertion of the claim was known or should have been known.” FAR 33.201

• When accrual begins is a factual matter depending on the nature of the claim

• Huge backlog in DCAA incurred cost audits have led to delays in contract close-outs beyond 6 years

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Statute of Limitations

• When does the clock start?

• For DCAA audits, particularly of contractor ICS, Government typically asserts claims after DCAA issues report and CO considers contractor’s response

• Government argues that 6 year statute of limitation (SOL) does not start to run until DCAA begins audit of ICS

• However, recent case law indicates that clock may start earlier – i.e., when the contractor submits information related to Government claim

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Statute of Limitations: Recent Case Law

• Raytheon Missile Systems (ASBCA, 1/28/13) – Government claim for $17M due to CAS non-compliance time-barred

• Raytheon Co. (ASBCA, 12/17/12) – precluded Government claims for inclusion of unallowable costs in ICS based on SOL

• Sikorsky Aircraft Corp. (COFC, 9/13/12) – Government claim for $80M related to non-compliance in cost accounting practices time-barred

• Boeing Co. (ASBCA, 1/6/12) – Government claim for $6.4M due to accounting charge in 2000 was time-barred

• KBR (ASBCA, 6/17/14) – Board dismissed Government’s claim for lack of jurisdiction because it was untimely 14

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Discussion Points

• To speed up audit, DCAA may no longer seek explanations of submissions and will simply issue negative findings

• DCAA may stop providing draft reports or reduce time for contractor comments

• Decreased time between CO receipt of report and CO final decision

• Less negotiation with CO before issuing of formal claim = more litigation

• Acceleration of disputes process – makes settlement more difficult

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Discussion Points

• Stronger defense to stale claims

• Provide CO with copy of relevant cost submissions as part of ICS or in response to DCAA requests

• Ensure that ICS are clear, well-documented, and understandable

• Expect increase in DCAA determinations that ICS are inadequate and must be resubmitted

• Government will argue that claim accrues at resubmission – effect of resubmission on SOL is an open question

• Make clear exactly what aspect of ICS is inadequate and what is being resubmitted

• If some areas were accepted from first submission they may still be time-barred 16

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Access to Records and Internal Audits

• DCAA continues to push for access to contractors’ internal audit reports – even when they have nothing to do with a business system review

• Pursuant to the 2013 National Defense Authorization Act (NDAA), DCAA now has statutory authority to access internal audit reports

• Pursuant to DCAA guidance (MRD 08-PAS-042(R), December 19, 2008), contractors must provide access to requested documents in support of an audit in a “timely manner”

• FAR 52.212-5 gives DCAA access to records

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Access to Records and Internal Audits

• Two Newport News decisions (4th Circuit, 1988) interpreted DCAA’s authority to use subpoena power to gain access to internal audits narrowly

• The decisions established that DCAA did not have statutory authority to subpoena subjective internal audit materials, and that its subpoena power was limited to objective underlying data related to pricing negotiations or performance of contract

• Section 832 of the 2013 National Defense Authorization Act broadened DCAA’s statutory authority for access to contractor internal audit reports

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Access to Records and Internal Audits

• DCAA issued MRD 13-PPS-007(R) on April 23, 2013, to address access to internal audit reports

• The MRD advises that DCAA must first make a written determination “that access to such reports is necessary to complete the required evaluations of contractor business systems”

• DCAA interprets Section 832 as allowing it to use internal audits to understand the efficiency of internal controls – which it does as part of its risk assessment in every audit

• The DCAM states that internal audit reports “may be useful to DCAA in the course of our audits” – a low threshold (DCAM 4-202(a))

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Access to Records and Internal Audits

• Auditors are to provide contractors with a “reasonable time period” to produce documents requested during an audit, but pursuant to DCAA guidance, documentation should generally be “readily available”

• DCAA continues to seek privileged records and may consider the failure to provide access to privileged documents a denial of access to records too (See MRD 12-PPS-018(R))

• KBR Decision (appeal of U.S. ex rel. Barko) – DC Circuit held that attorney-client privilege applies if obtaining legal advice was a significant purpose of the internal investigation “even if there were also other purposes” and rejected the District Court’s “primary purpose” test

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Discussion Points

• DCAA will continue to aggressively seek internal audit reports and privileged records, even when they have little or nothing to do with the subject audit

• Contractors should balance the goal of protecting sensitive proprietary or privileged information with the need to cooperate with DCAA to avoid a formal denial of access that could lead to a subpoena and potential litigation

• Disclosure of any privileged information to DCAA could waive such protection and create exposure for the company on a variety of fronts, such as false claims suits, qui tam actions, derivative lawsuits, and whistleblower actions

• Disclosures should be closely logged and monitored

• Consider a “read only” approach to manage the release of sensitive information

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Discussion Points

• DCAA’s 2013 Report to Congress identified many challenges that make it difficult to perform their mission • Forward Pricing – Adequacy of Proposals and Commercial Pricing

Documentation

• Access to subcontractor commercial pricing data

• Access to Internal Audit Reports

• DCAA has submitted legislative proposals to:

• Provide DCAA with the authority to subpoena “Data Other than Certified Cost or Pricing Data”

• Obtain unfettered access to contractor employees

• DCAA plans to propose a FAR Case to obtain read-only access to live, online data

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Contact Information

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Dave Nadler Partner

Dickstein Shapiro LLP 1825 Eye Street NW

Washington, DC 20006 (202) 420-2281

nadlerd@dicksteinshapiro.com

Christopher Wolf Vice President,

Contracts & Procurement The Louis Berger Group

1250 - 23rd St NW Washington, DC 20037

(202) 303-2680 cwolf@louisberger.com

Bill Walter Partner

Dixon Hughes Goodman‚ LLP 1410 Spring Hill Rd, Suite 500

Tysons, VA 22102 (703) 970-0509

bill.walter@dhgllp.com