When the Pentagon’s outsourcing boom started in the 1990s, the practice was praised as a secret weapon in the fight against big government and public-sector inefficiency.
Almost two decades and two wars later, the pendulum has started to swing in the opposite direction — following a steady stream of studies, investigations and revelations in recent years of fraud, waste and abuse in military contracts.
In the current climate, it is not surprising to see much handwringing and unease within the industry about a perceived fraying relationship with its biggest customer. Some of the apprehension may be exaggerated, but certain worries are justified, insiders and legal experts warn. Not only is the government determined to take back the jobs it outsourced years ago, but it also plans to unleash its frustrations in the form of new rules and regulations.
Scrutiny is nothing new in the defense industry, but nonetheless contractors can expect “more aggressive auditing” and generally tighter enforcement of existing regulations, says John Chierichella, a partner in the government contracts and regulated industries practice at the Washington, D.C., law firm Sheppard, Mullin, Richter & Hampton LLP.
There are specifically two groups of contractors that are going to be the targets of far more inspection and oversight than they’ve been accustomed to. The first group is companies that have “cost-reimbursement” contracts, also known as “cost-plus.” Under such arrangements, a contractor is paid for allowed expenses to a set limit, plus a stipulated profit margin.
By contrast, in fixed-price contracts, a company is paid a negotiated amount regardless of incurred expenses. These are not subject to as rigorous auditing as cost-plus contracts.
The other group of firms that the Pentagon is going to watch more closely is the “SETA” contractors, which are so named because they perform systems engineering and technical assistance work.
“I would expect reforms will aim at making life more difficult for contractors,” Chierichella says.
The Defense Department has been under relentless political fire for lapses in oversight and an inability to control rampant costs. A recent management shakeup at the Defense Contract Audit Agency allegedly stemmed from accusations that the organization let contractors get away with hundreds of millions of dollars of incorrectly booked costs against government contracts.
“There are going to be more audits; they’ll ask for more information,” and industry will have to fight harder to substantiate expenses that are charged to government contracts, says Chierichella.
Contracting officers are going to be far more prone to issue “notices of intent” to disallow expenses under cost-reimbursable contracts, he adds. “Contractors are going to have to, in my view, compile far more persuasive, more compelling, more complete responses to audits,” Chierichella says. “That’s what I see in my daily practice.”
Another hot-button issue in defense contracting is the Pentagon’s anticipated crackdown on “organizational conflicts of interest.” This will particularly affect large companies that provide consulting services and technical advice to the government on programs they also bid for.
“There is increased focus on systems engineering and technical assistance contractors; they are the ones that serve as the government’s ‘eyes and ears,’” says Chierichella. SETA contractors have an influential role in the direction a contract takes and the evaluation of contractors’ work. If a SETA contractor is affiliated with a company that sells products to the government, he notes, “You can see how they’re in a position to help their affiliate and hurt the affiliate’s competitors.”
Such conflicts of interest must be disclosed upfront by contractors. “This has always been an issue, but it’s now getting more currency,” Chierichella says. Under recent revisions to existing rules, a contractor not only has an obligation to identify all potential conflicts of interest when submitting proposals, but also must develop a detailed “mitigation plan” that tells the government in advance how it will deal with conflicts if they arise.
A number of large contractors now have to decide if they want to continue to do SETA work because of the potential impact on their other businesses. One the Pentagon’s top contractors, Northrop Grumman Corp., recently sold its consulting unit, TASC Inc., precisely to avoid conflicts of interest in instances when TASC might be advising the Pentagon on whether to acquire a certain weapons system that another division of Northrop Grumman sells to the Defense Department.
At the Pentagon, officials are being told to watch out for any potential conflicts, he says. “I wouldn’t call it a witch hunt, but when they find the witch, they’re going to burn it at the stake.”
Military acquisition managers, meanwhile, are beginning to come to grips with the idea that they need to rely less on contractors and become smarter about the high-tech weaponry for which they are responsible.
“We should interface with industry, to assist in managing, but we shouldn’t delegate that responsibility,” says Brig. Gen. Peter Fuller, the Army’s executive officer for soldier equipment. “This is not meant to denigrate any contractors,” he says, “but we ought to know what we really want, and be able to articulate it, understand it and manage it.”