Industry fires salvo at defense contracting rule

A revised rule on contractors' internal controls have differences in definitions, which can bring about unintended consequences, and problems with excessive payment penalties due to resources.

The second version of a regulatory proposal to add checks on contractors' internal operations hasn't resolved the problem of clarity and the appropriate penalties for deficiencies, several industry groups said in a group letter released on Jan. 10.

The Defense Department wants to make companies comply with particular business systems or be denied full payment for their work if a system doesn’t meet prerequisites, according to a proposal issued Dec. 3. It was a follow-up from the proposal released in January 2010.

Defense regulators reworked the initial proposal from a year ago to make the requirements for the six business systems virtually the same. DOD has proposed setting definitions of compliance on six internal business systems, including accounting , estimating, purchasing, earned value management, material management and accounting, and property management.

But differences remain in the definitions, which can bring about unintended consequences.

“They are not identical, and that is a potential source of confusion,” according to the letter signed by the Professional Services Council, TechAmerica, Aerospace Industries Association, U.S. Chamber of Commerce, National Defense Industrial Association and the American Council of Engineering Companies.

The proposal is designed to be a barrier against abuse. Government officials say defense agencies can protect themselves best from fraud if contractors’ businesses are set up to DOD's specifications. Officials want greater oversight of contractor business systems and are working out the details on appropriate internal company controls in the proposal.

“Weak control systems increase the risk of unallowable and unreasonable costs on government contracts,” officials wrote.

Along with the definitions, the industry groups also said the revised proposal has a problem with withholding payments to contractors. Neither the original nor the current version requires the Defense Contracting Audit Agency (DCAA) to identify evidence of the actual or potential costs of a system’s deficiency before deciding how much money to withhold from a company.

“Without evidence of a causal nexus between the deficiency identified and the likely magnitude of unallowable costs billed as a result, the amount withheld may be grossly disproportionate to the actual impact,” the industry groups wrote.

In reviewing comments on its initial proposal, respondents said withholding payments is likely to remain in effect for periods long after the contractor makes the correction. In the letter, the industry groups wrote that companies have raised concerns about untimely reviews, or no review at all, by DCAA to verify the contractor’s correction.

Regulators revised the initial rule to allow the contracting officer to end withholding a payment prior to an audit if the contractor submits evidence of correcting the deficiencies.

To further protect companies’ cash flow, the group suggested that regulators should authorize contracting officers to provide as many as three months for a company to make alterations to possible problems without a withholding assessment .

Finally, the group would like more people involved in decisions regarding penalties. DOD needs input from government program managers, project executive officers, and service acquisition executives on what percentage of payment to withhold from a company, the group said.

“This will ensure that all stakeholders are in agreement when the risk of harm to the government has been identified,” according to the letter.

The regulation isn't set yet. However, defense officials closed the month-long comment period on Jan. 3, and are now reviewing the comments for further action.

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